DBRS Comments on Q4 Earnings of Old National Bancorp – Senior at BBB (high)

DBRS today commented on the Q4 2008 earnings of Old National Bancorp (Old National or the Company). Even with higher credit costs and a $6.3 million check fraud loss, Old National reported net income of $6.6 million for the quarter. While the results were down from $17.0 million for the prior quarter and $22.0 million for Q4 2007, DBRS views the results and current credit fundamentals as in line for its ratings – BBB (high) for Issuer & Senior Debt – and Stable trend. On a sequential quarterly basis, a 148.7% increase in the provision for loan losses and lower non-interest income, primarily from weaker Company-owned life insurance revenues, more than offset net interest margin expansion of 17 basis points and solid deposit growth, resulting in a return on assets of 0.35%.

Non-performing assets (NPAs) were down at 1.46% of loans versus 1.57% at September 30, 2008, yet up from 0.96% at December 31, 2007. Even though NPAs were down compared to Q3 2008, problem and special mention loans increased significantly, which indicates more potential future problems. As a result, Old National dramatically increased its loan loss provision to $17 million from $6.8 million. Given the deteriorating environment, the Company expects provisions to be in the $40 million to $60 million range in 2009. Meanwhile, net charge-offs (NCOs) increased materially to 1.14% of average loans from 0.46% for the prior quarter and 0.79% for Q4 2007. NCOs increased in the commercial, commercial real estate and retail lending portfolios as the economic deterioration became more broad-based. DBRS notes that Q4 2008 NCOs included $3.2 million in exposure that was affected by loan officer misconduct (as discussed in prior DBRS quarterly comments). DBRS views the Company’s level of loan loss reserves to be sufficient to cover the current pace of losses. DBRS believes that further erosion in Old National’s asset quality is likely, given the continuing turmoil in the housing sector and a deteriorating economy. DBRS comments that Old National’s earnings are likely to be constrained by these economic factors for the next several quarters.

Deterioration in the securities portfolio has the potential to lead to other-than-temporarily impaired charges. Most worrisome is the Company’s portfolio of pooled trust preferred securities and a recently downgraded non-agency CMO. At the end of the fourth quarter, the $28.6 million pooled trust preferred portfolio had a market value of $19.7 million.

Positively, the Company’s NIM widened to 3.96% from 3.79% at Q3 2008, as funding costs dropped considerably more than asset yields. Old National also benefited from solid deposit growth and more rational loan pricing. Unlike most banks that have grown deposits through CDs, the Company managed to grow both non-interest bearing and NOW accounts by over 5% each during the fourth quarter. In November 2008, Old National announced its intent to acquire 65 branches in Indiana from Citizens Financial Group. The transaction is expected to be integrated in late March 2009 and will further benefit deposit funding.

In light of the $100 million preferred shares investment by the U.S. Treasury, DBRS notes that holding company liquidity and regulatory capital ratios have been enhanced. The investment also provides an additional capital cushion to absorb future credit costs and allows the Company to continue to lend in this difficult environment. The preferred dividend payments will cost $5 million a year after-tax. DBRS notes that the tangible common equity to tangible assets remains in the Company’s target range of 6% to 7%, at 6.51% at the end of the quarter.

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

The applicable methodology is Rating Banks and Bank Holding Companies Operating in the United States, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.