UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2003
Commission File Number 1-15817
OLD NATIONAL BANCORP
(Exact name of the Registrant as specified in its charter)
INDIANA 35-1539838
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
420 Main Street
Evansville, Indiana 47708
(Address of principal executive offices) (Zip Code)
(812) 464-1434
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act
Title of Each Class Name of each exchange on which registered
Common Stock, No Par Value New York Stock Exchange
Preferred Stock Purchase Rights
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of the Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Act). Yes [X] No [ ]
The aggregate market value of the Registrant's voting common stock held by
non-affiliates on June 30, 2003, was $1,460,687,361 (based on the closing price
on that date of $21.90, as quoted on the New York Stock Exchange). In
calculating the market value of securities by non-affiliates of the Registrant,
the Registrant has treated as securities held by affiliates as of June 30, 2003,
voting stock owned of record by its directors and principal executive officers,
and voting stock held by the Registrant's trust department in a fiduciary
capacity.
The number of shares outstanding of the Registrant's classes of common stock, as
of January 31, 2004, was 66,226,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Shareholders to be
held April 29, 2004, is incorporated by reference into Part III of this Form
10-K.
OLD NATIONAL BANCORP
2003 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I PAGE
Item 1. Business 3
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Item 2. Properties 10
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Item 3. Legal Proceedings 10
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Item 4. Submission of Matters to a Vote of Security Holders 10
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PART II
Item 5. Market for The Registrant's Common Equity and Related Stockholder Matters 10
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Item 6. Selected Financial Data 11
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk 29
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Item 8. Financial Statements and Supplementary Data 32
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 64
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Item 9A. Controls and Procedures 64
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PART III
Item 10. Directors and Executive Officers of the Registrant 65
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Item 11. Executive Compensation 65
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Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
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Matters 66
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Item 13. Certain Relationships and Related Transactions 66
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Item 14. Principal Accountant Fees and Services 66
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PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 67
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SIGNATURES 69
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2
OLD NATIONAL BANCORP
2003 ANNUAL REPORT ON FORM 10-K
PART I
ITEM 1. BUSINESS
GENERAL
Old National Bancorp ("Old National") is a financial holding company
incorporated in the State of Indiana and maintains its principal executive
office in Evansville, Indiana. Old National, through its wholly-owned banking
subsidiary, provides a wide range of services, including commercial and consumer
banking, depository services, lease financing and other traditional banking
services. Through its non-bank affiliates, Old National provides services to
supplement the banking business including fiduciary and trust services,
investment and brokerage services, asset management, insurance and other
financial services. As of December 31, 2003, Old National employed 3,019
full-time equivalent employees.
COMPANY PROFILE
Old National Bank, Old National Bancorp's wholly-owned banking subsidiary, was
founded in 1834 and is the oldest company in Evansville, Indiana. In 1982, Old
National Bancorp was formed and in 2001 became a financial holding company. Also
in 2001, Old National completed the consolidation of 21 bank charters enabling
Old National to operate under a common name with consistent product offerings
throughout the banking locations, improving back-office efficiency and allowing
Old National to provide more convenient service to customers. Over the past
several years, Old National has grown to include financial services operations
in Indiana, Illinois, Ohio, Kentucky, Tennessee and Missouri.
In 2002, Old National identified four components of growth essential to the
achievement of the company's long-term earnings and financial performance
objectives:
o In Old National's traditional banking markets, growth strategies will be
focused on adding products and services. Old National's operations in these
communities continue to account for a high percentage of the company's
revenue and the growth of revenue from these slower growth markets will
come primarily from providing additional services to current customers.
o Old National Signature Group is responsible for fee-based services such as
insurance, investment, trust, asset management, financial planning and
similar non-traditional banking services. It is anticipated that these
units will generate revenue growth at rates exceeding Old National's
traditional banking products.
o Mortgage lending is a traditional offering at Old National banking centers.
By aligning these mortgage initiatives more closely and focusing a
management team on them, Old National has improved efficiencies, added new
products and increased revenue. In addition, Old National plans to use
stand-alone mortgage offices to help gain entry into new markets.
o Old National is continuing to add to its presence in Indianapolis,
Louisville and St. Louis, where it anticipates opportunities to attract
high-value clients to Old National's strong service emphasis.
During the third quarter of 2003, Old National determined that it must intensify
its efforts to improve lending administration and overall operating efficiency
in order to improve its overall financial performance. Old National has
identified the following initiatives as having very high priority:
o Improving credit quality approval processes and disciplines and the
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reduction of non-performing loans in the portfolio
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Lending operations have been reorganized to realign the traditional
relationship management and credit analysis functions. Local lending and
customer relationship officers will still have primary responsibility for
business development and loan approval, but credit analysts independent of
local bank management will work with lenders on credit approvals. This
formalized process will ensure consistency in underwriting criteria across
the organization, while maintaining a strong commitment to being responsive
to customer needs. In addition to these efforts aimed at improving the
quality of new loans, additional staff and resources have been assigned to
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manage the problem loan portfolio. These efforts include intensified
work-out and restructuring efforts with borrowers, negotiations with
borrowers to move the credit relationship to other lenders, and the
consideration of the sale of pools of problem loans.
o Improving efficiencies and optimizing profit in all aspects of the
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operation through an intense company-wide review of revenue and expense
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opportunities
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Old National retained the services of EHS Partners, LLC to assist in this
project. EHS has worked with a wide range of financial institutions similar
to Old National that have experienced growth through acquisitions and
product expansion and had a desire to conduct a similar company-wide
operations review. The project, referred to as "Ascend," involves two
phases. The first phase is an intensive idea generation and evaluation
process which is expected to be completed in early April 2004. The
implementation of profit improvement strategies is expected to begin during
the second quarter of 2004 and to be fully implemented by the end of 2005.
ACQUISITION STRATEGY
Since the formation of Old National Bancorp in 1982, Old National has acquired
more than 40 financial institutions and financial services companies. As a part
of Old National's four component strategy as previously described, Old National
has acquired several financial services companies primarily to grow the non-bank
services segment and to achieve a presence in various targeted metro markets:
o Insurance and Risk Management based in Fort Wayne, Indiana, acquired in
August 2003, is an insurance agency that offers products including
commercial and personal property and casualty insurance, employee benefits
insurance and third party administrator services.
o Graham and Peat Insurance Agency based in St. Louis, Missouri, acquired in
June 2003, is an insurance agency that offers property and casualty and
life insurance.
o James L. Will Insurance Agency, Inc., based in Evansville, Indiana,
acquired in May 2003, is an insurance agency focused on commercial property
and casualty as well as personal lines of insurance.
o Terrill Group, Inc., based in St. Louis, Missouri, acquired in December
2002, is an insurance agency that offers property and casualty, health,
life, disability and accident insurance.
o Fund Evaluation Group, Inc., acquired July 2002, is an investment and
consulting firm based in Cincinnati, Ohio, that provides investment
consulting and performance management services to a wide range of
institutional clients.
In the future, Old National will continue to pursue opportunities to acquire
both financial institutions and financial services companies, focusing on the
following primary objectives:
o Acquire financial institutions in the Midwestern and South-central regions
of the United States, generally with assets in the range of $200 million to
$3 billion.
o Acquire financial services companies located in, but not limited to, the
same geographic markets that provide products and services consistent with
and complementary to those products and services offered by Old National
Signature Group.
As with previous acquisitions, the consideration paid by Old National will be in
the form of cash, debt or Old National Bancorp stock. The amount and structure
of such consideration is based on reasonable growth and cost savings assumptions
and a thorough analysis of the impact on both long and short term financial
results.
OPERATING SEGMENTS
Old National has been divided into three operating segments: community banking,
non-bank services and treasury. A description of each segment is described
below.
Community Banking Segment
The community banking segment, operating under the name of Old National Bank,
has traditionally been the most significant contributor to Old National,
historically representing approximately 80% of consolidated net income. The
primary goal of the community banking segment is to provide products and
services that address the client's needs and help clients reach their financial
goals by providing quality services at prices that are fair. Old National's
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banking centers focus on convenience factors such as location, adequate space
for private consultations, quick client access to routine transactions and good
parking.
As of December 31, 2003, Old National's affiliate bank operated over 120 banking
centers in Indiana, Illinois, Kentucky, Tennessee and a limited area in Ohio.
The community banking segment primarily consists of lending and depository
activities, but also includes services such as merchant services, cash
management services, payroll services, Internet banking and services relating to
the general banking business. In addition, the community banking segment
includes the Indiana Old National Insurance Company ("IONIC") and Central Life
Insurance Company, which reinsure credit life insurance. IONIC also provides
captive property and casualty insurance for Old National and reinsures most of
the coverage with non-affiliated carriers.
Lending Activities
Old National earns interest income on loans as well as fee income from the
origination of loans. Lending activities include loans to individuals, which
primarily consist of home equity lines of credit, residential real estate loans
and consumer loans, and loans to small business and commercial customers, which
include commercial loans, commercial real estate, letters of credit and lease
financing. Typically, fixed-rate residential real estate loans are sold to
secondary investors with servicing rights retained by Old National, with gains
or losses from the sales being recognized, while adjustable-rate loans are held
in the portfolio.
Depository Activities
Old National strives to provide depository services to individuals and
commercial customers that fit their needs at competitive rates. Old National
pays interest on the interest-bearing deposits and receives service fee revenue
on various accounts. The transaction accounts include products such as
noninterest-bearing demand, NOW, savings and money market, and time deposits.
Debit and ATM cards provide access to the customer's accounts 24 hours a day at
any ATM location. Old National also provides 24-hour telephone access as well as
other electronic banking services.
Non-bank Services Segment
The non-bank services segment provides a variety of financial services including
investment advisory and trust services, investment and brokerage services, asset
management consulting services and insurance agency services. Old National has
identified the non-bank services segment as an important growth opportunity.
This accelerates Old National's transition to a financial services company with
broader client relationships and less dependence on interest rate conditions.
The non-bank services, especially those geared toward high net worth clients,
help open new markets for Old National. Old National's non-bank services segment
operates in the same geographical markets as the community banking segment and
through acquisitions has broadened its scope to include Missouri and expanded
its area in Ohio.
Investment Advisory and Trust Services
Fiduciary and trust services are offered through an affiliate trust company
under the business name of Old National Trust Company. Signal Capital
Management, Inc., an affiliate of Old National Trust Company, provides fee-based
asset management and manages and sells mutual funds.
Investment and Brokerage Services
ONB Investments Services, Inc., a registered broker-dealer, operates as a
subsidiary of Old National Bank in order to provide bank customers with
convenient and professional investment services and a variety of brokerage
products. ONB Investment Services, Inc. offers a full-array of investment
options and investment advice to bank customers and members of the general
public.
Asset Management Consulting Services
Fund Evaluation Group, Inc. specializes in portfolio structure, investment
management research and performance reporting, providing asset management
consulting services to its investment customers.
Insurance Agency Services
Through its insurance agency subsidiaries, Old National offers full service
insurance brokerage services including commercial property and casualty, surety
loss control services, employee benefits consulting and administration, and
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personal insurance. These subsidiaries are insurance agencies that offer
products that are issued and underwritten by various insurance companies not
affiliated with Old National.
Treasury Segment
Treasury manages investments, wholesale funding, interest rate risk, liquidity
and leverage for Old National. Additionally, treasury provides other
miscellaneous capital markets products for Old National's corporate banking
customers.
Additional information about Old National's business segments is included in
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and Note 21 to the consolidated financial statements.
MARKET AREA
Old National operates primarily in the state of Indiana, with limited presence
in the northern part of the state. Old National is also located in the eastern
and southeastern regions of Illinois and central and western regions of Kentucky
and has a strong presence in Clarksville, Tennessee. These markets include a
number of densely populated areas as well as rural areas in which Old National
has achieved the first or second ranking in deposit share. The income classes
include some high-income areas as well as many middle-income and some
low-to-moderate income areas. In addition, through acquisitions, the market area
has expanded to include insurance agency operations based in St. Louis,
Missouri, and asset management consulting based in Cincinnati, Ohio. Old
National continues to add to its metropolitan strategy in order to increase its
presence within targeted cities including Indianapolis, Indiana; Louisville,
Kentucky; and St. Louis, Missouri. Old National is considering expansion into
additional larger metropolitan markets within a 250-mile radius of Old
National's Evansville, Indiana, headquarters.
Indiana, Old National's primary state of operations, has faced several long-term
challenges to its future growth and has been among the national leaders in job
losses over the past few years. According to a report issued by the U.S.
Conference of Mayors in coordination with the Indiana Association of Cities and
Towns, Indiana is the most highly industrialized state in the nation. Indiana
relies on manufacturing for 20.2% of jobs and 27.2% of Gross State Product as of
May 2003. This almost doubles the U.S. average dependence on manufacturing for
jobs and Gross State Product. The manufacturing industry has been one of the
most affected by the economic downturn experienced by the nation.
The following table reflects Old National's market share for significant markets
with most recent data available.
Old National Deposit Market Share and Number of Branch Locations
Deposits as of June 30, 2003
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Number of Deposit Market
Market Location Branches Share Rank
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Evansville, Indiana 15 1st
Clarksville, Tennessee 4 1st
Muncie, Indiana 8 2nd
Bloomington, Indiana 5 3rd
Terre Haute, Indiana 8 2nd
Danville, Illinois 4 1st
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Source: SNL Financial
COMPETITION
The banking industry and related financial service providers operate in a highly
competitive market. Within its six-state geography, Old National competes with
financial services providers such as local, regional and national banking
institutions, savings and loan associations, credit unions, thrifts, finance
companies and mortgage banking companies. In addition, Old National's non-bank
services segment faces competition with investment brokers, asset managers and
advisory services, money market and mutual fund companies and insurance
agencies.
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SUPERVISION AND REGULATION
Old National is registered as a bank holding company and has elected to be a
financial holding company. It is subject to the supervision of, and regulation
by, the Board of Governors of the Federal Reserve System ("Federal Reserve")
under the Bank Holding Company Act of 1956, as amended ("BHC Act"). The Federal
Reserve has issued regulations under the BHC Act requiring a bank holding
company to serve as a source of financial and managerial strength to its
subsidiary banks. It is the policy of the Federal Reserve that, pursuant to this
requirement, a bank holding company should stand ready to use its resources to
provide adequate capital funds to its subsidiary banks during periods of
financial stress or adversity.
The BHC Act requires the prior approval of the Federal Reserve to acquire more
than a 5% voting interest of any bank or bank holding company. Additionally, the
BHC Act restricts Old National's non-banking activities to those which are
determined by the Federal Reserve to be closely related to banking and a proper
incident thereto.
On July 30, 2002, the Senate and the House of Representatives of the United
States (Congress) enacted the Sarbanes-Oxley Act of 2002, a law that addresses,
among other issues, corporate governance, auditing and accounting, executive
compensation, and enhanced and timely disclosures of corporate information. The
New York Stock Exchange has also proposed corporate governance rules that were
presented to the Securities and Exchange Commission for review and approval. The
proposed changes are intended to allow stockholders to more easily and
efficiently monitor the performance of companies and directors.
Effective August 29, 2002, as directed by Section 302(a) of the Sarbanes-Oxley
Act, Old National's principal executive officer and principal financial officer
are required to certify that Old National's quarterly and annual reports do not
contain any untrue statements of a material fact. The rules also require that
these officers certify that they are responsible for establishing, maintaining
and regularly evaluating the effectiveness of Old National's internal controls;
they have made certain disclosures to auditors and the Audit Committee of the
Board of Directors about internal controls; and they have included information
in Old National's quarterly and annual reports about their evaluation and
whether there have been significant changes in Old National's internal controls
or in other factors that could significantly affect internal controls subject to
the evaluation.
On January 23, 2003, the Board of Directors of Old National Bancorp approved
various corporate governance matters to strengthen and improve its already
strong corporate governance practices. The Board adopted a Corporate Governance
and Nominating Committee Charter, amended the Audit Committee Charter and
adopted a Compensation Committee Charter. In addition, the Board of Directors
approved Corporate Governance Guidelines, a Code of Business Conduct and Ethics
which applies to all officers and employees as well as Directors of the
Corporation, and a Senior Financial and Executive Officer Code of Ethics. These
documents are available for review under the Corporate Governance link on Old
National's website at www.oldnational.com.
On October 26, 2001, the USA Patriot Act of 2001 was signed into law. Enacted in
response to the terrorist attacks in New York, Pennsylvania, and Washington,
D.C. on September 11, 2001, the Patriot Act is intended to strengthen U.S. law
enforcement's and the intelligence community's ability to work cohesively to
combat terrorism on a variety of fronts. The potential impact of the Patriot Act
on financial institutions of all kinds is significant and wide-ranging. The
Patriot Act contains sweeping anti-money laundering and financial transparency
laws and requires various regulations, including: (a) due diligence requirements
for financial institutions that administer, maintain, or manage private banks
accounts or correspondent accounts for non-U.S. persons; (b) standards for
verifying customer identification at account opening; (c) rules to promote
cooperation among financial institutions, regulators and law enforcement
entities in identifying parties that may be involved in terrorism or money
laundering; (d) reports by non-financial trades and business filed with the
Treasury Department's Financial Crimes Enforcement Network for transactions
exceeding $10,000; and (e) filing of suspicious activities reports by brokers
and dealers if they believe a customer may be violating U.S. laws and
regulations.
Under the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), a bank holding company is required to guarantee the compliance of
any insured depository institution subsidiary that may become "undercapitalized"
(as defined in FDICIA) with the terms of any capital restoration plan filed by
such subsidiary with its appropriate federal bank regulatory agency.
Bank holding companies are required to comply with the Federal Reserve's
risk-based capital guidelines. The Federal Deposit Insurance Corporation
("FDIC") and the Office of the Comptroller of the Currency ("OCC") have adopted
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risk-based capital ratio guidelines to which depository institutions under their
respective supervision are subject. The guidelines establish a systematic
analytical framework that makes regulatory capital requirements more sensitive
to differences in risk profiles among banking organizations. Risk-based capital
ratios are determined by allocating assets and specified off-balance sheet
commitments to four risk-weighted categories, with higher levels of capital
being required for the categories perceived as representing greater risk. Old
National's affiliate bank met all risk-based capital requirements of the FDIC
and OCC as of December 31, 2003. For Old National's regulatory capital ratios
and regulatory requirements as of December 31, 2003, see Note 19 to the
consolidated financial statements.
Old National's affiliate bank is subject to the provisions of the National Bank
Act, is supervised, regulated and examined by the OCC, and is subject to the
rules and regulations of the OCC, Federal Reserve and the FDIC.
A substantial portion of Old National's cash revenue is derived from dividends
paid to it by its affiliate bank. These dividends are subject to various legal
and regulatory restrictions as summarized in Note 19 to the consolidated
financial statements.
Both federal and state law extensively regulates various aspects of the banking
business, such as reserve requirements, truth-in-lending and truth-in-savings
disclosures, equal credit opportunity, fair credit reporting, trading in
securities and other aspects of banking operations.
Branching by Old National's affiliate bank is subject to the jurisdiction and
requires notice to or the prior approval of the OCC.
Old National and its affiliate bank are subject to the Federal Reserve Act,
which restricts financial transactions between banks and affiliated companies.
The statute limits credit transactions between banks, affiliated companies and
its executive officers and its affiliates. The statute prescribes terms and
conditions for bank affiliate transactions deemed to be consistent with safe and
sound banking practices, and restricts the types of collateral security
permitted in connection with a bank's extension of credit to an affiliate.
Additionally, all transactions with an affiliate must be on terms substantially
the same or at least as favorable to the institution as those prevailing at the
time for comparable transactions with nonaffiliated parties.
FDICIA accomplished a number of sweeping changes in the regulation of depository
institutions, including Old National's affiliate bank. FDICIA requires, among
other things, federal bank regulatory authorities to take "prompt corrective
action" with respect to banks which do not meet minimum capital requirements.
FDICIA further directs that each federal banking agency prescribe standards for
depository institutions and depository institution holding companies relating to
internal controls, information systems, internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth,
management compensation, a maximum ratio of classified assets to capital,
minimum earnings sufficient to absorb losses, a minimum ratio of market value to
book value of publicity traded shares and such other standards as the agency
deems appropriate.
The deposits of Old National's affiliate bank are insured up to $100,000 per
insured account by the Bank Insurance Fund ("BIF"), which is administered by the
FDIC, except for deposits acquired in connection with affiliations with savings
associations, which deposits are insured by the Savings Association Insurance
Fund ("SAIF"). Accordingly, Old National's affiliated bank pays deposit
insurance premiums to both BIF and SAIF.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 allows
for interstate banking and interstate branching without regard to whether such
activity is permissible under state law. Bank holding companies may now acquire
banks anywhere in the United States subject to certain state restrictions.
The Gramm-Leach-Bliley Act ("GLBA") permits bank holding companies which have
elected to become financial holding companies to engage in a substantially
broader range of non-banking activities, including securities, investment advice
and insurance activities, than is permissible for bank holding companies that
have not elected to become financial holding companies. Old National has elected
to be a financial holding company. As a result, Old National may underwrite and
sell securities and insurance. It may acquire, or be acquired by, brokerage
firms and insurance underwriters. GLBA established new requirements for
financial institutions to provide enhanced privacy protections to customers. In
June of 2000, the Federal banking agencies jointly adopted a final regulation
providing for the implementation of these protections. Financial institutions
are required to provide notice to consumers which
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details its privacy policies and practices, describes under what conditions a
financial institution may disclose nonpublic personal information about
consumers to nonaffiliated third parties and provides an "opt-out" method which
enables consumers to prevent the financial institution from disclosing customer
information to nonaffiliated third parties. Financial institutions were required
to be in compliance with the final regulation by July 1, 2001, and Old National
was in compliance at such date and continues to be in compliance.
In addition to the matters discussed above, Old National's affiliate bank is
subject to additional regulation of its activities, including a variety of
consumer protection regulations affecting its lending, deposit and collection
activities and regulations affecting secondary mortgage market activities. The
earnings of financial institutions are also affected by general economic
conditions and prevailing interest rates, both domestic and foreign and by the
monetary and fiscal policies of the United States government and its various
agencies, particularly the Federal Reserve.
Additional legislative and administrative actions affecting the banking industry
may be considered by the United States Congress, state legislatures and various
regulatory agencies, including those referred to above. It cannot be predicted
with certainty whether such legislative or administrative action will be enacted
or the extent to which the banking industry in general or Old National and its
affiliate bank in particular would be affected.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
The following is a cautionary note about forward-looking statements. In its oral
and written communication, Old National from time to time includes
forward-looking statements, within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward looking statements can include
statements about estimated cost savings, plans and objectives for future
operations, and expectations about performance as well as economic and market
conditions and trends. They often can be identified by the use of words like
"expect," "may," "could," "intend," "project," "estimate," "believe" or
"anticipate." Old National may include forward-looking statements in filings
with the Securities and Exchange Commission, such as this Form 10-K, in other
written materials, and in oral statements made by senior management to analysts,
investors, representatives of the media and others. It is intended that these
forward-looking statements speak only as of the date they are made, and Old
National undertakes no obligation to update any forward-looking statement to
reflect events or circumstances after the date on which the forward looking
statement is made or to reflect the occurrence of unanticipated events. By their
nature, forward-looking statements are based on assumptions and are subject to
risks, uncertainties and other factors. Actual results may differ materially
from those contained in the forward-looking statement. Uncertainties which could
affect Old National's future performance include, but are not limited to: (1)
economic, market, operational, liquidity, credit and interest rate risks
associated with Old National's business; (2) economic conditions generally and
in the financial services industry; (3) increased competition in the financial
services industry either nationally or regionally, resulting in, among other
things, credit quality deterioration; (4) volatility and direction of market
interest rates; (5) governmental legislation and regulation (see the discussion
under the heading "Supervision and Regulation" above), including changes in
accounting regulation or standards; (6) ability of Old National to execute its
business plan; (7) a weakening of the economy which could materially impact
credit quality trends and the ability to generate loans; (8) changes in the
securities markets; and (9) changes in fiscal, monetary and tax policies.
Investors should consider these risks, uncertainties and other factors in
addition to those mentioned by Old National in its other filings from time to
time when considering any forward-looking statement.
AVAILABLE INFORMATION
All reports filed electronically by Old National Bancorp with the Securities and
Exchange Commission ("SEC"), including the annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, proxy and
information statements, other information and amendments to those reports filed
(if applicable), are accessible at no cost on Old National's web site at
www.oldnational.com. These filings are also accessible on the SEC's web site at
www.sec.gov. The public may read and copy any materials filed by Old National
with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW,
Washington, DC 20549. The public may obtain information on the operation of the
Public Reference Room by calling the SEC at 1-800-SEC-0330.
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ITEM 2. PROPERTIES
The principal executive offices of Old National and its community banking,
non-banking services and treasury segments are currently located in leased space
in the multi-story Old National Bank building located at 420 Main Street,
Evansville, Indiana. The building is owned by a non-affiliated third party. Old
National began construction of a new headquarters building at One Main Street in
Evansville, Indiana, on June 27, 2002, with completion in 2004, at which time
this location will become the principal executive offices. On October 11, 2002,
Old National entered into a $52 million construction contract for the new
building with a company controlled by a director.
Old National's affiliate bank and subsidiaries conduct business primarily from
facilities Old National Bank owns. Of the over 120 banking and financial
services centers operated by Old National Bank in Indiana, Illinois, Kentucky,
Tennessee and Ohio, 47 are leased from non-affiliated third parties and the
remainder are owned by Old National Bank and are free from mortgages and major
encumbrances.
ITEM 3. LEGAL PROCEEDINGS
Old National has no material pending legal proceedings required to be disclosed
under Item 3. See Note 17 to the consolidated financial statements for further
discussion of Old National's legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders of Old National during
the fourth quarter of 2003.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Old National's stock is traded on the New York Stock Exchange ("NYSE") under the
ticker symbol ONB. Old National's shares began trading on the NYSE on February
15, 2002. The following table lists the NASDAQ price quotes, share volume and
dividend data from January 1, 2002 to February 14, 2002. The NYSE price quotes,
share volume and dividend data are used from February 15, 2002 to December 31,
2003.
---------------------------------------------------------------
Price Per Share
----------------------- Share Dividend
High Low Volume Declared
---------------------------------------------------------------
2003
First Quarter $22.71 $20.18 3,742,305 $0.18
Second Quarter 22.67 20.52 4,263,000 0.18
Third Quarter 22.82 21.29 3,785,250 0.18
Fourth Quarter 22.14 20.61 3,862,846 0.18
---------------------------------------------------------------
2002
First Quarter $22.36 $21.30 2,685,139 $0.15
Second Quarter 23.56 21.81 2,742,910 0.15
Third Quarter 24.04 20.69 3,352,703 0.18
Fourth Quarter 23.04 20.85 3,555,783 0.18
-----------------------------------------------------------------
Data adjusted for all stock dividends, including a 5% stock dividend to
shareholders of record on January 6, 2004, distributed on January 27,
2004.
In December 2003, a 5% stock dividend was declared to shareholders of record on
January 6, 2004. There were 25,459 shareholders of record as of December 31,
2003. Also, Old National declared $0.72 per share in dividends during the year
ended December 31, 2003, and $0.66 per share in dividends for the year ended
December 31, 2002. Old National's ability to pay cash dividends primarily
depends on cash dividends received from Old National Bank. Dividend payments
from Old National Bank are subject to various regulatory restrictions. See Note
19 to the consolidated financial statements for additional information.
10
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
- -------------------------------------------------------------------------------------------------------------------------------
Five-Year
(dollars in thousands, Growth
except per share data) 2003 2002 2001 2000 1999 1998 Rate
- -------------------------------------------------------------------------------------------------------------------------------
Results of Operations
Net interest income (1) $ 297,130 $ 314,606 $ 312,620 $ 289,510 $ 299,165 $ 277,892 1.3 %
Fee and service charge income 168,593 129,580 108,197 101,832 80,513 71,808 18.6
Net securities gains (losses) 23,556 12,444 4,770 (119) 2,637 1,090 N/M
Gain on branch divestitures -- 12,473 -- -- -- -- N/M
- -------------------------------------------------------------------------------------------------------------------------------
Total revenue (1) 489,279 469,103 425,587 391,223 382,315 350,790 6.9
- -------------------------------------------------------------------------------------------------------------------------------
Provision for loan losses 85,000 33,500 28,700 29,803 14,798 14,987 41.5
Salaries and
other operating expenses 299,716 257,845 245,109 228,034 223,897 199,088 8.5
Merger and restructuring costs -- -- 9,703 37,503 -- -- N/M
Income taxes (1) 34,150 59,826 49,031 34,187 50,363 51,272 (7.8)
- -------------------------------------------------------------------------------------------------------------------------------
Income from
continuing operations 70,413 117,932 93,044 61,696 93,257 85,443 (3.8)
Discontinued operations (after-tax) -- -- -- -- 4,101 (9,854) N/M
- -------------------------------------------------------------------------------------------------------------------------------
Net income $ 70,413 $ 117,932 $ 93,044 $ 61,696 $ 97,358 $ 75,589 (1.4)%
===============================================================================================================================
Per Share Data (2)
Net income (diluted) $ 1.05 $ 1.75 $ 1.36 $ 0.90 $ 1.36 $ 1.06 (0.1)%
Cash dividends paid 0.72 0.66 0.59 0.56 0.51 0.46 9.5
Book value at year-end 10.75 11.05 9.48 8.98 8.51 8.76 4.2
Stock price at year-end 21.76 22.04 21.81 24.63 25.42 27.73 (4.7)
Balance Sheet Data
(at December 31)
Total assets $9,353,896 $9,612,556 $9,080,473 $8,767,748 $8,086,012 $7,334,271 5.0 %
Loans (3) 5,586,455 5,769,635 6,132,854 6,348,313 5,714,688 5,058,460 2.0
Deposits 6,493,092 6,439,280 6,616,440 6,583,906 5,962,069 5,436,381 3.6
Other borrowings 1,624,092 1,234,014 1,083,046 863,165 768,055 675,745 19.2
Shareholders' equity 715,490 740,710 639,235 626,341 584,995 605,849 3.4
Performance Ratios
Return on average assets 0.74 % 1.27 % 1.05 % 0.73 % 1.25 % 1.08 %
Return on average
shareholders' equity 9.48 17.05 14.45 10.55 15.82 12.65
Dividend payout 68.69 37.25 43.13 62.84 36.52 40.38
Average equity to average assets 7.78 7.47 7.27 6.92 7.90 8.57
Net interest margin (1) 3.37 3.65 3.77 3.65 4.09 4.26
Efficiency ratio
(noninterest expense/revenue) (1) 61.26 54.97 59.87 67.87 58.56 56.75
Net charge-offs
to average loans (3) 1.21 0.34 0.45 0.39 0.17 0.24
Allowance for loan losses to
ending loans (3) 1.87 1.52 1.21 1.16 1.15 1.17
Other Data
Number of full-time
equivalent employees 3,019 2,941
Number of shareholders 25,459 25,718
Number of shares traded
(in thousands) (2) 15,653 12,337
- -------------------------------------------------------------------------------------------------------------------------------
(1) Includes the effect of taxable equivalent adjustments of $25.1 million for
2003, $25.2 million for 2002, $21.3 million for 2001, $19.6 million for
2000, $17.9 million for 1999, and $15.9 million for 1998 using the federal
statutory tax rate in effect of 35% for all periods.
(2) All share and per share data have been adjusted for stock dividends and
stock splits, including a 5% stock dividend to shareholders of record on
January 6, 2004, distributed on January 27, 2004. Diluted data assumes the
conversion of stock options and subordinated debentures.
(3) Includes residential loans held for sale.
N/M = Not meaningful
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
EXECUTIVE SUMMARY
The 2003 net income of Old National decreased significantly compared to previous
years. Old National was negatively affected by considerable credit quality
issues during 2003, resulting in substantially increased provisions for loan
losses. In addition, a reserve for the settlement of pending litigation resulted
in $10.0 million of additional expenses for the year. Weak loan demand in the
markets served by Old National as well as low interest rates negatively affected
the net interest margin.
As a result of management's balance sheet strategies, Old National's financial
condition showed a decrease in assets and liabilities at December 31, 2003,
reflecting heavy refinancing of residential real estate loans during the year, a
reduction in the investment portfolio, and a reduction of certificates of
deposits and borrowed funds. Management uses various indicators such as return
on assets, return on equity and asset quality ratios in order to evaluate the
performance of the business. These are discussed throughout this "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
FINANCIAL BASIS
The following discussion is an analysis of Old National's results of operations
for the years ended December 31, 2001 through 2003, and financial condition as
of December 31, 2003 and 2002. This discussion and analysis should be read in
conjunction with Old National's consolidated financial statements and related
notes. This discussion contains forward-looking statements concerning Old
National's business that are based on estimates and involves certain risks and
uncertainties. Therefore, future results could differ significantly from
management's current expectations and the related forward-looking statements.
See Item 1, "Business" for further information regarding forward-looking
statements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The "Management's Discussion and Analysis of Financial Condition and Results of
Operations," as well as disclosures found elsewhere in the annual report, are
based upon Old National's consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
Old National to make estimates and judgements that affect the reported amounts
of assets, liabilities, revenues and expenses. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses, the valuation of the mortgage
servicing rights and the valuation of goodwill and intangibles. Actual results
could differ from those estimates.
o Allowance for Loan Losses. The allowance for loan losses is maintained at a
level believed adequate by management to absorb probable losses inherent in
the consolidated loan portfolio. Management's evaluation of the adequacy of
the allowance is an estimate based on reviews of individual loans,
assessments of the impact of current and anticipated economic conditions on
the portfolio and historical loss experience. The allowance represents
management's best estimate, but significant downturns in circumstances
relating to loan quality and economic conditions could result in a
requirement for additional allowance in the near future. Likewise, an
upturn in loan quality and improved economic conditions may allow a
reduction in the required reserve. In either instance, unanticipated
changes could have a significant impact on results of operations.
The allowance is increased through a provision charged to operating
expense. Uncollectible loans are charged-off through the allowance.
Recoveries of loans previously charged-off are added to the allowance. A
loan is considered impaired when it is probable that contractual interest
and principal payments will not be collected either for the amounts or by
the dates as scheduled in the loan agreement. Old National's policy for
recognizing income on impaired loans is to accrue interest unless a loan is
placed on nonaccrual status.
o Mortgage Servicing Rights. Mortgage servicing rights are recognized as
separate assets when loans are sold with servicing retained. The total
price of loans sold is allocated between the loans sold and the mortgage
servicing rights retained based on the relative fair values of each. The
fair value of capitalized mortgage servicing rights is estimated by
calculating the present value of estimated future net servicing income
derived from related cash flows. Amortization of capitalized mortgage
servicing rights is determined in proportion to and over the period of
estimated net servicing income of the underlying financial assets.
Impairment of
12
mortgage servicing rights exists if the book value of the mortgage
servicing rights exceed its estimated fair value. In determining
impairment, mortgage servicing rights are stratified by interest rates.
Critical assumptions used in determining fair value include expected
mortgage loan prepayment rates, discount rates and other economic factors,
which are determined based on current market conditions. The expected rates
of mortgage loan prepayments are the most significant factors driving the
value of mortgage servicing rights. Increases in expected mortgage loan
prepayments reduce estimated future net servicing cash flows because the
life of the underlying loan is reduced. Fair values, using estimated
mortgage loan prepayment rates, are derived from a third-party statistical
model. Negative adjustments to the value, if any, are recognized through a
valuation allowance by charges against mortgage servicing income. The use
of a valuation allowance enables the recovery of this value as market
conditions become more favorable.
o Goodwill and Intangibles. Effective January 1, 2002, Old National adopted
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets".
SFAS No. 141 requires the use of the purchase method of accounting for all
business combinations initiated after June 30, 2001. SFAS No. 142
discontinued amortization of goodwill and indefinite-lived assets.
Intangible assets with a determinable useful life continue to be amortized
over that period. For purchase acquisitions, Old National is required to
record the assets acquired, including identified intangible assets, and the
liabilities assumed at their fair value, which in many instances involves
estimates based on third party valuations, such as appraisals, or internal
valuations based on discounted cash flow analyses or other valuation
techniques that may include estimates of attrition, inflation, asset growth
rates or other relevant factors. In addition, the determination of the
useful lives for which an intangible asset will be amortized is subjective.
Under SFAS No. 142, goodwill and indefinite-lived assets recorded must be
reviewed for impairment on an annual basis, as well as on an interim basis
if events or changes indicate that the asset might be impaired. An
impairment loss must be recognized for any excess of carrying value over
fair value of the goodwill or the indefinite-lived intangible with
subsequent reversal of the impairment loss being prohibited. The tests for
impairment fair values are based on internal valuations using management's
assumptions of future growth rates, future attrition, discount rates,
multiples of earnings or other relevant factors. The resulting estimated
fair values could have a significant impact on the carrying values of
goodwill or intangibles and could result in impairment losses affecting the
financials of the company as a whole and the individual lines of business
in which the goodwill or intangibles reside.
Management believes the accounting estimates related to the allowance for loan
losses; the capitalization, amortization and valuations of mortgage servicing
rights; and the valuation of goodwill and intangibles are "critical accounting
estimates" because: (1) the estimates are highly susceptible to change from
period to period because they require company management to make assumptions
concerning, among other factors, the changes in the types and volumes of the
portfolios, rates of future prepayments, valuation assumptions and anticipated
economic conditions, and (2) the impact of recognizing an impairment or loan
loss could have a material effect on Old National's assets reported on the
balance sheet as well as net income. Management has discussed the development
and selection of these critical accounting estimates with the Audit Committee of
the Board of Directors and the Audit Committee has reviewed the company's
disclosure relating to it in this Management's Discussion and Analysis.
NON-GAAP FINANCIAL MEASURES
In January 2003, the United States Securities and Exchange Commission ("SEC")
issued Regulation G, "Conditions for Use of Non-GAAP Financial Measures." A
non-GAAP financial measure is a numerical measure of a company's historical or
future performance, financial position or cash flow that excludes or includes
amounts or adjustments that are not in accordance with generally accepted
accounting principles ("GAAP"). Regulation G requires companies that present
non-GAAP financial measures to disclose a numerical reconciliation to the most
directly comparable measurement using GAAP as well as the reason why the
non-GAAP measure is an important measure. Management does not believe it has
used any non-GAAP financial measures in this annual report on Form 10-K.
ACQUISITION, CONSOLIDATION AND DIVESTITURE ACTIVITY
During 2003 and 2002, Old National acquired various financial services
companies. These acquisitions were accounted for as purchases in accordance with
SFAS No. 141, "Business Combinations." These key acquisitions in the asset
management consulting and insurance agency operations enhanced the growth of the
non-bank services
13
segment, also referred to as the Old National Signature Group, and expanded Old
National into its targeted metropolitan markets. See Note 2 to the consolidated
financial statements for more details regarding the various acquisitions.
During the third quarter of 2002, Old National finalized branch sales in markets
no longer considered consistent with the company's strategy resulting in a
pre-tax gain of $12.5 million and an after-tax gain of $8.3 million. The branch
sales resulted in a decrease in total loans of $107.3 million and total deposits
of $202.9 million. During 2001, Old National completed its One Bank
consolidation project that started in 1999 with the merger of its remaining
banking charters into one bank. The goals of One Bank included a single brand
image, common products offered throughout the banking locations and improved
back-office efficiency. In the second quarter of 2001, Old National further
streamlined its regional banking administrative structure and incurred after-tax
expenses of $5.9 million in the consolidation of acquisitions made in 2000.
RESULTS OF OPERATIONS
Earnings Summary
In 2003, Old National generated $70.4 million of net income and $1.05 net income
per share compared to $117.9 million and $1.75, respectively in 2002. The 2002
earnings included an $8.3 million, or $0.12 per share, after-tax gain on branch
sales. Old National's return on average assets was 0.74% and return on average
shareholders' equity was 9.48% for the year, which decreased significantly from
2002 ratios of 1.27% and 17.05%, respectively.
The most significant impact on net income in 2003 was the provision for loan
losses of $85.0 million, an increase of $51.5 million over the $33.5 million
recorded in 2002, resulting from significant deterioration in credit quality.
Other significant factors negatively affecting net income included weak
commercial loan demand, deterioration of the net interest margin from declining
interest rates, and a charge of $10.0 million pre-tax, or $6.7 million
after-tax, to establish a reserve related to litigation settlements. During
2003, Old National recognized $23.6 million of gains on the sales of investment
securities compared to $12.4 million recognized in 2002. In addition, record
origination volumes in mortgage operations and acquisitions in the non-bank
services segment had a positive impact on 2003 earnings results.
Business Line Results
Old National is managed in three primary business segments. Table 1 summarizes
Old National's business line results for the years ended December 31.
BUSINESS LINE RESULTS (TABLE 1)
-------------------------------------------------------------------
(dollars in thousands) 2003 2002 2001
-------------------------------------------------------------------
Community banking $58,759 $93,260 $78,671
Non-bank services 4,472 2,402 2,200
Treasury 13,916 13,988 18,093
Other (6,734) 8,282 (5,920)
-------------------------------------------------------------------
Consolidated net income $70,413 $117,932 $93,044
===================================================================
The 2003 community banking segment profit decreased $34.5 million from 2002.
Increases in noninterest income of $13.3 million over 2002, were offset by the
increased provision for loan losses of $51.5 million and decreases in net
interest income of $6.8 million. Net interest income suffered from the
refinancing of residential real estate loans, with many of the new loans being
sold into the secondary market, and weak commercial and commercial real estate
loan demand in the regions served by Old National. Noninterest income for 2003
increased primarily due to the increased mortgage banking activity during the
current year. Noninterest expense increased $8.3 million, or 3.4% primarily due
to outside processing expenses related to the third-party subcontracting of the
servicing functions of Old National's mortgage banking activities.
The 2003 non-bank services segment profit increased $2.1 million from 2002
primarily due to acquisitions of several insurance agencies and an asset
management company over the past year and a half. These acquisitions increased
noninterest income by $29.4 million and noninterest expense by $24.8 million
over 2002.
14
The treasury segment showed very little change in 2003 as compared to 2002, as
the net securities gains increase of $11.1 million in 2003 compared to 2002, was
offset by an $11.6 million decrease in net interest income for this segment.
Treasury's net interest income included income derived from the company's
interest rate risk position that was negatively impacted by declining interest
rates during most of 2003.
The "Other" segment profit included gains or charges which management chose not
to allocate to the various segments. "Other" for 2003 included expenses to
record the litigation reserve of $10.0 million and 2002 included the gain of
$12.5 million related to the sales of branches.
Net Interest Income
Net interest income, the difference between interest income earned on
interest-earning assets, such as loans and investments, and interest expense
incurred on interest-bearing liabilities, such as deposits and borrowed funds,
was the most significant component of Old National's earnings, comprising over
58% of Old National's 2003 revenues. Net interest income and net interest margin
in the following discussion is presented on a fully taxable equivalent basis,
which adjusts tax-exempt or nontaxable interest income to an amount that would
be comparable to interest subject to income taxes using the federal statutory
tax rate in effect of 35% for all periods. Net income is unaffected by these
taxable equivalent adjustments. Net interest income included taxable equivalent
adjustments of $25.1 million for 2003 and $25.2 million for 2002.
Net interest income and margin are influenced by many factors, primarily the
volume and mix of earning assets and funding sources and the interest rate
fluctuations. Other factors include accelerated prepayments of mortgage-related
assets and the composition and maturity of earning assets and interest-bearing
liabilities. Loans typically generate more interest income than investment
securities with similar maturities. Funding from customer deposits generally
cost less than wholesale funding sources. Factors, such as general economic
activity, Federal Reserve Board monetary policy and price volatility of
competing alternative investments, can also exert significant influence on Old
National's ability to optimize its mix of assets and funding and its net
interest income and margin.
Taxable equivalent net interest income was $297.1 million in 2003, a 5.6%
decrease from the $314.6 million reported in 2002. The net interest margin was
3.37% for 2003, compared to 3.65% reported for 2002. Average earning assets grew
$191.2 million, which primarily consisted of increased investment securities of
$417.6 million net of decreased loans of $226.8 million, while the yield on
average earning assets declined 103 basis points from 6.65% to 5.62%. Much of
the asset growth was funded by interest-bearing liabilities that increased
$172.5 million or 2.2%, and the cost of interest-bearing liabilities declined
only 83 basis points from 3.32% to 2.49%. Noninterest-bearing deposits provided
an additional $40.5 million in funding and other liabilities and equity
increased $75.1 million.
The decline in interest rates was the primary factor contributing to lower net
interest income and net interest margin in 2003. The target Federal funds rate,
the rate that dictates national prime rate and determines many other short-term
loan and liability rates, declined in June 2003 to 1.00% and was unchanged
through the remainder of the year. Market-driven interest rates, as evidenced by
the five-year United States Treasury Note yield, decreased during 2003 before
rebounding by the end of 2003. The five-year Treasury note yield fell from 2.93%
in January 2003 to 2.29% in May 2003 before increasing to 3.25% by December
2003.
The decrease in interest rates during 2003 had a significant impact on the mix
and yield of earning assets. Driven by lower rates, many of the company's
residential real estate loans were refinanced in 2003, with the new loan
production being sold into the secondary loan market, shrinking the residential
loan portfolio. Additionally, commercial and commercial real estate loans did
not grow appreciably during the year, a result of both continued weak loan
demand in our markets and more stringent loan underwriting standards. The
decline in loans shifted much of the company's asset growth to investment
securities, a lower yielding asset class compared to loans. In addition, many of
the company's investment securities matured, prepaid or were sold in 2003
because of lower rates and were replaced by lower yielding securities.
Table 2 presents a three-year average balance sheet and for each major asset and
liability category, its related interest income and yield or its expense and
rate for the years ended December 31. Table 3 shows fluctuations in net interest
income attributable to the impact of changes in the average balances of assets
and liabilities and the yields earned or rates paid for the years ended December
31.
15
THREE-YEAR AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS (TABLE 2)
- -----------------------------------------------------------------------------------------------------------------------------
2003 2002 2001
----------------------------- ----------------------------- ------------------------------
(tax equivalent basis, Average Interest Yield/ Average Interest Yield/ Average Interest Yield/
dollars in thousands) Balance & Fees Rate Balance & Fees Rate Balance & Fees Rate
- -----------------------------------------------------------------------------------------------------------------------------
Earning Assets
Money market investments $ 26,284 $ 314 1.19 % $ 25,841 $ 383 1.48 % $ 21,683 $ 805 3.71 %
Investment securities:
U.S. Treasury and
Government agencies (1) 2,338,860 94,475 4.04 1,934,693 100,076 5.17 1,254,893 79,644 6.35
States and political
subdivisions (4) 667,498 46,856 7.02 656,085 46,777 7.13 581,725 41,125 7.07
Other securities 122,507 5,956 4.86 120,467 7,135 5.92 159,501 10,155 6.37
- -----------------------------------------------------------------------------------------------------------------------------
Total investment securities 3,128,865 147,287 4.71 2,711,245 153,988 5.68 1,996,119 130,924 6.56
- -----------------------------------------------------------------------------------------------------------------------------
Loans: (2)
Commercial (4) 1,686,664 94,706 5.61 1,690,377 111,201 6.58 1,691,817 138,433 8.18
Commercial real estate 1,866,105 109,475 5.87 1,844,492 127,877 6.93 1,855,338 152,575 8.22
Residential real estate (3) 1,003,098 63,947 6.37 1,286,664 94,135 7.32 1,682,167 130,664 7.77
Consumer, net of
unearned income 1,095,567 79,142 7.22 1,056,730 84,976 8.04 1,051,673 97,627 9.28
- -----------------------------------------------------------------------------------------------------------------------------
Total loans (3) 5,651,434 347,270 6.14 5,878,263 418,189 7.11 6,280,995 519,299 8.27
- -----------------------------------------------------------------------------------------------------------------------------
Total earning assets 8,806,583 $494,871 5.62 % 8,615,349 $572,560 6.65 % 8,298,797 $651,028 7.84 %
=============== =============== ===============
Less: Allowance for
loan losses (93,154) (81,365) (74,491)
Non-Earning Assets
Cash and due from banks 178,189 186,534 180,227
Other assets 660,360 543,421 459,941
- ------------------------------------------- ---------- ----------
Total assets $9,551,978 $9,263,939 $8,864,474
=========================================== ========== ==========
Interest-Bearing Liabilities
NOW deposits $1,504,662 $ 13,550 0.90 % $1,215,858 $ 15,033 1.24 % $ 930,120 $ 14,712 1.58 %
Savings deposits 479,328 3,511 0.73 462,633 5,454 1.18 409,220 7,839 1.92
Money market deposits 612,044 5,729 0.94 644,037 10,003 1.55 778,366 25,864 3.32
Time deposits 3,061,922 115,881 3.78 3,468,623 156,070 4.50 3,706,416 205,199 5.54
- -----------------------------------------------------------------------------------------------------------------------------
Total interest-bearing
deposits 5,657,956 138,671 2.45 5,791,151 186,560 3.22 5,824,122 253,614 4.35
Short-term borrowings 687,588 7,258 1.06 688,958 10,971 1.59 583,035 21,862 3.75
Other borrowings 1,590,262 51,812 3.26 1,283,225 60,423 4.71 1,062,377 62,932 5.92
- -----------------------------------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 7,935,806 $197,741 2.49 % 7,763,334 $257,954 3.32 % 7,469,534 $338,408 4.53 %
=============== =============== ===============
Noninterest-Bearing
Liabilities
Demand deposits 752,788 712,308 664,347
Other liabilities 120,300 96,601 86,499
Shareholders' equity 743,084 691,696 644,094
- ------------------------------------------- ---------- ----------
Total liabilities and
shareholders' equity $9,551,978 $9,263,939 $8,864,474
=========================================== ========== ==========
Interest Margin Recap
Interest income/average
earning assets $494,871 5.62 % $572,560 6.65 % $651,028 7.84 %
Interest expense/average
earning assets 197,741 2.25 257,954 3.00 338,408 4.07
- -----------------------------------------------------------------------------------------------------------------------------
Net interest income
and margin $297,130 3.37 % $314,606 3.65 % $312,620 3.77 %
=============================================================================================================================
(1) Includes Government agency mortgage-backed securities.
(2) Includes principal balances of nonaccrual loans. Interest income relating
to nonaccrual loans is included only if received. Includes loan fees of
$8.9 million in 2003, $12.2 million in 2002 and $12.0 million in 2001.
(3) Includes residential loans held for sale.
(4) Interest on states and political subdivision investment securities and
commercial loans includes the effect of taxable equivalent adjustments of
$15.9 million and $9.2 million, respectively, in 2003; $16.0 million and
$9.2 million, respectively, in 2002; and $13.4 million and $7.9 million,
respectively, in 2001; using the federal statutory tax rate in effect of
35% for all periods.
16
NET INTEREST INCOME - RATE/VOLUME ANALYSIS (TABLE 3)
- -------------------------------------------------------------------------------------------------------
2003 vs. 2002 2002 vs. 2001
------------------------------------ ------------------------------------
Attributed to Attributed to
(tax equivalent basis, Total ----------------------- Total -----------------------
dollars in thousands) Change Volume Rate Change Volume Rate
- -------------------------------------------------------------------------------------------------------
Interest Income
Money market investments $ (69) $ 6 $ (75) $ (422) $ 108 $ (530)
Investment securities (1) (6,701) 21,689 (28,390) 23,064 43,761 (20,697)
Loans (1) (70,919) (15,038) (55,881) (101,110) (30,974) (70,136)
- -------------------------------------------------------------------------------------------------------
Total interest income (77,689) 6,657 (84,346) (78,468) 12,895 (91,363)
- -------------------------------------------------------------------------------------------------------
Interest Expense
NOW deposits (1,483) 3,086 (4,569) 321 4,026 (3,705)
Savings deposits (1,943) 160 (2,103) (2,385) 827 (3,212)
Money market deposits (4,274) (398) (3,876) (15,861) (3,275) (12,586)
Time deposits (40,189) (16,846) (23,343) (49,129) (11,932) (37,197)
Short-term borrowings (3,713) (18) (3,695) (10,891) 2,829 (13,720)
Other borrowings (8,611) 12,231 (20,842) (2,509) 11,741 (14,250)
- -------------------------------------------------------------------------------------------------------
Total interest expense (60,213) (1,785) (58,428) (80,454) 4,216 (84,670)
- -------------------------------------------------------------------------------------------------------
Net interest income $ (17,476) $ 8,442 $ (25,918) $ 1,986 $ 8,679 $ (6,693)
=======================================================================================================
The variance not solely due to rate or volume is allocated equally between the
rate and volume variances.
(1) Interest on investment securities and loans includes the effect of taxable
equivalent adjustments of $15.9 million and $9.2 million, respectively, in
2003; $16.0 million and $9.2 million, respectively, in 2002; and $13.4
million and $7.9 million, respectively, in 2001; using the federal
statutory tax rate in effect of 35% for all periods.
Provision for Loan Losses
The provision for loan losses is the charge to earnings that management
determines necessary to provide an adequate allowance for losses in the loan
portfolio. The provision for loan losses was $85.0 million for 2003, a
significant increase from the $33.5 million recorded in 2002. Refer to
"Allowance for Loan Losses and Asset Quality " section for further discussion of
non-performing loans, charge-offs and additional items impacting the provision.
Noninterest Income
Old National generates revenues in the form of noninterest income through fees
and sales commissions from its core banking franchise and other related
businesses, such as trust and asset management, investment products and
insurance. This source of revenue has grown as a percentage of total revenue to
39.3% in 2003 compared to 32.9% in 2002, which has been beneficial during this
downward turn in net interest income. Old National will continue to focus on
noninterest income revenue streams while carefully managing balance sheet risk
positions to ensure that Old National is well-positioned for the anticipated
turnaround in market conditions.
Noninterest income for 2003 was $192.1 million, an increase of $37.7 million, or
24.4% over the $154.5 million reported for 2002. In 2003, Old National realized
$23.6 million of gains on the sales of investment securities in comparison to
$12.4 million for the same period of 2002. Investment securities transactions
are considered as part of the continuing management of the balance sheet to
address interest rate and yield curve shifts.
Total fee and service charge income in 2003 increased 30.1% from 2002. Mortgage
banking revenue, a major component of this increase, totaled $19.1 million for
2003 compared to $14.5 million for 2002, an increase of $4.6 million, or 32.1%.
Residential real estate loan originations reached record levels in 2003 with
dollars of loans closed of $1.316 billion compared to $1.100 billion for 2002
and number of closed loans of 13,249 in 2003 compared to 11,537 in 2002. Trust
and asset management, insurance brokerage and investment product revenues
totaled $80.3 million during 2003 compared to $50.1 million during 2002. During
2003 and in the second half of 2002, Old National acquired various insurance
agencies and an asset management consulting company, which provided Old National
with additional sources of noninterest income. The acquisition of these
companies increased noninterest trust and asset management fees by $5.0 million,
insurance brokerage fees by $22.6 million and investment product revenue by $0.5
million over 2002 results. Deposit-related fees and service charges were $44.9
million in 2003 compared to $42.0 million for 2002, an increase of $2.9 million,
or 6.8%. This increase came from growth in transaction accounts, collection
initiatives and an increase in service charge rates.
17
Table 4 presents changes in the components of noninterest income for the years
ended December 31.
NONINTEREST INCOME (TABLE 4)
- -------------------------------------------------------------------------------------------
% Change From
Prior Year
----------------
(dollars in thousands) 2003 2002 2001 2003 2002
- -------------------------------------------------------------------------------------------
Trust and asset management fees $ 30,470 $ 24,387 $ 20,681 24.9 % 17.9 %
Service charges on deposit accounts 44,855 41,988 40,478 6.8 3.7
ATM fees 7,474 6,876 5,604 8.7 22.7
Mortgage banking revenue 19,144 14,496 9,737 32.1 48.9
Insurance premiums and commissions 39,225 16,686 13,296 135.1 25.5
Investment product fees 10,567 8,983 6,819 17.6 31.7
Bank-owned life insurance 6,922 7,944 5,349 (12.9) 48.5
Other income 9,936 8,220 6,233 20.9 31.9
- -------------------------------------------------------------------------------------------
Total fee and service charge income 168,593 129,580 108,197 30.1 19.8
Net securities gains 23,556 12,444 4,770 N/M N/M
Gain on branch divestitures -- 12,473 -- N/M N/M
- -------------------------------------------------------------------------------------------
Total noninterest income $192,149 $154,497 $112,967 24.4 % 36.8 %
===========================================================================================
Noninterest income to total revenue (1) 39.3 % 32.9 % 26.5 %
- --------------------------------------------------------------------------
(1) Total revenue includes the effect of a taxable equivalent adjustment of
$25.1 million in 2003, $25.2 million in 2002 and $21.3 million in 2001.
N/M = Not meaningful
Noninterest Expense
Old National strives to improve its efficiency through cost control efforts and
technology advancements while still providing quality customer service. In the
banking industry, the efficiency ratio, which is calculated by dividing
noninterest expense by the sum of taxable equivalent net interest income and
noninterest income, is often used to measure expense levels. The efficiency
ratio decreases when revenue is greater in relation to expenses and increases
when revenue is lesser in relation to expenses. A decreasing efficiency ratio
represents positive trends and improved efficiency. The efficiency ratio
increased to 61.26% in 2003 from 54.97% in 2002, representing a negative trend.
A company-wide program, "Ascend," has been initiated as discussed in Item 1,
"Business," which is designed to be an intense evaluation of every aspect of
operations for expense reductions and revenue growth ideas. As a result of this
program, Old National expects to have significant improvements in efficiency by
the end of the implementation phase in 2005.
Noninterest expense for 2003 totaled $299.7 million, an increase of $41.9
million, or 16.2% over the $257.8 million recorded in 2002. Salaries and
benefits, the largest component of noninterest expense, totaled $169.0 million
in 2003 compared to $148.5 million in 2002, an increase of $20.6 million, of
which $18.1 million directly related to acquisitions. Outside processing
expenses totaled $19.1 million for 2003 compared to $13.6 million recorded in
2002. This increase in 2003 primarily resulted from a full year of expense
related to the mortgage third-party servicing subcontractor compared to one-half
year in 2002. Other losses of $14.7 million in 2003 compared to $5.4 million in
2002, included a $10.0 million charge in 2003 to establish a reserve in
connection with litigation, which was partially settled during the fourth
quarter. For additional information, see Note 17 to the consolidated financial
statements. Overall, the remaining components of noninterest expense totaled
$96.9 million for 2003 compared to $90.3 million for 2002, an increase of 7.3%
or $6.6 million, with $6.1 million directly related to acquisitions.
Old National will complete construction of its principal executive offices in
2004. It is expected that the net increase to occupancy, equipment and other
noninterest expense components will have an annualized impact to net income per
share of $0.02. However, the impact does not take into account that the lease of
Old National's current headquarters would have increased substantially beginning
in 2005, decreasing the impact below $0.02.
Table 5 presents changes in the components of noninterest expense for the years
ended December 31.
18
NONINTEREST EXPENSE (TABLE 5)
- -------------------------------------------------------------------------------------------
% Change From
Prior Year
----------------
(dollars in thousands) 2003 2002 2001 2003 2002
- -------------------------------------------------------------------------------------------
Salaries and employee benefits $169,025 $148,450 $138,210 13.9 % 7.4 %
Occupancy 18,166 16,154 15,599 12.5 3.6
Equipment 14,296 15,153 16,206 (5.7) (6.5)
Marketing 11,085 11,026 8,109 0.5 36.0
FDIC insurance premiums 1,007 1,132 1,222 (11.0) (7.4)
Outside processing 19,078 13,640 10,757 39.9 26.8
Communications and transportation 11,595 11,738 10,907 (1.2) 7.6
Professional fees 9,111 8,959 7,415 1.7 20.8
Loan expense 7,041 6,496 6,416 8.4 1.2
Supplies 4,829 5,048 5,529 (4.3) (8.7)
Other losses 14,676 5,445 6,177 169.5 (11.9)
Goodwill amortization -- -- 5,909 -- (100.0)
Other intangible amortization 2,612 1,174 865 122.5 35.7
Other expense 17,195 13,430 11,788 28.0 13.9
- -------------------------------------------------------------------------------------------
Salaries and other operating expenses 299,716 257,845 245,109 16.2 5.2
Merger and restructuring costs -- -- 9,703 N/M N/M
- -------------------------------------------------------------------------------------------
Total noninterest expense $299,716 $257,845 $254,812 16.2 % 1.2 %
===========================================================================================
N/M = Not meaningful
Provision for Income Taxes
Old National records a provision for income taxes currently payable and for
income taxes payable in the future, which arise due to timing differences in the
recognition of certain items for financial statement and income tax purposes.
The major difference between the effective tax rate applied to Old National's
financial statement income and the federal statutory tax rate is caused by
interest on tax-exempt securities and loans. Old National's effective tax rate
was 11.4% in 2003 and 22.7% in 2002. The decreased tax rate in 2003 resulted
from a higher percentage of tax-exempt income to total income. The reduction in
2003 total income is discussed in the earnings summary above. See Note 11 to the
consolidated financial statements for additional details on Old National's
income tax provision.
Interim Financial Data
Table 6 provides a detailed summary of quarterly results of operations for the
years ended December 31. These results contain all normal and recurring
adjustments necessary for a fair and consistent presentation.
INTERIM FINANCIAL DATA (TABLE 6)
- -------------------------------------------------------------------------------------------------------------------------------
Quarters Ended 2003 Quarters Ended 2002
(unaudited, dollars ----------------------------------------------- ---------------------------------------------
and shares in thousands, December September June March December September June March
except per share data) 31 30 30 31 31 30 30 31
- -------------------------------------------------------------------------------------------------------------------------------
Interest income $ 111,176 $ 114,761 $ 120,233 $ 123,578 $ 131,052 $ 136,277 $ 139,704 $ 140,350
Interest expense 44,909 47,289 51,768 53,775 61,001 64,710 66,350 65,893
- -------------------------------------------------------------------------------------------------------------------------------
Net interest income 66,267 67,472 68,465 69,803 70,051 71,567 73,354 74,457
Provision for loan losses 26,000 27,500 22,500 9,000 7,500 11,000 7,500 7,500
Noninterest income 40,543 45,773 62,913 42,920 40,354 52,512 31,124 30,507
Noninterest expense 80,126 75,465 73,960 70,165 69,307 66,729 60,545 61,264
- -------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 684 10,280 34,918 33,558 33,598 46,350 36,433 36,200
Income tax expense (benefit) (4,592) (1,530) 7,851 7,298 6,869 11,521 7,920 8,339
- -------------------------------------------------------------------------------------------------------------------------------
Net income $ 5,276 $ 11,810 $ 27,067 $ 26,260 $ 26,729 $ 34,829 $ 28,513 $ 27,861
===============================================================================================================================
Net income per share (1)
Basic $ 0.08 $ 0.17 $ 0.41 $ 0.39 $ 0.40 $ 0.52 $ 0.42 $ 0.41
Diluted 0.08 0.17 0.41 0.39 0.40 0.52 0.42 0.41
- -------------------------------------------------------------------------------------------------------------------------------
Weighted average shares (1)
Basic 66,678 66,904 66,646 66,889 66,794 67,096 67,433 67,393
Diluted 66,728 67,071 66,699 66,945 66,863 67,279 67,603 67,495
- -------------------------------------------------------------------------------------------------------------------------------
(1) All share and per share data have been adjusted for stock dividends,
including a 5% stock dividend to shareholders of record on January 6, 2004,
distributed on January 27, 2004. Diluted data assumes the conversion of
stock options.
19
FINANCIAL CONDITION
Overview
Old National's assets at December 31, 2003, were $9.354 billion, a 2.7% decrease
compared to $9.613 billion recorded at December 31, 2002. Investments and loans
decreased $160.6 million and $106.9 million, respectively, and total liabilities
declined $233.4 million compared to December 31, 2002. Total shareholders'
equity decreased $25.2 million from year-end 2002.
Earning Assets
Old National's earning assets are comprised of loans and loans held for sale,
investment securities and money market investments. Earning assets were $8.518
billion at December 31, 2003, a decrease of 3.9% from December 31, 2002. During
the first half of 2003, investment securities increased as a temporary source of
earning assets. During the second half of 2003, Old National reduced its
investment portfolio due to fewer attractive investment opportunities and the
company's need to reduce its sensitivity to rising interest rates. Despite the
continued weakness in commercial lending and the specific sales of $62.7 million
of nonaccrual commercial and residential real estate loans, total loans
decreased only slightly as these factors were partially offset by consumer loan
growth.
Investment Securities
Old National classifies investment securities primarily as available-for-sale to
give management the flexibility to sell the securities prior to maturity if
needed, based on fluctuating interest rates or changes in the company's funding
requirements. However, Old National added 15- and 20-year fixed-rate mortgage
pass-through securities to its held-to-maturity investment portfolio during
2003.
At December 31, 2003, the investment securities portfolio was $2.917 billion
compared to $3.078 billion at December 31, 2002, a decrease of 5.2%. Investment
securities represented 34.2% of earning assets at December 31, 2003, compared to
34.7% at December 31, 2002. During 2002 and the first half of 2003, Old National
increased the investment portfolio as a short-term alternative source of earning
assets to offset declining residential real estate and minimal commercial and
consumer loan growth. During the second half of 2003, Old National began
decreasing the size of the investment portfolio and used the cash flows
generated by the declining investment portfolio to reduce borrowed funds.
Stronger economic activity and stronger commercial loan demand would likely
result in increased investments in loans and the investment portfolio would
stabilize or decrease. Continued weak commercial loan demand, however, may cause
Old National to use cash flows to reinvest in securities.
Investment securities available-for-sale portfolio had net unrealized gains of
$23.7 million at December 31, 2003, compared to $86.2 million at December 31,
2002. The decrease was a result of higher market interest rates and a smaller
portfolio of securities available-for-sale at December 31, 2003, compared to
December 31, 2002. Also, Old National realized pre-tax gains on sales of
securities from this portfolio of $23.6 million during 2003.
The investment portfolio had an average life of 4.86 years at December 31, 2003,
compared to 3.10 years at December 31, 2002. The average yields on
available-for-sale investment securities, on a taxable equivalent basis, were
4.90% in 2003 and 5.43% in 2002. The average yield on the held-to-maturity
portfolio was 4.29% in 2003.
At December 31, 2003, Old National had a concentration of investment securities
issued by certain states and their political subdivisions with the following
aggregate market values: $149.0 million by Indiana, which represented 20.8% of
shareholders' equity, and $119.4 million by Illinois, which represented 16.7% of
shareholders' equity. At December 31, 2002, the aggregate market values of the
concentration of certain states and their political subdivisions were $156.8
million by Indiana, which represents 21.2% of shareholders' equity, and $122.8
million by Illinois, which represents 16.6% of shareholders' equity. There were
no other concentrations of investment securities issued by an individual state
and its political subdivisions that were greater than 10% of shareholders'
equity.
Residential Loans Held for Sale
Residential loans held for sale were $16.3 million at December 31, 2003,
compared to $92.6 million at December 31, 2002. Residential loans held for sale
are loans that are closed, but not yet sold on the secondary market. The amount
of residential loans held for sale on the balance sheet varies depending on the
timing of movement of originations and loan sales to the secondary market. At
December 31, 2003, loan originations were down compared to December 31, 2002,
primarily due to an upturn in interest rates at the end of 2003.
20
Lending and Loan Administration
Old National's credit culture has historically featured decision-making near the
customer with corporate oversight. In 2003, due to continued credit quality
concerns, Old National implemented certain credit approval disciplines in order
to continue to focus on the reduction of problem and non-performing loans in the
portfolio, including a restructuring of the manner in which commercial loans are
analyzed and approved. Community-based loan personnel, which now include
independent underwriting and analytic support staff, continue to have the
authority to extend credit under guidelines established and administered by Old
National's Credit Policy Committee. This committee, which meets quarterly,
includes members from both the holding company and the bank. The committee
monitors credit quality through its review of information such as delinquencies,
problem loans and charge-offs and regularly reviews the loan policy to assure it
remains appropriate for the current lending environment.
Old National lends primarily to small- and medium-sized commercial and
commercial real estate customers in various industries including manufacturing,
agribusiness, transportation, mining, wholesaling and retailing. As measured by
Old National, the company had no concentration of loans in any single industry
exceeding 10% of its portfolio and has no exposure to foreign borrowers or
lesser-developed countries. Old National's policy is to concentrate its lending
activity in the geographic market areas it serves, primarily Indiana, Illinois,
Kentucky and Tennessee, with a focus on increasing its presence in the
metropolitan markets, including Indianapolis, Louisville and St. Louis. Old
National has been affected by weakness in the economy of its principal markets,
particularly in its home state of Indiana, which has resulted in minimal growth
of commercial and consumer loans and tighter credit underwriting standards. Old
National anticipates that when the economy in Old National's principal markets
begins to improve, commercial and consumer loans will begin to show higher
levels of growth.
In the past four years, commercial loans average growth rate was 4.9% per year
while commercial real estate grew 9.1% per year. Residential real estate loans
declined 18.7% per year while consumer loans rose 5.9% annually over the same
period. Table 7 presents the composition of the loan portfolio at December 31.
LOAN PORTFOLIO AT YEAR-END (TABLE 7)
- -----------------------------------------------------------------------------------------------------------------------------
Four-Year
(dollars in thousands) 2003 2002 2001 2000 1999 Growth Rate
- -----------------------------------------------------------------------------------------------------------------------------
Commercial $1,618,095 $1,696,347 $1,742,937 $1,606,509 $1,338,255 4.9 %
Commercial real estate 1,849,275 1,883,303 1,848,945 1,810,805 1,306,312 9.1
Consumer credit 1,163,337 1,053,620 1,064,109 1,042,629 926,345 5.9
- -----------------------------------------------------------------------------------------------------------------------------
Total loans excluding residential real estate 4,630,707 4,633,270 4,655,991 4,459,943 3,570,912 6.7
Residential real estate 939,422 1,043,816 1,449,080 1,890,872 2,148,974 (18.7)
- -----------------------------------------------------------------------------------------------------------------------------
Subtotal 5,570,129 5,677,086 6,105,071 6,350,815 5,719,886 (0.7)%
=========
Less: Unearned income 12 49 317 2,502 5,198
- -----------------------------------------------------------------------------------------------------------------------------
Total loans 5,570,117 5,677,037 6,104,754 6,348,313 5,714,688
Less: Allowance for loan losses 104,571 87,742 74,241 73,833 65,685
- -----------------------------------------------------------------------------------------------------------------------------
Net loans $5,465,546 $5,589,295 $6,030,513 $6,274,480 $5,649,003
=================================================================================================================
Commercial and Consumer Loans
Commercial and consumer loans are the largest classification within the earning
assets of Old National representing 54.4% of earning assets at December 31,
2003, a slight increase from 52.3% at December 31, 2002. At December 31, 2003,
commercial and commercial real estate loans decreased $78.3 million and $34.0
million, respectively, from December 31, 2002. During 2003, Old National sold
$48.2 million of non-performing commercial loans, which contributed to the
change in commercial and commercial real estate loans. A write-down of $11.3
million was recorded against the allowance for loan losses related to these
sales. Consumer loans, including automobile loans, personal and home equity
loans and lines of credit, and student loans, increased $109.8 million or 10.4%
at December 31, 2003, compared to December 31, 2002, primarily due to a renewed
focus on consumer lending.
Table 8 presents the maturity distribution and rate sensitivity of commercial
loans and an analysis of these loans that have predetermined and floating
interest rates. A significant percentage of commercial loans are due within one
year, reflecting the short-term nature of a large portion of these loans.
21
DISTRIBUTION OF COMMERCIAL LOAN MATURITIES AT DECEMBER 31, 2003
(TABLE 8)
--------------------------------------------------------------------
Within 1 - 5 Beyond
(dollars in thousands) 1 Year Years 5 Years Total
--------------------------------------------------------------------
Interest rates:
Predetermined $216,322 $383,597 $210,477 $ 810,396
Floating 531,657 224,078 51,964 807,699
--------------------------------------------------------------------
Total $747,979 $607,675 $262,441 $1,618,095
====================================================================
Residential Real Estate Loans
Residential real estate loans, primarily 1-4 family properties, have decreased
in significance to the loan portfolio over the past five years due to higher
levels of loan sales on the secondary market, primarily to Federal Home Loan
Mortgage Corporation or Federal National Mortgage Association. Old National
sells the majority of residential real estate loans originated as a strategy to
better manage interest rate risk and liquidity. These loans are sold with loan
servicing retained in order to maintain customer relationships and generate
noninterest income and fees. By using this strategy, Old National is able to
recognize an immediate gain in noninterest income versus a small net interest
income spread over a longer period of time. Old National sells the majority of
the residential real estate loans without recourse, currently having less than
1% of loans sold with recourse.
During 2003, residential real estate loans continued to liquidate at
extraordinary levels in the low interest rate environment and the related boom
in refinancing. As of December 31, 2003, residential real estate loans were
$939.4 million, a decrease of $104.4 million or 10.0% from December 31, 2002.
Old National's residential real estate loan portfolio was also affected by the
sales of delinquent loans in 2003. These sales were to improve credit quality
and reduce the level of non-performing loans and are not a part of Old
National's ongoing strategy. Delinquent residential real estate loans of $14.5
million were sold to independent investors resulting in write-downs of $3.4
million recorded against the allowance for loan losses. During 2003, Old
National developed additional mortgage products that fit within the company's
interest rate risk profile that will be retained by the bank. As a result of
this strategy, Old National would expect to see a stabilization of residential
real estate loans on the consolidated balance sheet.
Allowance for Loan Losses and Asset Quality Administration
Old National monitors the quality of its loan portfolio on an on-going basis and
uses a combination of detailed credit assessments by relationship managers and
credit officers, historic loss trends, and economic and business environment
factors in determining its allowance for loan losses. Old National records
provisions for loan losses based on current and projected loans outstanding,
grade changes, mix of loans and expected losses. A detailed loan loss evaluation
on an individual loan basis for the company's highest risk loans is performed
quarterly. Management follows the progress of the economy and how the continuing
slow recovery might affect Old National's borrowers in both the near and the
intermediate term. Old National has a formalized and disciplined independent
loan review program. Its loan review system evaluates loan administration,
credit quality and compliance with corporate loan standards. This program
includes periodic reviews conducted at the community bank locations as well as
regular reviews of problem loan reports, delinquencies and charge-offs.
Each month, problem loan reports are prepared and reviewed, which include
borrowers that show indications of being unable to meet debt obligations in the
normal course of business, and loans which have other characteristics deemed by
bank management to warrant special attention or have been criticized by
regulators in the examination process. Classified loans include non-performing
loans, past due 90 days and other problem loans while criticized loans, also
known as special mention loans, are loans that have potential weaknesses that
deserve management's close attention and require specific quarterly reviews by
the bank.
Assets determined by the various evaluation processes to be under-performing
receive special attention by Old National management. Under-performing assets
consist of: 1) nonaccrual loans where the ultimate collectibility of interest or
principal is uncertain; 2) loans renegotiated in some manner, primarily to
provide for a reduction or deferral of interest or principal payments because
the borrower's financial condition deteriorated; 3) loans with principal or
interest past due ninety (90) days or more; and 4) foreclosed properties.
A loan is generally placed on nonaccrual status when principal or interest
become 90 days past due unless it is well secured and in the process of
collection, or earlier when concern exists as to the ultimate collectibility of
principal or
22
interest. When loans are classified as nonaccrual, interest accrued during the
year is reversed against earnings; interest accrued in the prior year, if any,
is charged to the allowance for loan losses. Cash received while a loan is
classified as nonaccrual is recorded to principal.
Adjustments to the allowance for loan losses are made as deemed necessary for
probable losses inherent in the portfolio. While an estimate of future losses
is, by its very nature, difficult to precisely predict, management of Old
National believes that the methodology that it uses in determining an
appropriate reserve for future losses is reasonable.
Loan officers grade the larger commercial and commercial real estate loans in
the portfolio periodically as determined by loan policy requirements or
determined by specific guidelines based on loan characteristics as set by
management and banking regulation. Periodically, these loan grades are reviewed
independently by the loan review department. For impaired loans, an assessment
is conducted as to whether there is likely loss in the event of default. If such
a loss is determined to be likely, the loss is quantified and a specific reserve
is assigned to the loan. For the balance of the commercial and commercial real
estate loan portfolio, loan grade migration projections coupled with historic
loss experience within the respective grades is used to develop reserve
requirement ranges based on expected future losses.
A loan is considered impaired under SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan, an amendment of FASB Statement No. 5 and 15" when, based
on current information and events, it is probable that a creditor will be unable
to collect all amounts due according to the contractual terms of the loan
agreement. An impaired loan does not include larger groups of smaller-balance
homogeneous loans that are collectively evaluated for impairment, loans that are
measured at fair value or at the lower of cost or fair value, leases and debt
securities. During the third quarter of 2003, Old National revised its
interpretation of impaired loans to strictly follow SFAS No. 114. Previous to
this change, Old National's interpretation of impaired loans more conservatively
included all problem credits with a potential collateral deficiency in the event
of default and nonaccrual loans in larger groups of smaller-balance homogeneous
loans. Had Old National made this in the prior year, impaired loans would have
totaled $80.4 million rather than $303.2 million as reported at December 31,
2002. At December 31, 2003, the total impaired loans were $91.6 million of which
$60.6 million had an allocated reserve of $20.6 million and $31.0 million had no
specific reserve recorded.
Historic loss ratios adjusted for future expectations of economic conditions are
used in determining the appropriate level of reserves for consumer and
residential real estate loans. The methodology used by Old National to predict
losses on loans that are not impaired uses a system of allocating losses back to
the original time the respective loans were booked and then moving those losses
through the different loan grades as the loans migrate to higher risk
classifications.
Allowance for Loan Losses and Asset Quality
At December 31, 2003, the allowance for loan losses was $104.6 million, an
increase of $16.8 million compared to $87.7 million at December 31, 2002. As a
percentage of total loans held for investment, the allowance increased to 1.88%
at December 31, 2003, from 1.55% at December 31, 2002. During 2003, the
provision for loan losses amounted to $85.0 million, an increase of $51.5
million over 2002. Various factors led to Old National's higher provision in
2003. First, the amount necessary to cover the higher than normal losses in 2003
was significant. Second, loan collateral values in the markets served by Old
National deteriorated which led to the need for higher reserves in the event of
liquidation. Third, recent experience elevated the rate of expected future
losses.
The increase in the allowance for loan losses for commercial and commercial real
estate loans accounted for virtually all of the increase in the total reserve
from December 31, 2002, to December 31, 2003. For commercial and commercial real
estate loans, the reserve as a percentage of that portfolio increased to 2.64%
at December 31, 2003, from 2.22% at December 31, 2002. While the absolute level
of classified and criticized loans at December 31, 2003, decreased 21.5% from
December 31, 2002, bank management believed this level was appropriate given
continued economic weakness and stresses in the Midwestern region on commercial
borrowers. As a result, the reserve for commercial and commercial real estate
loans increased by $12.3 million.
The reserve for residential real estate loans as a percentage of that portfolio
increased to 0.5% at December 31, 2003, from 0.1% at December 31, 2002. This
increase reflected an increase in historical loss rates due to higher
residential real estate loan charge-offs during 2003, including the losses
resulting from the sales of non-performing
23
residential real estate loans. The reserve for consumer loans increased only
slightly and the reserve as a percentage of loans in this portfolio was
unchanged from December 31, 2002, to December 31, 2003 at 0.7% of the portfolio.
This was reflective of little or no change in the performance and loss
experience on the consumer loan portfolio. Table 9 details the allowance for
loan losses by loan category and the percent of loans in each category compared
to total loans at December 31.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES BY CATEGORY OF LOANS
AND THE PERCENTAGE OF LOANS BY CATEGORY TO TOTAL LOANS (TABLE 9)
- -------------------------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------ ---------------- ---------------- ---------------- ----------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
to Total to Total to Total to Total to Total
(dollars in thousands) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
- -------------------------------------------------------------------------------------------------------------------------
Commercial and
commercial real estate $ 91,671 62.2 % $ 79,412 63.1 % $ 65,669 58.9 % $ 61,450 53.8 % $ 53,460 46.3 %
Residential real estate 4,400 16.9 1,200 18.4 1,422 23.7 1,500 29.8 1,400 37.6
Consumer credit 8,500 20.9 7,130 18.5 7,150 17.4 10,883 16.4 10,825 16.1
- -------------------------------------------------------------------------------------------------------------------------
Total $104,571 100.0 % $ 87,742 100.0 % $ 74,241 100.0 % $ 73,833 100.0 % $ 65,685 100.0 %
=========================================================================================================================
Charge-offs, net of recoveries, totaled $53.4 million in 2003 and $20.0 million
in 2002. Additionally in 2003, write-downs of $14.7 million from loans
transferred to held for sale related to loan sales were recognized. The 2003
charge-offs included significant items including one loan relationship
write-down of $10.3 million and a $6.5 million single commercial credit
charge-off resulting from fraud in the customer's operation. Although net
charge-offs have been concentrated primarily in commercial loans reflecting
slowdown of the economy, no single industry segment represented a significant
share of total net charge-offs. The allowance to average loans, which ranged
from 1.18% to 1.85% for the last five years, was 1.85% at December 31, 2003.
Table 10 summarizes activity in the allowance for loan losses for the years
ended December 31, along with related statistics for the allowance and net
ch