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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 EarningsCall. This call is being recorded and made accessible to the public inaccordance with the SEC's Regulation FD. The call, along with the correspondingpresentation slides, will be archived for twelve months on the shareholderrelations page at www.oldnational.com. A replay of the call will also beavailable beginning at 1:00 pm Central today through November 12. To access thereplay, dial 1-800-642-1687, conference ID code 206-45931.

Those participating today will be analysts and members ofthe financial community. At this time, all participants are in a listen-onlymode. Then we will hold a question-and-answer session and instructions willfollow 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 thecall. We appreciate you're joining us for Old National Bancorp's third quarter2007 earnings conference call. With me today are our President and ChiefExecutive Officer, Bob Jones, our Chief Financial Officer, Chris Wolking, andour 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-lookingstatements that are subject to certain risks and uncertainties that could causethe Company's actual future results to materially differ from those discussed.These risks and uncertainties include, but are not limited, to those which arecontained in this slide deck and in the Company's filings with the SEC.

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

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

With that, I will turn the callover to Bob.

Bob Jones

Great. Thank you Lynell, and letme add my welcome to all of you that are joining us on the call this morning. Iwill 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 aslightly 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 continuedimprovement in two of our key drivers, credit quality and our net interestmargin. We did once again see a decline in our non-accrual loans, loans thatour classified and criticized loans. This decline in conjunction with ouroverall and continued improvement in the quality of our loan portfolio meantthat our AOOO model showed no need for a loan loss provision for the quarter.

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

Chris will give you a little more detail on thatparticularly that pertains the building of a model for the next quarter. Whilewe are very pleased with the overall improvement in our earnings, most notablyshown in our ROE 14.22%, and our ROA at 1.15%, I want to assure all of you onthe 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 theissues that exist in today's turbulent market. While we firmly believe thatwe've been extremely aggressive in both the identification of re-credits andour proactive approach to caution in the real estate market, I think, as all ofyou know, we have no sub-prime lending and we have been amongst the first tolimit our exposure to real estate development. We also want you to realize thatwe are not totally immune to these challenges and while we don't see any darkclouds on the horizon, we do remain appropriately cautious. This cautiousapproach does create some additional challenge for us knowing as it pertains togrowth.

Let me begin with the review of our balance sheetperformance on slide 8. As a precursor and say context for our balance sheetand the categories of commercial loans and leases which along with commercialreal 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 willbe our worse graded credits 6, 7, 8, and 9 that we worked out of the bank again that was $103.6million. Just to put these numbers into perspective, last quarter, we saw paydowns of only $259.6 million. Also on a year-to-date basis, we have seen paydowns in our category six loans and below again representing our worse qualitycredits of $225 million. So, the third quarter represented 46% of our totalyear payoffs in these lower quality loans again a prudent exercise on our part.

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

I would like to discuss on three other markets that did notshow growth for the quarter to better help you understand the dichotomy that Ireferenced in my opening comments as we balance our cautious approach tolending 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 linesbeing paid down. The bulk of those lines being agriculture related. None ofthese relationships left the bank and we have every reason to believe theyshould borrow again at these levels next year as to prepare for their crops. InTerre Haute, wedid exit one credit for $2.3 million which was on non-accrual.

In Jasper, we have a slightly different story. $4.4 millionof the decline is due to the normal amortization of a municipal lease portfoliowhich 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 declinein that market. Bloomingtonsaw the sale of three credits totaling at $3.1 million, Daryl will cover thoselater, along with the unexpected payoff of our public sector credit of $1million.

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

Now is the time to remove risk from our balance sheet and wedo 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 consumerloan portfolio. As a reminder, this slide reflects our traditional consumerloan portfolio, it does not include our home equity product. The vast majorityof our consumer sales I have put up the name that this traditional product toboth 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 ourconsumer loan portfolio. This growth is the result of the enhanced salesprocess the Barbara Murphy has put in place in our branches and it's a goodindicator that we believe the processes are working.

Let me turn to slide 10 for a quick look at our demanddeposits. What I believe is, we're seeing in our DDA balances, the companiesare paying down their lines and loans, as I previously noted and using theircash versus borrowing moneys if the company is do react to the economicenvironment. I would point out a particular note was again the positive growthin Northern Indiana which is again a goodindication that our integration is growing well in this very important market.

While we did not see growth in our outstandings for thequarter, we did see a net positive inflow for this quarter for accountopenings. We had a positive 56 for the quarter which is against the negative576 last quarter. On a year-to-date basis, we have seen a positive 607 of netnew checking accounts, which again I believe reinforces the sales process theBarbara has put in place is beginning to work.

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

Let me give you a brief overview how the process works andChris will give you more detail on the impact of these efforts during hisdiscussion the margin.

Looking at our Carmel Indiana market, we saw an $11.1million decline in total core deposits. $7.1 million of that was one accountthat moved to an off balance sheet product which we offer to our treasurygroup. This is a product that we offer through a third-party. It allows us toretain the relationship without having to pay a higher rate. Corporate-widethis has been a very concentrated effort by our sale staff of identifying thesevery special rate accounts and offering the off-balance sheet product both as ameans of retaining the relationship and serving the client needs. This effortis 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 thisquarter's presentation reviewing the trends in our classified, criticized, andnon-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 nowstand at approximately $130 million, eliminating what now appears to be atemporary bump up in the fourth quarter of 2006 and the increase in classifiedloans associated with the acquisition of St. Joseph Capital Bank at the end ofthe first quarter.

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

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

As the next slide shows, 90-plus delinquencies in ourportfolio were up in the quarter from two basis points to five basis pointswith total outstandings. The increase was reflected of roughly $1.1 million inadditional outstandings in this category from the prior quarter. On credit theamount of approximately $1 million accounted for much of the increase. As youcan see we have historically managed our 90-plus delinquencies well, and ourresults compare very favorably to the peer group against which we measure ourperformance.

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

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

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

Turning to slide 17, next net charge-offs for the quarterwere $3.3 million on an annualized 28 basis points of average loans. The nettotal was $1.4 million of write-downs associated with $4.7 million in loanssold 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 sameperiod last year. With the reduction in classified criticized, and non-accrual loans in the quarter, coupled with ourcontrolled net losses, our allowance for loan and lease loss analysis indicatedthat no provision expense in the quarter warranted.

As we have said previously, we continue our efforts toattempt to proactively manage and reduce risk in our money portfolio, andwanted to refresh your memory on some of the steps we have taken over the pastseveral years that we believe will help us to manage risk and losses throughthis next credit cycle. First, as Bob discussed earlier, Old National does nothave sub-prime lending operations, nor do we actively seek these types ofloans.

Second, as we have discussed over the last year, ourpurposely conservative stance on commercial real estate, we would notanticipate any change in the stance in the near future. Finally, we continue toreview closely our consumer loan book to make sure we are prepared for anycombination of economic weakness or stepbacks that could have detrimentaleffects 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 arenot immune to the credit cycle which seems to be developing. There is nodenying that the current disruption in the market related to the sub-primemortgage meltdown is significant for our industry. We have and will continue toclosely monitor the inevitable impact of this disruption on our bank's loanportfolios.

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

Chris Wolking

Thank you, Daryl. As I was preparing for our call today, Iwas struck by the similarities of this quarter's discussion with ourpresentation 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 marginimproved to 3.37%, from 3.20% in the second quarter. In the third quarter, asDaryl explained, we recovered $1.6 million of interest related to a commercialreal estate loan.

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

On to slide 20. We've broken down the components of ourmargin 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 interestrecovery. As noted earlier, nine basis points of our third quarter reportedmargin was due to the recovery of interest on another commercial real estateloan.

The yield on the investment portfolio increased from 5.10%in the second quarter to 5.19% in the third quarter. Additionally, we'vereduced our average investment portfolio $184.4 million from second quarter2007. Subtracting out the impact of the interest recoveries in both the secondand third quarters, loan yields were flat at 7.38% quarter-to-quarter. The changein the investment portfolio, combined with flat loan yields, gave us a 3 basispoint lift in the margin due to asset yield.

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

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

Our total borrowed fundsincreased $140.8 million on average compared to the second quarter. The declinein core deposits, however, was concentrated in our higher cost core funding,including certificates of deposit, money market accounts and public sectorcustomer NOW accounts. We also terminated their relationship with Merrill Lynchwhich reduced NOW balances by approximately $60 million during the thirdquarter. The cost of the Merrill deposit was at a premium to the federal fundsrate.

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

The change in the liability mix I noted above, the Company'scontinued attention to deposit pricing and the closing of the sale leasebacktransactions in the third and fourth quarters of 2007 should provide continuedmodest margin expansion from the normalized margin of 3.28% during the fourthquarter.

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

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

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

Notably, on a year-to-date basis, investment product feeswere 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, dueprimarily to lower insurance agency revenue. The third quarter declined inagency revenues, consistent with that which we have experienced in previousyears during the third quarter.

Moving to slide 24, non-interest expenses were $2.9 millionlower than second quarter 2007 and $2.6 million higher than the third quarter of2006. The third quarter of 2006 included the rehearsal of $1.5 million ofaccrued restricted stock expense. Additionally, third quarter 2007 included $1million of operating expense from the Northern Indianaregion which we acquired in the first quarter of 2007.

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

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

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

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

Most of the cash was used to call brokered certificates ofdeposit with cost ranging from 5% to 5.5%. As I noted earlier, we've alsoterminated $60 million deposits relationship for Merrill Lynch which cost about5.5% at the time we terminated the relationship.

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

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

It is important to note that we used an earnings rate of4.75% representing the current federal funds rate to calculate the expectedearnings on the cash. We believe that this is a conservative given the mannerin which we reduce the cash thus far but we felt there was an appropriate ratefor this illustration.

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

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

All these transactions have obviously debt financialbenefits 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. Theimprovements include new roofs; resurface parking lots and interior upgrades.

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

Bob Jones

Great, thank you, Chris. I want to be brief in my closing. Iam using slide 27. I just hope that everyone on the call gets to the sense ofour firm commitments to the three strategic competitors that we have operatedunder for three years. At the base of our need to continue to improve andmaintain a strong risk profile followed by the need to continue to enhance ourmanagement discipline. Both of which will lead to our ultimate goal ofproviding a consistent quality return to our shareholders in terms of theirearnings.

Simply stated, we would love to be known as beingconsistently borrowing. Clearly, we are not there yet, but I think we havetaken some major steps towards that goal. I also believe it would be very easyto deviate from our strategy during difficult times. We believe and just theopposite consistency is the key to better execution. With that very shorteditorial, let me say that we still remain comfortable with the guidance wegave 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 ourJanuary call for the full year. With that, we will be happy to open up to anyquestions you might have.

Question-and-AnswerSession

Operator

(Operator Instruction) Your first question comes from theline 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 loansales just given all the dislocation that we saw during second quarter?

Daryl Moore

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

Scott Siefers - Sandler O'Neill

Okay, excellent. And then let's see am I [tossed] back on; Ithink 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 shouldthink about reserves going forward. I know that the formula didn't cause you toreport the provision this quarter. But, it seems like the tone is appropriatelycautious going forward. So, how should we think about reserves?

Bob Jones

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

Erika Penala -Merrill Lynch

Okay.

Bob Jones

And we would be able to give you a little more color as wemove 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 theoccupancy expenses that are going to come on line, because of the saleleaseback, is this a consistent run rate to look forward to?

Bob Jones

I think Erika, it's a good first step. I think we realizedthat we need to continue to look at our expenses and continue to be moreprudent with our spending. So, again, in '08 in January we'll give you a little moreguidance. But, we realized that why it was a good first step or couple of stepsfor 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 withSandler 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 theexpenses. It looks like the communications expense was down $0.5 million or soin the quarter. Can you add any detail there?

Bob Jones

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

Charlie Ernst - Sandler O'Neill

Okay. Andthen the other expense line was had a pretty quarter and I might be including abunch of different things in there. But, I guess the bottom-line is, do youfeel like this is a decent number to run off other than the increase inoccupancy?

Chris Wolking

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

Charlie Ernst -Sandler O'Neill

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

Chris Wolking

I'll tackle that one too. As you've seen from our previousSEC releases, we are still slightly liability sensitive, but not nearly what wehave been in years passed. So, we feel like we'll still have some incrementalbenefit here from rates declining, but not significantly. I think the realbenefit to the margin has been the fundamental changes that we've made in ourdeposit 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 thatsignificant redeployed cash, it will be a nice lift on the margin goingforward. But, of course, that's offset by a lot of the occupancy expensesrelated to the transaction. So…

Bob Jones

I would just add, for modeling purposes, I think as Chrissaid, I would suggest to use the 328 for the third quarter, but as Chris and Iboth said, you should see a modest expansion in that margin as you look at thefourth 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 aboutyou guys?

Bob Jones

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

Chris Wolking

I think for modeling purposes, '07 as you look forwardreally 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 aFTE 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 withSunova.

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 ofquick questions. You guys are sort of kind of taking a dual-prong approach tothe view of credit, in the sense that all your hard work seems to continue topay off, yet you are sort of a mindful of kind of good economy. Can you providemaybe any more color, I mean in a sense of the nature of the types of loans thatyou guys have originated over the past year and half to two years, thediversity of such, maybe that gives you some confidence over the sort of loan-to-valuethat says kind of okay, yeah, things are going to normalize. But you keepsaying you don’t see anything on the immediate --

Bob Jones

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

Daryl Moore

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

So, we didn't put a lot of commercial real estate loans onthe books. The stuff that we were putting on was mainly commercial andindustrial. We had some consumer growth; it was really pretty plain vanillastuff. We didn't do a lot of residential subdivision lending, didn't do a lotof commercial real estate, construction or land development lending. So, wethink 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 Ithink that's where a lot of banks are getting problems -- is on the newexposures.

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

Michael Cohen -Sunova

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

Daryl Moore

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

So, I think when they talk about that, they are probablytalking about the non-performing, but there are going to be a lot of thosetypes 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 ofyour C&D book and the NPAs in that book and kind of what you were, you aresort of eluding. Is that where over the next two quarters you -- or a fewquarters you might expect to see the NPAs creep up?

Daryl Moore

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

Michael Cohen -Sunova

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

Bob Jones

Yeah. We've been pretty forthright about really wanting toconcentrate on Indiana, and we would includethe Louisvillemarket as part of that, but Louisville North up by 65. A lot of chatter in themarket. 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 stilljust doing a lot of conversations, nothing imminent. We continue to be open toany 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 theline 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 insurancepremiums. Looking at Q4 or going back to Q4 of 2006, I heard there's a bigjump, is there something seasonal that occurs there, or it is something completelydifferent?

Bob Jones

Yeah. Stephen, we had a reclassification in certain incomeassociated with our insurance operations that was classify from other incomeinto insurance premium. So that accounted for that increase. I think generallyspeaking, the insurance agency, the insurance market in Midwestis still something to a fairly soft market; pricing is typical right nowrelative to previous years. Plus in 2006, we had a weather event through Indiana that reduced ourcontingency revenue for 2007. So, generally speaking, 2007 has been a difficultyear for our agency relative to previous years.

Stephen Geyen - Stifel Nicolaus

Okay. Andjust if you can give me some thoughts on local economies, commercial realestate is probably hurting all over Indiana, just a C&I is particularly thestronger, 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 thechallenges, but we're clearly not in the same state of the economy as ourjoining states of Ohio and Michigan in particular. We do see moderategrowth in most of our markets. We have not seen some of the challenges thatwe've seen again as I said, Ohio and Michigan. Indianapolis is probablybeing a little more pressured in the housing and commercial real estate side.We are hearing and seeing some challenges there, Louisvillehas been just the opposite, Louisvillecontinues to have a very good economy. So, I will just characterize the economyin our market is okay, now robust, but again we don't have the significantchallenges that we see some of the other Midweststates.

Stephen Geyen -Stifel Nicolaus

Okay, thank you.

Bob Jones

Thank you.

Operator

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

Bob Jones

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

Operator

This concludes Old National's call. Once again, a replayalong with the presentation slides will be available for twelve months on theshareholder relations page of Old National's web site at www.oldnational.com. Areplay of a call will also be available by dialing 1-800-642-1687, conferenceID code 206-45931. This replay will be available through November 12. If anyonehas additional questions, please contact Lynell Walton at 812-464-1366. Thankyou 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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