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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, 2004
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.)
1 MAIN STREET
EVANSVILLE, INDIANA 47708
(Address of principal executive offices) (Zip Code)
(812) 464-1294
(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 in 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, 2004, was $1,611,437,618 (based on the closing price
on that date of $23.65, as quoted on the New York Stock Exchange). In
calculating the market value of securities held by non-affiliates of the
Registrant, the Registrant has treated as securities held by affiliates as of
June 30, 2004, 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 for benefit of its directors and principal executive
officers.
The number of shares outstanding of the Registrant's common stock, as of January
31, 2005, was 69,102,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Shareholders to be
held April 28, 2005, is incorporated by reference into Part III of this Form
10-K.
OLD NATIONAL BANCORP
2004 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I PAGE
- -------- ----
Item 1. Business 3
Item 2. Properties 10
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 10
PART II
Item 5. Market for the Registrant's Common Equity, Related Shareholder Matters and Issuer 11
Purchases of Equity Securities
Item 6. Selected Financial Data 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 13
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 34
Item 8. Financial Statements and Supplementary Data 37
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 74
Item 9A. Controls and Procedures 74
Item 9B. Other Information 74
PART III
Item 10. Directors and Executive Officers of the Registrant 74
Item 11. Executive Compensation 75
Item 12. Security Ownership of Certain Beneficial Owners and Management 75
Item 13. Certain Relationships and Related Transactions 75
Item 14. Principal Accountant Fees and Services 75
PART IV
Item 15. Exhibits and Financial Statement Schedules 76
SIGNATURES 79
2
OLD NATIONAL BANCORP
2004 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
loan and 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 wealth management
services, investment and brokerage services, investment consulting, insurance
and other financial services. As of December 31, 2004, Old National employed
2,743 full-time equivalent associates.
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, in 2001 became a financial holding company and is
currently the largest financial holding company headquartered in the state of
Indiana. 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 financial center locations, consolidating
back-office operations and allowing Old National to provide more convenient
service to clients. Over the past several years, Old National has grown to
include financial services operations in Indiana, Illinois, Kentucky, Tennessee,
Ohio and Missouri.
Old National has identified potential growth areas within its existing franchise
focused on community banking and building long-term client relationships. In
2004, Old National identified three strategic initiatives essential to the
achievement of the company's earnings and financial performance objectives:
- Strengthen Risk Environment
By the end of 2003, Old National had implemented its new lending structure
in which loan approvals require dual signatures from both market
originators and independent credit underwriters. This formalized process
ensures consistency in underwriting criteria across the organization while
maintaining a strong commitment to client needs. Other lending risk
management initiatives include intensified workout and restructuring
efforts, negotiations to move high-risk credit relationships to other
lenders and the sale of pools of problem loans.
During 2004, Old National created a compliance division, combining the
areas of compliance, risk management, vendor risk management, business
continuity and corporate security. By the end of 2004, this division
created new policies, programs and positions to ensure the appropriate
oversight of compliance with applicable laws and regulations and to
enhance operational risk management capabilities. In addition, during
2004, Old National fully implemented processes in compliance with Section
404 of the Sarbanes-Oxley Act for management's assessment of the
effectiveness of internal control over financial reporting.
- Leverage Expense Discipline
Project "Ascend," the company-wide profit improvement initiative announced
in late 2003, is well underway. The initial phases of the project, the
idea generation and evaluation phases, were completed during the second
quarter of 2004. The project is currently in the implementation phase,
with expectations of full implementation by the end of 2005. The idea
generation phase was conducted with the assistance of EHS Partners. The
project was an intense evaluation of every aspect of operations for
expense reductions and revenue growth ideas. The process which was
developed for analyzing and justifying initiatives and the disciplined
approach used in planning and implementing approved ideas is expected to
have a lasting impact on the corporate culture at Old National.
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- Achieve Consistent Quality Earnings
A key strategic goal for the company is to eliminate the volatility that
has plagued results in recent years and return to consistent quality
earnings. During 2000 to 2004, net income was impacted by several unique
items such as higher than usual provisions for loan losses; merger and
restructuring charges; a litigation reserve; gains on sales of assets,
credit card operations and securities; and nonrecurring charges related to
"Ascend." Even without those singular events, earnings generated by
ongoing operations were erratic. Quality revenue growth is key to this
initiative and is expected to be achieved by expanding relationships with
retail and commercial clients, maintaining a strong credit culture,
leveraging the distinctiveness of Old National's wealth management
service, integrating insurance products with relationship-building
initiatives and a focus on accountability at the local market level.
OPERATING SEGMENTS
Old National is divided into three operating segments: community banking,
non-bank services and treasury. A description of each segment follows.
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 clients' needs and help clients reach their financial
goals by providing a broad array of quality services. Old National's financial
centers focus on convenience factors such as location, space for private
consultations and quick client access to routine transactions.
As of December 31, 2004, Old National Bank operated more than 120 banking
financial centers in Indiana, Illinois, Kentucky, and a limited area in
Tennessee and in Ohio. The community banking segment primarily consists of
lending and depository activities along with merchant cash management, payroll,
Internet banking and other 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 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 commercial clients, which include commercial
loans, commercial real estate loans, 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 typically held
in the portfolio.
Depository Activities
Old National strives to serve individuals and commercial clients by providing
depository services that fit their needs at competitive rates. Old National pays
interest on the interest-bearing deposits and receives service fee revenue on
various accounts. Deposit accounts include products such as noninterest-bearing
demand, NOW, savings and money market, and time deposits. Debit and ATM cards
provide access to the clients' accounts 24 hours a day at any ATM location. Old
National also provides 24-hour telephone access and online banking 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 wealth management, investment and brokerage services,
investment consulting services and insurance agency services. Old National has
identified the non-bank services segment as an important component in achieving
revenue growth. This is consistent with Old National's transition to stronger
client relationships and less dependence on interest rate conditions. These
units serve clients of the community banking segment as well as members of the
general public.
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Wealth Management
Fiduciary and trust services targeted at high net worth individuals 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 mutual funds.
Investment and Brokerage Services
ONB Investment Services, Inc., a registered broker-dealer, operates as a
subsidiary of Old National Bank to provide clients with convenient and
professional investment services and a variety of brokerage products. This line
of business offers a full array of investment options and investment advice to
its clients.
Investment Consulting Services
Fund Evaluation Group, LLC, a subsidiary of Old National Bancorp, provides
investment consulting services specializing in portfolio structure, investment
management research and performance reporting.
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
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. Treasury also provides capital markets products,
including interest rate derivatives, foreign exchange and industrial revenue
bond financing for the company's commercial clients.
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 22 to the consolidated financial statements.
MARKET AREA
Old National provides financial services primarily in Indiana, with limited
presence in the northern part of the state, eastern and southeastern Illinois,
central and western Kentucky, northern Tennessee, western Ohio and eastern
Missouri, supporting both rural and urban communities.
The majority of existing Old National markets can be characterized as low-growth
and high-share markets. According to recent U.S. Census Bureau data, the 5-year
household growth projection for communities surrounding Old National offices is
less than 3%. Deposit market share information provided by FDIC statistics and
company information indicates that approximately 66% of existing client
households reside in communities in which Old National has 20% or greater
deposit market share. In contrast, new expansion markets in Indianapolis,
Indiana and Louisville, Kentucky offer exceptional market growth and share
increase opportunities with growth rates in excess of 5% and current deposit
market share of less than 2%. Median household income in the majority of markets
served by Old National averages $42,400, slightly under the 2003 census bureau
national median of $43,300. Median household income in targeted counties in the
expansion markets of Indianapolis and Louisville exceed national income levels,
reporting median household incomes of $49,300 and $46,400, respectively.
Two key growth strategies built around Old National market profiles focus on: 1)
increasing client household penetration with additional products and services in
low-growth, high-share markets; and 2) further investment into high-growth
markets. In 2004, expansion efforts continued with new offices opening in
Indianapolis, Indiana, O'Fallon, Illinois and Louisville, Kentucky.
After years of registering flat growth, Ball State University and Indiana
University's Kelly School of Business economists project employment will
increase 1.5 to 2 percent in 2005 for the state of Indiana, Old National's
primary state of operation. In addition, Indiana factory employment levels have
stabilized in what has been a challenged manufacturing sector.
5
The following table reflects Old National's market share for significant markets
with the most recent data available.
OLD NATIONAL DEPOSIT MARKET SHARE AND NUMBER OF BRANCH LOCATIONS
DEPOSITS AS OF JUNE 30, 2004
NUMBER OF DEPOSIT MARKET
MARKET LOCATION BRANCHES SHARE RANK
- --------------- --------- --------------
Evansville,Indiana 16 1st
Clarksville,Tennessee 5 2nd
Muncie,Indiana 7 3rd
Bloomington,Indiana 5 4th
Terre Haute,Indiana 6 2nd
Danville,Illinois 3 1st
Source: SNL Financial
ACQUISITION AND DIVESTITURE STRATEGY
Since the formation of Old National Bancorp in 1982, Old National has acquired
more than 40 financial institutions and financial services companies. In the
future, Old National will continue to pursue opportunities to acquire both
financial institutions and financial services companies. Acquisitions and
divestitures will be driven by a disciplined financial process and will be
consistent with the existing focus on community banking, client relationships
and consistent quality earnings. Targeted geographic markets for acquisitions
include mid-size markets within or near Old National's existing franchise with
average to above average growth rates.
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.
Old National plans to divest of selected non-strategic assets to better align
its operations with its market and product focus. See Note 23 to the
consolidated financial statements for further discussion regarding the expected
divestitures identified subsequent to December 31, 2004.
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, 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.
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. In response, the New York Stock Exchange also adopted new corporate
governance rules that are intended to allow shareholders to more easily and
efficiently monitor the performance of companies and directors.
6
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. Old National filed the Section 302(a) certifications with the
SEC and the Listed Company Manual Section 303A.12(a) CEO certification with the
New York Stock Exchange for the prior year.
On January 27, 2005, the Board of Directors approved amendments to the Corporate
Governance and Nominating Committee Charter, the Audit Committee Charter, the
Compensation Committee Charter, and the Code of Business Conduct and Ethics,
including changing the name of the Compensation Committee to the Compensation
and Management Development Committee. In addition, all associates are now
required annually to sign a written acknowledgement of the Code of Business
Conduct and Ethics as a basis of continued employment. The Senior Financial and
Executive Officer Code of Ethics remained intact as previously approved on
January 23, 2003. These corporate governance documents, and any future
amendments, will be available for review under the Corporate Governance link on
Old National's website at www.oldnational.com.
Effective August 14, 2003, pursuant to Section 404 of the Sarbanes-Oxley Act of
2002 the Company is required to include an internal control report of management
in its Annual Report on Form 10-K beginning with its first fiscal year ending
after June 15, 2004. The internal control report must contain (i) a statement of
management's responsibility for establishing and maintaining adequate internal
control over financial reporting, (ii) a statement identifying the framework
used by management to conduct the required evaluation of the effectiveness of
internal control over financial reporting, (iii) management's assessment of the
effectiveness of internal control over financial reporting as of the end of the
most recent fiscal year, including a statement as to whether or not internal
control over financial reporting is effective, and (iv) a statement that the
Company's independent auditors have issued an attestation report on management's
assessment of internal control over financial reporting. Refer to Item 8 for
Management's Report on Internal Control over Financial Reporting.
Effective October 28, 2004, the Board of Governors of the Federal Reserve System
("Board") adopted final amendments to Regulation CC and its commentary to
implement the Check Clearing for the 21st Century Act ("Check 21 Act"). The
Check 21 Act was enacted on October 28, 2003, and became effective on October
28, 2004.
To facilitate check truncation and electronic check exchange, the Check 21 Act
authorizes a new negotiable instrument called a "substitute check" and provides
that a properly prepared substitute check is the legal equivalent of the
original check for all purposes. A substitute check is a paper reproduction of
the original check that can be processed just like the original check. The Check
21 Act does not require any bank to create substitute checks or to accept checks
electronically. The Board's amendments: (i) set forth the requirements of the
Check 21 Act that apply to all banks, including those that choose not to create
substitute checks; (ii) provide a model disclosure and model notices relating to
substitute checks; and (iii) set forth bank endorsement and identification
requirements for substitute checks. The amendments to Regulation CC also clarify
some existing provisions of the rule and commentary. Old National is in
compliance with the Check 21 Act.
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 bank
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 businesses 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.
7
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
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, 2004. For Old National's regulatory capital ratios
and regulatory requirements as of December 31, 2004, see Note 20 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 20 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 publicly 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
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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 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 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 communications, 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. These statements 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) the ability of Old National to execute
its business plan and execute the "Ascend" project initiatives; (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 this and 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. The SEC maintains an Internet site that contains reports,
proxy and information statements and other information regarding issuers that
file electronically with the SEC, and Old National's filings are accessible on
the SEC's web site at www.sec.gov. The public may read and copy any
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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.
ITEM 2. PROPERTIES
The principal executive offices of Old National and its community banking,
non-banking services and treasury segments are currently located in the newly
constructed Evansville main financial center and corporate headquarters located
at 1 Main Street, Evansville, Indiana. The building is owned by Old National
Bank and is free from any encumbrances.
Old National's affiliate bank and subsidiaries conduct business primarily from
facilities Old National owns. Of the over 130 banking and financial services
centers operated by Old National in Indiana, Illinois, Kentucky, Tennessee, Ohio
and Missouri, 43 are leased from non-affiliated third parties and the remainder
are owned by Old National 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 18 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 2004.
10
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Old National's common stock is traded on the New York Stock Exchange ("NYSE")
under the ticker symbol ONB. The following table lists the NYSE price quotes,
share volume and dividend data for 2004 and 2003.
PRICE PER SHARE
---------------------- SHARE DIVIDEND
HIGH LOW VOLUME DECLARED
--------- --------- --------- ---------
2004
First Quarter $ 21.79 $ 20.02 6,498,660 $ 0.18
Second Quarter 24.33 20.89 8,714,895 0.18
Third Quarter 24.56 22.05 6,276,795 0.18
Fourth Quarter 25.41 22.90 5,702,865 0.18
--------- --------- --------- ---------
2003
First Quarter $ 21.63 $ 19.22 3,929,420 $ 0.17
Second Quarter 21.59 19.54 4,476,150 0.17
Third Quarter 21.73 20.28 3,974,513 0.17
Fourth Quarter 21.09 19.63 4,055,988 0.18
--------- --------- --------- ---------
Data adjusted for all stock dividends, including a 5% stock dividend to
shareholders of record on January 5, 2005, distributed on January 26, 2005.
In December 2004, a 5% stock dividend was declared to shareholders of record on
January 5, 2005. There were 26,639 shareholders of record as of December 31,
2004. Also, Old National declared $0.72 per share in dividends during the year
ended December 31, 2004, and $0.69 per share in dividends for the year ended
December 31, 2003. 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
20 to the consolidated financial statements for additional information.
In December 2003, the Board of Directors approved the repurchase of a maximum of
5% of outstanding stock during the calendar year 2004. Old National announced on
December 9, 2004, that the Board of Directors approved the continuation of the
stock repurchase program up to 5% of outstanding stock for 2005. The following
table summarizes the purchases of equity securities made by Old National during
the fourth quarter of 2004.
TOTAL NUMBER
OF
SHARES
PURCHASED
TOTAL AVERAGE AS MAXIMUM NUMBER OF
NUMBER PRICE PART OF PUBLICLY SHARES THAT MAY YET
OF SHARES PAID PER ANNOUNCED PLANS BE PURCHASED UNDER
PERIOD PURCHASED SHARE OR PROGRAMS THE PLANS OR PROGRAMS
------ --------- --------- ---------------- ---------------------
10/01/04 - 10/31/04 124,950 $ 23.19 124,950 2,143,552
11/01/04 - 11/30/04 34,545 23.75 34,545 2,107,542
12/01/04 - 12/31/04 113,190 24.51 113,190 1,989,549
-------- --------- ------- ---------
Total 272,685 $ 23.81 272,685 1,989,549
======== ========= ======= =========
Data adjusted for all stock dividends, including a 5% stock dividend to
shareholders of record on January 5, 2005, distributed on January 26, 2005.
11
ITEM 6. SELECTED FINANCIAL DATA
FIVE-YEAR
(dollars in thousands GROWTH
except per share data) 2004 2003 2002 2001 2000 1999 RATE
- ----------------------------------- ---------- ---------- ---------- ----------- ----------- ---------- ---------
RESULTS OF OPERATIONS
Net interest income (1) $ 274,702 $ 297,130 $ 314,606 $ 312,620 $ 289,510 $ 299,165 (1.7)%
Fee and service charge income 179,227 168,593 129,580 108,197 101,832 80,513 17.4
Net securities gains (losses) 2,936 23,556 12,444 4,770 (119) 2,637 N/M
Gain on branch divestitures - - 12,473 - - - N/M
---------- ---------- ---------- ----------- ----------- ---------- ------
Total revenue (1) $ 456,865 489,279 469,103 425,587 391,223 382,315 3.6
---------- ---------- ---------- ----------- ----------- ---------- ------
Provision for loan losses 22,400 85,000 33,500 28,700 29,803 14,798 8.6
Salaries and
other operating expenses 335,927 299,716 257,845 245,109 228,034 223,897 8.5
Merger and restructuring costs - - - 9,703 37,503 - N/M
Income taxes (1) 30,967 34,150 59,826 49,031 34,187 50,363 (9.3)
---------- ---------- ---------- ----------- ----------- ---------- ------
Income from
continuing operations 67,571 70,413 117,932 93,044 61,696 93,257 (6.2)
Discontinued operations (after-tax) - - - - - 4,101 N/M
---------- ---------- ---------- ----------- ----------- ---------- ------
Net Income $ 67,571 $ 70,413 $ 117,932 $ 93,044 $ 61,696 $ 97,358 (7.0)%
========== ========== ========== =========== =========== ========== ======
PER SHARE DATA (2)
Net income (diluted) $ 0.97 $ 1.00 $ 1.67 $ 1.29 $ 0.85 $ 1.30 (5.7)%
Cash dividends paid 0.72 0.69 0.63 0.56 0.53 0.49 8.0
Book value at year-end 10.15 10.24 10.52 9.03 8.55 8.10 4.6
Stock price at year-end 24.63 20.72 20.99 20.77 23.46 24.21 0.3
BALANCE SHEET DATA
(AT DECEMBER 31)
Total assets $8,898,304 $9,363,232 $9,612,556 $ 9,080,473 $ 8,767,748 $8,086,012 1.9%
Loans (3) 4,987,326 5,586,455 5,769,635 6,132,854 6,348,313 5,714,688 (2.7)
Deposits 6,414,263 6,493,092 6,439,280 6,616,440 6,583,906 5,962,069 1.5
Other borrowings 1,312,661 1,624,092 1,234,014 1,083,046 863,165 768,055 11.3
Shareholders' equity 703,208 715,490 740,710 639,235 626,341 584,995 3.7
PERFORMANCE RATIOS
Return on average assets 0.74% 0.74% 1.27% 1.05% 0.73% 1.25%
Return on average
shareholders' equity 9.51 9.48 17.05 14.45 10.55 15.82
Dividend payout 74.40 68.69 37.25 43.13 62.84 36.52
Average equity to average assets 7.79 7.78 7.47 7.27 6.92 7.90
Net interest margin (1) 3.31 3.37 3.65 3.77 3.65 4.09
Efficiency ratio
(noninterest expense/revenue)(1) 73.53 61.26 54.97 59.87 67.87 58.56
Net charge-offs
to average loans (3) 0.61 1.21 0.34 0.45 0.39 0.17
Allowance for loan losses to
ending loans (3) 1.72 1.70 1.52 1.21 1.16 1.15
OTHER DATA
Number of full-time
equivalent employees 2,743 3,019
Number of shareholders 26,639 25,459
Number of shares traded
(in thousands) (2) 27,193 16,436
---------- ----------
(1) Includes the effect of taxable equivalent adjustments of $23.9 million for
2004, $25.1 million for 2003, $25.2 million for 2002, $21.3 million for
2001, $19.6 million for 2000, and $17.9 million for 1999, 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 5, 2005, distributed on January 26, 2005. Diluted data assumes the
conversion of stock options, restricted stock and subordinated debentures.
(3) Includes residential loans held for sale.
N/M = Not meaningful
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
EXECUTIVE SUMMARY
Net income for 2004 decreased compared to previous years, impacted primarily by
nonrecurring charges related to "Ascend", decreased net securities gains and
reduced mortgage banking revenue. Weak loan demand in the markets served by Old
National as well as low interest rates continue to negatively affect the net
interest margin. Positive factors during 2004 included reduced provisions for
loan losses, increased insurance premiums and commissions, and increased service
charge income. In addition, 2003 included a $10.0 million reserve for the
settlement of pending litigation.
Old National's financial condition at December 31, 2004, reflected significant
reductions in loans, time deposits and borrowed funds. The reduction in loans
was primarily the result of two loan sales occurring during the year as well as
soft loan demand. Management uses various indicators such as return on assets,
return on equity and asset quality ratios 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, 2002 through 2004, and financial condition as
of December 31, 2004 and 2003. 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.
- - 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, pools of homogeneous 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 allowance. 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.
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 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.
13
Management follows the progress of the economy and how it 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
to evaluate 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.
Old National uses migration analysis as a tool to determine the adequacy
of the allowance for loan losses for non-retail loans that are not
impaired. Migration analysis is a statistical technique that attempts to
estimate probable losses for existing pools of loans by matching actual
losses incurred on loans back to their origination. The migration-derived
historical commercial loan loss rates are applied to the current
commercial loan pools to arrive at an estimate of probable losses for the
loans existing at the time of analysis.
Old National calculates migration analysis using several different
scenarios based on varying assumptions to evaluate the widest range of
possible outcomes. The amounts determined by migration analysis are
adjusted for management's best estimate of the effects of current economic
conditions, loan quality trends, results from internal and external review
examinations, loan volume trends, credit concentrations and various other
factors. Historic loss ratios adjusted for expectations of future economic
conditions are used in determining the appropriate level of reserves for
consumer and residential real estate loans.
Management's analysis of probable losses inherent in the portfolio at
December 31, 2004, resulted in a range for allowance for loan losses of
$7.2 million with the potential effect to net income ranging from a
decrease of $2.6 million to an increase of $2.1 million. These
sensitivities are hypothetical and are not intended to represent actual
results.
- - 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 mortgage servicing rights exists if the book value of the
mortgage servicing rights exceeds 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 are
derived by using a statistical modeling technique utilizing third-party
market-based prepayment rate assumptions. 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.
The decrease in fair value of mortgage servicing rights at December 31,
2004, to immediate 10% and 20% adverse changes in the current prepayment
assumptions would be approximately $0.9 million and $1.7 million,
respectively. A 10% and 20% adverse change in the discount rate assumption
would decrease the fair value of mortgage servicing rights at December 31,
2004, by $0.5 million and $0.9 million, respectively. These sensitivities
are hypothetical and are not intended to represent actual results. Also,
in reality, changes in one factor may result in changes in other factors,
which might magnify or counteract the sensitivities.
- - GOODWILL AND INTANGIBLES. For acquisitions, Old National is required to
record the assets acquired, including identified intangible assets, and
the liabilities assumed at their fair value. These often involve 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 Statement of Financial Accounting Standards ("SFAS") No.
142 "Goodwill and Other Intangible Assets," 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
14
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 determination of fair values is based on internal valuations using
management's assumptions of future growth rates, future attrition,
discount rates, multiples of earnings or other relevant factors. Changes
in these factors, as well as downturns in economic or business conditions,
could have a significant adverse 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 valuation 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." This
"Management's Discussion and Analysis" may contain non-GAAP financial measures.
For purposes of Regulation G, a non-GAAP financial measure is a numerical
measure of the registrant's historical or future financial performance,
financial position or cash flows that excludes amounts, or is subject to
adjustments that have the effect of excluding amounts, that are included in the
most directly comparable measure calculated and presented in accordance with
GAAP in the statement of income, balance sheet or statement of cash flows (or
equivalent statements) of the issuer; or includes amounts, or is subject to
adjustments that have the effect of including amounts, that are excluded from
the most directly comparable measure so calculated and presented.
In this regard, GAAP refers to generally accepted accounting principles in the
United States of America. Pursuant to the requirements of Regulation G, Old
National has provided reconciliations, as necessary, of the non-GAAP financial
measure to the most directly comparable GAAP financial measure. See the
"Earnings Summary" of this "Management's Discussion and Analysis" for non-GAAP
financial measures.
ACQUISITION, CONSOLIDATION AND DIVESTITURE ACTIVITY
During 2003, Old National acquired three insurance agency operations, which
enhanced the growth of the non-bank services segment. See Note 2 to the
consolidated financial statements for more details.
Subsequent to December 31, 2004, Old National committed to a plan to sell
selected non-strategic assets to better align its operations with its market and
product focus. See Note 23 to the consolidated financial statements for further
discussion regarding the expected divestitures identified subsequent to December
31, 2004.
15
RESULTS OF OPERATIONS
EARNINGS SUMMARY
In 2004, Old National generated $67.6 million of net income and $0.97 net income
per share compared to $70.4 million and $1.00, respectively in 2003. Old
National's return on average assets ("ROA") was 0.74% and return on average
shareholders' equity ("ROE") was 9.51% for the year, which was comparable to the
2003 ratios of 0.74% and 9.48%, respectively. Excluding the nonrecurring
implementation charges related to "Ascend" of $17.5 million after-tax, Old
National's return on average assets and return on average shareholders' equity
for the year ended December 31, 2004, was 0.93% and 11.97%, respectively, as
reconciled in Table 1 and compared to the year ended December 31, 2003.
ROA/ROE (TABLE 1)
ROA ROE
---- ----
As reported December 31, 2004 0.74% 9.51%
Effect of "Ascend" implementation charges 0.19 2.46
---- -----
Excluding "Ascend" implementation charges 0.93% 11.97%
==== =====
As reported December 31, 2003 0.74% 9.48%
==== =====
Lower interest rates, as well as the sale of $405.6 million of residential real
estate loans during the second quarter of 2004, weak commercial loan demand, and
the reduction of the average investment portfolio contributed to a decline of
$22.4 million in net interest income for 2004 compared to 2003.
Noninterest income decreased $10.0 million in 2004, the result of reduced net
securities gains and decreased mortgage revenue, offset primarily by increased
insurance premiums and commissions and service charge income. Increased mortgage
loan rates above the record low rates of 2003 hindered mortgage originations for
2004 compared to 2003. Details are discussed further in the "Noninterest Income"
section of this "Management's Discussion and Analysis."
Noninterest expense increased as a result of the nonrecurring pre-tax charges
related to "Ascend" of $25.5 million, or $17.5 million after tax, as well as
increased severance benefits related to reorganization of management and
increased occupancy expense due to the new Evansville main financial center and
corporate headquarters. Also, in 2003 a charge of $10.0 million pre-tax, or $6.7
million after-tax was recorded to establish a reserve related to litigation
settlements. The details of these expenses are discussed further in the
"Noninterest Expense" section of this "Management's Discussion and Analysis".
Also, see additional information on "Ascend" and details regarding the new
Evansville main financial center and corporate headquarters below.
The most significant positive impact on December 31, 2004 earnings was the
decrease in the provision for loan losses of $62.6 million, largely a result of
the reduction of nonperforming loans and charge-offs and reflective of enhanced
credit administration and underwriting functions during 2004.
The company-wide program, "Ascend," was announced in late 2003. The initial
phase of the project was conducted with the assistance of EHS Partners and was
an intense evaluation of every aspect of operations for expense reductions and
revenue growth ideas. At December 31, 2004, "Ascend" was in the implementation
phase. Ideas representing approximately $36.6 million of the targeted earnings
were complete, $27.8 million were on time, $3.1 million were late, $4.8 million
were at risk of completion, $4.7 million were withdrawn and an additional $3.5
million of new ideas had been identified. Initiatives arising from the project
are expected to be fully implemented by the end of 2005, with full realization
of benefits by 2006.
In 2001, the Board of Directors approved construction of a new Evansville main
financial center and corporate headquarters to be completed prior to expiration
of the operating leases on the buildings then occupied. Prior to this decision,
the Board of Directors evaluated renewal options for the leases on the
then-occupied buildings including capital investments that would be required for
improvements to the leased facilities. It was determined that the costs
associated with continuing the leases and making the required capital
investments would be relatively comparable to constructing a new building. The
new Evansville main financial center and corporate headquarters was placed into
service on August 11, 2004. At December 31, 2004, the total project cost was
$73.7 million including building
16
components of $58.4 million, furniture, fixtures and equipment of $7.3 million,
land of $4.9 million and capitalized interest of $3.1 million.
BUSINESS LINE RESULTS
Old National is managed in three primary business segments. Table 2 summarizes
Old National's business line results for the years ended December 31.
BUSINESS LINE RESULTS (TABLE 2)
(dollars in thousands) 2004 2003 2002
- -------------------------- ------- ------- ---------
Community banking $ 56,584 $50,043 $ 90,336
Non-bank services 2,882 4,628 1,222
Treasury 8,105 22,476 18,092
Other - (6,734) 8,282
-------- ------- ---------
Consolidated net income $ 67,571 $70,413 $ 117,932
======== ======= =========
The 2004 community banking segment profit increased $6.5 million from 2003. The
most significant impact on the community banking segment profit was the decrease
of $62.8 million in the provision for loan losses, which is reflective of
enhanced credit administration and underwriting functions during 2004, as well
as a decline in the loan portfolio. This decline in the provision was offset by
decreased noninterest income of $8.0 million, decreased net interest income of
$5.1 million and increased noninterest expense of $41.1 million. Noninterest
income was affected primarily by the decline in mortgage banking activity during
the current year. The decline in net interest income was reflective of a
decrease in average earning assets as well as an increase in the cost of
funding. The most significant contributors to the increase in noninterest
expense in 2004 were the nonrecurring charges related to "Ascend," severance
benefits related to reorganization of management and professional fees related
to compliance with banking regulations and the first year implementation of
Section 404 of the Sarbanes-Oxley Act.
The 2004 non-bank services segment profit decreased $1.7 million from 2003 which
is reflective of an increase in noninterest income of $17.6 million that was
offset by an increase in noninterest expense of $20.6 million. The growth in
noninterest income was primarily due to the insurance acquisitions made during
2003. The increase in noninterest expense can be partially attributed to these
acquisitions and partially to the allocation of the "Ascend" charges. The
treasury segment profit showed a decline of $14.4 million in 2004 as compared to
2003, primarily as a result of the net securities gains decrease of $20.6
million in 2004 compared to 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, or $6.7 million after tax.
NET INTEREST INCOME
Net interest income was the most significant component of Old National's
earnings, comprising over 57% of 2004 revenues. Net interest income and net
interest margin in the following discussion is presented on a fully taxable
equivalent basis, which adjusts tax-exempt interest income to an amount that
would be comparable to interest subject to income taxes. Net income is
unaffected by these taxable equivalent adjustments as an offsetting increase of
the same amount is made in the income tax section. Net interest income included
taxable equivalent adjustments of $23.9 million for 2004 and $25.1 million for
2003.
Net interest income and margin are influenced by many factors, primarily the
volume and mix of earning assets and funding sources and 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 client 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 $274.7 million in 2004, a 7.5%
decrease from the $297.1 million reported in 2003. The net interest margin was
3.31% for 2004, compared to 3.37% reported for 2003. The reduction in net
interest income was a result of the increase in the cost of funding without
offsetting increases in earning asset yields. Average earning assets declined by
$516.2 million, which consisted of decreased investment
17
securities of $274.3 million and decreased loans of $310.7 million, net of
increased money market investments of $68.8 million. The yield on average
earning assets declined 30 basis points from 5.62% to 5.32%. Average
interest-bearing liabilities declined by $441.3 million or 5.6%, which included
decreased borrowings of $400.1 million and decreased interest-bearing deposits
of $41.2 million. The cost of interest-bearing liabilities declined 27 basis
points from 2.49% to 2.22%. Noninterest-bearing deposits provided $50.3 million
in funding.
The continued decline in interest rates during 2003 and early 2004 had a notable
effect on the volume, mix and yield of average earning assets. The target
Federal funds rate, the rate that dictates national prime rate and determines
many other short-term loan and liability rates, began to rise in June 2004 from
1.00% to 2.25% by December 2004. Market-driven interest rates, as evidenced by
the five-year United States Treasury Note weekly yield, increased slowly but not
significantly during 2004 from 3.05% in January to 3.61% in December.
Significantly affecting average earning assets during 2004 was the sale of
$405.6 million of residential real estate loans at the end of the second quarter
of 2004. In addition, commercial and commercial real estate loans continued to
decline during 2004 as a result of continued weak loan demand in Old National's
markets, more stringent loan underwriting standards, and the sale of $43.1
million in nonaccrual commercial and commercial real estate loans during the
fourth quarter of 2004. During 2004, the company continued its strategy to
reduce its investment portfolio assets because of the narrow spreads available
on those assets in the current rate environment. However, at the end of 2004,
the investment portfolio increased slightly as a short-term investment of funds
from the fourth-quarter loan sale.
Table 3 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 4 shows fluctuations in net interest
income attributable to changes in the average balances of assets and liabilities
and the yields earned or rates paid for the years ended December 31.
18
THREE-YEAR AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS (TABLE 3)
2004 2003 2002
------------------------------ ---------------------------- -------------------------------
(taxable 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 $ 95,094 $ 1,318 1.39% $ 26,284 $ 314 1.19% $ 25,841 $ 383 1.48%
Investment securities: (5)
U.S. Treasury and
Government agencies (1) 2,062,855 79,777 3.87 2,338,860 94,475 4.04 1,934,693 100,076 5.17
States and political
subdivisions (4) 638,413 44,164 6.92 667,498 46,856 7.02 656,085 46,777 7.13
Other securities 153,329 6,355 4.14 122,507 5,956 4.86 120,467 7,135 5.92
---------- -------- ---- ---------- -------- ---- ---------- -------- ----
Total investment securities 2,854,597 130,296 4.56 3,128,865 147,287 4.71 2,711,245 153,988 5.68
---------- -------- ---- ---------- -------- ---- ---------- -------- ----
Loans: (2)
Commercial (4) 1,611,132 87,191 5.41 1,686,664 94,706 5.61 1,690,377 111,201 6.58
Commercial real estate 1,767,528 100,674 5.70 1,866,105 109,475 5.87 1,844,492 127,877 6.93
Residential real estate (3) 765,537 42,896 5.60 1,003,098 63,947 6.37 1,286,664 94,135 7.32
Consumer, net of
unearned income 1,196,490 78,718 6.58 1,095,567 79,142 7.22 1,056,730 84,976 8.04
---------- -------- ---- ---------- -------- ---- ---------- -------- ----
Total loans (3) 5,340,687 309,479 5.79 5,651,434 347,270 6.14 5,878,263 418,189 7.11
---------- -------- ---- ---------- -------- ---- ---------- -------- ----
Total earning assets 8,290,378 $441,093 5.32% 8,806,583 $494,871 5.62% 8,615,349 $572,560 6.65%
======== ==== ======== ==== ======== ====
Less: Allowance for
loan losses (97,779) (89,127) (81,365)
NON-EARNING ASSETS
Cash and due from banks 191,494 178,189 186,534
Other assets 739,403 660,360 543,421
---------- ---------- ----------
Total assets $9,123,496 $9,556,005 $9,263,939
========== ========== ==========
INTEREST-BEARING LIABILITIES
NOW deposits $1,735,613 $ 16,306 0.94% $1,504,662 $ 13,550 0.90% $1,215,858 $ 15,033 1.24%
Savings deposits 471,339 2,226 0.47 479,328 3,511 0.73 462,633 5,454 1.18
Money market deposits 586,957 6,428 1.10 612,044 5,729 0.94 644,037 10,003 1.55
Time deposits 2,822,872 86,311 3.06 3,061,922 115,881 3.78 3,468,623 156,070 4.50
---------- -------- ---- ---------- -------- ---- ---------- -------- ----
Total interest-bearing
deposits 5,616,781 111,271 1.98 5,657,956 138,671 2.45 5,791,151 186,560 3.22
Short-term borrowings 406,121 3,890 0.96 687,588 7,258 1.06 688,958 10,971 1.59
Other borrowings 1,471,621 51,230 3.48 1,590,262 51,812 3.26 1,283,225 60,423 4.71
---------- -------- ---- ---------- -------- ---- ---------- -------- ----
Total interest-bearing
liabilities 7,494,523 $166,391 2.22% 7,935,806 $197,741 2.49% 7,763,334 $257,954 3.32%
======== ==== ======== ==== ======== ====
NONINTEREST-BEARING
LIABILITIES
Demand deposits 803,074 752,788 712,308
Other liabilities 115,475 124,327 96,601
Shareholders' equity 710,424 743,084 691,696
---------- ---------- ----------
Total liabilities and
shareholders' equity $9,123,496 $9,556,005 $9,263,939
========== ========== ==========
INTEREST MARGIN RECAP
Interest income/average
earning assets $441,093 5.32% $494,871 5.62% $572,560 6.65%
Interest expense/average
earning assets 166,391 2.01 197,741 2.25 257,954 3.00
-------- ---- -------- ---- -------- ----
Net interest income
and margin $274,702 3.31% $297,130 3.37% $314,606 3.65%
======== ==== ======== ==== ======== ====
(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
$7.1 million in 2004, $8.9 million in 2003 and $12.2 million in 2002.
(3) Includes residential loans held for sale.
(4) Interest on states and political subdivisions investment securities and
commercial loans includes the effect of taxable equivalent adjustments of
$15.1 million and $8.8 million, respectively, in 2004; $15.9 million and
$9.2 million, respectively, in 2003; and $16.0 million and $9.2 million,
respectively, in 2002; using the federal statutory tax rate in effect of
35% for all periods.
(5) Yield information does not give effect to changes in fair value that are
reflected as a component of shareholders' equity.
19
NET INTEREST INCOME - RATE/VOLUME ANALYSIS (TABLE 4)
2004 VS. 2003 2003 VS. 2002
------------------------------------- ------------------------------------
(taxable equivalent basis, ATTRIBUTED TO ATTRIBUTED TO
TOTAL --------------------- TOTAL ------------------
dollars in thousands) CHANGE VOLUME RATE CHANGE VOLUME RATE
- -------------------------- -------- -------- ------- -------- ------- --------
INTEREST INCOME
Money market investments $ 1,004 $ 887 $ 117 $ (69) $ 6 $ (75)
Investment securities (1) (16,991) (12,715) (4,276) (6,701) 21,689 (28,390)
Loans (1) (37,791) (18,551) (19,240) (70,919) (15,038) (55,881)
-------- -------- ------- -------- ------- --------
Total interest income (53,778) (30,379) (23,399) (77,689) 6,657 (84,346)
-------- -------- ------- -------- ------- --------
INTEREST EXPENSE
NOW deposits 2,756 2,124 632 (1,483) 3,086 (4,569)
Savings deposits (1,285) (48) (1,237) (1,943) 160 (2,103)
Money market deposits 699 (254) 953 (4,274) (398) (3,876)
Time deposits (29,570) (8,179) (21,391) (40,189) (16,846) (23,343)
Short-term borrowings (3,368) (2,834) (534) (3,713) (18) (3,695)
Other borrowings (582) (3,997) 3,415 (8,611) 12,231 (20,842)
-------- -------- ------- -------- ------- --------
Total interest expense (31,350) (13,188) (18,162) (60,213) (1,785) (58,428)
-------- -------- ------- -------- ------- --------
Net interest income $(22,428) $(17,191) $(5,237) $(17,476) $ 8,442 $(25,918)
======== ======== ======= ======== ======= ========
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 $15.1 million and $8.8 million, respectively, in
2004; $15.9 million and $9.2 million, respectively, in 2003; and $16.0
million and $9.2 million, respectively, in 2002; using the federal statutory
tax rate in effect of 35% for all periods.
PROVISION FOR LOAN LOSSES
The provision for loan losses was $22.4 million in 2004, a significant reduction
from the $85.0 million recorded in 2003, which can be primarily attributed to
enhanced credit administration and underwriting functions during 2004. 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 client
fees and sales commissions from its core banking franchise and other related
businesses, such as wealth management, investment consulting, investment
products and insurance. This source of revenue has remained steady as a
percentage of total revenue at 39.9% in 2004 compared to 39.3% in 2003.
Noninterest income for 2004 was $182.2 million, a decrease of $10.0 million, or
5.2% compared to $192.1 million reported for 2003, impacted most significantly
by a $20.6 million reduction of net securities gains and a $10.7 million
decrease in mortgage revenue. In 2004, Old National realized $2.9 million of
gains on the sales of investment securities in comparison to $23.6 million for
2003. Investment securities transactions are considered part of the continuing
management of the balance sheet to address interest rate and yield curve shifts.
The decrease in mortgage banking revenue was primarily attributable to the
reduction in mortgage origination activity during 2004. Residential real estate
loan originations for 2004 were $0.587 billion compared to the record level of
$1.316 billion for 2003, with high levels of refinancing activity during 2003
being driven by unusually low interest rates. During 2004, net recoveries to the
mortgage servicing rights valuation allowance of $1.1 million and a net gain of
$2.7 million from the sale of $405.6 million of residential real estate loans in
the second quarter of 2004, partially offset reductions in income attributable
to decreased mortgage origination activity.
These decreases were partially offset by net increases of $21.3 million in fee
and service charge income, excluding mortgage revenue. Most of the growth
occurred in insurance premiums and commissions which increased by $14.0 million
or 35.6%, reflective of a full year's results for the insurance agencies
acquired during 2003. Also deposit-related fees and service charges were $48.5
million in 2004, compared to $44.9 million for 2003, an increase of $3.6
million, or 8.1%. The generation of increased revenue was primarily attributable
to processing changes and ideas developed through the "Ascend" process.
20
Table 5 presents changes in the components of noninterest income for the years
ended December 31.
NONINTEREST INCOME (TABLE 5)
% CHANGE FROM
PRIOR YEAR
----------
(dollars in thousands) 2004 2003 2002 2004 2003
- ---------------------- ---- ---- ---- ---- ----
Wealth management fees $ 19,897 $ 19,945 $ 19,209 (0.2) % 3.8 %
Investment consulting fees 11,542 10,525 5,178 9.7 103.3
Service charges on deposit accounts 48,466 44,855 41,988 8.1 6.8
ATM and debit card fees 8,852 7,474 6,876 18.4 8.7
Mortgage banking revenue 8,491 19,144 14,496 (55.6) 32.1
Insurance premiums and commissions 53,175 39,225 16,686 35.6 135.1
Investment product fees 12,025 10,567 8,983 13.8 17.6
Bank-owned life insurance 7,477 6,922 7,944 8.0 (12.9)
Other income 9,302 9,936 8,220 (6.4) 20.9
-------- -------- -------- ---- -------
Total fee and service charge income 179,227 168,593 129,580 6.3 30.1
Net securities gains 2,936 23,556 12,444 N/M N/M
Gain on branch divestitures - - 12,473 N/M N/M
-------- -------- -------- ---- -------
Total noninterest income $182,163 $192,149 $154,497 (5.2) % 24.4 %
======== ======== ======== ==== =======
Noninterest income to total revenue (1) 39.9 % 39.3 % 32.9 %
(1) Total revenue includes the effect of a taxable equivalent adjustment of
$23.9 million in 2004, $25.1 million in 2003 and $25.2 million in 2002.
N/M = Not meaningful
NONINTEREST EXPENSE
Noninterest expense for 2004 totaled $335.9 million, an increase of $36.2
million, or 12.1% over the $299.7 million recorded in 2003. Old National strives
to improve its efficiency through cost control efforts and technology
advancements while still providing quality client service. Driven by an increase
in nonrecurring expenses related to the "Ascend" project, as well as severance
benefits resulting from management reorganization, the efficiency ratio
increased to its highest level in the past six years of 73.53% in 2004 from
61.26% in 2003.
The "Ascend" project, as discussed in Item 1, "Business," was 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. Nonrecurring expenses related to "Ascend" are summarized in Table 6.
"ASCEND" (TABLE 6)
(dollars in thousands) 2004
- ---------------------- ----
Professional fees $14,790
Salaries and employee benefits 9,427
Other 1,258
-------
Total "Ascend" expenses $25,475
=======
Salaries and benefits, the largest component of noninterest expense, totaled
$192.7 million in 2004, compared to $169.0 million in 2003, an increase of $23.7
million, or 14.0%. This increase is primarily attributable to severance and
related benefits expense of $14.2 million recorded during 2004, including
expenses related to several members of management and senior executives leaving
the company during the year as well as terminations related to "Ascend"
reflected in the table above. The increase in salaries and employee benefits
expense is also reflective of a full year's operations for three insurance
agencies acquired during 2003.
Professional fees totaled $26.3 million for 2004 compared to $9.1 million for
2003, an increase of $17.2 million. As indicated above, consulting fees paid to
EHS Partners during 2004 in connection with "Ascend" accounted for $14.8 million
of the increase. Other increases related primarily to fees paid in connection
with strengthening compliance with banking regulations and first year
implementation of Section 404 of the Sarbanes-Oxley Act.
21
Other losses totaled $6.2 million, a decrease of $8.4 million compared to $14.7
million for 2003. This decrease was primarily attributable to the $10.0 million
charge in 2003 to establish a reserve in connection with litigation. For
additional information on litigation, see Note 18 to the consolidated financial
statements.
The remaining components of noninterest expense totaled $110.7 million for 2004
compared to $106.9 million for 2003. This increase is primarily attributable to
increased occupancy expense partially related to the new Evansville main
financial center and corporate headquarters, the provision for unfunded
commitments and increased processing expense offset partly by decreases in
several other noninterest expense accounts.
Old National completed construction of its principal executive offices in 2004.
It is estimated that the net increase to occupancy, equipment and other
noninterest expense components will have an annualized decrease to net income
per share of $0.01. However, the impact does not take into account that the
lease of Old National's previous headquarters would have increased substantially
beginning in 2005, reducing the effect below $0.01. See additional details of
the new Evansville main financial center and corporate headquarters in the
"Results of Operations" section of this "Management's Discussion and Analysis."
Table 7 presents changes in the components of noninterest expense for the years
ended December 31.
NONINTEREST EXPENSE (TABLE 7)
% CHANGE FROM
PRIOR YEAR
----------
(dollars in thousands) 2004 2003 2002 2004 2003
- ---------------------- ---- ---- ---- ---- ----
Salaries and employee benefits $192,718 $169,025 $148,450 14.0% 13.9%
Occupancy 20,444 18,166 16,154 12.5 12.5
Equipment 14,662 14,296 15,153 2.6 (5.7)
Marketing 10,051 11,085 11,026 (9.3) 0.5
Outside processing 21,124 19,078 13,640 10.7 39.9
Communications and transportation 11,128 11,595 11,738 (4.0) (1.2)
Professional fees 26,297 9,111 8,959 188.6 1.7
Loan expense 6,509 7,041 6,496 (7.6) 8.4
Supplies 4,019 4,829 5,048 (16.8) (4.3)
Other losses 6,235 14,676 5,445 (57.5) 169.5
Other expense 22,740 20,814 15,736 9.3 32.3
-------- -------- -------- ----- -----
Total noninterest expense $335,927 $299,716 $257,845 12.1% 16.2%
======== ======== ======== ===== =====
PROVISION FOR INCOME TAXES
Old National records a provision for income taxes currently payable and for
income taxes payable or benefits to be received 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 9.5% in 2004 and 11.4% in 2003. The decreased
tax rate in 2004 resulted from a higher percentage of tax-exempt income to total
income. The reduction in 2004 total income is discussed in the earnings summary
above. See Note 12 to the consolidated financial statements for additional
details on Old National's income tax provision.
22
INTERIM FINANCIAL DATA
Table 8 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 8)
(dollars and shares QUARTERS ENDED 2004 QUARTERS ENDED 2003
---------------------------------------------- -----------------------------------------------
in thousands, DECEMBER SEPTEMBER JUNE MARCH DECEMBER SEPTEMBER JUNE MARCH
except per share data) 31 30 30 31 31 30 30 31
- ---------------------------- --------- --------- --------- --------- --------- --------- --------- ---------
Interest income $ 102,171 $ 101,478 $ 105,428 $ 108,121 $ 111,176 $ 114,761 $ 120,233 $ 123,578
Interest expense 42,637 40,473 40,271 43,010 44,909 47,289 51,768 53,775
--------- --------- --------- --------- --------- --------- --------- ---------
Net interest income 59,534 61,005 65,157 65,111 66,267 67,472 68,465 69,803
Provision for loan losses - 7,400 7,500 7,500 26,000 27,500 22,500 9,000
Noninterest income 43,332 42,131 51,072 45,628 40,543 45,773 62,913 42,920
Noninterest expense 81,362 75,425 98,687 80,453 80,126 75,465 73,960 70,165
--------- --------- --------- --------- --------- --------- --------- ---------
Income before income taxes 21,504 20,311 10,042 22,786 684 10,280 34,918 33,558
Income tax expense (benefit) 2,909 2,127 (1,241) 3,277 (4,592) (1,530) 7,851 7,298
--------- --------- --------- --------- --------- --------- --------- ---------
Net income $ 18,595 $ 18,184 $ 11,283 $ 19,509 $ 5,276 $ 11,810 $ 27,067 $ 26,260
========= ========= ========= ========= ========= ========= ========= =========
Net income per share (1)
Basic $ 0.27 $ 0.26 $ 0.16 $ 0.28 $ 0.07 $ 0.17 $ 0.39 $ 0.37
Diluted 0.27 0.26 0.16 0.28 0.07 0.17 0.39 0.37
--------- --------- --------- --------- --------- --------- --------- ---------
Weighted average shares (1)
Basic 69,132 69,353 69,651 69,677 70,011 70,249 69,978 70,233
Diluted 70,022 70,067 70,160 69,783 70,064 70,425 70,034 70,292
========= ========= ========= ========= ========= ========= ========= =========
(1) All share and per share data have been adjusted for stock dividends,
including a 5% stock dividend to shareholders of record on January 5, 2005,
distributed on January 26, 2005. Diluted data assumes the conversion of stock
options and restricted stock.
FINANCIAL CONDITION
OVERVIEW
Old National's assets at December 31, 2004, were $8.898 billion, a 5.0% decrease
compared to $9.363 billion recorded at December 31, 2003. Investments increased
$95.5 million, loans decreased $605.3 million and total liabilities declined
$452.6 million compared to December 31, 2003. Total shareholders' equity
decreased $12.3 million since December 31, 2003.
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 $8.012
billion at December 31, 2004, a decrease of 5.9% from $8.518 billion at December
31, 2003. The reduction in earning assets is due to a decline in the loan
portfolio. At December 31, 2004, total loans, including residential loans held
for sale, decreased $599.1 million compared to December 31, 2003. This decline
can be attributed primarily to sales of $448.7 million in commercial, commercial
real estate and residential real estate loans during the year as well as to
continued weakness in commercial lending. Investment securities increased at
December 31, 2004, as a temporary source of earning assets; however, during 2004
Old National reduced its average investment portfolio in light of fewer
attractive investment opportunities and the company's desire to reduce its
sensitivity to rising interest rates.
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. Emerging Issues Task Force ("EITF") Issue 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments," may
potentially affect the treatment of investments in an unrealized loss position.
Until final guidance is issued by the FASB, it is uncertain whether this EITF
Issue will have a material impact on Old National. At December 31, 2004, Old
National does not believe any individual unrealized loss on available-for-sale
securities represents other-than-temporary impairment. The unrealized losses are
primarily attributable to changes in interest rates. Old National has both the
intent and ability to hold the securities for a time necessary to recover the
amortized cost.
23
At December 31, 2004, the investment securities portfolio was $2.963 billion
compared to $2.868 billion at December 31, 2003, an increase of 3.3%. Investment
securities represented 37.0% of earning assets at December 31, 2004, compared to
33.7% at December 31, 2003. During 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 and continuing into 2004,
Old National decreased the size of the investment portfolio and used the cash
flows generated by the declining investment portfolio to reduce borrowed funds.
At the end of 2004, investments increased slightly as a short-term investment of
funds from the fourth-quarter loan sale. Stronger economic activity and stronger
commercial loan demand would likely result in increased investments in loans and
a reduction in the investment securities portfolio.
Investment securities available-for-sale portfolio had net unrealized gains of
$9.3 million at December 31, 2004, compared to $23.7 million at December 31,
2003. These unrealized gains are driven by interest rate conditions. The
decrease was a result of higher market interest rates at December 31, 2004,
compared to December 31, 2003. Also, Old National realized pre-tax net gains on
sales of securities from the available-for-sale portfolio of $2.9 million during
2004 and $23.6 million during 2003.
As a result of a planned reduction, the investment portfolio had an effective
duration of 3.70 years at December 31, 2004, compared to 4.31 years at December
31, 2003. The weighted average yields on available-for-sale investment
securities were 4.08% in 2004 and 4.90% in 2003. The average yields on the
held-to-maturity portfolio were 4.31% in 2004 and 4.29% in 2003.
At December 31, 2004, Old National had a concentration of investment securities
issued by certain states and their political subdivisions with the following
aggregate market values: $143.2 million by Indiana, which represented 20.4% of
shareholders' equity, and $113.0 million by Illinois, which represented 16.1% of
shareholders' equity. At December 31, 2003, the aggregate market values of the
concentration of certain states and their political subdivisions were $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. 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 $22.5 million at December 31, 2004,
compared to $16.3 million at December 31, 2003. 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.
During 2004, loan originations were down compared to 2003, primarily due to a
reduced level of loan refinancing resulting from an upturn in interest rates
above the record low rates of 2003.
LENDING AND LOAN ADMINISTRATION
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 credit personnel, which now include independent underwriting and
analytic support staff, 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, as
well as outside directors. 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 clients in various industries including manufacturing,
agribusiness, transportation, mining, wholesaling and retailing. As measured by
Old National at December 31, 2004, 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. 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 a decline of commercial loans
and tighter credit underwriting standards. Old National anticipates that when
the economy in Old National's principal markets shows increased improvement,
commercial loans will begin to show higher levels of growth.
24
In the past four years, commercial, commercial real estate and residential real
estate loans declined 0.9%, 2.3% and 26.4% per year, respectively while consumer
loans rose 3.8% annually over the same period. Table 9 presents the composition
of the loan portfolio at December 31.
LOAN PORTFOLIO AT YEAR-END (TABLE 9)
FOUR-YEAR
(dollars in thousands) 2004 2003 2002 2001 2000 GROWTH RATE
---------- ---------- ---------- ---------- ---------- ----------
Commercial $1,550,640 $1,618,095 $1,696,347 $1,742,937 $1,606,509 (0.9) %
Commercial real estate 1,653,122 1,849,275 1,883,303 1,848,945 1,810,805 (2.3)
Consumer credit 1,205,657 1,163,325 1,053,571 1,063,792 1,040,127 3.8
---------- ---------- ---------- ---------- ---------- ----
Total loans excluding residential real estate 4,409,419 4,630,695 4,633,221 4,655,674 4,457,441 (0.3)
Residential real estate 555,423 939,422 1,043,816 1,449,080 1,890,872 (26.4)
---------- ---------- ---------- ---------- ---------- ----
Total loans 4,964,842 5,570,117 5,677,037 6,104,754 6,348,313 (6.0) %
Less: Allowance for loan losses 85,749 95,235 87,742 74,241 73,833 ====
---------- ---------- ---------- ---------- ----------
Net loans $4,879,093 $5,474,882 $5,589,295 $6,030,513 $6,274,480
========== ========== ========== ========== ==========
COMMERCIAL AND CONSUMER LOANS
Commercial and consumer loans are the largest classification within the earning
assets of Old National representing 55.0% of earning assets at December 31,
2004, a slight increase from 54.4% at December 31, 2003. At December 31, 2004,
commercial and commercial real estate loans decreased $67.5 million and $196.2
million, respectively, from December 31, 2003. During 2004, Old National sold
$43.1 million of non-performing commercial and commercial real estate loans,
which contributed to the change in commercial and commercial real estate loans.
A write-down of $3.4 million was recorded against the allowance for loan losses
related to these sales. Weak loan demand in Old National' s markets continued to
affect commercial loan growth in 2004. Consumer loans, including automobile
loans, personal and home equity loans and lines of credit, and student loans,
increased $42.3 million or 3.6% at December 31, 2004, compared to December 31,
2003, primarily the result of enhancements to marketing and customer contact
programs.
Table 10 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.
DISTRIBUTION OF COMMERCIAL LOAN MATURITIES AT DECEMBER 31, 2004 (TABLE 10)
WITHIN 1 - 5 BEYOND
(dollars in thousands) 1 YEAR YEARS 5 YEARS TOTAL
---------- ---------- ---------- ----------
Interest rates:
Predetermined $ 195,618 $ 343,836 $ 176,334 $ 715,788
Floating 577,253 205,301 52,298 834,852
---------- ---------- ---------- ----------
Total $ 772,871 $ 549,137 $ 228,632 $1,550,640
========== ========== ========== ==========
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 into 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 generally sold
with loan servicing retained in order to maintain client 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.
Residential real estate loans were $555.4 million at December 31, 2004, a
decrease of $384.0 million or 40.9% from December 31, 2003. The sale of $405.6
million of residential real estate loans during the year was the most
significant contributor to this decrease. At December 31, 2004, Old National was
in the process of making a strategic shift from the mortgage operations being
managed as a line of business with free-standing offices to being an integral
part of the focus on expanding customer relationships.
25
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 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 it 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 to
evaluate 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 or more and other loans deemed to have well-defined
weaknesses while criticized loans, also known as special mention loans, are
loans that are deemed to have potential weaknesses that deserve management's
close attention and also require specific monthly 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 interest. When loans are classified as nonaccrual, interest accrued
during the current 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 probable losses
is, by its very