Welcome to the Old National Bancorp First Quarter 2019 Earnings Conference Call. This call is being recorded and has been made accessible to the public in accordance with the SEC’s Regulation FD. Corresponding presentation slides can be found on the Investor Relations page at oldnational.com and will be archived there for 12 months.

Before turning the call over to management, I would like to remind everyone that as noted on Slide 2, certain statements on today’s call may be forward-looking in nature and are subject to certain risks, uncertainties and other factors that could cause actual results to differ from those discussed.

The company’s risk factors are fully disclosed and discussed within its SEC filings. In addition, certain slides contain non-GAAP measures which management believes provide more appropriate comparisons. These non-GAAP measures are intended to assist investors’ understanding of performance trends.

Reconciliation for these numbers are contained within the appendix of the presentation. I would now like to turn the call over to Bob Jones for opening remarks. Mr.

Jones?.

Great. Thank you, Carmen. And good morning, everyone. And thank you for joining us this morning. I know that many or probably in fact, all of you were hoping that you would not hear from me again. But given that my last day as CEO is May 2nd, we thought there would be value in giving you an update on our transition.

In short, it is going extraordinarily well. Jim and I have obviously had a great relationship for many years, and that relationship has gotten even stronger over the last few months. We have spent a great deal of time on transitional topics, meeting with clients and spending joint time with associates. Change is good and, in fact, it is very good.

And I've seen a genuine excitement, and increasing energy around the company as we have jointly made the rounds. I'm extraordinarily excited for the future of our company and extraordinarily proud of Jim and his leadership team. I have pledged Jim that I'll always be available for him if the need ever arises.

With that, let me turn the call over to Jim..

Good morning, and thank you, Bob. Your insights and humor on these calls are going to be missed for sure. I would characterize our first quarter results as consistent with our stated strategy and in line with our expectations. Net income was a record $56.3 million, and earnings per share were $0.32.

When adjusted for merger charges, earnings per share were $0.33. Total loans were down slightly due to lower line utilization, seasonally lower production and continued elevated levels of commercial clients selling their businesses. I'm confident we aren’t losing clients or opportunities because we aren’t competitive.

In fact, our markets remain strong and our clients continue to be optimistic. As a result, our commercial pipeline built nicely over the quarter and now stands at a record high. More importantly, the [excepted] [ph] loan category in our pipeline is up 49% quarter-over-quarter, and it continued to build nicely in April.

This should provide a good tailwind as we move into the second quarter. However, given the global backdrop and inconsistent economic data, we are also staying disciplined and continue to focus on lending in our footprint and not buying commercial credit. We do not believe this is the right time to stretch on credits and pricing.

Total deposits increased during the quarter and our beta remains a strong 18% cycle to date. Loans to deposits are also a low 84%. I remain focused on improving our operating leverage, which improved by almost 500 basis points year-over-year, and our adjusted efficiency ratio was below 60%.

In the first quarter, we announced that the Board authorized a share repurchase plan for up to 7 million shares. We would have been perfectly happy to not execute the plan, but industry price volatility during the quarter allowed us a window to repurchase 1.5 million shares at an average price of approximately $16.45.

Despite these repurchases, tangible book value per share grew by almost 5%, and tangible common equity to assets was up 19 basis points to 8.66%. The conversion from our former KleinBank systems and branches took place a week ago. The conversion went incredibly well with minimal client disruption.

It's important to note that cost savings from the former KleinBank are already starting to be realized, and we remain on track for a 40% annualized savings fully realized in the back half of the year. A quick update on M&A. Our strategy hasn't changed. We remain an active looker and a selective buyer.

However, my desire will be to spend 2019 more inwardly focused working to improve the associate and client experiences and execution. Having said that, scale is still very important. Technology investments and regulatory burdens are still very high. I've told the Board and our associates that we will remain patient and wait for the perfect pitch.

Much like Bob and I have been working through our transition, I've been working with Brendon on a smooth handoff of the CFO duties. I'm confident you'll quickly see why Brendon was the absolute right choice as our next CFO. With that introduction, I'll now turn the call over to Brendon..

Thank you, Jim. Turning to the quarter on Slide 4. GAAP earnings per share were $0.32 and our adjusted earnings per share were $0.33. Adjusted earnings per share excludes $1.2 million in merger-related charges, as well as debt securities losses. Moving to Slide 5, adjusted pretax pre-provision net revenue was 23% higher year-over-year.

This result was driven by increased scale from our recent partnerships, maintaining our strong low-cost deposit base and a continued focus on expense management. We also improved operating leverage by 491 basis points year-over-year. Slide 6 shows the trend in average outstanding loans, which benefited from a full quarter of the Klein partnership.

The quarter-over-quarter change in end of period loans was primarily driven by declines in the C&I and indirect portfolios. The decline in commercial outstandings is influenced by seasonal factors, lower line utilization and elevated levels of prepays due to business sales.

As Jim referenced, our period-end pipeline is the highest in the company's history. Moreover, the current pipeline shows an increase of 49% over prior quarter in the [accepted] [ph] category, which has historically carried a higher pull-through rate.

We are encouraged by both the level, and more importantly, the quality of our pipeline and feel that we are entering the second quarter with positive momentum. Loan portfolio yields, excluding accretion and interest collected on non-accrual, increased 7 basis points. New production loan yields of 4.77% exceeded the portfolio yield by 32 basis points.

Slide 7 shows our year-over-year change in earning assets. We continue to show progress in our ongoing efforts to deliver more optimal earning asset mix, with a focus on commercial loans.

Excess liquidity generated this quarter resulted in a higher percentage of securities compared to last quarter, with new money yields of 3.69% compared with a portfolio yield of 3.03%. That noted, we have continued to remix the balance sheet towards more productive commercial and commercial real estate loans and out of indirect and other loans.

Moving to Slide 8, our demonstrated ability to maintain a stable, low-cost core funding base in this challenging pricing environment is a clear competitive advantage and is a testament to both the quality of our banking franchise and the strength of the relationships we have built with our clients.

Our deposit beta is now 18% current cycle to date with a total cost of deposits of only 46 basis points. A disciplined approach to deposit pricing will remain a key focus, as we navigate the remainder of this rate cycle. Next on Slide 9, you'll see the detailed changes in our first quarter net interest income and corresponding margin.

Net interest margin, excluding accretion was 3.3%. A full quarter of positive impact from our recent Klein partnership was offset by fewer days, earning asset mix change and lower interest on non-accruals. Accretion decreased 6 basis points from the fourth quarter and is now less than 5% of total revenue.

Slide 10 shows trends in adjusted non-interest income. Both Mortgage Banking and Capital Markets showed nice revenue growth over the prior quarter, while other fee categories remained relatively stable. We ended the quarter with the largest mortgage pipeline in recent years and strong momentum in this line of business heading into the second quarter.

Also included on the slide is our purchase versus refi percentage for the mortgage business. Purchases accounting for 77% of our first quarter volumes, with only a modest increase in refi activity. Next, Slide 11 shows the trend in adjusted non-interest expenses.

The first quarter included an additional month of the Klein partnership, as well as a seasonal uptick in payroll related taxes and benefits. We are pleased with our continued ability to control expenses and remain on track for the anticipated cost savings from our Klein partnership in the back half of 2019.

Our adjusted efficiency ratio for the first quarter was 59.51%, a 299 basis point improvement from the first quarter of 2018. As Jim said, expense control is an important part of our culture, and we remain committed to generating positive operating leverage. Slide 12 has our credit metrics.

Credit conditions remained benign, with nonperforming and underperforming loans near cycle lows. We recorded $1 million in provision expense during the first quarter, while posting net charge-offs of $0.9 million.

The 63 basis point of reserves against organic loans and 340 basis points on loan marked against the acquired loans, we believe that we have adequate reserve coverage. Before we turn away from credit, we want to provide a brief update on CECL.

Progress towards complying with the new standard is on schedule with all credit models both built and validated. Second quarter activities will be concentrated on running sensitivity analysis and finalizing assumptions. We anticipate providing an estimated range of the day one impact in the third quarter.

Slide 13 provides some key takeaways from our first quarter performance. We are pleased with our results, driven by good execution against our strategic objectives. We maintained our strong low-cost deposit base with a low 18% deposit beta through the cycle.

We continue to have a disciplined approach to credit risk management, resulting in net charge-offs of just 3 basis points.

While loan growth was lower than our expectations, we ended the quarter with the highest pipeline in the company's history and remain optimistic about our ability to produce quality loans without compromising on the credit discipline that has served us well in prior cycles.

Lastly, we are driving positive operating leverage, improving our efficiency ratio and increasing profitability metrics. Slide 14 includes our outlook for 2019 and 1Q '19 starting points. We expect commercial loan production to increase based on both the size and quality of our pipeline. Commercial activity was skewed towards C&I versus CRE.

We have ample capacity for both asset classes. Net interest margin, excluding accretion is expected to continue benefiting from low-cost deposits and improving asset yields. But the shape of the current yield curve presents challenges.

Given the market's view of the past and short-term interest rates, we have gradually positioned our balance sheet to a more neutral footing to increase protection against the potential of downward rate shocks.

As the slide suggests, fees and expenses should follow normal seasonal patterns and remain very focused on continuing to drive positive operating leverage. Our full year tax rate is expected to be approximately 24% on an FTE basis and approximately 21% on a GAAP basis. We continue to expect tax credit amortization to be de minimis in 2019.

Lastly, we remain very optimistic about our opportunities in Minnesota. We recently completed our conversion of Klein, and our cost saves remain on track. With that, we're happy to answer any questions that you may have, and we do have the rest of the team with - here with us, including Jim Sandgren and Daryl Moore..

[Operator Instructions] Your first question comes from the line of Scott Siefers with Sandler O'Neill..

Morning, guys..

Good morning, Scott..

Hey. I guess just a quick question on expenses first. I think, at least relative to what I anticipated, the first quarter run rate when you exclude the merger-related charges came in a little better than I had anticipated.

And I guess as I was sort of thinking about things, I figured something in sort of the mid 120s might have been a better approximation for kind of the first half of the year, and then a step down in the second half as the cost savings from Klein were achieved.

Can you just sort of provide an update on sort of how you see it, you know, ideally, the second quarter trend looking and then you know, if that step down for the full year sort of still holds true?.

Well, as you know, seasonally expenses are always higher in the first half of the year. You're right, with that. I would just say that I don't - the first quarter was a pretty normal.

We have the merit increases, which affect our run rate starting April, and we were starting to realize some of the savings from Klein already as we said in my prepared comments, and fully expect them to hit in the second half of the year. So I don't think you’re that far off.

First quarter was pretty typical and there's a little bump for merit increases heading into the second quarter here..

Okay. All right, perfect. And then it sounds like you guys are still quite optimistic on the production side of things, but the overall net growth continues, it sounds like to get impacted by those paydowns that have been sort of nagging for the past few quarters.

Is there any sense that - that's abating? And how would you expect the average net growth to trend from here on out?.

Yes, Scott. This is Jim Sandgren. We're very optimistic as we roll into the second quarter, as both Jim and Brendon alluded to. We have continued to suffer from some elevated pay-offs again that happened in the first quarter with some large sales of companies, so that continues.

But as we look at the pipeline growing to $2 billion, and maybe even more importantly, our [excepted] [ph] category being in the highest level, typically those pull-throughs are 90% or higher. So we really feel good about that.

The other piece of the pipeline that I think is encouraging is that is a higher percentage of C&I and in the first quarter we did have more C&I production than we had in CRE. So that also feels pretty good to us.

Also, we still have about almost $550 million in construction advances on some of our commercial construction projects that obviously didn't get advanced on much in the first quarter due to some pretty tough weather in a lot of our markets..

And, Scott, our line utilization was down almost 3%, so that has really helped outstandings..

Yeah. Now that’s very good point. So, okay. That sounds great. Thank you, guys very much..

Thanks, Scott..

Your next question comes from the line of Chris McGratty with KBW..

Good morning, Chris..

Hey. Good morning, everybody. Jim, I think in your prepared remarks, you talked about buybacks given the opportunity with the stock.

Given your comment on loan growth and more optimism is what we're hearing, I think, should we be assuming that you take the foot off a little bit on the buyback, at least for the near term or is this kind of a fair level since capital levels actually still grew in the quarter?.

Yeah, I think we're being opportunistic. When we have volatility like we saw at the end of last year and really, in March I guess of this year, we're going to be opportunistic and step into it. And I think despite balance sheet growth, we have capacity because our capital levels were completely fine. So we'll just be optimistic..

Okay. And on the core margin, the betas - the deposit betas remain pretty low compared to peers. How should we be thinking, Brendon, maybe the next few quarters on core NIM trajectory given where we are with the curve and rate expectation shifting? Thanks..

Sure. I think with earning asset mix should continue to improve with the commercial loan production. So that will be certainly a benefit to margin. I'd pointed to you our new business rates on both investments and loans exceed the portfolio yield, so that should be a positive. And the big question mark is where deposits go from here.

But we generally feel good about the trajectory of the earning asset side..

Okay.

So margins potentially finding support not may be increasing a little bit after the compression this quarter? Or is stability kind of the message?.

Yes, I think stability probably a better term, yeah..

You know, obviously, it's a great environment. The belly part of the curve has been just been really, really tough in the first quarter. And so we've got a little bit of relief here. But we're hoping for rate environment going forward..

Got it. Great. Thank you..

Your next question comes from the line of Nathan Race with Piper Jaffray..

Morning, Nathan..

Hey, guys. Good morning. Maybe want to start on credit with Daryl. The criticized loans are up fairly noticeably in the quarter, I think up 10% on an absolute basis.

So just any color on what you're seeing there? And perhaps, an update on the healthcare credit that percolated towards the back half of last year as well?.

Yes, sure. The increase in this special mention and a little bit in the substandard really relate probably - well, relate to our commercial real estate portfolio. We talked over the past 3 or 4 quarters about how we're tightening that up. We don't see things significantly in that portfolio.

What we are seeing is it's just a slight increase in vacancy rates on some of the projects, as well as some concessions. And so for those that are behind what we projected when we approved those construction loans or those loans we slipped those into that special mention category until they begin stabilizing and that vacancy ticks up a little bit.

With respect to that one credit lapse in the fourth quarter, the healthcare credit, actually that's stabilized. We have some additional equity that was put in the project by one of the significant owners, and that's beginning to lease up the management company. So we're feeling better about that credit today..

Got it, that's helpful.

And perhaps, a follow-up in terms of that lack of absorption, is that in any particular geography or market or asset classes?.

You know, what we're seeing at this point in time, I would say it's across the asset classes, but if you had to have me pick one, I would say it's in the multifamily at least in our portfolio. And we have a concentration in markets. There's no particular market that is worse than the other.

We've generated more loans in some of the market, so - but - there is no market dynamic working there other than just the fact that we've got more multifamily loans in some of our markets than others..

Got it. Understood. And then if I could just ask one more on line utilization it looks like it ticked down 300 basis points compared to the fourth quarter.

Is that just seasonal or is there anything else there?.

No. We've been running - it's seasonal a little bit, but this was a bigger drop than we had seen, and I think that impacted the balances by close to $65 million. We would anticipate that utilization bouncing back up in the second quarter. So a little unusual..

Understood. I appreciate the color, guys. Thank you..

Your next question comes from the line of Terry McEvoy with Stephens..

Hey, Terry….

Good morning, everybody. Hi, good morning. The beta's remained really low.

So I guess my question is where do you see more future upward pressure on deposit cost? Would be in your legacy community markets or some of your newer, more metropolitan markets?.

This is Brendon, Terry. Yeah, I think the pressure is really coming from some of the newer markets. Legacy markets remain really low. The exception pricing request we get out of legacy markets are relatively lower compared to our newer markets. But the competition is tough and acquisition rates continue to be high.

But again, I'd say that we'll weather that storm better than most. So - but hoping that deposit pricing moderates from here, but we have not seen a major change in our clients expectations for rates, yeah..

Terry, you can imagine we have a lot of discipline around this process and lot of conversation to make sure that we're absolutely only repricing deposits we need to reprice, and it's been a good healthy process for us here at the company..

And then, Jim, a follow-up for you. You mentioned in the prepared remarks your inward focus, but if you see that perfect pitch, you're going to swing the bat.

Could you just talk about that perfect pitch in terms of size, markets, characteristics, to help us understand, now that you're up to that, what you're looking for?.

Great question. And it really hasn't changed at all. As you know that Bob and I have been both based on this side for a long, long time here.

And so for us, I think it's a bank between $1 billion and $3 billion that's in markets, that really adds to a market, where we don't have as much skill we'd like to be, that we can make sure that we did good cost saves out of.

So it's pretty much we’ve been looking for in the past, you know, right in our footprint that adds a scale to an important market for us where we have subscaled today and that we can rely on cost saves versus revenue growth..

Thanks. And then just the last one. I'm not quite sure what to make there, Klein added $35 million of loan production in the first quarter, which, as an analyst, I can just calculate 8% of the quarterly production.

Why is that bullet point there? I'm guessing it was better than expected and there's momentum within that market?.

Yeah, we definitely have a lot of momentum in that market. Now the conversion's behind us, a really strong commercial team that's added to our legacy Old National team up in Minnesota. So we feel good about the growth opportunities for us in that market..

We couldn't be more pleased with the team that we have in place, both in the commercial and the retail side. And we said earlier in our prepared comments, the conversion has gone incredibly well..

Great. Thanks, everyone..

Your next question comes from Scott Beury with Boenning & Scattergood..

Hi, Scott.

How are you?.

Hi, good morning.

Just first question, I guess, is a follow-up on, in terms of the pipeline, do you have any color you could give us in terms of how that's spread out geographically?.

Yeah, sure. Right now, a big chunk of that is in our Wisconsin, Minnesota, Michigan markets. We continue to have strong production and pipeline growth out of our Louisville [ph] Kentucky market as well. And then certainly, pockets of our Indiana markets. But really led by Wisconsin, Minnesota, Michigan right now..

Okay.

So the vast majority is - or maybe not the vast majority, but the bulk of it is really coming out of some of the newer markets?.

The largest piece, but we still have good pipelines in our out legacy markets as well..

Okay, that's helpful. And then on the earning asset mix, obviously loan demand, loan balances were a little more challenging this quarter, given some of the paydowns and some of the seasonal factors. But I noticed that you did have an increase in the securities, in the earning asset mix, as well as at period end.

And I was just curious, if you could kind of talk about that and give your expectations on whether that's going to kind of moderate, as you see some of these loans come through?.

Sure. Yeah. So as loan growth was a little softer in the first quarter, deposits were up. We had some excess liquidity. We put it to work in the investment portfolio. And as loans increase, we intend to improve that earning asset mix and we'll flex the investment portfolio as needed..

With loan to deposits 84% pretty - pretty strong funding base to support kind of earning asset growth..

Absolutely. All right. No, that's helpful. That's all I have. Thank you..

Thanks, Scott..

And your next question comes from the line of Jon Arfstrom with RBC Capital Markets..

Good morning, Jon.

How are you?.

Hey, good. Good morning to all of you. Just a couple of smaller ones, I think you know most of the big topics have been picked over. But can you touch on the capital markets driver.

This quarter, it was kind of a bigger item than - than I had expected, and that well - go to that one first just what's happened [ph] there?.

Yeah. Just real quick, I mean, you know it was a strong quarter, mostly I think on existing floating rate loans being swapped to fixed. And so with – that ebbs and flows, but it's a nice business to have -- nice business to be in and it really gives our client a lot of option to protect from a rate risk.

But mostly driven opportunistically when rates kind of fell here in the -- in the quarter..

Okay.

So not - not one big item in there?.

No, but we continue to see good momentum going into the second quarter with that business as well..

Okay. The other one is mortgage.

You talked about record pipelines and obviously it was a decent quarter this quarter, but what - what's possible there over the next couple of quarters?.

Well, you know, Chris very well Jon and he's pretty giddy about the business.

So we feel really good about heading into - to the quarter here with the pipeline continue to grow and really seeing nice opportunities out in Minnesota as well, which I think speaks a lot to both the former Anchor franchise and former Klein had good mortgage businesses, but together we're better.

And so I think the opportunities will continue to present themselves in Minnesota. And I think we’ll have some decent quarters going forward based on what I'm seeing in the pipeline so far..

Okay. And then I guess, the last one back to deposit pricing, I always talked about that quite a little bit, but you had a pretty big step up in checking and money market costs.

Is that would you call that Klein related or is you're just playing defense there? What - what was the driver the - the big increase in those two?.

Hey, Jon, this is Brendon. No, not competition. We have been running some targeted money market specials in select markets, where we have relatively low share and that's been driving some of the growth and some of the increase in pricing in that - in that line item..

So I think I would characterize it as a partly defensive and partly offensive. We're really trying to get new money in the door and the new money cost is obviously higher than we have on our existing books, but it's really trying to be as much offensive as anything else..

Okay. Okay. Thanks a lot..

Thanks, Jon..

And there are no further questions at this time..

Well, thanks everybody for their attendance. And as I said in my opening remarks, we're certainly going to miss Bob on this call, and I don't have nearly the sense of humor that he has and the - and the analogies. But thank you all for your participation. And as always, we'll be around for follow-ups..

This does conclude Old National's call. Once again, a replay along with the presentation slides will be available for 12 months on the Investor Relations page of Old National's website, oldnational.com. A replay of the call will also be available by dialing 1-855-859-2056. The conference ID 2358708. This replay will be available through May the 6th.

If anyone has additional questions, please contact Lynell Walton at 812-464-1366. Thank you again for your participation in today's call..