DBRS Confirms Old National Bancorp at BBB (high); Maintains Stable Trend and Withdraws Ratings

DBRS, Inc. (DBRS) has today confirmed the ratings of Old National Bancorp (Old National or the Company), including its Issuer & Senior Debt rating of BBB (high). At the same time, DBRS maintained the Stable trend on all ratings. Subsequent to the confirmation, DBRS withdrew the ratings of Old National. The decision to withdraw the ratings was made at DBRS’s discretion.

The confirmation and Stable trend reflect Old National’s deeply rooted banking franchise and sound balance sheet underpinned by its strong capital and liquidity profile. Ratings also consider the Company’s resilient, yet pressured earnings capacity and its geographic footprint that extends mostly through slower growth rural markets in Indiana, southern Illinois, southern Michigan, and Kentucky. Nonetheless, DBRS views positively, the Company’s continuing expansion into contiguous higher growth markets. In line with this strategy, on September 10, 2013, the Company announced its intent to acquire Tower Financial Corporation (Tower); a Fort Wayne, Indiana based community bank with seven banking centers and approximately $681 million of assets, including $439 million of loans. DBRS considers Tower to be a good strategic fit for the Company, given its similar business mix, customer composition, and organizational culture. Although there is execution and integration risk associated with the transaction, this risk is mitigated by Old National’s history of successfully integrating numerous acquisitions.

Old National’s earnings remain resilient, yet strained by a high expense base and pressured loan growth. On a QoQ basis, 3Q13 earnings declined 16.1% to $23.9 million, reflecting an 11.3% increase in non-interest expense and relatively flat revenue. Higher QoQ expenses were in part driven by multiple non-core items, including branch closure charges, merger costs and a contribution to the Old National Foundation. Excluding these items and non-core items from the prior quarter, adjusted non-interest expenses (DBRS calculated) were up approximately 5.0% sequentially, reflecting the additional operating costs associated with the Company’s 3Q13 acquisition of 24 branches in northern Indiana and southern Michigan. In addition, the Company’s high expense base also reflects its BSA/AML enhancement along with a lower degree of economies of scale driven by its rural footprint. That said, the Company has multiple efficiency initiatives in place, including branch consolidations. In part due to pressured revenue, the Company’s calculated efficiency ratio was a high 72.9% for 3Q13, or 69.1% on an adjusted basis.

Positively, the Company’s net interest income continues to benefit from a significant level of accretion related to its recent acquisitions. Indeed, in 3Q13, acquisition related accretion accounted for 63 bps of Old National’s high net interest margin of 3.96% (FTE basis). However, average earning assets declined 1.16% during the quarter, mostly reflecting a 3.0% decline in average securities and a 0.1% decrease in average loans. The slight decline in average loans was attributable to loan sales, and decreases in the acquired Integra Bank and Indiana Community Bancorp loan portfolios, reflecting the continuing workout of impaired loans. Importantly, and mostly offsetting these declines, average core loans continued to grow, and were up 1.3% QoQ.

Despite being impacted by lower levels of wealth management fees and mortgage banking income, Old National’s non-interest income improved during 3Q13, in part, reflecting revenue contribution from its 3Q13 branch acquisition. Positively, the Company’s fee income component as a percent of total revenues remains above the peer median, and provides diversity and stability to earnings.

Asset quality continues to improve, reflecting low loss rates and contracting levels of non-performing assets. Specifically, net charge-offs (excluding residential loans held for sale and covered assets) increased slightly to a still very low 0.03% of average loans for 3Q13, from 0.01% for 2Q13. Meanwhile, under-performing assets (excluding residential loans held for sale and covered assets) continued to contract and represented a manageable 2.74% of loans and OREO at September 30, 2013, down from 3.02%, at June 30, 2013. Although adequate at current loss rates, Old National’s loan loss reserves represented a relatively low 35% of nonperforming loans (excluding Integra covered loans) at the end of 3Q13. DBRS notes that credit marks taken on the Company’s recent acquisitions somewhat offset the modest coverage.

The Company’s funding and liquidity profile remain strong. Indeed, core deposits easily fund the loan portfolio at 127% of net loans (DBRS calculated at June 30, 2013). Meanwhile, a sizable securities portfolio, that represents 33% of total assets, and access to the FHLB and Federal Reserve discount window round out its liquidity profile. DBRS notes that the Company’s securities portfolio consists mostly of good quality agency mortgage-backed securities, and municipal securities.

A strong capital position provides solid loss absorption capacity and opportunity for growth, either through organic means or acquisition. Despite the repurchase of 750,000 shares of common stock in 2013, Old National maintains a high tangible common equity ratio of 8.41% (as of September 30, 2013), a Tier I capital ratio of 14.22% and a Total capital ratio of 15.10%. DBRS notes that capital will moderately contract after the Tower acquisition closes (in 1Q14), with an estimated tangible common equity ratio of 8.07%, a Tier 1 capital ratio of 13.30% and a total capital ratio of 14.20%.

Old National, a financial holding company headquartered in Evansville, Indiana, had $9.6 billion in assets at September 30, 2013.

Notes:
All figures are in U.S. Dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies include the DBRS Criteria: Intrinsic and Support Assessments and DBRS Criteria: Rating Bank Subordinated Debt & Hybrid Instruments with Discretionary Payments. These can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include company documents, the Federal Reserve, the Federal Deposit Insurance Corporation and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

[Amended on August 27, 2014, to reflect actual methodologies used]

Lead Analyst: Mark Nolan
Rating Committee Chair: William Schwartz
Initial Rating Date: 3 October 2005
Most Recent Rating Update: 12 October 2013

For additional information on this rating, please refer to the linking document under Related Research.