Old National Bancorp (ONB) Earnings Call Transcript & Summary

We really let our clients dictate in terms of what rate risk management they want to choose. Many of our clients that are doing these variable rate loans are utilizing our hedging services, and that's what we've seen really strong capital markets fees in the first half of the year. So it really doesn't matter for us whether they want to do fixed or whether they want to do a floating rate. Anything large side, we really want to keep that to the floating size and then use the hedge to offset their risk. And then we'll manage any rate risk on the back end. So for us, I think, again, just being naturally asset sensitive, I think it sets up well for this kind of environment. And that's without any management actions. We have some strings we can pull. I think that even makes it better.

Yes. Maybe shifting to the fee income side. Fee income has been one of the strongest parts of the quarter and you raised full year guidance. What gives you confidence that, that momentum is sustainable rather than cyclical here?

Yes. John wants to remind everybody in the room and everybody listening that the 2Q print was the print you should be using for your fee income going forward. First quarter ran -- I'm sorry, 1Q. He said correct me real time here. It's 1Q. I stand corrected. Thanks for having our CFO and Treasurer in the room. The 1Q is the right number. 2Q ran a little bit stronger. Capital markets was really nice throughout the entire year. I think that just bodes well. When we have a strong commercial pipeline, strong commercial closings, we're going to run better in the capital markets fee income side. Treasury management and wealth management continue to be a source of strength. We continue to invest in both those businesses. Both those businesses are important to our future. We really love our mortgage business. But obviously, with rates where they're at, it's just a softer expectation for the business. [indiscernible] And so that is I've been really happy with the [indiscernible] we've seen in treasury markets and wealth. Those are areas we want to continue to invest in and think about how do we need to continue to grow and expand. John and Tim Burke and I were recently talking about ways we want to strengthen our fee income businesses. And that's an area of focus for the next handful of years, is continue to drive a higher percentage of our total revenue coming out of our fee businesses. Much of that will come out of the existing businesses and ways we can accelerate growth there. And then to the extent that it makes sense to augment those businesses, and I'm not here to announce anything new today, just other than we know we need to drive higher fee income, and that will be a focus of ours going forward.

When you look at that investment, that future investment in fee income, is that getting a bigger wallet share from your existing customers? Or is that an opportunity to expand the customer base leading with fee income and then maybe backfilling with.

Yes, I think it's both. I think it's both. I think the good news is we see plenty of opportunity in our commercial book to cross-sell wealth management. It's shockingly low how much cross-sell we have there. So again, with the really quality people we have in place and the quality leadership, we think there's plenty of opportunity in that. We're trying to build out more sophisticated treasury management product set as we have increasingly opportunities with larger sized clients. So I think that's a real growth opportunity for us. The capital markets product set, there's probably 1 or 2 products we could add in there to kind of strengthen our capabilities there. Again, as we have the opportunity increasingly to serve a more middle market client opportunity set. And to the extent that there are other fee income businesses that we're not in today, I think we continue to explore what those look like and what makes sense to invest. Again, nothing to announce today other than this is an area that we know we need to concentrate on.

Yes. When you look at the expenses, the efficiency ratio continues to improve despite some of the investments you've been making. How should we think about balancing operating leverage with the opportunities that you just mentioned to make hires and bring in systems and products to expand the long-term revenue opportunity?

Yes, it's a great question. We start every budget cycle. We're in the middle of our current budget cycle for next year, and we start every budget cycle thinking that our expenses should grow no more than kind of GDP, so call that low single digits and drive revenue growth on top of that. They'll have that positive operating leverage contribution. And so for us, to the extent that we want to spend more money than that kind of low single-digit kind of natural inflationary growth, we have to find ways to fund it. And that just becomes more efficient, more effective. We do a really good job of being really disciplined. I know maybe every bank thinks they do the same good job. But I can tell you from just my firsthand experience, sometimes our CFO is not seen as the nice guy around the organization. Sometimes we've seen as a bad guy in the organization because he's holding the line. He holds the line with me on expenses. And it's always a healthy tension between wanting to invest in growing the business and the need to drive positive operating leverage. And I think we find the right tension there. We have been -- we made no secret that we're really active in terms of bringing new people in the organization, we continue to do that. So we continue to find ways to invest in people, both I think in the client-facing side, which we've done a lot of here lately, but also in the support side, just becoming a bigger, more sophisticated organization. So we're not shortchanging that as well and find ways to drive efficiency. Every single day, we're looking for ways to drive efficiency. I meet regularly with our Head of Operations about initiatives that he has underway to drive more efficiency and effectiveness. And so we just try to plow that back into the business so the expense line doesn't need to grow any more than that mid-single digit.

Component of that spend, I'm sure, is going to be AI. How AI has become really a focus across, obviously, the industry and all industries. Where are you seeing any tangible use cases today inside the bank? And how do you think AI can help improve that productivity and efficiency and profitability over time?

Well, let's just start with you have to wade through a lot of information coming at you about AI. You're trying to figure out what's real, what's not real. We recently had somebody in the office, and we were going through a couple of pitches they had for us relative to new initiatives. And in those pitches, there was one thing I was able to call out kind of immediately like it didn't feel like there was going to be an opportunity to be a better bank or a more efficient bank because of it. And they had just implemented something similar at a larger organization. And I said, well, what savings did they drive? Well, they didn't drive any savings out of it. So -- and then we recently just completed -- we're in the middle of a pilot phase where we were looking at something in our risk management area by using AI, and we thought we were going to have access to this proprietary database. And it turns out they weren't as far along as they thought they were. So we're constantly driving like what's real, what's not real, what can we implement versus others. Having said that, we're doing some pretty amazing things today. We're developing internal tools today using internal people that are really driving some great outcomes. Nobody is seeing, I don't think, dramatic efficiencies yet, at least in our space, seeing dramatic efficiencies, but we're accessing information like we've never accessed it before. And you know there's productivity gains. It's just hard to monetize those productivity gains. The data -- the use cases we're having in our data world, we're driving some great access to data that we haven't had as easily as we're able to achieve those things today. We're -- obviously, we look at our credit world and how do we go to market with the commercial world and how do we get more effective there. I think that's a combination of using really great partners who have some of these tools in front of them, but also implementing the tools ourselves. So as I go out and talk to other CEOs, and we compare notes, I'm the Chairman of the Mid-Size Bank coalition I'm on the Board and Vice Chair at the ABA, I have a lot of access to a lot of other organizations. And as I go out and benchmark ourselves, I feel like we're at or better than most of the organizations that we're speaking with regularly. I think we're all waiting for that revolution to happen. And it's coming. I think you can kind of feel it, whether some of the predictions are true that we heard over the weekend or not. This is an area that we continue to invest in and believe long term that our industry is going to have to drive efficiency gains. And those gains will ultimately, I think, be plowed back into our client relationships. So we can't stop investing in that space. But I don't think it also takes away from -- I think those are the self-funding aspects that will allow us to keep expenses very manageable and drive ultimately positive operating leverage.

Great. On credit, you continue to express confidence in the credit outlook and metrics improved again in second quarter. What trends are you seeing across the portfolio today? And are there any sectors or borrower groups that you're spending more time monitoring?

I don't think our guidance has changed at all. I think we've had that same level of the same feeling we had as we ended last quarter as we do today. We're not seeing broad-based demonstrated weakness. We are still -- we feel really good about our ability to continue to work out any criticized or classified loans. We're not seeing anything in any geography that gives us any kind of pause. And overall, I think the credit book is just getting stronger. Again, that's a knock on wood moment. But yes, we feel as good as we did as we ended last quarter.

Historically, Old National's experienced a lower conversion of nonperformers into charge-offs than I think a lot of peers. What do you think differentiates your approach? And why do you believe the credit outlook remains favorable with that?

Yes, it's a great question. We continue to have loans that we put in that criticized classified bucket refinanced out at par and by other banks, sometimes the government, interestingly enough in some of their programs. But we have this philosophy of calling it early. And so I use this analogy and it may be somewhat of a morbid analogy. But when our clients are maybe getting a little sniffle, we want to treat them first. We want to treat them early and put them in the hospital and make sure they come out healthy on the other side. And we're not waiting for that to get materially worse before we put them in the hospital. And that's -- I think that's where banks wait sometimes too long. A majority of our nonaccrual loans are paying as agreed. That's just a historical philosophy we have, and we think it serves us well to call it early. And that allows us to -- sometimes our criticized and class, sometimes they generally run higher than our peers. But if you go back and look at relative to charge-off rates, we usually have less volatility and less total charge-offs relative to what that leading indicator might suggest. But that's just a historical philosophy that I think has served us incredibly well.

Yes. On capital, you remain active on buybacks while supporting strong organic growth. How are you thinking about optimal capital levels over the longer term, particularly if we get some of the benefits from Basel III revisions that could create some more capital flexibility?

Yes. So we obviously want to use capital today to support our organic growth. And the good news is that very high teens ROATCE levels, we have plenty of capital generation to support organic growth and continue to optimize our capital through buybacks and dividends. As we publicly stated, acquisitions aren't a part of our current thinking and don't anticipate them that changing anytime here in the future. We're really focused in on that. And we can -- a lot of investors talk to us today about acquisitions, and we can talk about that at some point. But for us, that capital generation is significant. So it's more of a challenge about like just manage the buyback program. And investor feedback was like if you're accruing capital, that could be a signal that you may be interested in M&A, and we didn't want to give that signal. So we wanted to make sure we manage through that. So the share repurchase program will be a continued active part of that. Basel III, once we have clarity around that, could allow us to even think a little bit more about a stronger buyback program. One of our binding constraints typically tends to be our tangible common equity ratio, which today we have, we believe, plenty of tangible common equity ratio. The problem becomes in environments of stress, people look at that TCE number. Today, they're not paying that much attention to it. They're paying attention to obviously CET1 and everybody believes we've got enough CET1 plus more than enough, plus if we get some relief from Basel III, which could be 100 basis points more to us, that even gives us more flexibility. But ultimately, at the end of the day, we got to make sure that we both look at what our regulatory capital requirements are, but also our real tangible equity that we need to -- in a different kind of environment, a more stressed environment. So -- both those things are ways we have a healthy tension, but I think it generally supports just given our higher earnings rate, more buybacks in the future for us.

If we're able to have you join us a year from now and investors view Old National differently than they are today, maybe higher stock price, what do you think is going to be the biggest driver of that change?

We strive for consistency every single day. We don't want to wake up and surprise you as an analyst, our investor base, our team members, our clients, our communities, right? We strive for that consistency. This is old-fashioned basic banking concept, right? And so for us, the highest compliment we can get is you delivered what you said you were going to deliver and you did a little bit better. That is the ultimate compliment for us is we said we achieved what we said we're going to do. and we did it the right way. We believe in no easy shortcut ways to growth. It's old-fashioned basic banking, a really granular deposit base, a really granular loan base, not taking outsized risk in footprint business by and large. And so the highest comment we give is -- and if people go back and look, I think, at our history here, they would say whether it was -- there was coming off a partnership or coming off of a period of organic growth, you did what you said and you did it slightly better.

Great. I think that's probably a good spot to end it on. Thanks very much for joining us. Hope you have a great rest.

Well, Jared, I just want to thank you all. I was just leaning in before our meeting here to let them know that I was really pleased with the meetings we're having here today, and thanks for your support. We appreciate the opportunity to be here today.

Great. Thanks. Thanks.