Old National Bancorp (NYSE:ONB) Q4 2013 Earnings Call February 3, 2014 11:00 AM ET
Lynell Walton - SVP, Director of Investor Relations
Chris Wolking - CFO and Senior Executive Vice President
Daryl Moore - Chief Credit Officer and EVP
Bob Jones - CEO, President
Scott Siefers - Sandler O'Neill
Emlen Harmon - Jefferies
Chris McGratty - KBW
Taylor Brodarick - Guggenheim Securities
Jon Arfstrom - RBC Capital Markets
Peyton Green - Sterne Agee
Welcome to the Old National Bancorp Fourth Quarter and Full Year 2013 Earnings Conference Call. This call is being recorded and has been made accessible to the public in accordance with the SEC's Regulation FD. The call, along with corresponding presentation slides, will be archived for 12 months on the Investor Relations page at oldnational.com. A replay of the call will also be made available beginning at 8:00 a.m. Central Time on February 4 through February 17. To access the replay, dial 1 (855) 859-2056, conference ID code 34095437.
Those participating today will be analysts and members of the financial community. (Operator Instructions)
At this time, the call will be turned over to Lynell Walton for opening remarks. Ms. Walton?
Thank you, Holly. And good morning, everyone. Joining me today on Old National Bancorp's fourth quarter and full year 2013 earnings conference call are Bob Jones, Chris Wolking, Daryl Moore, Jim Ryan and Joan Kissel.
Some comments today may contain 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. Please refer to the forward-looking statement disclosure contained on Slide 5, as well as our SEC filings, for a full discussion of the company's risk factors.
Additionally, as you review Slide 6, certain non-GAAP financial measures will be discussed on this conference call. References to non-GAAP measures are only provided to assist you in understanding Old National's results and performance trends and should not be relied upon as a financial measure of actual results. Reconciliations for such non-GAAP measures are appropriately referenced and included within the presentation.
Turning to Slide 7, we’ve laid out highlights of our fourth quarter as our continued focus on our three strategic comparatives again produced another strong quarter for Old National.
We reported net income for the quarter of $24.5 million or $0.25 per share, which represents a 6.7% increase over net income from the fourth quarter of 2012. Our balance sheet and capital positions remain strong as we not only repurchased 890,000 shares of ONB stock in the quarter but we again increased our quarterly cash dividend and ended the year with a strong 8.5% tangible common equity to tangible assets ratio.
We reported a net interest margin of 4.11% for the fourth quarter aided by strong accretion income and a continued decline in interest-bearing deposit costs. Our transformation in the higher growth markets continued as we consolidated or sold a total of seven branches in the quarter and saw an improved efficiency ratio of 66.6%. And just a few weeks ago, we announced our intent to partner with United Bancorp and enter the vibrant market of Ann Arbor Michigan.
Moving to Slide 8, many of the thing highlights apply when you look at our full-year 2013 results of $100.9 million in net income or $1 per share, a 10.1% increase over 2012 earnings and the highest net income since 2002. Indeed, Old National 2013 financial performance was record-breaking in many ways. We reported our best return on assets since 2002, best return on equity since 2008, and our lowest efficiency ratio since 2006.
In addition, two of our fee-based businesses: wealth management and investments, had their best year in over a decade. And thanks to our credit and production team, we’re reporting our lowest level of net charge-offs in almost 30 years.
2013 also saw Old National’s entry into Southern Michigan with a branch purchase and of course, we have two pending partnerships, Tower Financial in Fort Wayne, Indiana and United Bancorp in Ann Arbor Michigan.
With that introduction, I’ll turn the call over to Chris.
Thank you, Lynell. I will start my presentation with Slide 10. Without securities gains and merger and integration expenses, pretax, pre-provision income was $39.7 million for the fourth quarter 2013.
Fourth-quarter 2013 pretax, pre-provision income was $8.5 million higher than third quarter and $5.7 million higher than fourth quarter of 2012. Fourth-quarter net interest income was up compared to Q3 largely due to higher accretion income.
Noninterest income was lower in the quarter due to higher indemnification asset expense and lower deposit service charge revenue. Operating expenses declined across most categories in Q4 as we saw the benefits of our third and fourth quarter branch consolidations and sales and the implementation of productivity improvement and expense savings projects.
Annual pretax pre-provision income was up 11.7% in 2013 over 2012. Accretion of purchase accounting discount contributed $59 million in 2013 compared to $57.3 million 2012. The $1.7 million increase in accretion income contributed to total net interest income that was $8.7 million higher in 2013 compared to 2012.
Noninterest income was also higher in 2013 as insurance, brokerage and wealth management all had better revenue in 2013 compared to 2012. Although we incurred significantly lower other real estate owned expense in 2013 compared with 2012, generally operating expenses were higher in 2013 as we expanded into the Columbus, Indiana and Southern Michigan markets with our acquisitions.
While Daryl will talk further about credit performance for the quarter, I will note that we incurred $2.3 million in provision expense in the fourth quarter, which came close to matching our $2.4 million fourth-quarter net charge-offs. For the full year of 2013, we recaptured $2.3 million of previously expensed loan-loss provision.
Slide 11 shows loan production data for 2012 and 2013. This is data we use internally to track performance among our regions and reflects new loan origination and excludes commercial and commercial real estate loan renewals and purchase loans. For newly originated lines of credit, we use 50% of the committed line to include in-production numbers.
In total, 2013 loan production was $52.6 million higher than 2012 loan production. We saw a higher production in all loan categories during the year except for residential mortgage. Mortgage loan originations for home purchases was fairly stable during the year but refinance volumes declined steadily. Mortgage refinance originations were $15.6 million in Q4 of 2013 compared to $73 million in Q4 of 2012.
Moving to Slide 12, you will see in the top graph that the commercial loan pipeline declined $423 million in Q4 from $444 million in the third quarter. The pipeline peaked at $507 million in the second quarter of this year. While the pipeline is down from earlier in the year, it was 27 -- from earlier in the year was $27 million higher than fourth quarter of 2012. Also, it is important to note that the loans proposed segment of the pipeline is $140 million, up from $118 million in the third quarter.
In the second draft of the slide, note that our commercial line of credit utilization declined in the fourth quarter. Most of the decline was due to lower line utilization by three major customers in a single region and we don't believe the change in fourth quarter reflects a broad-based decline in customer line usage.
Slide 13 shows average total loan trends during 2013. I’ve broken down the totals into FDIC covered loans, which is the yellow segment of each stack bar, and total non-covered assets, the blue segment of the bar. Total non-covered loans include purchase loans. The balance in the FDIC covered loan category declined during the year because much of the covered asset portfolio is impaired and we continue to actively work out of these loans.
We sold $11.6 million of commercial leases mid-third quarter and $96.9 million of residential mortgages on the last day of Q3. Because these transactions happened during the third quarter, they had a significant impact on fourth-quarter average loans. Additionally we continue to work out of the impaired assets we acquired in our purchase of Indiana Community. Excluding the impact of the loans and leases we sold and the change in the impaired assets, total average non-covered loans were $58.1 million higher than the third quarter 2013 average.
Slide 14 breaks down our noninterest income for the fourth quarter. Total noninterest income was $44.1 million. If we start at the bottom of the bar chart you will see that indemnification asset expense was $3.4 million in the quarter, up from third quarter. Our total FDIC indemnification asset declined to $88.5 million from $91.6 million at the end of the third quarter.
I’d like to make a few comments specifically about our FDIC indemnification asset. At the end of 2013, the total IA was comprised of $64.3 million of loss share coverage related to the portfolio of remaining covered loans and $9.4 million in coverage related to specific OREO properties for a total of $73.7 million. This is the portion of the total FDIC loss share asset watch closely. The $14.8 million of the remainder of the total IA are current receivable claims pending payment by the FDIC.
Of the $64.3 million loss share coverage related to the portfolio of loans, $55.8 million is related to commercial loans and $8.5 million is related to single-family real estate loans. Commercial loans are subject to the five-year timeline for coverage originally set at the date of the purchase of the Integra balance sheet. FDIC coverage for the commercial loans expires September 30, 2016, so we have 11 quarters remaining on this coverage.
Single-family real estate loans are subject to a 10-year timeline. As of the end of 2013 we expect $41.5 million of the remaining $73.7 million loss-share coverage will become indemnification payments from the FDIC and $32.2 million will be amortized over the remaining life of the FDIC coverage and offset by future accretion income.
Service charges on deposits were $12.8 million in the quarter, $1.2 million of which was generated by the deposit accounts for newly acquired Michigan and Northern Indiana branches. Total deposit service charges declined $1.1 million from the third quarter and we expect continued downward pressure on deposit service charge income.
Other income of $7.9 million for the quarter was down $1.8 million from Q3. Third quarter included $1.6 million related to the renewal of a large processing contract and $1 million from a high single BOLI benefit. Fourth quarter included approximately $700,000 in gains from the sale of branches.
Fees from our fee-based businesses were down slightly from third-quarter of 2013 and were flat compared to fourth quarter of 2012. Mortgage banking revenue was $400,000 lower in the quarter compared to third quarter and was $1 million lower than the fourth quarter of 2012.
Investment brokerage revenue was down $600,000 compared to the third quarter but was $600,000 higher than fourth quarter of 2012. Debit card related income was $7 million in the fourth quarter compared to $6.2 million in the third quarter, reflects a full quarter of activity from the new branches in Michigan and Northern Indiana.
Slide 15 shows full-year noninterest income for 2013 compared to 2012. Total noninterest income was $6 million higher in 2013 than in 2012. I want to highlight the increased revenue from our fee-based businesses reflected in the slide.
Total revenue from wealth management, insurance, mortgage and investment brokerage was up significantly from 2012. Total fee revenue increased $7.4 million from 2012 to $82.4 million. Wealth management revenue was up $1.9 million; insurance increased $1.4 million; mortgage was up $700,000 and investment brokerage revenue increased $3.3 million, or full 26% over 2012.
I have also noted the total noninterest revenue contribution from our recent acquisitions for 2012 and 2013 in the bullet points in Slide 15. Indiana contributed -- Indiana Community contributed $7.9 million in revenue for 2013 and the acquired Northern Indiana and Michigan branches contributed $3.9 million in 2013.
On Slide 16, I’ve broken down noninterest expenses for the third quarter. As promised and expected, we saw a significant decrease in our noninterest expense in the fourth quarter compared to third-quarter of 2013. Operational expenses declined to $85.1 million from $80.5 million in the third quarter. We realized the savings in the quarter from our branch consolidations and sales and our expense reduction and productivity improvement projects.
As noted in the bullet point on the slide, the new branches in Michigan and Northern Indiana added $3.4 million in operational expenses for the fourth quarter of 2013. Fourth-quarter acquisition and integration costs were $2.5 million compared to $2.3 million in the third. The $2.5 million in the fourth quarter costs included $1.8 million related to the integration of the Bank of America branches and approximately $700,000 related to the pending acquisition of Tower Bancorp. Acquisition costs related to Tower will likely increase in the first quarter of 2014 as we move towards closing and conversion.
Other expenses in the fourth quarter of $600,000 included a previously disclosed $500,000 civil money penalty assessed by the OCC to resolve the BSA/AML consent order.
Slide 17 shows the comparison of total non-interest expenses for 2013 compared to 2012. Operational expenses reflected in the blue segment of the bar chart increased $12.5 million in 2013 from 2012 to $343.9 million. Our new Indiana Community in Northern Indiana and Michigan branches accounted for $12.8 million in new operational expenses for the year.
Slide 18 shows our total revenue for 2013 and the trend in total revenue since 2009. Since 2011 we have talked about the contribution of accretion income to pretax pre-provision income and net interest margin. While important, accretion income has only averaged 10.6% of total revenues since 2011. Excluding accretion income, revenue has grown 12.2% since 2009.
Also, pretax, pre-provision income includes IA expense and operational expenses in credit, special assets, credit administration, tax, accounting and audit that we would not likely incur if we were not managing the FDIC covered assets or other purchase loans. We believe that showing [ph] accretion revenue as a portion of total revenue provides important context for the overall impact of accretion on the company’s performance and balances our focus on the impact of accretion on net interest margin and pretax pre-provision income.
We have discussed our 65% targeted efficiency ratio frequently over the past several quarters and Slides 19 and 20 show the trends in our efficiency ratios. Slide 19 shows the trend in the annual efficiency ratio since 2009. I included the average efficiency ratio of our peer group over the same period for comparison.
The reported efficiency ratio excludes expense associated with amortization of intangibles and securities gains and losses but includes merger and integration expenses. Our efficiency ratio declined from 80.5% in 2009 to 68.6% in 2013. At 68.6% for 2013, we’re closing on the peer group average of 63.7%. The average ratio for our peer group increased from 59.9% during the same timeframe.
Slide 20 shows our quarterly reported efficiency ratios for 2013 along with the efficiency ratio, excluding the acquisition costs and operating income and expenses of our branch acquisition and the pending Tower Bancorp transaction.
As you know, a portion of executive and managers’ incentives this year was dependent on our ability to meet an efficiency ratio target of 65% in the fourth quarter. Also as discussed previously, because the Michigan and Northern Indiana branch acquisition and Tower transaction were not anticipated when we prepared our 2013 budget, results from those operations were excluded from our quarter end executive performance calculation.
I discussed expenses and noninterest income for both quarters that impacted our efficiency ratio on earlier slides. The fourth-quarter revenue was also lifted by higher than anticipated accretion income due to the better than expected workout of Indiana Community loans.
We are pleased with our reported fourth-quarter efficiency ratio of 66.5% which includes the operations in an important market for us that should perform very well in the future. We are very pleased with our adjusted efficiency ratio of 63.9%. Both ratios reflect success with our productivity improvement and expense reduction efforts.
Slide 21 tracks our asset growth against the changes in our full-time equivalent employees. I've also noted the quarters where we acquired banks or branch networks and the numbers of employees of these institutions at closing. Full-time equivalent employees declined from 2,658 in Q3 2013 to 2,608 at the end of the fourth quarter. The decrease in FTE in Q4 was better than originally anticipated due primarily to our ability to fill open positions with that [ph] that had been displaced by consolidations sooner than expected. We expect FTE employees to increase by the end of first quarter of 2014 due primarily to the closing of the Tower Bancorp transaction.
Slide 22 shows our net interest margin in the fourth quarter and the trends in net interest margin during the year. Net interest margin on a fully taxable equivalent basis was 4.11% in Q4, up from 396 in the third quarter. As expected, core interest margin declined three basis points from third quarter to 3.30%.
Certificate of deposit costs declined from 1.20% in the third quarter to 97 basis points in the fourth quarter. Offsetting some of this benefit to the margin was a decline in the yield of our investment portfolio from 3% to 2.87% in the quarter. Importantly, non-interest-bearing demand deposits increased $57.2 million on average during the quarter, which also helped core margin.
In the fourth quarter, accretion from acquired assets and liabilities accounted for 81 basis points for our net interest margin or $16.8 million. Accretion income should decline as acquired loans mature or are otherwise paid out. We expect somewhat lower accretion income from acquired loans in 2014 with a larger decline in 2015. Since we've not yet closed on either Tower or UBMI, of course, we have not marked these assets to fair value but our initial reviews of these portfolios indicate the percentage discount to adjust to fair value will be lower for these portfolios compared to previous acquisitions.
Core margin in the first quarter of 2014 should be approximately equal to fourth-quarter margin although the repricing of loans and the reinvestment of investment portfolio cash flows at lower interest rates may have an impact on earning asset yield.
Accretion income was higher than anticipated in the fourth quarter due to the successful workout of several impaired credits in the quarter. Accretion income on a quarterly basis will likely continue to be somewhat variable.
Slide 23 depicts the output of our interest rate sensitivity models. I will continue to provide interest rate sensitivity information to you quarterly. The graphs show output from our net interest income at risk models for two of the several scenarios we run on a monthly basis. The blue line is the percentage change we expect to two years’ net interest income if future interest rates were as implied by the interest rate swap yield curves for each of the dates on the horizontal axis. The forward yield curves used for this model at 12/31/2013 are included in the appendix.
As of 12/31, our model expects an increase in net interest income of 2.19% if interest rates change as the yield curve predicts. We consider this our most likely two-year rate scenario.
The red line is a rate scenario required by the regulators and depicts the trend of possible impacts on two years net interest income if rates are shocked immediately upward 200 basis points along the entire yield curve from actual interest rates as of the dates listed. In this scenario, our model indicates that based on the balance sheet at 12/31/2013, total net interest income would decline 3.34% if rates were shocked up 200 basis points. We are well within our guidelines of minus 8.5% for rate sensitivity for this scenario. I've included in the appendix a slide with these interest rates used as of 12/31 as well.
The most material assumptions driving our rate risk models are related to the repricing of our non-maturity deposits and the expected prepayments of mortgage whole loans and mortgage investments. We believe we treat the repricing of non-maturity deposits in a conservative fashion. In our current modeling, 40% of our total non-maturity deposits reprice immediately at 62% to 100% of the corresponding increase in the federal funds rate.
We're currently evaluating our deposit repricing assumptions with the help of a third-party and our preliminary analysis indicates that deposit assumptions may be conservative and repricing may not be as quick or as comprehensive as our current models depict.
Overall we are comfortable with our net -- with our current exposure to interest rates but we continue to pay close attention to our balance sheet and the output of our rate risk models [ph]. We expect to continue to reinvest much of our investment portfolio of cash flows into short maturity of floating-rate securities and we continue to sell most residential mortgage production with a maturity of 15 years or longer.
Since there was so much attention to the potential impact of the final Volcker Rule on community banks, I will take this opportunity to explain the impact on Old National, particularly as it pertains to pooled trust preferred securities.
As of 12/31/2013 we owned four different pooled trust preferred securities with an amortized cost after OTTI of $19.2 million. The market value of these securities was $8 million on 12/31/2013. These securities are held as available-for-sale so the difference between amortized cost and market is reflected in other comprehensive income and are therefore included in tangible equity.
All of these securities were on the list of the regulators’ acceptable investments. So we are not required to sell any of these securities. It is important to acknowledge and thank the many individuals and organizations, especially the American Bankers Association who helped shape the final ruling by the regulators on trust preferred securities.
On Slides 24 and 25 are graphs of our key capital ratios as of 12/31/2013. On Slide 24, you will see that our tangible common equity ratio increased to 8.5% as of 12/31. I rolled forward our third-quarter tangible equity to year-end in the chart below the graph on Slide 24, you'll note that we repurchased 889,000 shares of stock with a value of $13.2 million during the fourth quarter. For the full year we repurchased about 1.6 million shares of stock. So it was 80% of the 2 million share authorized buyback for 2013.
The board reauthorized 2 million share buyback for 2014 and a 10% increase in 2014 first-quarter dividend at our January meeting. The first-quarter dividend is $0.11 per share compared to $0.10 per share last quarter.
Slide 25 shows our tier 1 risk based capital ratio at 12/31 of 14.3%, up from 14.2% as of 9/30/2013. While most of our tier 1 equity is common equity and retained earnings we do have $28 million of trust preferred equity. Our tier 1 capital ratio continues to track above the average ratio of our per group – peer banks.
Our capital base gives us a latitude to grow organically, acquire additional banks and businesses using cash or continue to return capital to shareholders. We evaluate all of these opportunities constantly and expect to execute capital decisions for the best interest of our shareholders in the long term.
Both the Tower and UBMI acquisitions, which we expect to close in 2014, include a mix of stock and cash in the purchase consideration.
Slide 26 is my final slide. We have had several questions about our total cost and investments to improve our BSA/AML processes at the company. The first chart shows our total investment in BSA/AML processes during the three years elapsed time of this project. In total, we expensed or capitalized $5.8 million. Our new BSA/AML technology went active in 2013, so we began depreciating our investment. Plus our staffing began to come back to the steady-state we believe will be required to manage the program in the future.
We compared our total annual costs in 2013 to what we were spending prior to the project, you will note that our annual costs, including depreciation and amortization of our investment, salaries and benefits for staff and audit, increased to $2 million in 2013.
I’ll now turn the call over to Daryl Moore for his credit presentation.
Thank you, Chris. On Slide 28, we show the trailing five quarter summary of net charge-offs for both the bank’s FDIC loss share covered portfolio, which is depicted by the yellow bar as well as for our non-covered portfolio which includes our legacy portfolio along with all of the non-covered acquired portfolios which have come to us in our partnership transaction.
In the most recent quarter, we posted consolidated net losses of roughly $2.4 million representing an annualized net charge-off rate for the period of 19 basis points. Consolidated net charge-offs for the year totaled $5.3 million, which represented 10 basis points of average loans. This 10 basis point rate is the lowest rate posted by the bank in almost 30 years.
2013 net charge-offs for the covered portfolio were 63 basis points while net charge-offs for the non-covered portfolio were very respectable 7 basis points for the year. Interestingly, we posted the strong net charge-off results with lower gross losses and not by extraordinarily high recoveries in 2013. In fact, at $11.7 million, consolidated portfolio recoveries for the year were $2.3 million lower than 2012 recovery levels and the lowest of any year over the past four years.
On Slide 29, we show trends in our noncovered special mention, substandard and doubtful loans. The bottom two graphs on the slide show that we continued our most recent downward trends in both substandard accruing and substandard non-accruing and doubtful loans in the quarter with loans in those categories falling $7.4 million and $11 million respectively.
During the full year 2013, we made good progress in lowering the risk in our portfolios as we reduced non-covered substandard accruing loans by 24% and substandard non-accruing and doubtful loans by 36%. Special mention loans, on the other hand, increased by $5.9 million in the quarter. As you might expect, this is a category that has quite a bit of individual credit movement in it every quarter and this quarter was no exception.
We did have several credits in the road construction industry that were added to this category in the period but at this point in time, we would not anticipate that these credit would be downgraded in the near future due to the current backlogs and general balance sheet strengths of the majority of these borrowing exposures.
Slide 30 shows our trends in allowance for loan-loss coverage of non-covered, non-performing assets. On consolidated basis, you can see that we continue our modestly improving trend, increasing our coverage from 32% to 35%. Improvement came as a result of a reduction in non-performing assets of $12.7 million in the quarter, offset in part by the reduction in allowance for loan losses of $600,000.
As we have commented in the past, this coverage number does not include the currently outstanding marks on either the Monroe, Indiana Community Bank or the non-covered Integra portfolios.
In that regard, as we move to Slide 31, you can see that we have laid out for you the combined allowance for loan losses and loan marks as a percent of the pre-marked loan portfolio for each of our differently tracked portfolios.
Similar to the past quarters, the combined allowance in marks to pre-marked loan balance percentages appear to appropriately rank in reserve for the risk level in each of the portfolios with the highest risk portfolio being Integra portfolio followed by the most recently acquired Indiana Community Bank portfolio.
You can see that combined allowance in marks represent roughly 8% of the pre-marked Monroe portfolio, 15% of Indiana Community Bank portfolio and 31% of the Integra portfolio. Obviously the majority of the Integra portfolio is also subject to our loss share agreement with the FDIC.
On a combined basis, the allowance for loan losses and loan marks as a percent of the pre-marked loan portfolio now stand at 3.69% as compared to 4.05% at the end of last quarter.
Finally, on Slide 33 we display trends and fourth quarter results with respect to portfolio delinquency levels. At 42 basis points 30-day or greater non-covered delinquencies showed improvement from last quarter’s end level of 51 basis points and continue to compare very favorably to peer results of 99 basis points in the trailing quarter.
Accruing 90-plus day non-covered loan delinquencies fell to roughly $200,000 in the quarter to a level that is too low to meaningfully measure against period end loans and considerably lower than that of our peers whose average trailing quarter results stand at 39 basis points.
2013 was a good year in terms of improving credit quality results with very low net charge-offs and declining levels of both substandard accruing and substandard non-accruing and doubtful loans. With these improvements in credit quality, we now have the opportunity to begin to take on more measured risks as we look at new lending opportunities and we will do so in a very intentional and well-planned manner.
With those comments, I’ll turn the call over to Bob for concluding remarks.
Thank you, Daryl. And good morning to each of you on the phone. I will begin my remarks on Slide 34 with a quick overview of the general economic outlook for 2014 and our markets and then follow that with a more specific view on Old National’s plan for 2014.
In general, the overall tenor of our clients is more positive than it has been in some time. Sales volumes across most sectors appear to be increasing and there is a general sense of business as usual amongst our clients. Consumer spending appears to have been strong in the fourth quarter as evidenced by our indirect auto volume and commentary we've received from other retail clients.
There also appears to be a sign that capital spending and business investment are picking up. For those of you that were with us for our investor day, Berry Plastics announced an additional 336 jobs in Indiana and they also purchased a controlling interest in a Chinese plastics company.
The unemployment rate for Indiana dropped to 6.8%, which is the lowest amongst Midwestern states and Indiana added 42,600 new jobs in 2013. Overall I would suggest that there is a growing optimism amongst business and consumers as we head into 2014. But given the false starts that we have seen in the past, I’ll be interested to see if the first quarter data and sentiment reflects the continued momentum.
For Old National, like the wise sage Yogi Berra said it is déjà vu all over again. Our strategy will remain consistent with what we've been executing for some time now with three primary focuses: continuing to grow our core revenue; continuing to focus on expenses; and continue our ongoing efforts to transform our delivery system by improving its growth dynamics.
Let me briefly touch on each of these areas. With regard to core revenue, nothing dramatically new here in the banking area. Our focus will be to leverage the investments we’ve made into new markets and to continue to build upon the strong market share that we have in our legacy communities.
One area of continued challenge as Chris noted will be our service charge revenue. For our insurance group, we have made strategic investments in people, filling a much-needed void in global, along with strengthening certain product sets in key markets like Indianapolis and Evansville.
We’re also seeing the positive effects of our sales efforts and our referral programs, which along with a hardening renewal rates should allow us to see an increase in revenue from our insurance group. Our wealth business will continue to benefit from our new markets and a slight expansion of their sales force but this will be somewhat tempered by the soft start to 2014 from the equity markets.
Our investment group had a record year in 2013. While we would love to see growth continue at that same pace, we do not expect this to occur as an upward trend in interest rates may dampen this growth. On the expense side, this will continue to be a focus for us. We have currently over 20 projects in process as part of our culture of efficiency.
The target our board has set for management’s 2014 incentive is a fourth-quarter efficiency ratio of 64.5%. This does represent a slight decline from our fourth quarter incentive efficiency ratio of 63.9% in 2013 but it is important to note not included in that 63.9% was a negative impact of our Michigan branch purchase which we estimated approximately $2.3 million for the two quarters we owned them in 2013, nor does that number include the headwinds of declining accretion that Chris previously addressed in 2013.
In addition, as part of our normal course of operations, we will be making strategic investments in our technology infrastructure such as the new teller system and mobile banking, which will ultimately improve our efficiency but there is an upfront cost. I should note that our fourth-quarter 2014 target does not include the impact associated with Tower or UBMI or any other acquisitions we will announce this year.
Our efforts to transform our franchise will continue. This will include continue to review our current branches and markets to ensure that they are meeting our profit targets. Last year, this ongoing evaluation resulted in 22 branch closures along with the sale of 12 branches.
Mergers and acquisitions remains a core focus for Old National. With two partnerships currently in the pipeline, we could effectively execute additional partnerships this year but we will remain diligent in terms of the markets and the return to our shareholders.
Overall, much like our clients we are optimistic for 2014. We feel we have made credible progress in transforming our franchise which along with our ongoing focus on core revenue and expense management should lead to a continued positive trend and performance.
Let me close by quickly covering our most recent partnerships. With regard to our Northern Indiana and Michigan branch purchase, we continue to see positive results. Total loans doubled during the fourth quarter and our core deposits grew fourth quarter versus third quarter which we found very encouraging. But it will be sometime until they become a meaningful contributor to our bottom line.
As we previously discussed with Tower, we have lost some very talented people. But as I also said we put into place a plan that was designed to retain our clients and attract new team members and we remain very optimistic. While it’s early to date we have not had any meaningful attrition in commercial or mortgage clients. In a few days after those associates left, all commercial clients were divided up and a Tower associate made personal phone calls to each of them. The Tower board has also been incredibly supportive in committing to assist us in whatever we need with the team's efforts.
We've also been introducing Old National associates of those clients as needed. We're also very encouraged by the talent we are interviewing in the hiring process and we expect to have a new team in place very soon composed of associates from the local market.
United Bank announced their 2013 earnings of $8.8 million, which was slightly better than we had modeled. We held a full three days of introductory meeting shortly after announcement and on January 29 we kicked off the integration process with our 20 teams. We’re very encouraged by both the associate and the client reaction to our announcement.
Holly, at this time, we are now ready to take questions.
(Operator Instructions) And your first question will come from the line of Scott Siefers with Sandler O'Neill.
Scott Siefers - Sandler O'Neill
Bob, maybe first question is for you. You provided some good color there at the end just on the overall kind of top-level tenor and commentary from your customer base. I was hoping you maybe can get a little more specific with your thoughts on what that will mean for your guys' core loan growth in particular. I'm really just hoping you can help with sort of square the lower utilization, which I understand had some noise, the lower pipeline, with what seems to be a better -- I guess better outlook for your customer base broadly?
I think, Scott, I think as you look at the fourth-quarter pipeline, it is up over the fourth quarter of ‘12 and I would say that the trend -- those percentages are probably going to be fairly consistent in ’14. We don’t see robust growth, we see good solid growth much as we saw through ’13, may be slightly better. The pipeline is a good point to look at as well as those proposed are actually loans that we've approved and are moving forward that number was up in a nice way. So I think the bodes potentially well for the first quarter and beyond.
The line utilization – it’s an anomaly. We had three large credits that we hope will come back in, very very good clients. One is a educational institution. One sells sweets, I’ll leave at that. Then the other one is in the software technology business. So there's no consistency to the area, it’s just – they are seasonal in nature and we generally see a little bit of decrease in the fourth quarter. But our guys are active, the approval process is working very well and I think we are optimistic for growth in ’14.
Scott Siefers - Sandler O'Neill
And then Daryl had made a comment towards the end of his remarks about taking more measure risk, kind of more I guess -- I read it as more deliberately more intentionally. And kind of any change in the risk appetite or how you guys are thinking about things?
I mean we are who we are. Our clients know it, our folks know it. I think what we’ve really developed over the last few years is a wonderful spirit of cooperation between our origination group and our credit group. And I think what we are seeing as looking at presenting better options to our clients rather than just yes or no. Daryl and his team are working very hard to give us better options. And I think as Daryl and his approval folks are able to get out in the market more now, they are able to help us on joint calls and help us with structure issues that, with all the workouts we’ve had in the past, we probably haven't had so.
But Daryl and I aren’t going to change our stripes overnight and getting Daryl to even say measured risk was a bit of a push for us but – guys, we are who we are and we are proud of our track record and we’re not going to change our stripes.
Scott Siefers - Sandler O'Neill
And then maybe just one final one on the service charge pressure you guys had noted. Of course, that's kind of an industry issue, but I just was curious for any more color you might have on what you guys are seeing, how you're responding, et cetera.
Well the responses, as you know we did increase our fees here a couple quarters ago. And I think you saw the benefit of that. We’re seeing presentments down on the overdraft side which is really a reflection of the economy and I think the education that the industry and banks have done in helping people understand the charges that they incur. So I actually -- while it is a negative to us in terms of earnings, I think it’s another reflection of the positive trends in the economy where you are seeing people not having overdrawn, people getting better educated. So and that’s really where the big pressure is coming right now.
Your next question will come from the line of Emlen Harmon with Jefferies.
Emlen Harmon - Jefferies
A question on the expense outflow kind of the efficiency ratio target that you're giving. How much of reaching that target is a function of just improving the revenue in the Southwest Michigan and Northern Indiana acquired branches and how much is just kind of more general expense stuff across the landscape if you will?
It’s a great question. I think a couple points. What the incentive target is -- may not necessarily reflect what we might have in our budget, and I’ll just leave at that. But for us it is really all about expenses. As we talk to our board we do not go in and say we’re going to grow revenue at X or many of you heard I call that if, it comes it’s great; if it didn’t come, I don’t want to – so it is really about reducing our costs and as I said we’ve got over 20 projects. We will continue to benefit from those projects and there is an ongoing commitment. It goes all back, Emlen, to this culture we are trying to create, which is – it’s not a one-time event, it is for us an ongoing way to look at the way we spend our money.
Emlen, this is Chris. I might just add to that -- that 64.5 does an awful lot for my ability to keep our business line managers and staff people focused on just what Bob said productivity improvements, rationalizing every expense, thinking about the benefits and costs associated with each increase in FTE. So it’s a very important element of our monthly scorecard discussion. So we saw a real impact from that I think in 2013 and it was our decision that that was important point to continue to reinforce in 2014.So I think just like Bob said, everybody takes it in the spirit that it’s delivered. It’s just important way for us to keep focused on, on expense improvements.
Emlen Harmon - Jefferies
I mean is there anything -- when you guys think about, again, the Southwest Michigan and the Northern Indiana branches, anything within those that would make you think you couldn't get to a kind of efficiency ratio that the rest of the bank has reached over time?
No, no at all. In fact, I would tell you just the opposite. I would tell you that economy up there – if you didn’t see there was a great article about Grand Rapids in over the weekend in the New York Times. And the economy is strong. We’ve got very very good people. It’s just to build that loan portfolio and match those deposit is going to take some time. Obviously they are going to benefit from the UBMI acquisition as we get more name recognition in those markets. But I couldn’t be more happy with the team we’ve got up in there and then the receptivity in the market. But to do it in our measured credit manner it’s going to take us little bit of time but it will be profitable for time and for a long time versus just short time.
Your next question will come from the line of Chris McGratty with KBW.
Chris McGratty - KBW
Bob, on the utilization comments, you cited one specific market that was softer, but you didn't -- maybe I missed it. You didn't specify which market it was. Could you provide that?
It’s our Evansville market, Southwest Indiana and all three of the large folks we talked about are all based here in Evansville and it’s just -- nothing reflective of the economy, it’s just – we’ve got an education facility, a candy manufacturer and a software company and it is what it is.
Chris McGratty - KBW
Now for 2014, on an organic basis, should we expect the loan growth to be driven by the consumer and the residential book, or can the commercial grow at similar rates?
I think the commercial can. I would tell you that I think I believe that consumer – again you are seeing a little more optimism, you are seeing a little more indirect. You are going to see less in the mortgage side clearly but we feel relatively optimistic on the commercial side with the team we’ve got in place and the markets we see and the activity we’re seeing.
Chris McGratty - KBW
Just a quick one on the buyback. You bought more stock in the fourth quarter. Was that a function of just two pending deals or how should we think about your actual ability to buy stock in 2014?
No. In fact, Chris, I think we had that kind of in place obviously with the $2 million share buyback. We look at that really independently of our acquisition outlook although it has a bearing of course. But when you're only paying out 40 percentages of earnings and organic growth was measured, we just had that opportunity and we felt like it was an important opportunity to materialize. And as we talked about in other calls we’ve got cash components too for our pending acquisition. It’s just a way to get our common equity about where we think it should be. So nothing special, just kind of part of the overall day-in and day-out discussion about capital utilization.
I would just add to that. Chris, I think it reflects our board's commitment to returning to the shareholder because obviously they are very engaged in the process and as we saw the opportunity we felt it made a lot of sense to return some value back to the shareholders.
Chris McGratty - KBW
So we should -- you would direct the sell side to potentially put the buyback in our 2014 estimates?
Hard to say. We still got the closings for the transactions. It’s going to be tough. Probably not at this juncture, I wouldn’t model it as opportunistic, it would be nice surprise if we do but I think at this stage with two pending acquisitions and what we see in the pipeline in terms of other opportunities and the fact we increased the dividend, I think are all points our board will look at – and if the economy comes back even quicker than we expect, then earnings are a little better, then that might change.
Chris McGratty - KBW
Last one. I just want to make sure I heard you. Chris, on your 64.5%, I think you said something about a 64.5% efficiency ratio. Did I miss a target for 2014, or is that kind of where the incentives will be?
That is for 2014 target for incentive purposes for the fourth quarter.
Chris McGratty - KBW
So 64.5% by Q4 2014 and then what adjustments besides merger-related costs should I be -- will you guys be making?
And your next question will come from the line of Taylor Brodarick with Guggenheim Securities.
Taylor Brodarick - Guggenheim Securities
I guess just one question on the technology investment. Any kind of quantitative targets on what that would reduce on the expense side? And do you think that would lead to any revenue synergies, any type of I guess gathering more revenue through a more dynamic tech platform?
I don’t see it on the revenue side as much as I really see the opportunity to reduce cost because our current teller system may have been designed in the late 1800s. In all honesty, it is a very old system, it is cumbersome to use and the early returns were actually just last week at our first pilot branch that is up and running and it’s gone so well that we are going to accelerate the rollout. Where we will get benefit will be in those areas in the cost – really too early to give you any indication on what that will impact.
But as we get further rollout and we get a better sense of where we can eliminate work steps in that, we will let you know.
Your next question comes from the line of Jon Arfstrom with RBC Capital Markets.
Jon Arfstrom - RBC Capital Markets
Just maybe a question for Daryl or Chris on the provision. What are you guys thinking on the provision for 2014? When I look at the quarter, it looks like maybe it was driven more by charge-offs than anything else, and overall credit continues to get better. So my assumption is just maybe provision that matches growth and that's about it? Is it a fair way to look at it?
Jon, I would say provision that matches growth and net losses, I think you can generally target in that area for 2014.
Jon Arfstrom - RBC Capital Markets
And then just a smaller question maybe for you, Bob, on your antiquated teller system comment, did you hit your goal of rolling out mobile banking in January? And if so, how has it gone so far?
I like smaller questions associated with me, Jon, small anything with me is good. We actually did hit our mobile banking goal. It works very well. My wife actually deposited two checks. My wife still uses a pocket calendar that is handwritten so that tells you that if my wife can do it anybody can do it. It’s been very well received and I think again there is an opportunity for us to improve the efficiencies in the backroom.
Jon Arfstrom - RBC Capital Markets
For what it's worth, Bob, my parents still use the drive-through for the dog biscuits.
We like that. It’s okay – if you come through Jon, we will give you a soccer.
Your next question comes from the line of Peyton Green with Sterne Agee.
Peyton Green - Sterne Agee
Just a question on the efficiency outlook. I mean certainly progress has been made over the last four or five years. I was just wondering maybe, Bob, if you could give some color as to -- are we at a point where it shifts from being so expense focused to one where really it's thinking about it in the context of $2 of revenue for every $1 of expense, or what’s your thought there? Maybe just give us some kind of context.
It’s a great question, Peyton. I would tell you I don't think we are there yet. I think we still believe we've got areas of redundancy that if we can eliminate will improve the client experience as well as our associate experience. And that really is around cost. So I don't think we’re at a point where we can do hi5s in the end zone but we’re going to continue to focus on costs and I think eventually you will get to a point in normalcy if that’s the right word where – but we've always said we’re not a sub-60 but we would like to be closer to 60 and I think we are getting there. And I think the way we get there is to continue to focus on cost, and anything that comes on the top line is just pure gravy.
Peyton Green - Sterne Agee
And then second question would be, I mean, the charge-off rate certainly is extraordinary and has been quite strong for an extended period of time. How should we think of just a general reserve or provision expense per unit of loan growth going forward? I mean any measure of potential charge-offs would still seem to be a lower reserve than where you ended the year. Is that a fair way to think about it?
Yes, I think so but I think even Daryl would acknowledge that 10 basis points is just not something that either we’re going to target or that we can potentially see year-over-year at that level. There is – we’ve acquired portfolios and if those loans move into core, there -- I would go back over history, we’ve traditionally been somewhere in that 20 to 35 basis points charge-offs, maybe somewhere in there for your modelling. But I just don't believe the 10 basis points is -- we can get there but I am not sure that’s what we want.
It’s interesting because we talked to our credit management the other day and we all agreed that long term 10 basis point is probably not the right thing for this company. And we have to tweak and – that’s to my point, my comments earlier we are going to have to tweak what we’re doing to take on a bit of incremental well-planned risk to drive additional revenue that makes sense and that will of course have incremental increases in the charge-off rates. But I don’t think there is anybody sitting around this table that has aspirations to be 10 basis points for the balance of the history for this company.
I believe we will still be under peer numbers but I think that’s just our credit culture.
Peyton Green - Sterne Agee
And then maybe Chris addressed this and I missed it. But of the BSA/AML costs, I guess it was $5 million, almost $6 million over the term.
Peyton Green - Sterne Agee
How much would you expect to see the ‘14 expense rate drop versus the ‘13 just on a marginal basis?
The ‘13 number feels like something we are going to see here for the next couple years as we work through the depreciation of the investments. So I think the $2 million we talked about in 2013 is a fair number for 2014 as well.
Peyton Green - Sterne Agee
So just all assuming they drop year over year --
Given the increased pressure and the focus on the regulators on BSA/AML, I think if I dropped my cost there, my EIC would be in my office fairly quickly. It continues to be a very very big focus for the regulators.
At this time there are no further questions.
Great. I think everybody knows the spiel at the end. If you have any further questions, let Lynell know. As always, we appreciate everybody’s interest and we look forward to seeing everybody as we get and hit the conference and NDR circuit. So thank you very much .i
This concludes Old National’s call. Once again 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 by dialing 1-855-859-2056, conference ID code 34095437. This replay will be available through February 17. If anyone has any additional questions, please contact Lynell Walton at 812-464-1366. Thank you for your participation in today’s conference call.
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