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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER 1-15817
-----------------------------------------------------
OLD NATIONAL BANCORP
(Exact name of Registrant as specified in its charter)
INDIANA 35-1539838
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
ONE MAIN STREET 47708
EVANSVILLE, INDIANA (Zip Code)
(Address of principal executive offices)
----------------
(812) 464-1294
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to the filing requirements for
at least the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock. The Registrant has one class of common stock (no par value) with
65,845,000 shares outstanding at October 31, 2004.
OLD NATIONAL BANCORP
FORM 10-Q
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheet
September 30, 2004 and 2003, and December 31, 2003 3
Consolidated Statement of Income
Three and nine months ended September 30, 2004 and 2003 4
Consolidated Statement of Changes in Shareholders' Equity
Nine months ended September 30, 2004 and 2003 5
Consolidated Statement of Cash Flows
Nine months ended September 30, 2004 and 2003 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 18
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 29
Item 4. Controls and Procedures 32
PART II OTHER INFORMATION 33
SIGNATURES 35
2
OLD NATIONAL BANCORP
CONSOLIDATED BALANCE SHEET
(dollars and shares in thousands) SEPTEMBER 30, DECEMBER 31,
(unaudited) 2004 2003 2003
- ------------------------------------------------------------------------- -------------- ------------- --------------
ASSETS
Cash and due from banks $ 205,495 $ 172,962 $ 222,385
Money market investments 163,098 97,025 14,504
-------------- ------------- --------------
Total cash and cash equivalents 368,593 269,987 236,889
Investment securities - available-for-sale, at fair value:
U.S. Treasury 67,195 13,194 26,057
U.S. Government agencies and corporations 633,713 602,702 580,820
Mortgage-backed securities 1,191,735 1,426,944 1,298,881
States and political subdivisions 631,893 653,456 655,068
Other securities 146,034 116,169 145,514
-------------- ------------- --------------
Investment securities - available-for-sale 2,670,570 2,812,465 2,706,340
Investment securities - held-to-maturity, at amortized cost:
Mortgage-backed securities (fair value $184,426, $214,813, and
$209,316, respectively) 185,392 217,536 210,905
Residential loans held for sale 22,061 16,922 16,338
Loans:
Commercial 1,586,600 1,684,795 1,618,095
Commercial real estate 1,713,795 1,832,500 1,849,275
Residential real estate 554,079 934,175 939,422
Consumer credit, net of unearned income 1,227,196 1,134,789 1,163,325
-------------- ------------- --------------
Total loans 5,081,670 5,586,259 5,570,117
Allowance for loan losses (96,322) (92,650) (95,235)
-------------- ------------- --------------
Net loans 4,985,348 5,493,609 5,474,882
-------------- ------------- --------------
Premises and equipment, net 212,237 168,873 181,398
Goodwill 129,947 129,479 129,251
Other intangible assets 39,490 42,714 41,912
Mortgage servicing rights 16,381 14,790 14,659
Accrued interest receivable and other assets 351,696 358,144 350,658
-------------- ------------- --------------
Total assets $ 8,981,715 $ 9,524,519 $ 9,363,232
============== ============= ==============
LIABILITIES
Deposits:
Noninterest-bearing demand $ 825,721 $ 756,367 $ 823,146
Interest-bearing:
NOW 1,823,368 1,491,781 1,612,145
Savings 470,954 445,817 441,427
Money market 581,822 644,822 608,177
Time 2,706,264 3,058,250 3,008,197
-------------- ------------- --------------
Total deposits 6,408,129 6,397,037 6,493,092
Short-term borrowings 338,531 653,953 414,588
Other borrowings 1,405,522 1,470,937 1,624,092
Guaranteed preferred beneficial interests in subordinated debentures - 163,207 -
Accrued expenses and other liabilities 117,187 117,616 115,970
-------------- ------------- --------------
Total liabilities 8,269,369 8,802,750 8,647,742
-------------- ------------- --------------
SHAREHOLDERS' EQUITY
Preferred stock, 2,000 shares authorized, no shares issued or outstanding - - -
Common stock, $1 stated value, 150,000 shares authorized,
66,221, 63,629 and 66,575 shares issued and 65,960, 63,629, and 66,575
shares outstanding, respectively 65,960 63,629 66,575
Capital surplus 567,714 523,426 581,224
Retained earnings 64,317 125,483 53,107
Accumulated other comprehensive income, net of tax 14,355 9,231 14,584
-------------- ------------- --------------
Total shareholders' equity 712,346 721,769 715,490
-------------- ------------- --------------
Total liabilities and shareholders' equity $ 8,981,715 $ 9,524,519 $ 9,363,232
============== ============= ==============
The accompanying notes to consolidated financial statements are an integral part
of this statement.
3
OLD NATIONAL BANCORP
CONSOLIDATED STATEMENT OF INCOME
THREE MONTHS ENDED NINE MONTHS ENDED
(dollars and shares in thousands, except per share data) SEPTEMBER 30, SEPTEMBER 30,
(unaudited) 2004 2003 2004 2003
- -------------------------------------------------------- -------------- ------------ ------------- -------------
INTEREST INCOME
Loans including fees:
Taxable $ 68,260 $ 78,580 $ 215,333 $ 245,050
Nontaxable 4,203 4,314 12,894 12,860
Investment securities, available-for-sale:
Taxable 19,082 22,141 57,970 72,336
Nontaxable 7,275 7,496 21,978 23,351
Investment securities, held-to-maturity, taxable 1,944 2,140 6,028 4,756
Money market investments 714 90 824 219
-------------- ------------ ------------- -------------
Total interest income 101,478 114,761 315,027 358,572
-------------- ------------ ------------- -------------
INTEREST EXPENSE
Deposits 26,866 32,659 83,179 107,234
Short-term borrowings 704 1,643 2,757 6,225
Other borrowings 12,903 12,987 37,818 39,373
-------------- ------------ ------------- -------------
Total interest expense 40,473 47,289 123,754 152,832
-------------- ------------ ------------- -------------
Net interest income 61,005 67,472 191,273 $ 205,740
Provision for loan losses 7,400 27,500 22,400 59,000
-------------- ------------ ------------- -------------
Net interest income after provision for loan losses 53,605 39,972 168,873 146,740
-------------- ------------ ------------- -------------
NONINTEREST INCOME
Trust and asset management fees 7,734 7,604 23,276 22,687
Service charges on deposit accounts 12,622 11,471 35,773 33,830
ATM fees 2,265 1,831 6,420 5,723
Mortgage banking revenue 246 8,039 7,065 17,307
Insurance premiums and commissions 11,655 10,056 40,545 27,371
Investment product fees 2,547 2,633 9,507 7,994
Bank-owned life insurance 1,787 1,689 5,622 5,129
Net securities gains 303 75 2,309 23,555
Other income 2,972 2,375 8,314 8,010
-------------- ------------ ------------- -------------
Total noninterest income 42,131 45,773 138,831 151,606
-------------- ------------ ------------- -------------
NONINTEREST EXPENSE
Salaries and employee benefits 43,281 43,408 146,076 129,203
Occupancy 5,187 4,684 14,705 13,741
Equipment 3,745 3,735 10,783 11,261
Marketing 2,702 2,829 7,092 8,054
Outside processing 5,109 4,975 15,698 14,028
Communication and transportation 2,646 2,953 8,366 8,846
Professional fees 3,195 1,964 23,308 6,831
Loan expense 1,471 2,177 4,742 5,172
Supplies 1,002 1,072 3,035 3,682
Other losses 2,203 1,471 4,899 3,040
Other expense 4,884 6,197 15,861 15,732
-------------- ------------ ------------- -------------
Total noninterest expense 75,425 75,465 254,565 219,590
-------------- ------------ ------------- -------------
Income before income taxes 20,311 10,280 53,139 78,756
Income tax expense (benefit) 2,127 (1,530) 4,163 13,619
-------------- ------------ ------------- -------------
Net income $ 18,184 $ 11,810 $ 48,976 $ 65,137
============== ============ ============= =============
NET INCOME PER COMMON SHARE
Basic $ 0.28 $ 0.17 $ 0.74 $ 0.97
Diluted 0.27 0.17 0.73 0.97
-------------- ------------ ------------- -------------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING
Basic 66,051 66,904 66,247 66,813
Diluted 66,731 67,071 66,692 66,880
-------------- ------------ ------------- -------------
DIVIDENDS PER COMMON SHARE $ 0.19 $ 0.18 $ 0.57 $ 0.54
The accompanying notes to consolidated financial statements are an integral part
of this statement.
4
OLD NATIONAL BANCORP
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
ACCUMULATED
OTHER TOTAL
(dollars and shares COMMON STOCK CAPITAL RETAINED COMPREHENSIVE SHAREHOLDERS'
in thousands) (unaudited) SHARES AMOUNT SURPLUS EARNINGS INCOME EQUITY
- --------------------------------- ------ ------------ ------------- ------------- ---------------- ----------------
BALANCE, DECEMBER 31, 2002 63,856 $ 63,856 $ 528,379 $ 96,652 $ 51,823 $ 740,710
Net income - - - 65,137 - 65,137
Unrealized net securities losses,
net of $(20,842) tax - - - - (27,808) (27,808)
Reclassification adjustment for
gains included in net income,
net of $(7,850) tax - - - - (15,705) (15,705)
Net unrealized derivative gains
on cash flow hedges,
net of $512 tax - - - - 790 790
Reclassification adjustment on
cash flow hedges,
net of $84 tax - - - - 131 131
Stock issued for acquisitions 929 929 20,393 - - 21,322
Cash dividends - - - (36,306) - (36,306)
Stock repurchased (1,461) (1,461) (31,510) - - (32,971)
Stock issued under stock
option and stock purchase plans 305 305 6,164 - - 6,469
------ ------------ ------------- ------------- ---------------- ----------------
BALANCE, SEPTEMBER 30, 2003 63,629 $ 63,629 $ 523,426 $ 125,483 $ 9,231 $ 721,769
====== ============ ============= ============= ================ ================
BALANCE, DECEMBER 31, 2003 66,575 $ 66,575 $ 581,224 $ 53,107 $ 14,584 $ 715,490
Net income - - - 48,976 - 48,976
Unrealized net securities gains,
net of $1,704 tax - - - - 2,667 2,667
Reclassification adjustment for
gains included in net income,
net of $(961) tax - - - - (1,348) (1,348)
Net unrealized derivative losses
on cash flow hedges,
net of ($1,092) tax - - - - (1,689) (1,689)
Reclassification adjustment on
cash flow hedges,
net of $93 tax - - - - 141 141
Cash dividends - - - (37,766) - (37,766)
Adjustments to stock issued
for prior acquisitions (3) (3) (61) - - (64)
Stock repurchased (1,145) (1,145) (25,010) - - (26,155)
Stock issued under stock
option, restricted stock and
stock purchase plans 533 533 11,561 - - 12,094
------ ------------ ------------- ------------- ---------------- ----------------
BALANCE, SEPTEMBER 30, 2004 65,960 $ 65,960 $ 567,714 $ 64,317 $ 14,355 $ 712,346
====== ============ ============= ============= ================ ================
The accompanying notes to consolidated financial statements are an integral part
of this statement.
5
OLD NATIONAL BANCORP
CONSOLIDATED STATEMENT OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
(dollars in thousands) (unaudited) 2004 2003
- ----------------------------------------------------------------------------- --------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 48,976 $ 65,137
--------------- --------------
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation 10,089 9,793
Amortization of other intangible assets 2,390 1,810
Net premium amortization on investment securities 6,197 10,421
Amortization of unearned stock compensation 378 -
Provision for loan losses 22,400 59,000
Net securities gains (2,309) (23,555)
Net gains on sales and write-downs of loans and other assets (3,712) (10,545)
Residential real estate loans originated for sale (268,456) (742,230)
Proceeds from sale of residential real estate loans 266,204 827,181
Increase in other assets (4,980) (29,769)
Increase in accrued expenses and other liabilities 2,228 12,856
--------------- --------------
Total adjustments 30,429 114,962
--------------- --------------
Net cash flows provided by operating activities 79,405 180,099
--------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash and cash equivalents of subsidiaries acquired - 1,497
Purchases of investment securities available-for-sale (751,547) (2,014,121)
Proceeds from maturities, prepayments and calls
of investment securities available-for-sale 525,752 1,212,310
Proceeds from sales of investment securities available-for-sale 260,441 1,008,711
Purchases of investment securities held-to-maturity - (237,190)
Proceeds from maturities, prepayments and calls
of investment securities held-to-maturity 24,811 19,020
Purchases of subsidiary, net of cash acquired - (14,335)
Proceeds from sale of loans 404,424 47,934
Net principal collected from (loans made to) customers 61,955 (4,477)
Proceeds from sale of premises and equipment and other assets 4,787 1,079
Purchases of premises and equipment (46,006) (41,191)
--------------- --------------
Net cash flows provided by (used in) investing activities 484,617 (20,763)
--------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits and short-term borrowings:
Noninterest-bearing demand deposits 2,575 (22,062)
Savings, NOW and money market deposits 214,395 152,554
Time deposits (301,933) (172,735)
Short-term borrowings (76,057) (264,396)
Payments for maturities on other borrowings (273,636) (137,728)
Proceeds from issuance of other borrowings 54,543 381,600
Cash dividends paid (37,766) (36,306)
Common stock repurchased (26,155) (32,971)
Common stock issued under stock option, restricted stock
and stock purchase plans 11,716 6,469
--------------- --------------
Net cash flows used in financing activities (432,318) (125,575)
--------------- --------------
Net increase in cash and cash equivalents 131,704 33,761
Cash and cash equivalents at beginning of period 236,889 236,226
--------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 368,593 $ 269,987
=============== ==============
Total interest paid $ 123,404 $ 156,052
Total taxes paid $ 11,419 $ 22,184
The accompanying notes to consolidated financial statements are an integral part
of this statement.
6
OLD NATIONAL BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include the
accounts of Old National Bancorp and its wholly-owned affiliates ("Old
National") and have been prepared in conformity with accounting principles
generally accepted in the United States of America and prevailing practices
within the banking industry. Such principles require management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities and the disclosures of contingent assets and liabilities at the date
of the financial statements and amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. All
significant intercompany transactions and balances have been eliminated. Certain
prior year amounts have been reclassified to conform with the 2004 presentation.
Such reclassifications had no effect on net income. In the opinion of
management, the consolidated financial statements contain all the normal and
recurring adjustments necessary for a fair statement of the financial position
of Old National as of September 30, 2004 and 2003, and December 31, 2003, and
the results of its operations for the three and nine months ended September 30,
2004 and 2003. Interim results do not necessarily represent annual results.
NOTE 2 - IMPACT OF ACCOUNTING CHANGES
In March 2004, the Emerging Issues Task Force ("EITF"), a unit of the Financial
Accounting Standards Board ("FASB"), reached a consensus on EITF Issue 03-1,
"The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments." This EITF Issue provides guidance on evaluating when securities
losses should be deemed "other-than-temporary" and, consequently, written down
through earnings. In November 2003, a consensus was reached on the section of
this EITF Issue that mandates certain disclosures in annual financial statements
for all investments in an unrealized loss position for which
"other-than-temporary" impairments have not been recognized. The recognition and
measurement guidance of this EITF Issue was effective for reporting periods
beginning after June 15, 2004, and the disclosure requirements were effective
for annual financial statements for fiscal years ending after December 15, 2003.
Old National made the required disclosures in Note 3 to the consolidated
financial statements of the 2003 annual report. On September 30, 2004, the FASB
issued a Final FASB Staff Position that delayed the effective date for the
measurement and recognition guidance included in this EITF Issue to enable the
FASB to issue implementation guidance. Until such guidance is finalized, it is
uncertain whether this EITF Issue will have a material impact on Old National.
In December 2003, the Financial Accounting Standards Board revised Statement of
Financial Accounting Standards ("SFAS") No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits." This statement requires annual
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. In addition, interim
disclosure of the components of net periodic benefit costs is required. 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 10.
In December 2003, the FASB revised FASB Interpretation No. 46 ("FIN 46R"),
"Consolidation of Variable Interest Entities," which was initially released in
January 2003. FIN 46R 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 46R was effective for companies with
"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 46R. This change also resulted in the remaining debt being disclosed in
"other borrowings" beginning with the period ending December 31, 2003, compared
to the separate disclosure on the balance sheet prior to that date. 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 was after March 15, 2004. Old National
consolidated various low income housing partnerships on March 31, 2004, for
which the impact on the results of operations and financial position was
immaterial.
7
Old National applies Accounting Principles Board Opinion No. 25 and related
Interpretations in accounting for stock-based compensation plans, under which no
compensation cost has been recognized for any of the periods presented, except
with respect to restricted stock plans as disclosed in the accompanying table.
In accordance with SFAS No. 148, "Accounting for Stock-based Compensation -
Transition and Disclosure" and SFAS No. 123, "Accounting for Stock-Based
Compensation," Old National has presented in the following table net income and
net income per share adjusted to proforma amounts had compensation costs for Old
National's stock-based compensation plans been recorded based on fair values at
grant dates. All per share data has been adjusted for stock dividends, including
a 5% stock dividend distributed to shareholders on January 27, 2004.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(dollars in thousands, except per share data) 2004 2003 2004 2003
- ----------------------------------------------------------- ----------- ----------- ------------ ----------
Net income as reported $ 18,184 $ 11,810 $ 48,976 $ 65,137
RESTRICTED STOCK:
Add: restricted stock compensation expense included
in reported net income, net of related tax effects 245 - 245 -
Deduct: restricted stock compensation expense
determined under fair value based method for all
awards, net of related tax effects (238) - (238) -
STOCK OPTIONS:
Deduct: stock option compensation expense
determined under fair value based method for all
awards, net of related tax effects (779) (1,128) (3,297) (3,439)
----------- ----------- ------------ ----------
Proforma net income $ 17,412 $ 10,682 $ 45,686 $ 61,698
=========== =========== ============ ==========
Basic net income per share:
As reported $ 0.28 $ 0.17 $ 0.74 $ 0.97
Proforma 0.26 0.16 0.69 0.92
Diluted net income per share:
As reported $ 0.27 $ 0.17 $ 0.73 $ 0.97
Proforma 0.26 0.16 0.69 0.92
----------- ----------- ------------ ----------
NOTE 3 - 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 period,
adjusted to reflect all stock dividends. Diluted earnings per share reflects
additional common shares that would have been outstanding if dilutive potential
common shares had been issued. The following table reconciles basic and diluted
net income per share for the three and nine months ended September 30.
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 2004 SEPTEMBER 30, 2003
(dollars and shares ---------------------------------------------- ------------------------------------------
in thousands,
except per share data) INCOME SHARES AMOUNT INCOME SHARES AMOUNT
- ----------------------------- -------------- ------ ------------- -------------- ------ ----------
BASIC NET INCOME PER SHARE
Income from operations $ 18,184 66,051 $ 0.28 $ 11,810 66,904 $ 0.17
============= ==========
EFFECT OF DILUTIVE SECURITIES
Restricted stock - 42 - -
Stock options - 638 - 167
-------------- ------ -------------- ------
DILUTED NET INCOME PER SHARE
Income from operations
and assumed conversions $ 18,184 66,731 $ 0.27 $ 11,810 67,071 $ 0.17
============== ====== ============= ============== ====== ==========
8
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2004 SEPTEMBER 30, 2003
(dollars and shares ------------------------------------------------ ------------------------------------------
in thousands,
except per share data) INCOME SHARES AMOUNT INCOME SHARES AMOUNT
- ----------------------------- -------------- ------ ------------- -------------- ------ ----------
BASIC NET INCOME PER SHARE
Income from operations $ 48,976 66,247 $ 0.74 $ 65,137 66,813 $ 0.97
============= ==========
EFFECT OF DILUTIVE SECURITIES
Restricted stock - 42 - -
Stock options - 403 - 67
-------------- ------ -------------- ------
DILUTED NET INCOME PER SHARE
Income from operations
and assumed conversions $ 48,976 66,692 $ 0.73 $ 65,137 66,880 $ 0.97
============== ====== ============= ============== ====== ==========
NOTE 4 - INVESTMENT SECURITIES
The market value and amortized cost of investment securities as of September 30
are set forth below:
AMORTIZED UNREALIZED UNREALIZED FAIR
(dollars in thousands) COST GAINS LOSSES VALUE
- ---------------------- --------------- ------------- ------------- -------------
2004
Available-for-sale $ 2,644,759 $ 48,587 $ (22,776) $ 2,670,570
Held-to-maturity 185,392 308 (1,274) 184,426
--------------- ------------- ------------- -------------
2003
Available-for-sale $ 2,798,478 $ 53,420 $ (39,433) $ 2,812,465
Held-to-maturity 217,536 - (2,723) 214,813
--------------- ------------- ------------- -------------
NOTE 5 - 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. Interest rate risk on Old National's
residential loans held for sale has been hedged using fair value hedge
accounting in accordance with SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended. The loans' carrying bases
reflects the effects of the SFAS No. 133 adjustments. At September 30, 2004 and
2003, Old National had residential loans held for sale of $22.1 million and
$16.9 million, respectively. As of September 30, 2004 and 2003, ineffectiveness
related to the hedge as calculated in accordance with SFAS No. 133 was
immaterial.
During the third quarter of 2004, Old National entered into an ongoing agency
agreement with a third party for assistance with facilitation of periodic loan
sales. At September 30, 2004, no loans were held for sale under this
arrangement. During the second quarter of 2004, residential real estate loans
held for investment of $405.6 million were reclassified to residential loans
held for sale and sold for $404.4 million resulting in a write-down on loans
transferred to held for sale of $1.2 million, which was recorded as a reduction
to the allowance for loan losses. Also in connection with this transaction,
mortgage servicing rights of $2.7 million were capitalized, and a net gain of
$2.7 million was recognized. During the third quarter of 2003, nonaccrual
residential real estate loans of $3.4 million and commercial loans of $48.2
million held for investment were reclassified to loans held for sale and sold
for $2.2 million and $36.9 million, respectively. This resulted in write-downs
on loans transferred to held for sale of $1.2 million and $11.3 million,
respectively, which were recorded as reductions to the allowance for loan
losses. Also, during the second quarter of 2003, nonaccrual residential real
estate loans held for investment of $11.1 million were reclassified to
residential loans held for sale and sold for $8.9 million resulting in a
write-down on loans transferred to held for sale of $2.2 million, which was
recorded as a reduction to the allowance for loans losses.
9
NOTE 6 - ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses was as follows:
(dollars in thousands) 2004 2003
- -------------------------------------------------- ------------- ------------
Balance, January 1 $ 104,571 $ 87,742
Transfer to allowance for unfunded commitments (8,581) (6,771)
Additions:
Provision charged to expense 22,400 59,000
Deductions:
Write-downs on loans transferred to held for sale 1,177 14,744
Loans charged-off 29,417 39,414
Recoveries (8,526) (6,837)
------------- ------------
Net charge-offs and other charges 22,068 47,321
------------- ------------
Balance, September 30 $ 96,322 $ 92,650
============= ============
During the third quarter of 2004, Old National reclassified $8.6 million of the
allowance for loan losses related to unfunded loan commitments to other
liabilities. Prior period amounts deemed to be material were reclassified for
conformity of presentation and comparability of ratios related to the allowance
for loan losses.
The following is a summary of information pertaining to impaired loans at
September 30:
(dollars in thousands) 2004 2003
- ----------------------------------------------------- ------------ ------------
Impaired loans without a specific valuation allowance $ 25,393 $ 40,797
Impaired loans with a specific valuation allowance 68,469 58,028
------------ ------------
Total impaired loans $ 93,862 $ 98,825
============ ============
Valuation allowance related to impaired loans $ 26,233 $ 20,614
------------ ------------
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. Impaired loans do 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 or debt
securities.
For the nine months ended September 30, 2004, the average balance of impaired
loans was $91.0 million for which no interest was recorded. For the nine months
ended September 30, 2003, the average balance of impaired loans was $235.5
million for which no interest was recorded. No additional funds are committed to
be advanced in connection with impaired loans. Loans deemed impaired are
evaluated primarily using the fair value of the underlying collateral.
During the third quarter of 2003, Old National revised its interpretation of
impaired loans to strictly follow SFAS No. 114. Prior 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 applied the current interpretation in the prior year, average
impaired loans at September 30, 2003, would have totaled $103.0 million rather
than $235.5 million.
NOTE 7 - GOODWILL AND OTHER INTANGIBLE ASSETS
At September 30, 2004 and 2003, Old National had goodwill in the amount of
$129.9 million and $129.5 million, respectively. During the quarter ended
September 30, 2004, Old National performed its annual goodwill impairment
testing resulting in no impairment. The change in the carrying amount of
goodwill by segment for the nine months ended September 30, 2004, was as
follows:
10
COMMUNITY NON-BANK
(dollars in thousands) BANKING SERVICES TOTAL
- ----------------------------------------------- ------------- -------------- -----------
Balance, January 1 $ 70,944 $ 58,307 $ 129,251
Adjustments to goodwill acquired in prior year - 696 696
------------- -------------- -----------
Balance, September 30 $ 70,944 $ 59,003 $ 129,947
============= ============== ===========
Old National continues to amortize definite-lived intangible assets over the
estimated remaining life of each respective asset. At September 30, 2004, Old
National had $36.7 million in unamortized intangible assets compared with $39.9
million in unamortized intangible assets at September 30, 2003. 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 September 30:
GROSS CARRYING ACCUMULATED NET CARRYING
(dollars in thousands) AMOUNT AMORTIZATION AMOUNT
- ------------------------------------ ----------------- --------------- --------------
2004
Amortized intangible assets:
Core deposit $ 5,574 $ (3,499) $ 2,075
Customer business relationships 36,608 (3,628) 32,980
Non-compete agreements 1,100 (124) 976
Technology 1,300 (641) 659
----------------- --------------- --------------
Total amortized intangible assets 44,582 (7,892) 36,690
Unamortized intangible assets:
Trade name 2,800 - 2,800
----------------- --------------- --------------
Total intangible assets $ 47,382 $ (7,892) $ 39,490
================= =============== ==============
2003
Amortized intangible assets:
Core deposit $ 5,574 $ (2,890) $ 2,684
Customer business relationships 36,676 (1,421) 35,255
Non-compete agreements 1,100 (69) 1,031
Technology 1,300 (356) 944
----------------- --------------- --------------
Total amortized intangible assets 44,650 $ (4,736) 39,914
Unamortized intangible assets:
Trade name 2,800 - 2,800
----------------- --------------- --------------
Total intangible assets $ 47,450 $ (4,736) $ 42,714
================= =============== ==============
Total amortization expense associated with intangible assets for the three
months ended September 30 was $0.8 million in 2004 and $0.7 million in 2003.
Year-to-date amortization expense as of September 30, 2004 and 2003, was $2.4
million and $1.8 million, respectively.
The following is the estimated amortization expense for the future years:
ESTIMATED
(dollars in thousands) AMORTIZATION
FOR THE YEARS ENDED: EXPENSE
- ---------------------- -------------
2004 remaining $ 782
2005 3,055
2006 2,840
2007 2,376
2008 2,213
2009 2,122
Thereafter 23,302
-------------
Total $ 36,690
=============
11
NOTE 8 - MORTGAGE SERVICING RIGHTS
Mortgage servicing rights derived from loans sold with servicing retained were
$16.6 million and $16.2 million at September 30, 2004 and 2003, respectively.
Loans serviced for others are not included in the consolidated balance sheet of
Old National. The unpaid principal balance of mortgage loans serviced for others
at September 30 was $1.967 billion in 2004 and $1.706 billion in 2003. At
September 30, 2004 and 2003, the fair value of capitalized mortgage servicing
rights was $17.1 million and $14.8 million, respectively. Old National's key
economic assumptions used in determining the fair value of mortgage servicing
rights were a weighted average prepayment rate of 319 PSA and discount rates
ranging from 9.0% to 10.50% at September 30, 2004, and a weighted average
prepayment rate of 305 PSA and a discount rate of 8.5% at September 30, 2003.
The following summarizes the activities related to mortgage servicing rights and
the related valuation allowance at September 30:
(dollars in thousands) 2004 2003
- ------------------------------------------------ ----------- ----------
Balance before valuation allowance, January 1 $ 15,790 $ 13,423
Rights capitalized 5,454 7,485
Amortization (4,613) (4,748)
----------- ----------
Balance before valuation allowance, September 30 16,631 16,160
----------- ----------
Valuation allowance:
Balance, January 1 (1,131) (2,056)
Additions to valuation allowance (2,190) (5,749)
Reductions to valuation allowance 3,071 6,435
----------- ----------
Balance, September 30 (250) (1,370)
----------- ----------
Mortgage servicing rights, net $ 16,381 $ 14,790
=========== ==========
NOTE 9 - FINANCING ACTIVITIES
The following table summarizes Old National's other borrowings at September 30:
(dollars in thousands) 2004 2003
- ------------------------------------------------------------------------------- ------------ ------------
OLD NATIONAL BANCORP:
Medium-term notes, Series 1997 (fixed rates
3.50% to 7.03%) maturities August 2007 to
June 2008 $ 110,000 $ 113,200
Junior subordinated debentures (fixed rates
8.00% to 9.50%) maturities March 2030
to April 2032 150,000 -
SFAS 133 fair value hedge and other basis adjustments 4,951 (1,559)
OLD NATIONAL BANK:
Securities sold under agreements to repurchase (fixed rates 1.67% to 4.73% and
variable rates 1.61% to 2.55%) maturities March 2006 to December 2008 248,000 198,000
Federal Home Loan Bank advances (fixed rates
4.28% to 8.34% and variable rates 1.97% to
2.03%) maturities November 2004 to October 2022 569,924 812,428
Senior unsecured bank notes (fixed rate 3.95%
and variable rates 1.88% to 2.03%) maturities
January 2005 to February 2008 165,000 190,000
Subordinated bank notes (fixed rate 6.75%)
maturing October 2011 150,000 150,000
Capital lease obligation 4,530 -
SFAS 133 fair value hedge and other basis adjustments 3,117 8,868
------------ ------------
Total other borrowings $ 1,405,522 $ 1,470,937
============ ============
12
Contractual maturities of other borrowings at September 30, 2004, were as
follows:
(dollars in thousands)
- -----------------------------------------------------
Due in 2004 $ 35,008
Due in 2005 195,082
Due in 2006 202,402
Due in 2007 160,034
Due in 2008 343,037
Thereafter 461,891
SFAS 133 fair value hedge and other basis adjustments 8,068
-------------
Total $ 1,405,522
=============
FEDERAL HOME LOAN BANK
Federal Home Loan Bank advances had weighted-average rates of 5.30% and 5.39% at
September 30, 2004 and 2003, 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.
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.
In accordance with FIN 46R, the outstanding junior subordinated debentures
related to these trust preferred securities were reclassified to "other
borrowings" at December 31, 2003, from the separate disclosure on the balance
sheet prior to that date.
CAPITAL LEASE OBLIGATION
On January 1, 2004, Old National entered into a long-term capital lease
obligation for a new branch office building in Owensboro, Kentucky, which
extends for 25 years with one renewal option for 10 years. The economic
substance of this lease is that Old National is financing the acquisition of the
building through the lease and accordingly, the building is recorded as an asset
and the lease is recorded as a liability. The fair value of the capital lease
obligation was estimated using a discounted cash flow analysis based on Old
National's current incremental borrowings rate for similar types of borrowing
arrangements.
13
At September 30, 2004, the future minimum lease payments under the capital lease
were as follows:
MINIMUM
(dollars in thousands) LEASE
FOR THE YEAR ENDING: PAYMENTS
- -------------------------------------------- -------------
2004 remaining $ 93
2005 371
2006 371
2007 371
2008 371
Thereafter 13,265
-------------
Total minimum lease payments 14,842
Less amounts representing interest 10,312
-------------
Present value of net minimum lease payments $ 4,530
=============
NOTE 10 - EMPLOYEE BENEFIT PLANS
RETIREMENT PLAN
The following table sets forth the components of the net periodic benefit cost
for Old National's noncontributory defined benefit retirement plan for the three
and nine months ended September 30:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(dollars in thousands) 2004 2003 2004 2003
- ---------------------------------- ---------- --------- ---------- ---------
Service cost $ 485 $ 460 $ 1,507 $ 1,406
Interest cost 999 1,000 2,973 2,846
Expected return on plan assets (901) (636) (2,653) (1,776)
Amortization of prior service cost 8 8 24 24
Amortization of transitional asset (108) (108) (324) (324)
Recognized actuarial loss 392 348 1,181 945
---------- --------- ---------- ---------
Net periodic benefit cost $ 875 $ 1,072 $ 2,708 $ 3,121
========== ========= ========== =========
STOCK-BASED COMPENSATION
Under the 1999 Equity Incentive Plan, Old National is authorized to grant up to
7.3 million shares of common stock. At September 30, 2004, 6.3 million shares
were outstanding under the plan, including 6.0 million stock options and 0.3
million shares of restricted stock issued, not outstanding, as described below,
and 1.0 million shares were available for issuance. Old National accounts for
its stock-based compensation plans in accordance with APB Opinion 25 and related
Interpretations, under which no compensation cost has been recognized, except
with respect to restricted stock plans. See Note 2 for proforma net income and
net income per share data.
Stock Options
On February 2, 2004, Old National granted 0.3 million stock options to key
employees at an option price of $21.45, the closing price of Old National's
stock on that date. The options vest 100% on December 31, 2004, and expire in
ten years. 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. 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. At September 30, 2004, Old National had 6.0 million of
stock options outstanding.
Restricted Stock
On July 22, 2004, Old National's Board of Directors approved a restricted stock
award to certain key officers. The shares vest at the end of a thirty-two month
period based on the achievement of certain targets. Shares are subject to
certain restrictions and risk of forfeiture by the participants. At September
30, 2004, 0.3 million shares were issued, not outstanding at an estimated value
of $6.5 million.
14
NOTE 11 - INCOME TAXES
The following is a summary of the major items comprising the differences in
taxes computed at the federal statutory rate and as recorded in the consolidated
statement of income for the three and nine months ended September 30:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(dollars in thousands) 2004 2003 2004 2003
- ---------------------------------- ---------- ---------- ----------- ------------
Provision at statutory rate of 35% $ 7,109 $ 3,598 $ 18,599 $ 27,565
Tax-exempt income (4,560) (4,630) (13,960) (14,288)
Other, net (422) (498) (476) 342
---------- ---------- ----------- ------------
Income tax expense (benefit) $ 2,127 $ (1,530) $ 4,163 $ 13,619
========== ========== =========== ============
Effective tax rate 10.5% (14.9)% 7.8% 17.3%
---------- ---------- ----------- ------------
For the three months ended September 30, 2004, the effective tax rate was
significantly higher than for the three months ended September 30, 2003. For the
nine months ended September 30, 2004, the effective tax rate was significantly
lower than for the nine months ended September 30, 2003. Tax-exempt income has
remained relatively flat as illustrated above; however, the percentage of
tax-exempt income to total income has fluctuated among the periods presented,
resulting in the corresponding fluctuations in the effective rates.
NOTE 12 - COMPREHENSIVE INCOME
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(dollars in thousands) 2004 2003 2004 2003
- ------------------------------------------------------------------------- --------- ----------- ---------- ----------
Net income $ 18,184 $ 11,810 $ 48,976 $ 65,137
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the period, net of tax 43,021 (45,842) 2,667 (27,808)
Less: reclassification adjustment for securities gains realized in net
income, net of tax (185) (46) (1,348) (15,705)
Cash flow hedges:
Net unrealized derivative gains (losses) on cash flow hedges, net of tax (2,205) (208) (1,689) 790
Less: reclassification adjustment on cash flow hedges, net of tax 47 43 141 131
--------- ----------- ---------- ----------
Net unrealized gains (losses) 40,678 (46,053) (229) (42,592)
--------- ----------- ---------- ----------
Comprehensive income (loss) $ 58,862 $ (34,243) $ 48,747 $ 22,545
========= =========== ========== ==========
NOTE 13 - 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 in 1995 of First
National Bank & Trust Company, Carbondale, Illinois, ("First National"), which
Old National acquired in 1999. These lawsuits are pending against Old National
Bank, as successor to First National, and were filed by alleged third-party
creditors of certain structured settlement trusts. The lawsuits filed by the
third-party creditors allege actual damages totaling approximately $31 million,
as well as unspecified punitive damages and other damages and attorneys' fees.
In addition, certain of the corporate defendants in these lawsuits have filed
lawsuits asserting contribution and indemnity against Old National Bank. The
cases are pending in the City of St. Louis and St. Louis County in Missouri; St.
Clair County, Madison County and Cook County in Illinois; and U.S. Federal
District Court in southern Illinois.
During the fourth quarter of 2003, Old National established a reserve of $10
million for settlement of certain of the lawsuits pending in the City of St.
Louis and St. Louis County in Missouri and St. Clair County and Madison County
in Illinois. As of September 30, 2004, Old National has paid $9.1 million of
this reserve to settle a number
15
of lawsuits representing approximately $12 million in alleged damages. The
approximate $0.9 million remaining in the reserve for litigation settlement is
deemed at this time to be adequate to cover the remaining exposure of
approximately $3.0 million.
Old National has obtained a summary judgement in its favor at the trial court
level on lawsuits representing $16 million of the estimated $31 million
exposure. These cases were in Cook County, Illinois and are currently on appeal
to the Court of Appeals in Illinois. It is not expected that future judgments or
settlements in these matters will have a material impact on Old National's
results of operations.
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 $1.374
billion, commercial letters of credit of $14.4 million and standby letters of
credit of $109.8 million at September 30, 2004. At September 30, 2003, loan
commitments were $1.409 billion, commercial letters of credit were $28.3 million
and standby letters of credit were $79.5 million. These commitments are not
reflected in the consolidated financial statements. At September 30, 2004, the
balance of the allowance for unfunded loan commitments was $8.7 million.
At September 30, 2004 and 2003, Old National had credit extensions of $72.8
million and $75.7 million, respectively, with various unaffiliated banks related
to letter of credit commitments issued on behalf of Old National's customers. At
September 30, 2004 and 2003, Old National provided collateral to the
unaffiliated banks to secure credit extensions totaling $40.9 million and $38.7
million, respectively. Old National did not provide collateral for the remaining
credit extensions.
NOTE 14 - FINANCIAL GUARANTEES
Old National holds instruments, in the normal course of business with customers,
that are considered financial guarantees in accordance with FIN 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." 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 September 30, 2004,
the notional amount of standby letters of credit was $109.8 million, which
represents the maximum amount of future funding requirements, and the carrying
value was $0.4 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 to the consolidated financial statements of
the 2003 annual report.
NOTE 15 - 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.
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 changes by management. Income taxes
are allocated using the effective tax rate. Tax-exempt income is primarily
within the treasury segment, creating a tax benefit for this segment.
Intersegment sales and transfers are not significant.
16
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.
The following table summarizes financial information concerning segments for the
three and nine months ended September 30:
COMMUNITY NON-BANK
(dollars in thousands) BANKING SERVICES TREASURY OTHER TOTAL
- ------------------------------------- ------------- ----------- ------------ ----------- -------------
THREE MONTHS ENDED SEPTEMBER 30, 2004
Net interest income (loss) $ 66,717 $ 108 $ (2,060) $ (3,760) $ 61,005
Provision for loan losses 7,343 - 57 - 7,400
Noninterest income 17,212 22,132 2,161 626 42,131
Noninterest expense 57,987 20,463 109 (3,134) 75,425
Income tax expense (benefit) 4,212 552 (2,637) - 2,127
Segment profit 14,387 1,225 2,572 - 18,184
Total assets 5,336,181 119,040 3,374,712 151,782 8,981,715
------------- ----------- ------------ ----------- -------------
THREE MONTHS ENDED SEPTEMBER 30, 2003
Net interest income (loss) $ 72,014 $ 57 $ (5,595) $ 996 $ 67,472
Provision for loan losses 27,500 - - - 27,500
Noninterest income 24,698 18,921 1,816 338 45,773
Noninterest expense 55,912 17,983 236 1,334 75,465
Income tax expense (benefit) 2,422 296 (4,248) - (1,530)
Segment profit 10,878 699 233 - 11,810
Total assets 5,809,293 133,301 3,474,004 107,921 9,524,519
------------- ----------- ------------ ----------- -------------
NINE MONTHS ENDED SEPTEMBER 30, 2004
Net interest income (loss) $ 208,770 $ 416 $ (7,310) $ (10,603) $ 191,273
Provision for loan losses 22,227 - 173 - 22,400
Noninterest income 56,359 70,640 8,531 3,301 138,831
Noninterest expense 191,130 68,227 2,510 (7,302) 254,565
Income tax expense (benefit) 11,578 883 (8,298) - 4,163
Segment profit 40,194 1,946 6,836 - 48,976
Total assets 5,336,181 119,040 3,374,712 151,782 8,981,715
------------- ----------- ------------ ----------- -------------
NINE MONTHS ENDED SEPTEMBER 30, 2003
Net interest income (loss) $ 211,988 $ 180 $ (9,903) $ 3,475 $ 205,740
Provision for loan losses 59,000 - - - 59,000
Noninterest income 66,463 54,019 28,827 2,297 151,606
Noninterest expense 163,523 49,723 572 5,772 219,590
Income tax expense (benefit) 14,076 1,491 (1,948) - 13,619
Segment profit 41,852 2,985 20,300 - 65,137
Total assets 5,809,293 133,301 3,474,004 107,921 9,524,519
------------- ----------- ------------ ----------- -------------
17
PART I. FINANCIAL INFORMATION
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
EXECUTIVE SUMMARY
Net income for the three months ended September 30, 2004, increased compared to
the three months ended September 30, 2003, primarily due to lower provisions for
loan losses, a result of the improvement in Old National's credit quality
performance. While expenses remained relatively steady, the improvement from
lower provisions was somewhat offset by decreases in mortgage banking revenue
and net interest income. Net income for the nine months ended September 30,
2004, decreased significantly compared to the nine months ended September 30,
2003, impacted primarily by nonrecurring charges related to "Ascend", decreased
securities gains and reduced mortgage banking activity offset in part by reduced
provisions for loan losses.
Old National experienced a decrease in assets and liabilities at September 30,
2004, compared to September 30, 2003 and December 31, 2003, reflective of the
disposition of residential real estate loans during the second quarter of 2004
and reductions in the commercial loan and investment portfolios. As a result,
borrowed funds and deposits also reflect a reduction at September 30, 2004.
Management uses various indicators such as return on assets, return on equity
and asset quality ratios 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 AND FORWARD-LOOKING STATEMENTS
This discussion analyzes Old National's results of operations for the three and
nine months ended September 30, 2004 and 2003, and financial condition as of
September 30, 2004, compared to September 30, 2003 and December 31, 2003.
This management's discussion and analysis contains certain forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Forward-looking statements include expressions such as "expects,"
"intends," "believes," "anticipates," and "should," which are statements of
belief as to the expected outcomes of future events. Internal and external
factors that might cause a difference include, but are not limited to, market,
economic, operational, liquidity, credit and interest rate risks associated with
Old National's business, competition, government legislation and policies,
ability of Old National to execute its business plan and implement the "Ascend"
project initiatives, credit quality trends and the ability to generate loans,
and other matters discussed in this management's discussion and analysis. These
risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements. Actual
results could materially differ from those presented. Old National undertakes no
obligation to release revisions to these forward-looking statements or reflect
events or conditions after the date on which the forward-looking statement is
made or to reflect the occurrence of unanticipated events.
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 this 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.
- - 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 allowance. In either instance,
unanticipated changes could have a significant impact on results of
operations.
18
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.
- - 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 exceeds 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.
- - GOODWILL AND INTANGIBLES. For acquisitions, Old National is required to
record the assets acquired, including identified intangible assets, and
the liabilities assumed at their fair values. These often involve
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 Statement of Financial Accounting Standards ("SFAS") No. 142
"Goodwill and Other Intangible Assets," 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 determination of 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. Changes in these factors, as well as downturns in economic or
business conditions, could have a significant adverse 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 valuation 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." This
"Management's Discussion and Analysis" may contain non-GAAP financial measures.
For purposes of Regulation G, a non-GAAP financial measure is a numerical
measure of the registrant's historical or future financial performance,
financial position or cash flows that excludes amounts, or
19
is subject to adjustments that have the effect of excluding amounts, that are
included in the most directly comparable measure calculated and presented in
accordance with GAAP in the statement of income, balance sheet or statement of
cash flows (or equivalent statements) of the issuer; or includes amounts, or is
subject to adjustments that have the effect of including amounts, that are
excluded from the most directly comparable measure so calculated and presented.
In this regard, GAAP refers to generally accepted accounting principles in the
United States. Pursuant to the requirements of Regulation G, Old National
Bancorp has provided reconciliations, as necessary, of the non-GAAP financial
measure to the most directly comparable GAAP financial measure. See the
"Earnings Summary" of this "Management's Discussion and Analysis" below for
Non-GAAP financial measures.
RESULTS OF OPERATIONS
EARNINGS SUMMARY
Old National reported net income of $18.2 million for the three months ended
September 30, 2004, an increase of $6.4 million or 54.0% from the $11.8 million
recorded for the three months ended September 30, 2003. For the nine months
ended September 30, 2004, net income was $49.0 million, a reduction of 24.8%
from the $65.1 million recorded for the nine months ended September 30, 2003. On
a diluted per share basis, net income was $0.27 for the three months ended
September 30, 2004, compared to $0.17 for the three months ended September 30,
2003. Diluted earnings per share were $0.73 for the nine months ended September
30, 2004, compared to $0.97 for the nine months ended September 30, 2003.
Positive factors affecting the results of operations for the three months ended
September 30, 2004, as compared to the three months ended September 30, 2003,
included decreased provisions for loan losses and increased insurance premiums
and commissions, and service charge income. These factors were offset by
decreased net interest income and decreased mortgage origination activity. The
sale of $405.6 million of residential real estate loans during the second
quarter of 2004 and the reduction of the investment portfolio significantly
contributed to the decrease in net interest income. In addition, the
capitalization of interest related to the construction of the new Evansville
main banking center and corporate headquarters was discontinued on August 11,
2004 when the building was placed in service, causing an increase in interest
expense for the three months ended September 30, 2004, compared to September 30,
2003. See additional details of the new Evansville main banking center and
corporate headquarters below.
The decrease in the results of operations for the nine months ended September
30, 2004, compared to the nine months ended September 30, 2003, was primarily
attributable to the nonrecurring pre-tax charges relating to "Ascend" of $25.5
million, or $17.4 million after tax, that were recorded primarily during the
second quarter of 2004. Other factors included decreased net interest income,
decreased mortgage origination activity, reduced securities gains, and severance
payments to three executive officers who left the company during the first
quarter of 2004. Partially offsetting these items were reduced provisions for
loan losses and increased trust and asset management fees, insurance premiums
and commissions, investment product fees, and service charge income.
For the three months ended September 30, 2004, Old National's return on average
assets was 0.81% and return on average shareholders' equity was 10.58%, compared
to 0.49% and 6.37%, respectively, for the three months ended September 30, 2003.
Old National's return on average assets was 0.71% and return on average
shareholders' equity was 9.20% for the nine months ended September 30, 2004,
compared to 0.90% and 11.59% for the nine months ended September 30, 2003,
respectively. Excluding the nonrecurring implementation charges related to
"Ascend" of $17.4 million, after-tax, Old National's return on average assets
and return on average shareholders' equity for the nine months ended September
30, 2004, was 0.96% and 12.48%, respectively, as reconciled in the following
table and compared to the nine months ended September 30, 2003.
Return on Return on
Assets Equity
- ----------------------------------------- --------- ---------
As reported September 30, 2004 0.71% 9.20%
Effect of "Ascend" implementation charges 0.25% 3.28%
---- -----
Excluding "Ascend" implementation charges 0.96% 12.48%
==== =====
As reported September 30, 2003 0.90% 11.59%
==== =====
20
In 2001, the Board of Directors approved construction of a new Evansville main
banking center and corporate headquarters to be constructed prior to expiration
of the operating leases on the buildings then occupied. Prior to this decision,
the Board of Directors evaluated renewal options for the leases on the
then-occupied buildings including capital investments that would be required for
improvements to the leased facilities. It was determined that the costs
associated with continuing the leases and making the required capital
investments would be relatively comparable to constructing a new building. The
new Evansville main banking center and corporate headquarters was placed into
service on August 11, 2004. The total project cost is approximately $73.6
million including building components of $58.4 million, furniture, fixtures and
equipment of $7.2 million, land of $4.9 million and capitalized interest of $3.1
million.
NET INTEREST INCOME
Net interest income and margin are influenced by many factors, primarily the
volume and mix of earning assets, funding sources and interest rate
fluctuations. 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. Net income is unaffected by these taxable
equivalent adjustments as an offsetting increase of the same amount is made in
the income tax section. Net interest income included taxable equivalent
adjustments of $6.0 million and $6.2 million for the three months ended
September 30, 2004 and 2003, respectively. Taxable equivalent adjustments for
the nine months ended September 30, 2004 and 2003, were $18.1 million and $18.9
million, respectively.
Taxable equivalent net interest income was $67.0 million and $209.4 million for
the three and nine months ended September 30, 2004, respectively, compared to
$73.6 million and $224.6 million reported for the three and nine months ended
September 30, 2003, respectively. The reduction in net interest income reflects
a smaller portfolio of average earning assets when compared to the three and
nine months ended September 30, 2003. Average earning assets were $8.117 billion
for the three months ended September 30, 2004, compared to $8.880 billion for
the three months ended September 30, 2003, a decrease of 8.6% or $763.0 million.
Average earning assets were $8.338 billion for the nine months ended September
30, 2004, compared to $8.872 billion for the nine months ended September 30,
2003, a decrease of 6.0% or $534.0 million.
The decrease in interest rates during 2003 and early 2004 had a significant
impact on the volume, mix and yield of earning assets. Driven by lower rates,
many of the company's residential real estate loans were refinanced in 2003.
Because new loan production was sold into the secondary loan market, residential
real estate loans declined in 2003 and 2004. Additionally, the sale of $405.6
million of residential real estate loans at the end of the second quarter of
2004 significantly impacted earning assets for the three and nine months ended
September 30, 2004, compared to the three and nine months ended September 30,
2003. Commercial and commercial real estate loans declined during 2003 and
during the first nine months of 2004, a result of continued weak loan demand in
Old National's markets and more stringent loan underwriting standards. In a
continuation of a strategy begun during 2003, the company continued to reduce
its investment portfolio assets because of the narrow spreads available on those
assets in the current rate environment. The net interest margin was relatively
unchanged at 3.30% and 3.35% for the three and nine months ended September 30,
2004, respectively, compared to 3.32% and 3.38% for the three and nine months
ended September 30, 2003, respectively.
PROVISION FOR LOAN LOSSES
The provision for loan losses was $7.4 million and $22.4 million for the three
and nine months ended September 30, 2004, respectively, compared to $27.5
million and $59.0 million for the three and nine months ended September 30,
2003, respectively. The lower provisions in 2004 are the result of improvements
in credit quality as well as the continued reduction in classified loans. Refer
to the "Allowance for Loan Losses and Asset Quality" section of this
"Management's Discussion and Analysis" for further discussion of non-performing
loans, charge-offs and additional items impacting the provision.
NONINTEREST INCOME
Noninterest income for the three months ended September 30, 2004, was $42.1
million, a decrease of $3.7 million, or 8.0% from the $45.8 million reported for
the three months ended September 30, 2003. For the nine months ended September
30, 2004, noninterest income amounted to $138.8 million, a decrease of $12.8
million or 8.4% over the $151.6 million reported for the nine months ended
September 30, 2003. Total fee and service charge income, excluding gains on
sales of securities, was $41.8 million and $136.5 million for the three and nine
months ended
21
September 30, 2004, respectively compared to $45.7 million and $128.1 million
for the three and nine months ended September 30, 2003, respectively.
Primarily as a result of insurance agency acquisitions beginning in the second
quarter of 2003, insurance premiums and commissions, increased to $11.7 million
and $40.5 million for the three and nine months ended September 30, 2004,
compared to $10.1 million and $27.4 million for the three and nine months ended
September 30, 2003, a 15.9% and 48.1% increase, respectively.
Income related to service charges on deposit accounts increased to $12.6 million
and $35.8 million for the three and nine months ended September 30, 2004,
compared to $11.5 million and $33.8 million for the three and nine months ended
September 30, 2003, a 10.0% and 5.7% increase, respectively. The generation of
increased revenue was attributable to growth in transaction accounts as well as
an increased sales and marketing focus on this element of revenue.
Mortgage banking revenue decreased to $0.2 million for the three months ended
September 30, 2004, compared to $8.0 million for the three months ended
September 30, 2003, a $7.8 million decrease. For the nine months ended September
30, 2004, mortgage banking revenue was $7.1 million compared to $17.3 million
for the nine months ended September 30, 2003, a $10.2 million or 59.2% decrease.
These decreases were primarily attributable to the reduction in mortgage
origination activity during 2004. Residential real estate loan originations for
the three months ended September 30, 2004, were $137.0 million compared to
$407.6 for the three months ended September 30, 2003. Residential real estate
loan originations for the nine months ended September 30, 2004, were $0.470
billion compared to $1.132 billion for the nine months ended September 30, 2003.
For the nine months ended September 30, 2004, net recoveries to the mortgage
servicing rights valuation allowance of $0.8 million and a net gain of $2.7
million from the sale of $405.6 million of residential real estate loans in the
second quarter of 2004, partially offset reductions in income attributable to
decreased mortgage origination activity.
Net securities gains increased by $0.2 million and decreased by $21.2 million
for the three and nine months ended September 30, 2004 and 2003, respectively.
The gains in 2003 were part of a continuing strategy to address the impact of
interest rate and yield curve shifts on the investment portfolio.
NONINTEREST EXPENSE
Noninterest expense for the three months ended September 30, 2004, totaled $75.4
million, relatively unchanged compared to $75.5 million for the three months
ended September 30, 2003. For the nine months ended September 30, 2004,
noninterest expense was $254.6 million, an increase of $35.0 million or 15.9%
over the $219.6 million recorded for the nine months ended September 30, 2003.
Salaries and benefits, the largest component of noninterest expense, remained
stable for the three months ended September 30, 2004, compared to the three
months ended September 30, 2003, and totaled $146.1 million for the nine months
ended September 30, 2004, compared to $129.2 million for the nine months ended
September 30, 2003, an increase of $16.9 million or 13.1%. The increase for the
nine months ended September 30, 2004, is primarily attributable to nonrecurring
expenses related to "Ascend", including severance costs for employees whose
positions have been or will be eliminated and expenses related to broad-based
incentive programs for employees participating in the "Ascend" project. Other
factors significantly affecting the increase in salaries and employee benefits
for the nine months ended September 30, 2004, included $2.9 million in severance
expense related to three senior executives, including the chief executive
officer, who left the company during the first quarter of 2004 and additional
salaries and benefit expenses attributable to acquisitions of insurance agencies
that occurred after the first quarter of 2003.
Professional fees totaled $3.2 million for the three months ended September 30,
2004, compared to $2.0 million for the three months ended September 30, 2003, an
increase of $1.2 million or 62.8%. The increase related primarily to fees paid
in connection with complying with Section 404 of the Sarbanes-Oxley Act and
upgrading internal systems and controls. For the nine months ended September 30,
2004, professional fees were $23.3 million compared to $6.8 million for the nine
months ended September 30, 2003, an increase of $16.5 million. Consulting fees
paid to EHS Partners during 2004 in connection with "Ascend" accounted for the
majority of these increases for the nine months ended September 30, 2004.
22
All other components of noninterest expense totaled $28.9 million for the three
months ended September 30, 2004, compared to the $30.1 million for the three
months ended September 30, 2003. For the nine months ended September 30, 2004
and 2003, all other components of noninterest expense totaled $85.2 million and
$83.6 million, respectively. The increase for the nine months ended September
30, 2004 was attributable to write-downs of surplus real estate of $1.0 million
in connection with "Ascend". Also affecting the increase for the nine months
ended September 30, 2004, was increased occupancy expense partially related to
the new Evansville main banking center and corporate headquarters and increased
processing expense partially offset by decreases in several other noninterest
expense accounts. See additional details of the new Evansville main banking
center and corporate headquarters in the "Results of Operations" section of this
"Management's Discussion and Analysis."
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. The provision for income tax
expense, as a percentage of pre-tax income, was 10.5% for the three months ended
September 30, 2004, compared to the income tax benefit of 14.9% for the three
months ended September 30, 2003. The provision for income tax expense, as a
percentage of pre-tax income, was 7.8% for the nine months ended September 30,
2004, compared to 17.3% for the nine months ended September 30, 2003. While
tax-exempt income has remained relatively flat, the percentage of tax-exempt
income to total income has fluctuated among the periods presented, resulting in
the corresponding fluctuations in the effective tax rates.
FINANCIAL CONDITION
OVERVIEW
For the three and nine months ended September 30, 2004, Old National continued
balance sheet strategies initiated in the second half of 2003 to mitigate its
sensitivity to rising interest rates, including continued reductions in the
investment and residential real estate loan portfolios as well as reductions in
certificates of deposit and borrowed funds. Old National's assets at September
30, 2004, were $8.982 billion, a 5.7% decrease compared to September 30, 2003,
and a 5.4% decrease compared to December 31, 2003. Investments and loans
decreased $174.0 million and $504.6 million, respectively, since September 30,
2003, and decreased $61.3 million and $488.4 million, respectively, since
December 31, 2003. Total liabilities declined $533.4 million compared to
September 30, 2003, and $378.4 million since December 31, 2003. Total
shareholders' equity decreased $9.4 million from September 30, 2003, and
decreased $3.1 million compared to December 31, 2003
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 $8.123
billion at September 30, 2004, a decrease of 7.0% from September 30, 2003, and a
decrease of 6.2% since December 31, 2003. The reduction in earning assets is due
to a continuation of balance sheet strategies initiated by management during the
second half of 2003. Old National reduced its investment portfolio in light of
fewer attractive investment opportunities and the company's desire to reduce its
sensitivity to rising interest rates. Total loans at September 30, 2004,
including residential loans held for sale, decreased $499.5 million compared to
September 30, 2003, and $482.7 million compared to December 31, 2003. This
decrease can be attributed primarily to the sale of $405.6 million in
residential real estate loans during the second quarter of 2004 as well as to
continued weakness in commercial lending. These decreases are partially offset
by the growth in consumer loans. Money market investments at September 30, 2004,
increased by $66.1 million from September 30, 2003, and $148.6 million from
December 31, 2003, which is attributable to the investment of a portion of the
proceeds from the sale of residential real estate loans during the second
quarter of 2004.
INVESTMENT SECURITIES
The majority of Old National's investment securities are classified as
available-for-sale, which gives 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. Emerging Issues Task Force
("EITF") Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments," may potentially impact the treatment of
investments in an unrealized loss position. Until final guidance is issued by
the Financial Accounting Standards Board ("FASB"), it is uncertain whether this
EITF Issue will have a material impact on Old National.
23
At September 30, 2004, the investment securities portfolio was $2.856 billion
compared to $3.030 billion at September 30, 2003, a decrease of $174.0 million
or 5.7%. Investment securities decreased $61.3 million at September 30, 2004,
compared to December 31, 2003, a decrease of 2.8%. Despite these decreases,
investment securities as a percentage of earning assets remained relatively flat
at 35.2% at September 30, 2004, 34.7% at September 30, 2003, and 34.2% at
December 31, 2003. During 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 and continuing into 2004, Old
National decreased 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 a reduction in the investment
securities portfolio.
The investment securities available-for-sale portfolio had net unrealized gains
of $25.8 million at September 30, 2004, compared to net unrealized gains of
$14.0 million at September 30, 2003, and $23.7 million at December 31, 2003.
These unrealized gains are impacted by interest rate conditions.
The investment portfolio had an effective duration of 3.66 years at September
30, 2004, compared to 4.24 years at September 30, 2003, and 4.31 years at
December 31, 2003. The average yield on investment securities, on a taxable
equivalent basis, was 4.49% for the three months ended September 30, 2004,
compared to 4.71% for the three months ended September 30, 2003, and 4.70% for
the three months ended December 31, 2003. Average yields on investment
securities, on a taxable equivalent basis, were 4.55%, 4.95% and 4.98% for the
nine months ended September 30, 2004 and 2003, and for the year ended December
31, 2003, respectively. The decrease from December 31, 2003 to September 30,
2004, was due to maturities or sales of higher coupon bonds coupled with the
purchase of shorter duration lower yielding bonds as part of the company's
strategy to reduce the maturity of the portfolio.
RESIDENTIAL LOANS HELD FOR SALE
Residential loans held for sale were $22.1 million at September 30, 2004,
compared to $16.9 million at September 30, 2003, and $16.3 million at December
31, 2003. 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. During the three and nine months ended
September 30, 2004, residential real estate loan origination activity was down
as compared to the three and nine months ended September 30, 2003, primarily due
to a reduced level of loan refinancing.
COMMERCIAL AND CONSUMER LOANS
Commercial and consumer loans are the largest classification within the earning
assets of Old National representing 55.7% of earning assets at September 30,
2004, an increase from 53.3% at September 30, 2003, and 54.4% at December 31,
2003. At September 30, 2004, commercial and commercial real estate loans were
$3.300 billion, a decrease of $216.9 million since September 30, 2003, and a
decrease of $167.0 million since December 31, 2003. During the third quarter of
2003, Old National sold $48.2 million of non-performing commercial loans. Weak
loan demand in Old National's markets impacted commercial loan growth in 2003
and continues into 2004.
At September 30, 2004, consumer loans, including automobile loans, personal and
home equity loans and lines of credit, and student loans, increased to $1.227
billion, an increase of $92.4 million or 8.1% compared to $1.135 billion at
September 30, 2003, and an increase of $63.9 million or 7.3% compared to $1.163
billion at December 31, 2003. This growth was primarily the result of
enhancements to marketing and customer contact programs.
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 into the secondary market, primarily to Federal Home Loan
Mortgage Corporation and Federal National Mortgage Association. Old National
sells the majority of residential real estate loans it originates as a strategy
to better manage interest rate risk and liquidity. These loans are generally
sold with loan servicing retained in order to maintain customer relationships
and generate noninterest income and fees. By using this strategy, Old National
is generally 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.
24
At September 30, 2004, residential real estate loans were $554.1 million, a
decrease of $380.1 million or 40.7% from September 30, 2003, and $385.3 million
or 54.7% from December 31, 2003. The sale of $405.6 million of residential real
estate loans during the three months ended June 30, 2004, was the most
significant contributor to this decrease. In comparison, Old National's
residential real estate loan portfolio was also affected by the sales of $14.5
million of delinquent loans in the second and third quarters of 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.
ALLOWANCE FOR LOAN LOSSES AND ASSET QUALITY ADMINISTRATION
Old National monitors the quality of its loan portfolio on an ongoing 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 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.
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, loans past due 90 days or more and other loans deemed to have
well-defined weaknesses while criticized loans, also known as special mention
loans, are loans that are deemed to 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 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.
Old National analyzes on a semi-annual basis the composition of the loan
portfolio to determine if there is any concentration of loans in any single
industry exceeding 10% of its portfolio, and has determined that no such
concentration exists as of September 30, 2004, as measured by Old National. In
addition, Old National has no exposure to foreign borrowers or lesser-developed
countries.
ALLOWANCE FOR LOAN LOSSES AND ASSET QUALITY
At September 30, 2004, the allowance for loan losses was $96.3 million, an
increase of $3.7 million compared to $92.7 million at September 30, 2003, and an
increase of $1.1 million compared to $95.2 million at December 31, 2003. As a
percentage of total loans, including loans held for sale, the allowance
increased to 1.89% at September 30, 2004, from 1.65% at September 30, 2003, and
1.70% from December 31, 2003. The improvement in coverage of total loans at
September 30, 2004, is a result of increased provisions during 2003 followed by
reductions in total loans during 2004, primarily the sale of $405.6 million of
residential real estate loans during the three months ended June 30, 2004.
In keeping with evolving industry practice, during the three months ended
September 30, 2004, $8.6 million of the allowance for loan losses account, which
represented the amount attributable to the allowance for unfunded loan
commitments, was reclassified into a liability account on the balance sheet. The
allowance for unfunded loan commitments has been reclassified for quarterly
periods beginning September 30, 2003, for consistency in presentation. The
balance of the allowance for unfunded loan commitments was insignificant for
reclassification prior to September 30, 2003. See Note 6 to the consolidated
financial statements for additional details.
For the three months ended September 30, 2004, the provision for loan losses
amounted to $7.4 million, a decrease of $20.1 million from the three months
ended September 30, 2003. The provision for the nine months ended
25
September 30, 2004, amounted to $22.4 million compared to $59.0 million for the
nine months ended September 30, 2003. The reduced provisions are reflective of a
decline in under-performing assets and total criticized and classified loans
since September 30, 2003 and December 31, 2003, as further discussed below.
Net charge-offs for the three months ended September 30, 2004, totaled $6.1
million compared to $26.1 million for the three months ended September 30, 2003,
which included $12.5 million in write-downs on residential real estate loans and
commercial loans sold. Net charge-offs for the nine months ended September 30,
2004, including $1.2 million of write-downs on the residential real estate loans
sold, totaled $22.1 million compared to $47.3 million for the nine months ended
September 30, 2003, which included $14.7 million in write-downs on residential
real estate and commercial loans sold. Net charge-offs to average loans were
0.48% and 0.54% on an annualized basis for the three and nine months ended
September 30, 2004, respectively, as compared to 1.85% and 1.11% for the three
and nine months ended September 30, 2003.
Under-performing assets totaled $116.6 million at September 30, 2004, a decrease
of $14.8 million from September 30, 2003, and slightly lower than the $118.5
million at December 31, 2003. As a percent of total loans and foreclosed
properties, under-performing assets at September 30, 2004, were 2.28%, a
reduction from the September 30, 2003 ratio of 2.34% and an increase from the
December 31, 2003 ratio of 2.12%. Nonaccrual loans decreased to $106.0 million
at September 30, 2004, compared to $110.2 million at September 30, 2003, and
increased slightly from $104.6 million at December 31, 2003.
Changes to separate the loan production functions from the underwriting
functions, significant strengthening of the commercial underwriting processes
and the elevation of the Credit Policy Committee to a board level committee have
all served to continue the emphasis on improving credit quality over the past
year. Management believes that it has appropriately identified and reserved for
loan losses related to nonaccrual loans at September 30, 2004. Approximately
$41.3 million of commercial nonaccrual loans less than thirty days delinquent
were contractually performing at September 30, 2004. Management will continue
its efforts to reduce the level of non-performing loans and is currently
considering additional sales of troubled and non-performing loans, which could
result in additional write-downs to the allowance for loan losses.
The total portfolio of loans identified by Old National as problem credits
continues to decline. Total classified and criticized loans were $473.3 million
at September 30, 2004, a decrease of $134.8 million from September 30, 2003, and
$86.3 million from December 31, 2003. 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.
Old National has been affected by weakness in the economy of its markets, which
has resulted in minimal growth of commercial loans and tighter credit
underwriting standards. Management expects that trends in nonaccrual loans will
be influenced by the degree to which the economy strengthens. 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.
26
The table below shows the various components of under-performing assets:
SEPTEMBER 30, DECEMBER 31,
(dollars in thousands) 2004 2003 2003
- --------------------------------------------------- ------------- ---------------- ---------------
Nonaccrual loans $ 106,002 $ 110,165 $ 104,627
Renegotiated loans - - -
Past due loans (90 days or more) 6,722 11,406 5,120
Foreclosed properties 3,842 9,809 8,763
------------- ---------------- ---------------
Total under-performing assets $ 116,566 $ 131,380 $ 118,510
============= ================ ===============
Classified loans (includes non-performing loans,
past due 90 days and other problem loans) $ 268,474 $ 384,997 $ 343,943
Criticized loans 204,844 223,161 215,700
------------- ---------------- ---------------
Total criticized and classified loans $ 473,318 $ 608,158 $ 559,643
============= ================ ===============
Asset Quality Ratios: (1)
Non-performing loans/total loans (1) (2) 2.08% 1.97% 1.87%
Under-performing assets/total loans and
foreclosed properties (1) 2.28 2.34 2.12
Under-performing assets/total assets 1.30 1.38 1.27
Allowance for loan losses/under-performing assets 82.63 70.52 80.36
------------- ---------------- ---------------
(1) Items referring to loans are net of unearned income and include
residential loans held for sale.
(2) Non-performing loans include nonaccrual and renegotiated loans.
PREMISES AND EQUIPMENT
Premises and equipment was $212.2 million at September 30, 2004, an increase of
$43.4 million or 25.7% since September 30, 2003, and an increase of $30.8
million or 22.7% since December 31, 2003. The increase is primarily due to the
construction of Old National's Evansville main banking center and corporate
headquarters, which began in April 2002, and has an estimated total project cost
of $73.6 million. The building was placed in service on August 11, 2004.
GOODWILL AND OTHER INTANGIBLES
Goodwill was $129.9 million at September 30, 2004, an increase of $0.5 million
since September 30, 2003 and an increase of $0.7 million since December 31,
2003. The increase is attributable to adjustments to purchase prices for
previous acquisitions in the non-bank segment of the company offset by the
removal of goodwill related to the sales of the Greencastle, Indiana insurance
operations during the third quarter of 2004 and the Fort Wayne, Indiana trust
operations during the fourth quarter of 2003. Other intangible assets related to
customer business relationships decreased to $39.5 million at September 30,
2004, from $42.7 million at September 30, 2003, and $41.9 million at December
31, 2003, primarily due to amortization. Old National performs impairment
testing of goodwill and other intangibles on an annual basis. As of September
30, 2004 and 2003, there was no impairment.
FUNDING
Total funding, comprised of deposits and wholesale borrowings, was $8.152
billion at September 30, 2004, a decrease of 6.1% from $8.685 billion at
September 30, 2003, and a decrease of 5.9% from $8.532 billion at December 31,
2003. Total deposits were $6.408 billion, including $3.702 billion in
transaction accounts and $2.706 billion in time deposits at September 30, 2004.
Total deposits increased 0.2% or $11.1 million compared to September 30, 2003,
and decreased 1.7% or $85.0 million compared to December 31, 2003. Transaction
accounts increased 10.9% or $363.1 million compared to September 30, 2003, and
8.3% or $217.0 million compared to December 31, 2003. Time deposits decreased
11.5% or $352.0 million compared to September 30, 2003, and 13.4% or $301.9
million compared to December 31, 2003. Old National experienced growth in demand
deposits and other low cost transaction accounts offset by a reduction in time
accounts when comparing these time periods due to the lower rate environment and
customer preference for transaction accounts. The reduction in time accounts
from September 30, 2004, compared to September 30, 2003 and December 31, 2003,
was also due to the maturity of a group of higher interest rate certificates of
deposits during the first quarter of 2004.
Old National uses wholesale funding to augment deposit funding and to help
maintain its desired interest rate risk position. At September 30, 2004,
wholesale borrowings, including short-term borrowings and other borrowings,
decreased 23.8% and 19.3% from September 30, 2003 and December 31, 2003,
respectively. Wholesale funding was increased during the first half of 2003 to
finance investment portfolio growth, offset a reduction in certificates
27
of deposits, and take advantage of favorable interest rates. During the second
half of 2003 and continuing into 2004, wholesale borrowings decreased as the
investment portfolio growth slowed. Wholesale borrowings as a percentage of
total funding was 21.4% at September 30, 2004, compared to 26.3% at September
30, 2003, and 23.9% at December 31, 2003. The lower level of earning assets,
primarily due to a residential real estate loan sale of $405.6 million during
second quarter of 2004, reduced the company's reliance on wholesale funding.
Refer to the "Liquidity Management" section of this "Management's Discussion and
Analysis" regarding information pertaining to a shelf registration filed during
the third quarter of 2004.
CAPITAL RESOURCES AND REGULATORY GUIDELINES
Shareholders' equity totaled $712.3 million at September 30, 2004, a reduction
of 1.3% or $9.4 million from September 30, 2003, and a decrease of $3.1 million
or 0.6% compared to December 31, 2003. The primary contributors to the decline
in shareholders' equity at September 30, 2004, compared to September 30, 2003,
were decreased net income for the year ended December 31, 2003, compared to the
year ended December 31, 2002, as well as for the nine months ended September 30,
2004, compared to the nine months ended September 30, 2003, and the absence of
stock issuances for acquisitions during the nine months ended September 30,
2004, compared to the nine months ended September 30, 2003. These factors were
offset by changes in the components of comprehensive income during the nine
months ended September 30, 2004, compared to the nine months ended September 30,
2003.
As reflected in the Consolidated Statement of Changes in Shareholders' Equity,
Old National paid cash dividends of $0.19 and $0.57 per share for the three and
nine months ended September 30, 2004, respectively, decreasing equity by $37.8
million, compared to cash dividends of $0.18 and $0.54 per share for the three
and nine months ended September 30, 2003, respectively, (restated for the 5%
stock dividend distributed on January 27, 2004), which decreased equity by $36.3
million. Old National purchased shares of its stock in the open market under an
ongoing repurchase program, reducing shareholders' equity by $26.2 million
during the nine months ended September 30, 2004, and $33.0 million during the
nine months ended September 30, 2003. Shares issued for stock options,
restricted stock and stock purchase plans increased shareholders' equity by
$12.1 million during the nine months ended September 30, 2004, compared to $6.5
million during the nine months ended September 30, 2003.
Old National and the banking industry are subject to various regulatory capital
requirements administered by the federal banking agencies. Old National's
consolidated capital position remains well above regulatory guidelines as
evidenced by the following comparisons of key industry ratios.
REGULATORY
GUIDELINES SEPTEMBER 30, DECEMBER 31,
MINIMUM 2004 2003 2003
---------- ----- ----- ------------
RISK-BASED CAPITAL:
Tier 1 capital to total avg assets (leverage ratio) 4.00% 7.69% 7.27% 7.34%
Tier 1 capital to risk-adjusted total assets 4.00 11.43 11.07 10.97
Total capital to risk-adjusted total assets 8.00 15.22 14.74 14.65
Shareholders' equity to assets N/A 7.93 7.58 7.64
---- ----- ----- -----
On October 28, 2004, the Board of Directors adopted a resolution authorizing
management to file an S-3 Registration statement with the Securities and
Exchange Commission for the purpose of amending the Old National Bancorp Stock
Purchase and Dividend Reinvestment Plan. The plan has two main purposes. First,
the plan allows investors and shareholders a convenient, low-cost way to buy
shares and reinvest cash dividends in additional shares of Old National common
stock. Secondly, the plan gives Old National the ability to raise capital by
selling newly issued shares of common stock. A key feature is the ability for
Old National to sell newly issued shares at a discount from the market price.
Common stock totaling 3.5 million shares can be issued under this plan. Old
National anticipates filing the S-3 during November 2004.
28
ITEM 3. QUANTITIVE 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 market instruments as market interest rates change. Changes in the
slope of the yield curve and the pace of interest rate changes 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
administration of this policy to the Funds Management Committee, a committee of
the Board of Directors, and the Balance Sheet Management Committee, a committee
comprised of senior company management. The Funds Management Committee meets
quarterly and oversees adherence to policy and recommends policy changes to the
Board. The Balance Sheet Management Committee meets monthly and provides
guidance to Treasury and other operating units of the company regarding the
execution of asset and liability management strategies.
Old National uses two modeling techniques to quantify the impact of changing
interest rates on the company, Net Interest Income at Risk and Economic 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.
Economic Value of Equity is used to evaluate 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 various 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 of 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 Economic 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 guideline 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. The current guideline for
the allowable fluctuation in Economic Value of Equity is +/- 12% in a 200 basis
point shock to the yield curve. In addition to the output of the model in up and
down 200 basis points shocks to the yield curve, Old National has provided the
output of its rate risk model in up and down 50 and 100 basis point yield curve
shocks to provide a better understanding of Old National's sensitivity to market
interest rate changes.
At September 30, 2004, modeling indicated that Old National was at its policy
limit of Net Interest Income at Risk in an up 200 basis points yield curve
shock. Estimated Change in Economic Value of Equity, however, in an up 200 basis
points yield curve shock is -4.63%, well within the policy limit of -12%.
Estimated Change in Economic Value of Equity in a down 200 basis point yield
curve shock is - 14.42%, outside of the company's policy guideline of - 12%. The
Funds Management Committee has deemed this an acceptable risk given the
company's outlook for rising interest rates. The following table shows Old
National's market risk in various interest rate scenarios.
29
INTEREST RATE RISK /STATIC BALANCE SHEET MODEL
ESTIMATED 24- MONTH ESTIMATED CHANGE
CUMULATIVE IMPACT ON IN ECONOMIC
INTEREST RATE NET INTEREST INCOME VALUE OF EQUITY
CHANGE ---------------------------------------- -------------------------------------
(basis points) POLICY ACTUAL POLICY ACTUAL
- -------------- -------- ------ --------- ------
2004
+200 +/- 5.00% -5.03% +/- 12.00% -4.63%
+100 -2.19 -1.13
+50 -1.01 -0.13
-50 0.40% -1.10%
-100 0.64 -3.56
-200 +/- 5.00% -2.70 +/- 12.00% -14.42
---- -------- ----- --------- ------
2003
+200 +/- 5.00% -5.89% +/- 12.00% -9.69%
+100 -2.57 -4.02
+50 -1.18 -1.70
-50 1.28% 1.90%
-100 1.18 2.40
-200 +/- 5.00% -0.55 +/- 12.00% -2.43
---- -------- ----- --------- ------
The most significant change in the company's rate risk profile is reflected in
the decrease in the company's Estimated Change in Economic Value of Equity
resulting from an up 200 basis points yield curve shock. Economic Value of
Equity at risk changed from -9.69% in September 2003 to -4.63% in September
2004. The company reduced its long term exposure to rising interest rates by
reducing the effective duration of the investment portfolio to 3.66 years at
September 30, 2004, compared to 4.24 years at September 30, 2003, by selling $
405.6 million residential mortgages in June 2004, and by executing $365.0
million in forward-starting interest rate swaps that become effective in 6 to 21
months. Old National will pay a fixed rate and receive a floating rate on these
derivatives beginning on future dates. These derivatives will serve to fix the
interest rates of future debt issuance. The fixed interest rates range from
2.75% to 4.69% and have maturities of 2 to 3 years after the swaps become
effective.
Old National uses derivatives, primarily interest rate swaps, to manage interest
rate risk in the ordinary course of business. The company's derivatives had a
market value of -$2.3 million at September 30, 2004 compared to a market value
of $17.7 million at September 30, 2003. The decline in market value is due both
to the increase in interest rates during the year and the fact that Old National
terminated certain receive fixed rate swaps. As explained above, Old National
added forward-starting pay fixed rate swaps in 2004. All of these transactions
served to better position the company's balance sheet for rising rates. See Note
16 to the consolidated financial statements of the 2003 annual report for
further discussion of derivative financial instruments.
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. 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 September 30, 2004, are shown in the following table.
30
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
All three ratings agencies have issued a stable outlook in conjunction with
their ratings as of September 30, 2004.
As of September 30, 2004, Old National Bank had the capacity to borrow $831.7
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 maintains
relationships in capital markets with brokers and dealers to issue certificates
of deposits and short-term and medium-term bank notes as well. In addition, at
September 30, 2004, Old National had $685 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
September 30, 2004, the parent company's other borrowings outstanding was $265.0
million, compared with $111.6 million at September 30, 2003. This increase in
other borrowings was driven by the reclassification of guaranteed preferred
beneficial interests in subordinated debentures as described in Note 9 to the
consolidated financial statements. Old National Bancorp, the parent company, has
no debt scheduled to mature in the next 12-months. 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 of the 2003 annual report.
On August 19, 2004, Old National Bancorp filed a Form S-3 for a $750 million
global shelf registration with the Securities and Exchange Commission. The
shelf, once effective, will permit the issuance of a variety of securities
including debt, common and preferred stock, depositary shares, units and
warrants of Old National Bancorp. The proceeds of any issuance will be added to
the general funds of the Company and may be used for debt reduction or debt
refinancing, including the refinancing of our outstanding capital securities,
investments in or advances to subsidiaries, repurchase of shares of our common
stock or other securities, and other general corporate purposes.
31
ITEM 4. 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 Form 10-Q, 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.
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.
32
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
NONE
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(c) ISSUER PURCHASES OF EQUITY SECURITIES
TOTAL NUMBER
OF SHARES
TOTAL AVERAGE PURCHASED AS MAXIMUM NUMBER OF
NUMBER PRICE PART OF PUBLICLY SHARES THAT MAY YET
OF SHARES PAID PER ANNOUNCED PLANS BE PURCHASED UNDER
PERIOD PURCHASED SHARE OR PROGRAMS THE PLANS OR PROGRAMS
- ------------------- --------- -------- ---------------- ---------------------
07/01/04 - 07/31/04 253,700 24.16 253,700 2,320,191
08/01/04 - 08/31/04 122,400 23.60 122,400 2,193,538
09/01/04 - 09/30/04 40,000 24.51 40,000 2,153,144
------- -------- ------- ---------
Quarter-to-date 416,100 $ 24.03 416,100 2,153,144
======= ======== ======= =========
NOTE: Old National announced on December 4, 2003, that the board of directors
approved the continuation of the company's stock repurchase program up to 5% of
the company's outstanding stock for 2004.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
ITEM 5. OTHER INFORMATION
(a) On September 7, 2004, Old National entered into a Severance Agreement and
a Change of Control Agreement with its President and Chief Executive
Officer, Robert G. Jones. The Severance Agreement is filed as an exhibit
to this Form 10-Q, and the Change of Control Agreement is incorporated by
reference as an exhibit to this Form 10-Q.
ITEM 6. 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 September 30, 2002).
3(ii) By-Laws of Old National, amended and restated effective April
22, 2004 (incorporated by reference to Exhibit 3(ii) of Old
National's Quarterly Report on Form 10-Q for the quarter ended
March 31, 2004).
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,
33
filed with the Securities and Exchange Commission on September 22,
1999).
10 Material contracts
(a) Severance Agreement, between Old National and Robert G. Jones, is
filed herewith.*
(b) Form of Severance Agreement for Thomas F. Clayton, Michael R.
Hinton, Daryl D. Moore and John S. Poelker, as amended
(incorporated by reference to Exhibit 10(a) of Old National's
Quarterly Report on Form 10-Q for the quarter ended March 31,
2004).*
(c) Severance Agreement, between Old National and James A. Risinger
(incorporated by reference to Exhibit 10( c) of Old National's
Quarterly Report on Form 10-Q for the quarter ended March 31,
2004).*
(d) Form of Change of Control Agreement for Thomas F. Clayton, Michael
R. Hinton, Daryl D. Moore John S. Poelker, and Robert G. Jones, as
amended (incorporated by reference to Exhibit 10(b) of Old
National's Quarterly Report on Form 10-Q for the quarter ended
March 31, 2004).*
(e) Old National Bancorp 1999 Equity Incentive Plan (incorporated by
reference to Old National's Form S-8 filed on July 20, 2001).*
(f) First Amendment to the Old National Bancorp 1999 Equity Incentive
Plan, is filed herewith.*
(g) Form of "Performance-Based" Restricted Stock Award Agreement
between Old National and Robert G. Jones, Thomas F. Clayton,
Michael R. Hinton, Daryl Moore, and John S. Poelker, is filed
herewith.*
(h) Form of Executive Stock Option Award Agreement between Old National
and Robert G. Jones, Thomas F. Clayton, Michael R. Hinton, Daryl
Moore, and John S. Poelker, is filed herewith.*
(i) 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).
(j) 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).
(k) 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 September 30, 2003).*
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
34
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OLD NATIONAL BANCORP
--------------------
(Registrant)
By: /s/ John S. Poelker
--------------------------------
John S. Poelker
Executive Vice President and Chief Financial Officer
Duly Authorized Officer and Principal Financial Officer
Date: November 9, 2004
35