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Old National Bancorp (NASDAQ:ONB)

Q3 2007 Earnings Call

October 29, 2007 11:00 am ET

Executives

Lynell Walton - VP of IR

Bob Jones - President and CEO

Chris Wolking - CFO

Daryl Moore - CCO

Analysts

Scott Siefers - Sandler O'Neill

Erika Penala - Merrill Lynch

Charlie Ernst - Sandler O'Neill

Michael Cohen - Sunova

Stephen Geyen - Stifel Nicolaus

Operator

Welcome to the Old National Bancorp's Third Quarter 2007 Earnings Call. This call is being recorded and made accessible to the public in accordance with the SEC's Regulation FD. The call, along with the corresponding presentation slides, will be archived for twelve months on the shareholder relations page at www.oldnational.com. A replay of the call will also be available beginning at 1:00 pm Central today through November 12. To access the replay, dial 1-800-642-1687, conference ID code 206-45931.

Those participating today will be analysts and members of the financial community. At this time, all participants are in a listen-only mode. Then we will hold a question-and-answer session and instructions will follow at that time.

At this time, the call will be turned over to Lynell Walton, Vice President of Investor Relations, for opening remarks. Ms. Walton?

Lynell Walton

Thank you, Laney, and good morning to all of you on the call. We appreciate you're joining us for Old National Bancorp's third quarter 2007 earnings conference call. With me today are our President and Chief Executive Officer, Bob Jones, our Chief Financial Officer, Chris Wolking, and our Chief Credit Officer, Daryl Moore.

Before we begin, I would like to refer you to slide three, and to point out that the presentation today does contain certain forward-looking statements that are subject to certain risks and uncertainties that could cause the Company's actual future results to materially differ from those discussed. These risks and uncertainties include, but are not limited, to those which are contained in this slide deck and in the Company's filings with the SEC.

Slide four contains our non-GAAP financial measures information. Various numbers in this presentation have been adjusted for certain items to provide more comparable data between periods and as an aid to you in establishing more realistic trends going forward. Included in the appendix to this presentation, are the reconciliations for such non-GAAP data. We feel that these adjusted metrics provide a meaningful look at our third quarter performance as well as ongoing financial trends.

Slide five is our agenda for the call. First, Bob Jones will provide an overview of our improved third quarter earnings results, which include the continuation of many other positive trends that began in the second quarter. Daryl Moore will then lead the discussion of our improving credit quality metrics. Chris Wolking will discuss in detail our third quarter financial analysis of certain segments of our third quarter results. Chris will also discuss the anticipated impact of our most recent sale leaseback transactions. Bob Jones will complete it with our expectations for the remainder of 2007, and then we will open the call for questions.

With that, I will turn the call over to Bob.

Bob Jones

Great. Thank you Lynell, and let me add my welcome to all of you that are joining us on the call this morning. I will begin my comments with slide seven on your presentation. As you all know, this morning we announced earnings of $0.34 per share, which represent a slightly over 13% increase over the prior quarter of 2007, and slightly over 6% over the third quarter of 2006.

As I have seen for the quarter, it's much the same as we discussed last quarter. We did see continued improvement in two of our key drivers, credit quality and our net interest margin. We did once again see a decline in our non-accrual loans, loans that our classified and criticized loans. This decline in conjunction with our overall and continued improvement in the quality of our loan portfolio meant that our AOOO model showed no need for a loan loss provision for the quarter.

Daryl, as usual, will give you more in depth review later on in the call. We also did see a 17 basis point increased in our net interest margin for the quarter. This increase is due to impart to our continued effort to reduce our dependency on high cost funding, an overall much more disciplined approach to pricing, all which we have discussed with you in the past.

Chris will give you a little more detail on that particularly that pertains the building of a model for the next quarter. While we are very pleased with the overall improvement in our earnings, most notably shown in our ROE 14.22%, and our ROA at 1.15%, I want to assure all of you on the phone that we remain diligent in our outlook for the credit environment, that we are not arrogant enough to think that we can totally escape any of the issues that exist in today's turbulent market. While we firmly believe that we've been extremely aggressive in both the identification of re-credits and our proactive approach to caution in the real estate market, I think, as all of you know, we have no sub-prime lending and we have been amongst the first to limit our exposure to real estate development. We also want you to realize that we are not totally immune to these challenges and while we don't see any dark clouds on the horizon, we do remain appropriately cautious. This cautious approach does create some additional challenge for us knowing as it pertains to growth.

Let me begin with the review of our balance sheet performance on slide 8. As a precursor and say context for our balance sheet and the categories of commercial loans and leases which along with commercial real estate. In the third quarter of 2007, we did see a combined pay down of $319.7 million of that $103.6 million was grade 6 or below credit. These will be our worse graded credits 6, 7, 8, and 9 that we worked out of the bank again that was $103.6 million. Just to put these numbers into perspective, last quarter, we saw pay downs of only $259.6 million. Also on a year-to-date basis, we have seen pay downs in our category six loans and below again representing our worse quality credits of $225 million. So, the third quarter represented 46% of our total year payoffs in these lower quality loans again a prudent exercise on our part.

Let me give you some additional detail by market to further explain what happened with our balance sheet. We were very pleased that our Louisville and Indianapolis market did show good growth for the quarter, 7.9% and 3.4% respectively. These two markets, along with Carbondale, led the way from a growth perspective. I should also note that our newest market, Northern Indiana, did show some slight growth, and albeit very small, it does give us some comfort that we were moving past integration issues and getting back into the selling mode and I won't make any jokes about Notre Dame football.

I would like to discuss on three other markets that did not show growth for the quarter to better help you understand the dichotomy that I referenced in my opening comments as we balance our cautious approach to lending with the drive for growth.

Let me start with Terre Haute. We saw $26.2 million decline in outstandings. As you peel back that onion $17.2 million of that decline was due to lines being paid down. The bulk of those lines being agriculture related. None of these relationships left the bank and we have every reason to believe they should borrow again at these levels next year as to prepare for their crops. In Terre Haute, we did exit one credit for $2.3 million which was on non-accrual.

In Jasper, we have a slightly different story. $4.4 million of the decline is due to the normal amortization of a municipal lease portfolio which is really a business that we are not very active than anymore. These, along with the exit of $4.2 million of those lower grade credits, I referenced contribute to the decline in that market. Bloomington saw the sale of three credits totaling at $3.1 million, Daryl will cover those later, along with the unexpected payoff of our public sector credit of $1 million.

The message I am trying to deliver here is, that we are in a balancing act in the field. We ask our relationship managers to understand and abide by our cautious approach to lending, many times working at moving credits out of the bank which requires time. At the same time, we do want them to appropriately build their balance sheets. Given the uncertainties that exist in the market today, we do believe this approach is prudent. We do not believe this is a time to give, to add more risk to the portfolio and quite frankly, we believe just the opposite.

Now is the time to remove risk from our balance sheet and we do not believe in growth for growth sakes, and I hope you understand that.

Let me turn to slide 9 to take a quick look at our consumer loan portfolio. As a reminder, this slide reflects our traditional consumer loan portfolio, it does not include our home equity product. The vast majority of our consumer sales I have put up the name that this traditional product to both our direct mail basis and the focus for our sales teams. Given that focus, we are pleased that this was the third straight quarter that we have grown our consumer loan portfolio. This growth is the result of the enhanced sales process the Barbara Murphy has put in place in our branches and it's a good indicator that we believe the processes are working.

Let me turn to slide 10 for a quick look at our demand deposits. What I believe is, we're seeing in our DDA balances, the companies are paying down their lines and loans, as I previously noted and using their cash versus borrowing moneys if the company is do react to the economic environment. I would point out a particular note was again the positive growth in Northern Indiana which is again a good indication that our integration is growing well in this very important market.

While we did not see growth in our outstandings for the quarter, we did see a net positive inflow for this quarter for account openings. We had a positive 56 for the quarter which is against the negative 576 last quarter. On a year-to-date basis, we have seen a positive 607 of net new checking accounts, which again I believe reinforces the sales process the Barbara has put in place is beginning to work.

Let me turn to slide 11, and I'll give you our customer review of our new branches. As you look at slide 11, let me just point out a couple of key points. As I mentioned at the beginning of the call, we have worked very hard to reduce our high cost funding and to move away from special accounts. This effort affect to these branches particularly our since many of the promotional accounts resign in our newer offices.

Let me give you a brief overview how the process works and Chris will give you more detail on the impact of these efforts during his discussion the margin.

Looking at our Carmel Indiana market, we saw an $11.1 million decline in total core deposits. $7.1 million of that was one account that moved to an off balance sheet product which we offer to our treasury group. This is a product that we offer through a third-party. It allows us to retain the relationship without having to pay a higher rate. Corporate-wide this has been a very concentrated effort by our sale staff of identifying these very special rate accounts and offering the off-balance sheet product both as a means of retaining the relationship and serving the client needs. This effort is reflected in expansion of our margin, as Chris will discuss later.

Now, it's my pleasure to turn the call over to Daryl Moore, our Chief Credit Officer.

Daryl Moore

Thank you, Bob. I would like to begin my part of this quarter's presentation reviewing the trends in our classified, criticized, and non-accrual loans. As slide 13 shows, classified loans fell during the quarter, showing a decline of slightly more than $1.5 million in the period, and now stand at approximately $130 million, eliminating what now appears to be a temporary bump up in the fourth quarter of 2006 and the increase in classified loans associated with the acquisition of St. Joseph Capital Bank at the end of the first quarter.

This quarter continues our general trend of declining classified loans over the last 14 quarters. Year-to-date, we've now reduced classified loans $23 million, representing a 15% reduction in those outstandings since the end of 2006.

Slide 14 shows our criticized loan trends over the last 14 quarters. As we have discussed in prior calls, our trendline showed good progress resulting from our efforts to reduce criticized loans up until the third and fourth quarters of 2006, where we posted elevated levels. We're pleased to be able to report to you that in the third quarter we continue the progress we made in the first two quarter 2007 by reducing criticized loans by another $11 million in the period. Year-to-date, we have reduced criticized loans by $41 million, representing a 34% reduction from 2006 year-end totals.

As the next slide shows, 90-plus delinquencies in our portfolio were up in the quarter from two basis points to five basis points with total outstandings. The increase was reflected of roughly $1.1 million in additional outstandings in this category from the prior quarter. On credit the amount of approximately $1 million accounted for much of the increase. As you can see we have historically managed our 90-plus delinquencies well, and our results compare very favorably to the peer group against which we measure our performance.

As you can see on slide 16, non-accrual loans fell $9 million to roughly $49 million at quarter's end. During the quarter, we made very good progress with two of the three largest non-accruals reported at the end of second quarter. Last quarter's second largest non-accrual totaled $5.7 million was collected in full, excluding principal, interest, late fees and costs.

Last quarter's third largest non-accrual account was the loan in the amount of $5.2 million. In the third quarter, we took title to the asset which secure this loan and will be marking these assets for sale before the end of the year. $3.9 million of the $4.3 million increase in the OREO at the end of the quarter was related to this account with an additional $1.3 million moved to the repossessed asset account. With respect to our largest non-accruals at the end of the third quarter, we now have only two loans with balances of $2 million or greater.

As with any financial institution, we continue to closely monitor our criticized and classified loans. This is especially true in these more difficulty economic times for banks you're more likely to see a relatively higher incident of deterioration of these assets in to the non-accrual category.

Turning to slide 17, next net charge-offs for the quarter were $3.3 million on an annualized 28 basis points of average loans. The net total was $1.4 million of write-downs associated with $4.7 million in loans sold in the quarter.

The first nine months of the year net charge-offs stand at $11.7 million or an annualized 32 basis point of average loans, compared to $14.2 million or an annualized 39 basis points of average loans for the same period last year. With the reduction in classified criticized, and non-accrual loans in the quarter, coupled with our controlled net losses, our allowance for loan and lease loss analysis indicated that no provision expense in the quarter warranted.

As we have said previously, we continue our efforts to attempt to proactively manage and reduce risk in our money portfolio, and wanted to refresh your memory on some of the steps we have taken over the past several years that we believe will help us to manage risk and losses through this next credit cycle. First, as Bob discussed earlier, Old National does not have sub-prime lending operations, nor do we actively seek these types of loans.

Second, as we have discussed over the last year, our purposely conservative stance on commercial real estate, we would not anticipate any change in the stance in the near future. Finally, we continue to review closely our consumer loan book to make sure we are prepared for any combination of economic weakness or stepbacks that could have detrimental effects on that portfolio.

While we seem to have, at least at the present time, somewhat bucked trend of increasing credit risk, we are fully aware that we are not immune to the credit cycle which seems to be developing. There is no denying that the current disruption in the market related to the sub-prime mortgage meltdown is significant for our industry. We have and will continue to closely monitor the inevitable impact of this disruption on our bank's loan portfolios.

With that, I will turn the call over to Chris Wolking.

Chris Wolking

Thank you, Daryl. As I was preparing for our call today, I was struck by the similarities of this quarter's discussion with our presentation to you last quarter. Major trends we discussed in July, improvement in our credit metrics and improvement in our net interest margin, are still in place and drove our strong results in the third quarter.

We will begin on slide 19. Our reported net interest margin improved to 3.37%, from 3.20% in the second quarter. In the third quarter, as Daryl explained, we recovered $1.6 million of interest related to a commercial real estate loan.

As you may recall from our last conference call, we recovered $1 million in interest related to another loan in the second quarter. If we subtract the impact from both recoveries, net interest income increased to $58 million in the third quarter from $57.6 million in the second. And net interest margin increased from 3.14% to 3.28%. The 14 basis point increase in the normalized net interest margin is our second consecutive quarterly improvement to 14 basis points. The normalized margin of 3.28% in the third quarter of 2007 is 13 basis points higher than our third quarter 2006 margin.

On to slide 20. We've broken down the components of our margin improvement. I'll take you though these components in more detail. Starting with the 3.20% recorded net interest margin in the second quarter, have subtracted the 6 basis point lift from our second quarter interest recovery. As noted earlier, nine basis points of our third quarter reported margin was due to the recovery of interest on another commercial real estate loan.

The yield on the investment portfolio increased from 5.10% in the second quarter to 5.19% in the third quarter. Additionally, we've reduced our average investment portfolio $184.4 million from second quarter 2007. Subtracting out the impact of the interest recoveries in both the second and third quarters, loan yields were flat at 7.38% quarter-to-quarter. The change in the investment portfolio, combined with flat loan yields, gave us a 3 basis point lift in the margin due to asset yield.

Interest-bearing deposit costs declined significantly from 3.52% in the second quarter to 3.38% in the third quarter. This reflects the continued deposits pricing discipline by our banking business line managers. The average rate on NOW accounts declined 27 basis points and the average rate on money markets accounts declined 25 basis points in the third quarter, compared to the second quarter of 2007.

All the cost of our borrowed funding also declined in the third quarter. The improvement in our net interest-bearing deposit cost was largely responsible for the 12 basis point improvement in our net interest margin related to interest-bearing liability cost. Change in our liability mix was primarily responsible for the 2 basis point decline in margin due to mix, volume and other. Total core deposits were down $416.4 million on average compared to second quarter 2007.

Our total borrowed funds increased $140.8 million on average compared to the second quarter. The decline in core deposits, however, was concentrated in our higher cost core funding, including certificates of deposit, money market accounts and public sector customer NOW accounts. We also terminated their relationship with Merrill Lynch which reduced NOW balances by approximately $60 million during the third quarter. The cost of the Merrill deposit was at a premium to the federal funds rate.

The increase in borrowed funding was concentrated in federal fund purchased in repurchase agreements, at rates generally lower than the cost of the core deposits they replaced. We did, however, experience a $15.9 million decline in non-interest-bearing demand deposits, offset partially by an increase in core equity of $8.4 million. We defined core equity as total equity, not including the adjustment for OCI. This significant change in the mix of funding contributed to the 2 basis point decrease in margin, attributable to mix, volume and other.

The change in the liability mix I noted above, the Company's continued attention to deposit pricing and the closing of the sale leaseback transactions in the third and fourth quarters of 2007 should provide continued modest margin expansion from the normalized margin of 3.28% during the fourth quarter.

Slide 21 shows the trend in our cost of interest-bearing deposits. Where brokerage CDs are included in our deposit cost, deposit cost declined 12 basis points from second quarter 2007 to 3.47%. We expect that our third quarter deposit cost will compare favorably to the deposit cost of our peer group.

On slide 22, we will see that our tangible common equity to tangible assets and tangible equity to tangible assets ratios improved again in the third quarter of 2007. At 6.27%, our tangible common equity to tangible assets ratio was within our 6% to 7% target range. We did not repurchase shares during the third quarter.

We are pleased with the continued improvement in our non-interest revenue. On slide 23, you will note that fees, services charges and other revenue was up $2 million or 5.7% October third quarter 2006. Deposit services charges, investment product fees and mortgage revenue continue to show improvement over 2006.

Notably, on a year-to-date basis, investment product fees were up $2 million or 31% through September 2007 over the same period in 2006. Non-interest income was down $1.1 million from the second quarter of 2007, due primarily to lower insurance agency revenue. The third quarter declined in agency revenues, consistent with that which we have experienced in previous years during the third quarter.

Moving to slide 24, non-interest expenses were $2.9 million lower than second quarter 2007 and $2.6 million higher than the third quarter of 2006. The third quarter of 2006 included the rehearsal of $1.5 million of accrued restricted stock expense. Additionally, third quarter 2007 included $1 million of operating expense from the Northern Indiana region which we acquired in the first quarter of 2007.

These factors contributed to the increase in salary and benefits costs over the third quarter 2006. Occupancy expenses up $400,000 from the second quarter 2007 because we had a partial quarter's lease expense for the branches that were sold and leased back in September.

Slide 25, details the results of the sale leaseback transactions we closed during 2006 and 2007. We have executed three separate transactions since the fourth quarter of 2006. On December 20, 2006 we closed on the sale on leaseback of three of our corporate headquarters' facilities. On September 19, 2007 we closed on the sale on leaseback of 26 financial centers and on October 19 of 2007, we closed on the sale and lease of an additional 40 centers.

We expect to close on the sale on leaseback of nine more financial centers before the end of the year. We leased these facilities for terms of 10 to 25 years. The total gain on the sale of these facilities is approximately $122 million. It is important to understand that the majority of this gain is deferred and will be amortized over the terms of the individual leases with only approximately $5.6 million to be recognized in 2007. We anticipate recognizing a gain of $3.8 million related to the October 19 transaction and a gain of approximately $1.2 million on the remaining nine financial centers that should close later in the fourth quarter.

I should note here that we expect to use these gains, stocks and other expenses in the quarter. Cumulatively, the three transactions that have already closed, generated $213.9 million in cash after tax and other selling expenses, which reduced to entire wholesale borrowing during 2007.

Most of the cash was used to call brokered certificates of deposit with cost ranging from 5% to 5.5%. As I noted earlier, we've also terminated $60 million deposits relationship for Merrill Lynch which cost about 5.5% at the time we terminated the relationship.

The remaining transaction, that should close before the end of 2007, is expected to generate an additional $12.5 million in cash which we also expect to use to reduce wholesale funding.

We detailed the first full-year impact of these transactions and the remaining broader points on slide 25. Amortization of the deferred gain of $6.4 million, the savings and depreciation expense of approximately $5 million and the earnings on the redeployed cash of approximately $11 million are the positive impact for the transaction. Of course, this is partially offset by the new lease expense of $20 million for the full-year.

It is important to note that we used an earnings rate of 4.75% representing the current federal funds rate to calculate the expected earnings on the cash. We believe that this is a conservative given the manner in which we reduce the cash thus far but we felt there was an appropriate rate for this illustration.

Overall, the transaction should have a favorable impact on earnings of $2.4 million pre-tax or approximately $2.5 per share annually.

Finally, you will note that we are still holding eight additional financial centers as available for sale that we expect to be subject to future sale on leaseback transactions.

All these transactions have obviously debt financial benefits for the company. It is important to know that they allowed us to make $1.6 million in property improvements to several of our facilities. The improvements include new roofs; resurface parking lots and interior upgrades.

By financial managers Joan Kissel, our Controller and Doug Gregurich, our Tax Manager, both of whom were instrumental in completing these transactions, they and I are available today after the call to answer any follow-up questions you may have on the sale leaseback. With that I will turn the call back to Bob Jones for final comment.

Bob Jones

Great, thank you, Chris. I want to be brief in my closing. I am using slide 27. I just hope that everyone on the call gets to the sense of our firm commitments to the three strategic competitors that we have operated under for three years. At the base of our need to continue to improve and maintain a strong risk profile followed by the need to continue to enhance our management discipline. Both of which will lead to our ultimate goal of providing a consistent quality return to our shareholders in terms of their earnings.

Simply stated, we would love to be known as being consistently borrowing. Clearly, we are not there yet, but I think we have taken some major steps towards that goal. I also believe it would be very easy to deviate from our strategy during difficult times. We believe and just the opposite consistency is the key to better execution. With that very short editorial, let me say that we still remain comfortable with the guidance we gave you for the full-year. Our full-year earnings should between $1.11 and $1.17.

As you began to think about 2008, we will be guidance on our January call for the full year. With that, we will be happy to open up to any questions you might have.

Question-and-Answer Session

Operator

(Operator Instruction) Your first question comes from the line of Scott Siefers with Sandler O'Neill.

Scott Siefers - Sandler O'Neill

Good morning, guys.

Bob Jones

Hi Scott, how you doing?

Scott Siefers - Sandler O'Neill

Good, how is everyone over there doing?

Bob Jones

Good.

Scott Siefers - Sandler O'Neill

Good. I just had a couple of questions just on credit. First, the loans sales in this quarter, were those all non-performing loans?

Daryl Moore

Yes. They were.

Scott Siefers - Sandler O'Neill

Okay. And how are you finding the market for secondary loan sales just given all the dislocation that we saw during second quarter?

Daryl Moore

Yeah, Scott, it's interesting what we have found, as we continue to talk to our loan sale advisors, is that everything exclusive of one-to four-family residential loans there still appears to be a fairly vibrant market for them, pricing maybe up slightly, but not materially. If you've got residential one-to four-family development acquisition, development projects, they are trading probably at about $0.50 on a $1. So, many banks are not even putting those in the loan sales. But, that seems to be today, the only segment that's been hit very hard.

Scott Siefers - Sandler O'Neill

Okay, excellent. And then let's see am I [tossed] back on; I think that should do it for now. Good. Thanks, everyone.

Bob Jones

Thanks Scott

Operator

Your next question comes from the line of Erika Penala with Merrill Lynch.

Bob Jones

Hey Erika, how are you?

Erika Penala - Merrill Lynch

I am doing well. How are you?

Bob Jones

We are doing great.

Erika Penala - Merrill Lynch

Daryl, I just wanted to tick your brain about how we should think about reserves going forward. I know that the formula didn't cause you to report the provision this quarter. But, it seems like the tone is appropriately cautious going forward. So, how should we think about reserves?

Bob Jones

Yeah, Erika, if you don't mind I might chime in and then let Daryl fill in the blanks. But, I think that's in part why we want to hold off till January to give guidance for 2008. And I want to assure everybody on the phone, we don't see any dark clouds. And again, as I think, you all know we've been conservative, but I think we're been appropriately cautious. We also would be naïve to think that we won't return to some normalization of credit cost as we begin to think about 2008. Daryl, do have anything to add? Hope that answers the question.

Erika Penala - Merrill Lynch

Okay.

Bob Jones

And we would be able to give you a little more color as we move to January call.

Erika Penala - Merrill Lynch

And also my other question is on the expense line. Efficiency management was excellent this quarter and should we -- excluding the occupancy expenses that are going to come on line, because of the sale leaseback, is this a consistent run rate to look forward to?

Bob Jones

I think Erika, it's a good first step. I think we realized that we need to continue to look at our expenses and continue to be more prudent with our spending. So, again, in '08 in January we'll give you a little more guidance. But, we realized that why it was a good first step or couple of steps for efficiency. We’ve still got some opportunities there.

Erika Penala - Merrill Lynch

Okay. Thanks for taking my call.

Bob Jones

Thank you.

Operator

Your next question comes from the line of Charlie Ernst with Sandler O'Neill.

Charlie Ernst - Sandler O'Neill

Good morning.

Bob Jones

Hey, Charlie, how are you doing?

Charlie Ernst - Sandler O'Neill

Good. How are you guys? Just a follow-up a little bit on the expenses. It looks like the communications expense was down $0.5 million or so in the quarter. Can you add any detail there?

Bob Jones

Yeah, I would say of that maybe related to [St. Joe] in the second quarter. Again, it's just prudent watching of expenses, I think that you'll remember in the first quarter we'd put in some pretty tight controls and a lot of that begins to show its full commitment in the third and quarters beyond.

Charlie Ernst - Sandler O'Neill

Okay. And then the other expense line was had a pretty quarter and I might be including a bunch of different things in there. But, I guess the bottom-line is, do you feel like this is a decent number to run off other than the increase in occupancy?

Chris Wolking

Charlie, this is Chris Wolking. I think that when you look just a little bit, I think in quarters passed we talked about 40ish, 49 to a little bit higher than that for salary and benefits. So, we had a little bit of a benefit, I think, in the third quarter. But, as Bob said, I think its continued attention, continued management of those expenses, and we feel pretty good about our continued ability to keep a little lid on expenses. But, there is always work to be done.

Charlie Ernst - Sandler O'Neill

Okay. And then I think you guys touched on the margin briefly saying that it would be -- you think it's going to be up some. Can you add some color, especially given the rate cuts?

Chris Wolking

I'll tackle that one too. As you've seen from our previous SEC releases, we are still slightly liability sensitive, but not nearly what we have been in years passed. So, we feel like we'll still have some incremental benefit here from rates declining, but not significantly. I think the real benefit to the margin has been the fundamental changes that we've made in our deposit pricing, our continued attention to keeping an efficient balance sheet, if you will, making sure we deploy our funding appropriately into good assets, and the benefit from the sale/leaseback. When you look at the sale/leaseback transaction, the impact on the margin, just on the margin itself, when you think of that significant redeployed cash, it will be a nice lift on the margin going forward. But, of course, that's offset by a lot of the occupancy expenses related to the transaction. So…

Bob Jones

I would just add, for modeling purposes, I think as Chris said, I would suggest to use the 328 for the third quarter, but as Chris and I both said, you should see a modest expansion in that margin as you look at the fourth quarter.

Chris Wolking

Right.

Charlie Ernst - Sandler O'Neill

Okay. And then lastly, can you just comment on the tax rate? It's been very volatile this year, what's a good tax rate to be thinking about you guys?

Bob Jones

Taxes themselves, we don't expect significant changes going forward. I can't give you too much more color on that Charlie. I will be happy to address that question offline, if we feel like it's appropriate, as I'm prepare to deal with -- to answer that question right now.

Chris Wolking

I think for modeling purposes, '07 as you look forward really is not in a nominalization in the short-term?

Charlie Ernst - Sandler O'Neill Asset Management

So, if I take kind of year-to-date, you are around 30% on a FTE basis, and that’s prior not too bad to be thinking about?

Chris Wolking

Yes, that's not too bad at all.

Charlie Ernst - Sandler O'Neill Asset Management

Okay, great.

Bob Jones

Continue to benefit from previous year's losses and such.

Charlie Ernst - Sandler O'Neill Asset Management

Thanks a lot you guys.

Chris Wolking

Thanks Charlie.

Operator

Your next question comes from the line of Michael Cohen with Sunova.

Michael Cohen - Sunova

Hi.

Bob Jones

Hey Michael, how are you?

Michael Cohen - Sunova

Doing great. How are you guys?

Bob Jones

Welcome to the call.

Michael Cohen - Sunova

Thank you for taking my question. I just had a couple of quick questions. You guys are sort of kind of taking a dual-prong approach to the view of credit, in the sense that all your hard work seems to continue to pay off, yet you are sort of a mindful of kind of good economy. Can you provide maybe any more color, I mean in a sense of the nature of the types of loans that you guys have originated over the past year and half to two years, the diversity of such, maybe that gives you some confidence over the sort of loan-to-value that says kind of okay, yeah, things are going to normalize. But you keep saying you don’t see anything on the immediate --

Bob Jones

We still see major dark clouds, I don’t want anybody who gets to sense [or rather have] any challenges that we do believe we've got the right control. I think Daryl can give you a little more color.

Daryl Moore

Yeah, Michael. Let me tell you, as Bob said earlier, and as we said on prior calls, a year plus ago we decided that the commercial real estate area was really not something that we are going to take a lot of risk in, and although, we did originate some commercial real estate loans, in our underwriting was, if you just look at the deals that we lost was a lot more conservative than what was going on in the market.

So, we didn't put a lot of commercial real estate loans on the books. The stuff that we were putting on was mainly commercial and industrial. We had some consumer growth; it was really pretty plain vanilla stuff. We didn't do a lot of residential subdivision lending, didn't do a lot of commercial real estate, construction or land development lending. So, we think that at least right now, those are segments that we see some weakness in, in the book that we've got, but we don't have a lot of new exposure, and I think that's where a lot of banks are getting problems -- is on the new exposures.

So, I think that's why you hear us saying, we are glad we've got the proposals we have, we're glad we addressed the risk when we did, but we are not immune, because of the existing projects we have and some of those customers from the CNI side that have some sort of and gentle exposure to the one or more family real estate markets are probably going to show some weakening over the next couple of quarters, and we just realize that and understand that, that's going to affect our portfolio.

Michael Cohen - Sunova

Sure, that's helpful. You had also mentioned, I think you said, in terms of loan sales, was it NPAs of construction and development or trading at $0.50 on the dollar or just any construction and development loans are accreting at $0.50 on a dollar?

Daryl Moore

What the guys are saying is, their wonderful family acquisition and development loans that are troubled are accreting at $0.50 on the dollar. Those you have to keep mind a very interesting loan, because when you have a residential acquisition development loan that it shows some weakness, you've got a lot of slow adsorption and when you've got slow adsorption you have to look at your interest reserves and then that translates back to the value of the projects. So if you a got project like that, that is significantly behind where you thought was going to be, a lot of those projects are going to have a more than a couple of quarters on them, they aren’t going to go to non-performing.

So, I think when they talk about that, they are probably talking about the non-performing, but there are going to be a lot of those types of loans they are going to split through that category.

Michael Cohen - Sunova

And can you just refresh our memory as to the total size of your C&D book and the NPAs in that book and kind of what you were, you are sort of eluding. Is that where over the next two quarters you -- or a few quarters you might expect to see the NPAs creep up?

Daryl Moore

I think that if you look at the riskiness of any bank's portfolio, I would say that, yeah, that would be the first portfolio where you would show non-performers probably creep into that risk profile. I don’t have all our statistics today. We can follow back up with you on the total dollars in the NPA net portfolio.

Michael Cohen - Sunova

Great. And then, I don’t know if you guys have a kind of near-term outlook. There certainly have been banks buying in the Indiana market. Can you sort of give an update on your thought process and your kind of appetite for M&A within Indiana or would you be looking to kind of go to continuous markets outside of Indiana.

Bob Jones

Yeah. We've been pretty forthright about really wanting to concentrate on Indiana, and we would include the Louisville market as part of that, but Louisville North up by 65. A lot of chatter in the market. We continue to do a lot of dating. But, as my team has heard me say, much like my dating career in college, I wasn’t very successful. So, I am still just doing a lot of conversations, nothing imminent. We continue to be open to any opportunities, particularly if it pertains to the state of Indiana.

Michael Cohen - Sunova

Okay great. Thank you so much for your time.

Bob Jones

Thanks.

Operator

(Operator Instructions) Your next question comes from the line of Stephen Geyen with

Stifel Nicolaus.

Stephen Geyen - Stifel Nicolaus

Good morning.

Bob Jones

Hey Steve, how are you?

Stephen Geyen - Stifel Nicolaus

I am well, thank you. Just a quick question on the insurance premiums. Looking at Q4 or going back to Q4 of 2006, I heard there's a big jump, is there something seasonal that occurs there, or it is something completely different?

Bob Jones

Yeah. Stephen, we had a reclassification in certain income associated with our insurance operations that was classify from other income into insurance premium. So that accounted for that increase. I think generally speaking, the insurance agency, the insurance market in Midwest is still something to a fairly soft market; pricing is typical right now relative to previous years. Plus in 2006, we had a weather event through Indiana that reduced our contingency revenue for 2007. So, generally speaking, 2007 has been a difficult year for our agency relative to previous years.

Stephen Geyen - Stifel Nicolaus

Okay. And just if you can give me some thoughts on local economies, commercial real estate is probably hurting all over Indiana, just a C&I is particularly the stronger, in some areas risk to others and consumer how the consumers behaving, look at Evansville, Louisville Indianapolis, Northern Indiana?

Bob Jones

Sure. I would say that we're not immune to some of the challenges, but we're clearly not in the same state of the economy as our joining states of Ohio and Michigan in particular. We do see moderate growth in most of our markets. We have not seen some of the challenges that we've seen again as I said, Ohio and Michigan. Indianapolis is probably being a little more pressured in the housing and commercial real estate side. We are hearing and seeing some challenges there, Louisville has been just the opposite, Louisville continues to have a very good economy. So, I will just characterize the economy in our market is okay, now robust, but again we don't have the significant challenges that we see some of the other Midwest states.

Stephen Geyen - Stifel Nicolaus

Okay, thank you.

Bob Jones

Thank you.

Operator

(Operator Instructions) And there are no further questions at this time.

Bob Jones

Great, Laney. Again for all of you, if you have any further questions, call Lynell, or Chris or myself. And we thank you for your time and we look forward to see talking to you in January.

Operator

This concludes Old National's call. Once again, a replay along with the presentation slides will be available for twelve months on the shareholder relations page of Old National's web site at www.oldnational.com. A replay of a call will also be available by dialing 1-800-642-1687, conference ID code 206-45931. This replay will be available through November 12. If anyone has additional questions, please contact Lynell Walton at 812-464-1366. Thank you for your participation in today's conference call.

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Source: Old National Bancorp Q3 2007 Earnings Call Transcript
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