Old National Bancorp /In/ Q4 FY2021 Earnings Call

Welcome to the Old National Bancorp Fourth-Quarter and Full-Year 2021 Earnings Conference Call. This call is being recorded and has been accessible to the public in accordance with the SEC's Regulation FD. Corresponding presentation slides can be found on the Investor Relations page at oldnational.com and will be archived there for 12 months. Management would like to remind everyone that certain statements on today's call may be forward-looking in nature and are subject to certain risks and uncertainties and other factors that could cause actual results to differ from those discussed. The Company's risk factors are fully disclosed and discussed within the SEC filings. In addition, certain slides contain non-GAAP measures, which management believes provide more appropriate comparisons. These non-GAAP measures are intended to assist investors in understanding the performance trends. Reconciliations for these numbers are contained within the appendix of the presentation. I'd now like to turn the call over to Jim Ryan for opening remarks. Mr. Ryan?

Good morning and happy New Year. We are pleased to host our call to discuss our 2021 results and update on our pending partnership with First Midwest Bank. Let's start on Slide 4. We are pleased to share our full-year 2021 results. I would categorize this year's results as better than planned. 2021 EPS was $1.67, adjusted EPS was $1.73 with an adjusted net income of more than $286 million. Our adjusted return on average tangible common equity was north of 15%, and our adjusted efficiency ratio was approximately 57%. Highlights include 7% commercial loan growth driven by record commercial production of $3.9 billion coupled with net recoveries of $4.8 million for the year. We also saw record wealth management revenues in 2021. I'm particularly pleased that commercial loans are now up 20% in total from 2019 levels, excluding the impact of PPP. That’s significant growth amid a global pandemic, and we've maintained a consistently strong credit profile in the process. We've opportunistically leaned in when several of our competitors rose, and we continue to benefit from that stance, taking share by doing what we do best, consistent, quality growth. Moving to Slide 5, our fourth quarter EPS was $0.34. Adjusted EPS was $0.37. We saw strong commercial loan production of $1.1 billion during the quarter, with excellent credit quality. Our pipeline ended the year at a robust $2.5 billion. A quick update on hiring. We opportunistically added significant talent during the quarter, especially on our commercial and wealth management teams. Building upon our recent success in St. Louis, we have hired two industry veterans to start an LPO in Kansas City, which should be operating at full strength later in the quarter. We've also begun recruiting talent in Chicago, anticipating that Chicago and Minneapolis will be a significant focus in 2022. In summary, our talent pipeline remains strong. I am personally active in recruiting key team members, and we will continue to make these vital investments throughout the year. Moving to Slide 6, which contains a quick refresher on some of our accomplishments and next steps with our partnership with First Midwest. As you know, both companies have tremendous integration history and experience, and as a result, our work is going very well. We have decided and communicated the organizational structure and leadership positions for all client segments and support areas. We've also settled on our core processing system and supporting applications. Our team member engagement and excitement remain strong, and as a result, we've seen minimal attrition in our client-facing roles. Our combined leadership teams continued to meet and build a collective long-term strategy and develop tactics to accelerate our combined growth. While we are still waiting on Federal Reserve approval, we continue to have frequent and constructive dialogue with the Fed staff, who assure us our application is complete and ready for review at the Board level. We expect we will hear positive news this quarter. As soon as we hear, we will move expeditiously towards the close. With a more elongated and expected regulatory approval process and the global pandemic-related issues affecting the availability of labor and IT equipment, we now expect our systems conversion to occur in July. Given the delayed systems conversion, we expect to achieve closer to 50% of the run rate savings we modeled in 2022. We still expect to achieve 100% of the original model savings of $109 million in 2023. Lastly, despite potential distractions from the lingering pandemic-related issues and our transformational merger, we remain highly focused on serving our clients and communities. I think our results for the quarter and the year illustrate the success of those efforts. Our success would not have been possible without one of the strongest teams in the industry. I'm also grateful for the hundreds of team members who are focused on the successful integration of the combined companies. Thank you, and I will now turn the call over to Brendon.

Thanks, Jim. Turning to Slide 7, our GAAP earnings per share was $0.34, and our adjusted earnings per share was $0.37. Adjusted earnings exclude $6.7 million in merger-related charges, as well as $400,000 in debt securities gains. Slide 8 shows the trend in commercial loans and the related pipeline and production trends, all excluding the impact of PPP loans. Q4 represents our sixth consecutive quarter of organic loan growth, with 2021 commercial outstandings increasing over 7%, with both CRE and C&I showing solid growth. Strong commercial production of $1.1 billion was well balanced across all our major markets. We're also pleased that the strong fourth-quarter production did not have a significant impact on our pipeline, which ended the year at $2.5 billion, the highest year-end level on record. The size and quality of the pipeline, which includes almost $500 million in the accepted category, supports our optimistic outlook on loan growth heading into 2022. Turning briefly to pricing, new money yields on C&I were 3.39%, which are now well above portfolio yields. New CRE production yields were slightly lower for the quarter at 2.59%. More than 80% of that production is indexed to short-term rates with good spreads, but relatively low absolute coupons. While this puts some pressure on margins in the near term, it does position us well for a rising rate environment. The investment portfolio increased this quarter as deposit growth once again outpaced total loan growth. We continue to put much of the excess liquidity to work in our investment portfolio. New money yields on investments improved 18 basis points quarter-over-quarter to 1.8%, with portfolio duration shorter by a quarter of a year. Moving to Slide 9, we again saw meaningful increases in both period-end and average deposit balances. Quarterly growth came largely from our retail clients, with business clients drawing down on non-interest-bearing accounts. Total cost of deposits for the quarter was 5 basis points, while total interest-bearing liabilities were 28 basis points, both down one basis point from Q3. Next, on Slide 10, you will see details of our net interest income and margin. Net interest income excluding PPP decreased just $300,000, which was consistent with both our expectations and goal of maintaining stable NII throughout this challenging rate environment. Net interest margin decreased 15 basis points from the prior quarter to 2.77%, and core margin excluding accretion in PPP declined 11 basis points to 2.59%. Access liquidity and interest collected on non-accrual loans accounted for 6 basis points of the decline. Slide 11 shows trends in adjusted non-interest income. Adjusted non-interest income for the quarter at $51 million was $2 million lower than Q3, largely due to seasonal declines in mortgage. Our wealth line-of-business finished with a strong fourth quarter, which resulted in record revenue for the year. Our capital markets business had another strong quarter. It finished the year just shy of last year's record revenue. Mortgage production was up slightly in the quarter, but a seasonal decline in the size of the pipeline resulted in a $3.9 million decrease in revenue. Next, Slide 12 shows the trend in adjusted non-interest expenses. Adjusting for merger charges and tax credit amortization, non-interest expense was $123 million. The quarter-over-quarter increase was driven by additional lending incentives, related to strong commercial and mortgage production. Additionally, increases in the marketing and professional fees categories were related to investments in Minnesota marketing efforts and the establishment of a new brand for our high net worth wealth division that we discussed last quarter. Turning to PPP loans on Slide 13, you will see a roll forward of those balances, which totaled $169 million at quarter-end. Unamortized fees on the remaining loans totaled $6.4 million. We anticipate most of the remaining loans will be forgiven in the first half of 2022, and the related fees recognized accordingly. Slide 14 shows our credit trends. Credit conditions continue to be benign, and our commercial and consumer portfolios continued to perform exceptionally well. Delinquencies ticked up 1 basis point to end the quarter at a very low 11 basis points. We were pleased to post a fifth consecutive quarter ending net recovery position, resulting in full-year net recoveries of $4.8 million. The non-performing loans to total loan ratio once again hit a CECL low at 92 basis points. While this metric remains higher than peers, the net charge-off to NPL ratio is significantly better than peers. We believe our approach to downgrading troubled credits early, and our patient approach to workouts results in better outcomes for our clients, and ultimately lower costs for the bank. On Slide 15, you will see the details of our fourth-quarter allowance, which stands at $107 million, a slight decline from Q3. Credit loss expectations showed a slight improvement quarter-over-quarter, but the related reserve release was largely offset by additional reserves for loan growth. While our outlook on credit remains optimistic, we believe it is still prudent to maintain above-average levels of qualitative reserves, which stood at $37 million at quarter-end. As a reminder, we also continue to carry $34 million in unamortized marks from our acquired portfolios. As I wrap up my comments, here are some key takeaways. We are very pleased with the fundamental results of the quarter and year. Strong commercial loan growth led to stable core net interest income, despite interest rate headwinds. Our fee-based businesses led by wealth, mortgage, and capital markets continue to perform well and provide a great launching point for 2022. Expenses remained well-controlled, and our strong credit quality continues to keep credit costs low. Slide 16 includes thoughts on our outlook for 2022. We ended the quarter with a healthy $2.5 million commercial pipeline, which supports our favorable outlook on loan growth. This historically low interest rate environment will continue to put pressure on net interest income, which should be mitigated through continued earning asset growth. Rising short-term rates will have a positive impact on earnings as we have gradually repositioned the balance sheet to a more asset-sensitive position. The PPP loan forgiveness process continued for our clients. We expect run-off of most of the remaining balances and related fee recognition to occur in the first half of 2022. We expect our fee businesses to continue to perform well. We are encouraged by the momentum in our wealth business and the strong commercial activity should help maintain the high level of performance in our capital markets business. Mortgage revenue should follow industry trends and be seasonally lower in the first quarter. Our other fee lines are expected to be stable in the near term. ONB standalone expenses are expected to rise 2% to 3% in 2022 and should follow typical seasonal patterns. The estimate includes an expectation of slightly higher merit increases related to inflation and continued strategic investments in both revenue talent and technology. A brief update on taxes. We continue to expect a reduction in the volatility caused by our tax credits, as we work through the last of the remaining one-year historical tax credit commitments. In total, we are expecting approximately $12 million in tax credit amortization for the year, with a corresponding ONB standalone full-year effective tax rate of approximately 17% to 18%. The pro forma ran for the combined company will be in the range of 21% to 22%. In light of the delayed close of our merger with F&B, we wanted to provide an update on the combined company expense expectations. Our June 1 announcement assumed 75% of the annualized cost synergies would be realized in 2022. The first-quarter closing of the deal and the corresponding July conversion date is now expected to reduce the '22 impact to approximately 50% of the total synergies, with the majority realized in the second half of the year. That said, we are still confident we will realize 100% of a $109 million in targeted savings, which will help us deliver meaningful, positive operating leverage. In other words, the magnitude of the savings is unchanged, but the timing has now elongated by 90 days. With that, we are happy to answer any questions that you may have, and we do have the full team here, including Jim Sandgren, Daryl Moore, and John Moran. Also joining us this morning is Mark Sander, President and COO of First Midwest Bank.

Your first question comes from the line of Ben Gerlinger with Hovde Group.

Good morning, Ben.

Good morning. I was wondering if we could take a moment to discuss loan growth during the pandemic. Old National and First Midwest have performed quite well, consistently growing loans throughout this period, especially when you compare it to Fed HA data. In the fourth quarter, Old National's figures were slightly lower, which makes sense when we consider the fourth quarter run rate. You've managed to do better overall. With your comments about the first quarter indicating positive prospects for future growth, I’m interested in your observations at the client level regarding their loan needs and what that might mean for you in the first half of 2022.

Yes, Ben, this is Jim Sandgren. I think you nailed it. Obviously, really strong production in the fourth quarter, pipeline is down a little bit seasonally. In the process of building those back up, I will tell you, I think from grassroots, our clients feel really optimistic in spite of the challenges that they continue to face around labor and supply chain. But the other thing that caused a little concern in the fourth quarter was high level of payoffs. Again, the highest level that we've seen in a number of years and I don't know if that will continue in the first quarter or not. But I do think the pipeline continues to reflect that our customers are investing and growing, if they can find the labor. So again, we think we'll get off to a good start, just not knowing exactly where those payoffs will continue to land.

And Mark, would you like to add anything from your perspective?

I think it's very similar to what Jim said. Pipelines are strong. Customers I think are optimistic. There is still a fair amount of liquidity in the system, of course, and payoffs are elevated. But our production is good and solid, and should position us well for loan growth coming right out of the box in Q1.

That's helpful. Brendon, could you share your thoughts on the yield curve expectations moving forward? I know you have two balance sheets merging, and the margin is currently at its lowest point. With the market anticipating three to four rate hikes in 2022 and possibly a few more after that, I’m interested in your perspective on where the margin might end up as we close out 2022 with everything coming together.

Sure. Yes. And I think you're right. I think short of rate changes, I think we're getting close to the floor, and I think we're all the way there yet. I think there could continue to be some margin compression without some help from the Fed. We have looked at both balance sheets and the margin impact from rate increases. And how we'd like to model that up Ben is against the forward curve, and so we think the ONB standalone is going to get some upward movement to about 2% to 3% in NII on a standalone basis, and when we fold in FMB, which has a slightly more asset-sensitive balance sheet, which has a little more cash on hand, we think that's closer to 3% to 4%. Again, to get the forward rate, which is now kind of 3.5 to 4 rate hikes embedded in there.

Okay, great. That's helpful. I will step back, solid way to end the year.

Thanks, Ben.

Your next question is from Scott Siefers with Piper Sandler.

Good morning, Scott.

Good morning, everyone. I appreciate you taking my question. Brendon, I wanted to follow up on some of your comments about rate sensitivity. Could you elaborate on which areas of the curve you're most sensitive to, or ideally, where you'll be most sensitive on a pro forma basis? Do you gain the most benefit at the start of the tightening cycle, or does it require a few hikes for you to experience the full advantage?

No. I think we gain right from the start with short-term hikes. It shouldn't make a significant difference from quarter to quarter. Ultimately, the long-term impact will depend on how the middle and long-end of the curve develop over time. However, in the initial quarters, we’ll benefit right from the beginning.

Okay. Perfect. How do your thoughts on deposit betas fit into the equation?

Yes. So what we modeled was, I think, a fairly conservative view of deposit betas that are a little below for the long-term full-cycle rates. But in that 10% to 20%, which frankly could be a very conservative assumption, given how we reacted for the first three rate hikes last cycle. I think we'll be able to manage deposit betas very low for the first year.

Okay. Perfect. Thank you. And then just as it relates to the closure of that transaction, how quickly would you guys be able to close after you do receive Fed approval? I imagine you're pretty much good to go, just sort of waiting on that green light. But what kind of timeframe would we be looking at?

We need at least 15 days from the time we receive approval, and it's likely we would close at the beginning or end of a month, or at the start of the following month, to keep our accounting clean and orderly. It really depends on when we get the approval and how close we are to the beginning of the next month. However, we are prepared to close as soon as we receive the go-ahead.

Perfect. Alright, good. Thank you guys very much.

Your next question is from Terry McEvoy with Stephens.

Good morning, Terry.

Good morning, everyone. Jim, maybe start with a question for you. Old National resolved that issue in Indianapolis, a day before the Fed approved a few transactions. You guys obviously weren't on that list. Is there anything that I'm missing out there that maybe I just haven't picked up on? And is there anything you can share with us that gives you confidence that the transaction can close here in the first quarter?

We are engaged in positive discussions, and I believe it's mainly a timing issue. As you can imagine, the Fed has numerous priorities at the moment. Recently, two Fed governors went through their confirmation hearings, and there are many factors at play. We are patiently waiting, and the previous three announcements were pending longer than ours. I have no reason to think we won't receive good news soon, and we are prepared to move toward closing. There are no outstanding questions or issues that we are aware of, and we feel confident and ready for approval.

Great. And it seems like every week a large bank announces a new deposit product to reduce overdraft fees. Could you maybe just talk about the Old National overdraft structure and product? How does that compare to First Midwest, and whether you think you need to make any changes going forward when the two companies combine?

I would just say, we're aligning our process and products together as we come together during the conversion in July. We've been spending a lot of time on that. That probably means slightly lower income for the Old National Deposit Service Charge Program, and we are looking at, like everybody else, what's going on in the industry. We're not going to be immune from those changes in the future. I think it's a little early to know exactly how it's going to shake out for banks our size, but clearly that the national banks are moving towards a program. So we're going to continue to watch it. We're going to continue to do the right things. And I would say our programs are right in the middle with everybody else, as we align the two programs, and we'll just have to wait and see ultimately if there's a standard that gets set and how that might impact us in the future.

Thanks. And if I could squeeze in one more. You mentioned recruiting in Chicago. Is that because you see the pro forma company just having the ability to have a larger platform and the need for more lenders? Or do you expect some attrition and you want to fill some holes, so to speak, in the company?

We've really seen almost no or minimal attrition so far and don't expect to have any. I mean, our teams from day one saw the opportunity, right. And we're excited about what that might mean for them. I just think there's an opportunity to continue to invest; we have a great story to tell. When we get a chance to tell the story to potential team members, they like it, they feel the energy, they feel the opportunity that's in front of them. And so it's being more opportunistic around that, and I just believe there's always an opportunity to add talent. And so we're just going to continue to go out and do that. But nothing that we're worried about in terms of our existing team, we have great team members in Chicago today, who are completely capable of doing the work, but I do think there's more opportunity, and we will have a bigger balance sheet. I think there'll be more middle-market opportunities for us as we just combine the two companies. And we'll continue to take advantage of that client set and make sure we have team members who can fill those needs.

Thank you, Jim.

Thanks, Terry.

Your next question is from Chris McGratty with KBW.

Good morning, Chris.

Morning, Jim. Question on just a balance sheet position to close and pro forma. Brendon, maybe a question for you. Any tweaks that you might be doing on either side of the balance sheet to put your best foot forward pro forma?

Yeah. Chris, yes. We're taking a look at that. I guess what we can tell you now is anything that we do will not be material to the overall balance sheet. And certainly anything we do, we'll be looking to do in an EPS and capital-neutral way.

Okay. And then, once you close, you obviously are in a very strong capital position, what are the philosophical thoughts on a buyback at these levels?

Obviously, don't want to do anything ahead of any kind of Federal Reserve approval. So I think once, hopefully we receive approval here soon. I think we can look back at our capital and just make any actions going forward. We're obviously going to be at the low point once we close and mark the balance sheet. And so we'll be looking at that, and we will be looking at it quite frankly as what's the best return of capital, right? And so we'll just continue to do what we've always done. We probably run a little more capital on average than some of our peers, especially given our credit quality, but we'll make sure we do the appropriate things for shareholders and manage capital and take a look at that. But as Brendon said, it's still too early. We're looking at the balance sheet and any potential actions we might take. But if we do anything it's going to be pretty minimal.

Okay. But post-closing, the message on a buyback it's on the table, but it's balanced against the growth, is that the right interpretation?

Absolutely.

Okay. And then maybe one more on deposits. I think we as analysts continue to be surprised by the pace and the stickiness of the deposits. What are you seeing, incrementally on deposit growth? What are your expectations for maybe the next 6 months to 9 months?

Yes, Chris. So I think we were a little surprised too at the acceleration of the growth again here in the fourth quarter. It slowed a bit in the third and picked back up pace. And as we studied this and looked at past cycles, our view is that this sticks around for longer. And that growth may moderate a bit, but we don't see that, at least in the near term, this is going to run out of the bank very quickly. That said, we are prepared. We have a tremendous amount of bank liquidity. If it starts getting ahead of us, I think we have a really strong balance sheet and great liquidity position to manage through that too.

Got it. Thanks, Brendon.

If you would like to ask a question, please proceed. Your next question is from Jon Arfstrom with RBC Capital Markets.

Morning, Jon.

Hey. Good morning, everyone. Maybe obvious your balance Slide 16, your NII guide, I'm assuming that assumes no rate increases. Is that right, Brendon?

Yes. That's correct. That's exactly how we're thinking about it.

Okay.

Yes.

Sure. In your expense guidance of 2% to 3%, how much of that is attributed to hiring versus other natural expense pressures, such as compensation in technology?

The two biggest factors are clear. Our merit process is more pronounced than it has been in the past. We anticipated this and tried to address it a couple of years ago, but we are also speeding up some of those increases, especially for lower wage earners. Our hiring will likely remain consistent with last year's levels, so that's factored into the run rate to some extent. However, on average, the new hires are more costly than our current team members. Like other banks I have seen, we will not be immune to these trends. Historically, we would not have expected our expense growth to have been flat year-over-year, but now we are projecting an increase of 2% to 3%, depending on specific needs.

And then if you set aside the synergies from the merger, it's safe to assume that we should expect similar type growth at First Midwest on their core?

Yes. Similar.

Yeah, okay. And then one more thing on lending. It's obviously picked up a little bit for the industry in terms of commercial; you guys have certainly bucked that trend and had better growth. But do you expect the pipeline to continue to increase? Is there anything different in terms of the loan growth story that's emerging right now or is it just really more of the same?

Yeah, Jon. I would think that pipelines will continue to rebuild and grow, like they did last year. We haven't seen anything to the contrary, but certainly stay very close to our customers. But again, optimism for our customer base continues to be good in spite of the challenges that are faced in them with supply chain and labor. And that would add some of our new talent coming online, Jon, and their ability to run out their non-competes and things like that, I think gives us more confidence. The team we're just putting in place right now in Kansas City, again, those will all be net additive to the pipeline as we continue to hire new talent and get them in ready place to be successful.

Okay. Okay. And any theme on the new talent you're hiring? Is it just big bank fatigue wanting to come to a company like yours, but any thematic story behind that?

I believe a lot of it is true. It can be challenging to perform your duties and serve clients and communities at some of the largest institutions. However, they recognize a growth opportunity and a bit of an entrepreneurial spirit here, which is exciting to be a part of. Unfortunately, some of the largest competitors we face have lost that capability. Nonetheless, we are very optimistic about our story, and clearly, it is effective. We are currently navigating year-end processes, but I am confident we will continue to attract new talent as we enter the New Year and will have plenty of opportunities ahead of us.

Okay. Alright. Thank you.

At this time, there are no additional questions.

Thank you all for joining us today. I understand you have a busy schedule ahead. As always, Lynell, John, Brendon, and I are here to take your calls. We appreciate your participation. Have a wonderful day.

Thank you. This concludes Old National’s call. A replay along with the presentation slides will be available for 12 months on the Investor Relations page of Old National’s website, oldnational.com. A replay of the call will also be available starting February 1st. If anyone has additional questions, please reach out. Thank you for participating in today's conference call. You may now disconnect.