Jul 28, 2008
Executives
Robert G. Jones - President, Chief Executive Officer, Director Christopher A.
Wolking - Senior Executive Vice President, Chief Financial Officer Daryl D. Moore - Executive Vice President, Chief Credit Officer Barbara A.
Murphy - Senior Executive Vice President, Chief Banking Officer Lynell J. Walton - Vice President - Investor Relations Joan Kissel – [Corporate Controller] James A.
Sandgren - Regional President
Analysts
Erika Penala - Merrill Lynch Scott Siefers - Sandler O’Neill & Partners L.P. Charlie Ernst - Sandler O’Neill & Partners L.P.
Mac Hodgson - Suntrust Robinson Humphrey Eileen Rooney - Keefe, Bruyette & Woods Stephen Geyen - Stifel Nicolaus & Company, Inc. Michael Cohen - SuNOVA Capital
Operator
Welcome to the Old National Bancorp second quarter 2008 earnings conference call. (Operator Instructions) At this time the call will be turned over to Lynell Walton, Vice President of Investor Relations for opening remarks.
Lynell J. Walton
We appreciate you joining us for Old National Bancorp’s second quarter 2008 earnings conference call. With me today are Old National Bancorp management members Bob Jones, Chris Wolking, Daryl Moore, Barbara Murphy, and Joan Kissel.
Before we begin our presentation I would like to refer you to Slide 3 and point out that the presentation today does contain forward-looking statements that are subject to certain risks and uncertainties that could cause the company’s actual future results to materially differ from those discussed. These risks and uncertainties include but are not limited to those which are contained in this slide and in the company’s filings with the SEC.
Slide 4 contains our non-GAAP measures information. Various numbers in this presentation have been adjusted for certain items to provide more comparable data between periods and as an aid to you in establishing more realistic trends going forward.
Included in the presentation are the reconciliations for such non-GAAP data. We feel that these adjusted metrics provide a meaningful look at our current performance as well as our performance going forward.
At Old National we are continually committed to providing honest and open communications regarding the analysis of our financial performance, and given the unprecedented negativity surrounding the entire financial services sector feel it increasingly more important to do so. This commitment has led us to provide more granularity in three key areas, those being credit, capital and the investment portfolio.
We have continued to provide balance sheet data for our banking regions and new financial centers as well as significant non-interest income and expense items although these slides are included in the Appendix to the presentation. We will not be covering these specific slides during our prepared comments; however, we will be happy to answer any questions on these items during the Q&A session.
Slide 5 is our agenda for the call. First, Bob will provide Old National’s perspective of the current economic environment, give you an update on the Indianapolis fraud incident we disclosed to you in April, as well as provide highlights of our second quarter earnings results.
Daryl will then lead the discussion of our credit quality metrics providing more granularity in the areas of our non-accrual loans, delinquency trends, and our home equity portfolio. Next, Chris will detail our expanding net interest margin, provide commentary on our capital position, and detail the specific holdings within our investment portfolio.
Bob will then conclude with guidance for earnings and several other financial metrics, and then we will open the call for your questions. I’ll now turn the call over to our CEO Bob Jones.
Robert G. Jones
Before I review our performance for the second quarter, I thought it would be important for me to give you Old National’s perspective on the economy today. I believe that this is important because it will give you a sense of the perspective we are taking to address the issues that we see facing our industry.
As we have said for some time now, we do see difficulty in the economy and it is having its continued effect on our industry. We continue to believe that Old National is very well positioned to navigate through these difficult times, but as we have also previously said we are neither arrogant enough nor naïve enough to believe that we can totally escape the challenges that exist in today’s market.
In our view we are quarters, not months away from seeing a recovery. We do believe that the housing challenges are moving into other sectors, most notably commercial real estate.
We also believe that the effects of inflation will be felt by the consumer who is dealing with record gas and food prices, the combination of which will affect their disposable income. Bottom line is that we continue to be very cautious and we continue to position ourselves for what portends to be a difficult period of time.
We obviously hope that the markets turn around quicker but feel the prudent approach to meeting these challenges is to stay with the consistent approach we have used over the last few years. Our clients appreciate the consistency and while we are conservative we are also there for them in the long term.
If we are wrong and the markets turn quicker than we expect them to, it may cost us a few cents a year in earnings by missing out on some growth opportunities. On the other hand if we choose the opposite approach of becoming more aggressive too soon, the challenges would be great.
For that reason we will stay with the conservative approach. But all is not doom and gloom especially in our home state of Indiana where a recent CNBC poll Indiana was rated as the 13th top state for doing business.
We were the highest ranked state in the Midwest. In addition the State of Indiana just announced its third straight year with a budget surplus.
While we have seen our share of challenges in Indiana, the state much like Old National is positioned well to meet these challenges. Now let me comment on the fraud in Indianapolis.
As you can see from the charts we provided you in the earnings release we did charge off $10.9 million related to the fraud this quarter. This amounted to 93 basis points of our 135 basis point net charge off ratio.
We continue to work with the borrowers that were affected by the fraud. We have hired an outside firm of forensic accountants to help us through our investigation and to date we have not discovered any additional loans that were affected nor have we discovered any control issues.
Our decision to charge off these credits is based on the continued documentation challenges and the subsequent collateral deficiencies as well as the slowing economy. We continue to work with outside counsel as it relates to criminal and civil charges and we continue to review our opportunities for insurance coverage.
Obviously this is an ongoing investigation and we continue to focus on the best solutions as we work out of these credits. We will be pleased to answer your questions at the end of the call.
With all that as a backdrop, let’s turn to Slide 7 to begin the review of our quarter. Given the slowing economy and the challenging times in the industry, we were very pleased this morning to announce earnings of $0.30 per share.
Our net income for the quarter was equal to our earnings of the second quarter of 2007 and it did represent a 3.4% increase over the reported earnings of the first quarter of 2008. Driving our performance was a continued improvement in our net interest margin which increased 17 basis points over last quarter and 65 basis points over the second quarter of last year.
We also saw good commercial loan growth this quarter, 4.9% is measured end of period over end of period over last quarter. This loan growth was driven by excellent performance in four markets: Vincennes, Evansville, Terre Haute, and Southern Illinois.
Daryl will give you more detail on our credit performance but we did see a small drop in our non-accrual classified and criticized loans. This is in part due to the previously-mentioned large charge off we took related to the Indianapolis fraud.
Given the current environment we are very committed to maintaining a strong capital position. We were therefore very pleased that our tangible common equity ratio increased 19 basis points to 6.75%.
At 6.75% we are in the higher end of our target range of 6% to 7% which we feel is very appropriate in these times. As you are aware our Board did declare a $0.23 per share dividend for the quarter last week as an affirmation of our capital position.
Let me now turn the presentation over to Daryl Moore to give you additional insight into our credit performance.
Daryl D. Moore
I’d like to begin my part of this quarter’s presentation reviewing the charge-offs for the quarter as shown on Slide 9. All charge-offs in the quarter were an elevated 1.35% of average outstandings.
As Bob previously mentioned 93 basis of that 135 basis point loss rate related to the Indianapolis fraud incident. If you recall, 26 basis points of the 52 basis point loss rate in the first quarter also related to the fraud matter.
Without the fraud-related write downs the annualized loss rate for the first six months of the year would have been 34 basis points. While the fraud related losses taken on specific loans to date have not exceeded the aggregate amount initially set aside for those particular loans, we have found it necessary to increase the allowance for losses against the remaining outstandings in this fraud-related portfolio by roughly $1.5 million.
The amounts necessary to fund this additional reserve were a part of the provision made in the second quarter. The provision for loan losses through the first half of the year totaled $27.6 million with charge-offs of $22 million for the same period, this resulted in a year-to-date date increase in the allowance for loan losses of $5.6 million.
As Slide 10 reflects non-accrual loans dipped to 1.43% of total loans, down from 1.5% last quarter. In terms of dollars non-accrual loans fell $2.2 million in the quarter.
While in today’s environment any drop in non-accruals during the quarter could be seen as significant success, we do need to keep in mind that $10.9 million write down in the fraud loan portfolio that Bob referenced earlier did serve to decrease the non-accrual outstandings during the quarter. Conversely, partially offsetting the benefits of this write down it should be noted that $4.5 million of loans previously identified as fraud-related loans were downgraded from the substandard category into the non-accrual category in the quarter.
Obviously non-accrual levels are not where we would like for them to be and given our outlook on the economic environment previously outlined by Bob it may be difficult to move these levels down in the near term. The next slide gives a little more color on the exposure we have in our large non-accrual relationships.
As you can see at the end of the second quarter we had eight relationships in non-accruals with exposures of $2 million or greater. The exposure in these relationships totaled $34.7 million and the impairment associated with those relationships was $12.4 million.
In breaking out these largest non-accrual exposures, you can see from the slide that the balances are just slightly skewed to the commercial real estate portfolio. In terms of geographic distribution of these largest non-accrual loans $19.6 million or more than half of the outstandings were originated out of our Indianapolis area.
Of this $19.6 million total $12.3 million is associated with the fraud incident. As Slide 12 shows we continue to manage our 90+ delinquent loans well.
We now have three consecutive quarters under our belt with 90+ delinquency rates at the 3 basis point level. I believe that these levels would compare very favorably to most peer groups against which you would measure us.
As the next slide shows other real estate owned as a percent of total loans did move up in the second quarter increasing $1 million to a level of $3.3 million at quarter’s end. Increases in the quarter came from both the 1 to 4 family residential and the commercial real estate portfolios.
Moving to Slide 14 classified loans which do include non-accrual loans fell during the quarter to 3.16% of total period ending loans. This fall of 12 basis points from the first quarter represents a $4 million reduction with classified loans now standing at $149.8 million.
With regard to our largest classified loans not in non-accrual there was a fair amount of movement in the quarter with four of the five largest in that category having been downgraded to the category in the current quarter. Of these four large downgrades three are involved in commercial real estate development-related activities.
This particular industry segment continues to show significant stress and we would expect it to continue to do so over a number of quarters to come. Slide 15 shows our criticized loan trends.
Criticized loans fell to 2.06% of total loans in the second quarter down from the 2.21% level at the end of the first quarter. In terms of dollars this represents a $6.3 million reduction in the current quarter.
Aggregate exposure in our top 20 criticized loans also fell slightly in the quarter. Because we believe that changes in the levels of criticized loans can be a leading indicator of future credit risk trends we continue to monitor this category very closely, and given the current economic environment, we believe we could see increases in criticized loans over the immediate term.
Another leading credit indicator is our 30+ delinquency rate. As the next slide shows since the beginning of 2007 our overall delinquencies have remained fairly constant running in the 60 to 70 basis point range.
With regard to specific segment delinquencies, Slide 17 shows our 30-day and greater delinquencies in commercial real estate, residential real estate, and home equity line of credit portfolios. As you can see, while commercial real estate delinquencies declined 6 basis points in the current quarter they are 10 basis points higher than the levels at the end of the second quarter last year.
Delinquencies in the residential real estate portfolio reflect a decreasing trend over the last four quarters with delinquencies now down to 134 basis points, a 30 basis point improvement from the second quarter 2007 levels. Home equity line of credit delinquencies rose 52 basis points in the quarter and are now 56 basis points higher than levels posted at the same date last year.
As you can see from the chart at the bottom of the slide our commercial real estate exposure continues to fall as a percent of total loans while our residential real estate and home equity line of credit portfolios have remained relatively steady over the last year as a percent of total loans. I think it’s important to remind everyone that our first mortgage residential real estate portfolio consists mainly of legacy-type loans as in recent years the majority of our production has been originated for sale into the secondary market.
The home equity line portfolio is obviously a portfolio that we are all watching closely as both delinquencies and loss rates are up from 2007 levels. As you can see on Slide 18 we’ve broken out our home equity line of credit portfolio for you into loan-to-value bands.
Roughly 35% of our current commitments are in lines with original loan-to-value ratios of 80% or greater. With regard to actual outstandings approximately 42% of outstandings were on lines where the original loan-to-value ratio equaled or exceeded 80%.
Turning to Slide 19 large dollar exposures in our home equity line book are broken out for your review. As you can see commitments of $0.5 million or greater represent only 3% of total commitments, and total commitments of $100,000 or greater including those of $0.5 million or more collectively represent only 25% of total commitments.
So the individual exposure levels in this portfolio are fairly granular. The final slide in the credit section shows Old National’s commercial real estate exposure as a percent of capital compared to community mid-size and large bank group averages.
As has been the case over some quarters, our exposure continues to be lower than that of both the mid-size and community bank sects. Maybe more importantly in this environment the level of commercial real estate exposure as a percent of the ever-increasing and important capital level continues to decline.
I’ll wrap up my section of the presentation with only a short reiteration of Bob’s previous comments that it is our opinion that we are not at the bottom of this credit cycle and that we expect to continue to see challenges across virtually every portfolio at least in the near term. With those remarks I’ll turn the call over to Chris.
Christopher A. Wolking
I will begin on Slide 22. As Bob said in his introduction, our net interest margin increased to 3.85% in the second quarter, 17 basis points from a margin of 3.68% in the first quarter of 2008.
At 3.85% our net interest margin is 65 basis points higher than second quarter 2007 and 85 basis points higher than our first quarter 2007 margin. Net interest income increased 2.6% for $1.7 million compared to the first quarter of 2008.
Average earning assets declined $118.4 million during the quarter due primarily to the large decline in our investment portfolio. Based on average balances for the quarter the investment portfolio was down $142.9 million compared to the first quarter of 2008.
Average total loans increased $24.4 million in the second quarter led by a $62.2 million increase in average commercial loans and leases. Slide 23 illustrates the monthly trend in our fully taxable equivalent net interest margin beginning in June 2007.
The net interest margin in March 2008 was 3.77%. We improved to 3.85% in April and 3.88% in May before declining to 3.81% in June.
Because our net interest income continues to be somewhat liability sensitive our net interest margin improved during April and May in step with the 75 basis point decline in the federal funds target rate from the middle of March to the end of April. Additionally, our banking center managers remain focused on maintaining appropriate deposit pricing during the quarter.
In June the net interest margin declined 7 basis points from May largely due to the fact that the federal funds rate stopped declining and we began to see the impact on the margin of our decision to bring our net interest income rate sensitivity closer to a neutral position. Slide 24 highlights the impact to our margin from declining short-term rates.
Lower asset yields during the second quarter reduced the margin by 31 basis points while lower interest-bearing liability costs lifted the margin 48 basis points. I’d like to provide a little more detail on the margin impact of the decline in liability cost during the quarter.
Interest-bearing deposit costs including the costs of brokered certificates of deposit declined 56 basis points during the second quarter. Our borrower lending rates declined 57 basis points.
While we experienced a $141.1 million decline in average quarter deposits during the quarter much of the decline was in expensive retail certificates of deposits and NOW accounts. During the second quarter we replaced a large portion of our shortest term wholesale lending federal funds purchased with federal home loan bank advances and brokered certificates of deposit with maturities of up to five years.
Extending the maturity of our wholesale funding in the second quarter continued the work we began in the first quarter to reduce our liability sensitivity and decrease our exposure to rising short-term interest rates. Slide 25 shows the quarterly trend in our cost of interest-bearing deposits compared to our peer group.
As we have discussed in past quarters our ability to maintain our deposit base at a lower cost than our peers contributed to our improved margin in 2007 and 2008. During the first quarter of 2008 our interest-bearing deposit costs including the cost of brokered certificates of deposit were 30 basis points lower than our peers.
While we don’t get [inaudible] peer data for the second quarter we believe that we sustained a similar relationship to our peers’ costs of deposits during the second quarter. We expect our margin to be in the range of 3.75% to 3.85% for the remainder of 2008.
Lower short-term rates were a major driver of our improved margin during the second quarter and we benefitted from the fact that the federal funds target rate declined further than we had expected. Our margin forecast anticipates that we won’t have an increase in the federal funds target rate until early fourth quarter.
Additionally, we expect to continue to extend the maturity of our wholesale funding and retail certificates of deposit to further reduce our exposure to rising short-term interest rates. This will likely increase our cost of interest-bearing liabilities during this second half of 2008.
On Slide 26 note that tangible common equity as a percentage of tangible assets increased to 6.75%. Tangible equity as a percentage of tangible assets decreased to 6.21% in the second quarter.
Tangible common equity increased $6.5 million during the second quarter while tangible assets declined $121.1 million by June 30. The difference between the market value and book value of the investment portfolio at June 30, 2008 contributed to a decrease of $29.1 million in other comprehensive income for the quarter.
The decrease in other comprehensive income related to the investment portfolio valuation that counted for much of the decline in our tangible equity to tangible assets ratio. Because $1.9 billion or 95% of our $2 billion investment portfolio is treated as available for sale it is understandable that volatility in the fixed income security market would impact our security valuations and tangible equity.
Slide 27 is intended to give you a better understanding of our investment portfolio. The federal agency fixed income portfolio is comprised totally of senior debentures.
We do not own the subordinated debt or preferred stock of the federal agencies. At June 30, 2008 the market value of our agency security portfolio was $333.2 million.
As you can see on the slide $179.9 million or 54% of our total agency portfolio is comprised of Fannie Mae senior debt. Fannie Mae is the largest holding in our agency portfolio.
Of the remaining agency senior debt $64.1 million is Freddie Mac exposure, $79.2 million is federal home loan bank exposure, and $10 million is exposure to the federal farm credit system. The market value of our mortgage security portfolio was $1.1 billion at June 30.
77.5% or $854 million of our mortgage securities were CMO structures with collateral guaranteed by the federal agencies or pass-through mortgage securities issued by the agencies. $247.8 million of our mortgage securities are non-agency CMOs.
Our non-agency CMOs are all rated AAA by the various debt ratings agencies and are comprised of fixed interest rate, jumbo or all-day mortgage collateral. Our corporate securities portfolio is made up of two major components.
The market value of our portfolio of trust preferred securities totaled $49.2 million at June 30, 2008. Additionally, of the remaining $134.7 million of corporate securities $111 million is managed by an outside investment manager unaffiliated with Old National Bancorp.
Of the $49.2 million trust preferred securities $38.5 million are pool trust preferred securities comprised of nine different issues. We had no real estate investment trust exposure in our pools.
The issuers in our securities are primarily banks but the pools do include a limited number of insurance companies. 11 million of our pool trust preferred securities are currently rated AA or higher, 18.8 million are rated A2, and 8.7 million are rated A3.
The corporate security portfolio managed by the outside manager is managed to the Lehman Intermediate Corporate Bond Index. All of the holdings are investment grade and by policy no single company exposure can exceed 4% of the value of the manager’s total portfolio.
The market value of our municipal securities was $328 million at June 30. Approximately 69% or $226 million for our municipal portfolio is ensured by the Monoline Insurance Companies.
But of the $226 million insured portfolio only 15% or approximately $34 million does not have an underlying investment grade debt rating. The unrated insured portfolio of municipals represents approximately 10% of our total municipal securities portfolio and under 2% of our entire securities portfolio.
We did not incur other than temporary impairment on our investment portfolio in the second quarter. Of all of our portfolios we are monitoring our non-agency CMOs and pool trust preferred securities most closely for other than temporary impairment.
Seven of our pool trust preferred securities totaling $27.5 million in market value at June 30 are rated lower than AA and subject to the guidance of EITF 9920. We rigorously model and stress test the cash flows of these securities for possible impairment.
The current defaults and deferrals and our outlook for defaults and deferrals in the pools did not warrant OTTI in the second quarter. As we continue to monitor these securities it is possible that we may have OTTI on these securities in future quarters.
We stress test our non-agency CMOs by modeling losses equal to 50% of the current 60-day+ delinquencies of the tranch. These securities did not warrant OTTI in the second quarter.
All of our trust preferred securities and non-agency CMO securities are considered available for sale on our balance sheet. As such the impact of the market value adjustments of these securities is currently reflected in our tangible equity and our tangible equity ratios.
Finally, I’d like to point out that we generated $1.1 million in net gains from calls of federal agency and other investment securities during the second quarter. Our total securities gains were $2.1 million for the quarter.
Other expenses included a charge of $692,000 for impairment to intangibles related to our insurance agency. This information is referenced in our earnings release and in the slides and the appendix.
I’ll turn the presentation back to Bob for final comments.
Robert G. Jones
As Chris said and Lynell said, before I provide you with our guidance let me remind you that in the appendix of this presentation you will find additional detail related to our geographic performance as well as other financial metrics. And I also again would mention if there is information that you’d like us to include or things we could do differently, please let Lynell know.
I hope that during this call you were able to gain a sense of our view of the economy and what we feel is a realistic and honest approach to dealing with the challenges that we see. As we note in every release and every investor presentation we operate under three strategic imperatives, the third one being providing our shareholders with a consistent quality return.
The focused execution of our strategies allows us to achieve that goal and deviating from that particularly during difficult times will not happen at Old National. It is that consistent approach that allows us to affirm our guidance for the full year at $1.13 to $1.19.
This is an affirmation of what we told you in our original guidance that was issued at the beginning of 2008 which we again affirmed following our first quarter. Our cautious view of the economy and the credit markets have us slightly increasing our net charge-offs and provision guidance for the year.
These numbers are also tempered by our continued efforts towards resolution of our Indianapolis fraud. You may remember at the end of last quarter we gave charge-off guidance of 55 to 65 basis points and provision guidance of $27 million to $33 million.
We are able to offset the effect of the higher credit costs with the improved performance of our margin. As Chris said we are raising our guidance for the full year to 3.75% to 3.85%.
At this time we will be more than happy to answer your questions.
Operator
(Operator Instructions) Our first question comes from Erika Penala - Merrill Lynch.
Erika Penala - Merrill Lynch
I’m sorry if I missed this during the prepared remarks, but do you believe that you’ve taken all the losses that you think will stem out of the Indianapolis fraud incident?
Robert G. Jones
It’s hard to say if we’ve taken all the losses. As Daryl said we think we’ve properly provisioned for it.
We’ll continue to work through the situation but the provision is there to cover the losses.
Erika Penala - Merrill Lynch
A more macro question related to credit, did you get a sense that in the second quarter whether or not the stimulus helped debt service on the consumer side?
Daryl D. Moore
I think that when you talk to our collection people they will tell you that yes, in fact, it did help a bit. It was similar in attributes to when people begin to get their tax returns back, we saw some of that cash flowing in to keep payments current.
So I would say yes we did see that a bit and we’ll watch to see what the next quarters bring in terms of delinquencies to see where there’s any material difference.
Robert G. Jones
Erika, another tangential affect of the stimulus checks was that they did reduce overdrafts for the quarter. We saw the deposit activity offset some of our normal overdrafts.
Erika Penala - Merrill Lynch
And this is more of a housekeeping question, but I think in the slide presentation you mentioned that your exposure to first mortgage and HELOC was about 16.5%. If we look at call report data from last quarter, the resi mortgage exposure is 24.5%.
What’s the shortfall? What’s the difference between how you’re filing with the call reports and how you showed the information in the slides?
Daryl D. Moore
Great question. When we look at this internally all the time, it is a difference between how things are reported on the call report versus what we do internally.
And if recall right, the call report is more collateral based than internally where we focus more on purpose based.
Robert G. Jones
Example Erika, if we did a small business loan and took a mortgage on somebody’s house, that may show up in our call report because the collateral is the first mortgage whereas the original purpose of that loan is business so we would classify that as business purposes but on the call report it’s not. The cash flow is coming from the business.
Erika Penala - Merrill Lynch
The $75 million expense run rate was a little higher than I expected. Was there anything related to the Indianapolis fraud incident in that run rate that may not reoccur in the next two quarters?
Robert G. Jones
We did have some legal costs that we expensed in the quarter but also the charge down on the intangibles in that expense rate. Chris referenced the $669,000 on the write down of the intangible on our insurance.
Just so you know what that’s related to, we lost a large client in our insurance agency in Fort Wayne. As we looked at the good will associated with that and the effect of that large client, we determined that we had to write down the good will because of that large client loss.
Christopher A. Wolking
An appropriate run rate is $73.5 million for the quarter.
Operator
Our next question comes from Scott Siefers - Sandler O’Neill & Partners L.P.
Scott Siefers - Sandler O’Neill & Partners L.P.
Just one or two tic tac questions and one strategic one. Daryl, how much of the Indianapolis fraud situation is still left on nonperformer though has not been charged off as of yet?
Daryl D. Moore
At the end of June we had about $16 million in non-accrual that related to that issue and we’ve got, Scott, about just slightly less than $7 million in provision against that.
Robert G. Jones
If you look at the release, Scott, on page 2 it’s got a pretty good breakdown of that on the press release, so if you need further info.
Scott Siefers - Sandler O’Neill & Partners L.P.
And Bob, just a kind of strategic question. There’s sort of a diminishing pool of strong banks out there that have the capital wherewithal to potentially do some M&A; in other words, take over some guys that might be a little more challenged in this kind of environment.
How are you thinking about things from an M&A perspective? Has your thinking changed at all, etc.?
Robert G. Jones
One, I think you’re right Scott but I would also tell you that we’re going to be very disciplined in anything we look at. I hate to use food analogies but they work for me that I’m not willing to take anything that’s going to give me indigestion at this time.
So any opportunities we have are going to be consistent with our strategy which is really Northern Indiana, the area between Indianapolis and Louisville we call the I-65 corridor. We’re going to be very, very cautious.
Because of our belief that we haven’t hit the bottom yet I’m going to be very cautious before I acquire something that would cause us to set back in our forward momentum. And I do believe that there’s going to be more opportunity in the upcoming quarters than what we’ve already seen.
Operator
Our next question comes from Charlie Ernst - Sandler O’Neill & Partners L.P.
Charlie Ernst - Sandler O’Neill & Partners L.P.
I just wanted to talk a little bit about loan growth. You guys had a quarter of loan expansion which hasn’t happened a whole lot in the last three or four years.
Can you just talk about what you’re seeing and what your expectations are maybe over the next year or two?
Robert G. Jones
A year or two might be a little long. One, I think it’s a reflection on the great work that Barbara Murphy has brought to our banking group.
Very disciplined, very focused. That growth is really in our sweet spot of C&I growth.
Particularly noteworthy that’s in markets that most notably you wouldn’t look as higher growth markets and I think again it reflects on that discipline. I think Charlie it also reflects a little bit on the fact that some of our competitors aren’t able to possibly do the lending.
We’re fortunate to have with us in the room our Regional President for three of those markets which is Jim Sandgren. Maybe Jim can talk a little bit about what he’s seeing in the market.
Jim covers Evansville, Vincennes and Southern Illinois which are three of our top four markets.
James A. Sandgren - Regional President
We had some really nice opportunities specifically in a couple of our markets, in Evansville and Vincennes, to do some very high rated lending to a couple of local universities, very high credit worthiness and it provided a lot of additional lending on the balance sheet. So we’ve seen some nice opportunities there.
Robert G. Jones
And as we look forward Charlie you’re not going to see robust growth; you’re going to see what we said last quarter. If you look at a percent reason, slight growth but offset as well by our continued view towards real estate.
Operator
Our next question comes from Mac Hodgson - Suntrust Robinson Humphrey.
Mac Hodgson - Suntrust Robinson Humphrey
I was curious if you could provide some more color on commercial real estate. I know you mentioned that the housing challenges are moving into commercial real estate and then I think Daryl you mentioned four large downgrades in the commercial real estate category.
Can you provide any more color about what you’re seeing in the market place, maybe use those credits as an example?
Robert G. Jones
Just to remind you before Daryl gives you the granularity that we’ve been almost two years of caution towards real estate and I think we’re beginning to see that caution become a fact but let’s have Daryl give you a little more granularity there.
Daryl D. Moore
Mac, a couple of things. One is I don’t need to tell anybody that we’ve had, every bank has had issues with regard go to the one to four family kind of subdivision lending and we’ve got not a lot of that on our balance sheet but we’ve got some and most of it is showing signs of stress, slower absorptions, just like every other bank.
What we’re beginning to see in addition to that is kind of the commercial retail. These strip centers that were being built in anticipation of larger residential developments being built around them, we’re beginning to see as the large residential developments don’t happen, these retail centers are beginning to come out of ground, get finished and not leased up.
What that does is that spills over then into your existing retail as leases are coming up for maturity, the existing tenants are saying “Hey listen, I can go to this new place or I can go someplace else to get lower lease rates,” and so to keep them in their facilities, they’re lowering their existing lease rates. So you’ve got a lot of supply, you’ve got existing lease rates coming down, and it’s just on these projects that are at 110 coverage last year, it’s putting them very close to being break-even in terms of cash flow.
With regard to our properties that kind of these four non-accruals that went on in the past quarter, one of them - really one, two, three of those are related to the fraud incident. One of those was downgraded into the nonperforming.
The others that we see having gone in, we have one very legacy hotel. We don’t have a big hotel industry so we don’t know much about it but this is kind of an older one that got downgraded.
And then one warehousing. We had a warehousing facility that was a little weak that we took.
So it’s kind of across the board, Mac. I can’t tell you that it’s in one segment of commercial real estate.
We’re just seeing weakness kind of across the entire portfolio.
Mac Hodgson - Suntrust Robinson Humphrey
Can you maybe remind me what the total exposure is to subdivision lending or that kind of one to four family side of commercial real estate and then maybe if you had to break out of commercial real estate in the commercial retail category, that would be helpful as well?
Daryl D. Moore
Yes, I can give you some real general numbers. Our subdivision lending is less than $25 million today outstanding at the end of the quarter so it’s not significant.
Mac, I can tell you what our breakdown on retail commercial real estate is but you’ve got to understand that many banks classify things differently, but it’s in our area in the $80 million to $90 million range as we classify it.
Operator
Our next question comes from Eileen Rooney - Keefe, Bruyette & Woods.
Eileen Rooney - Keefe, Bruyette & Woods
I just had a couple of follow up questions. We were just talking about the commercial real estate aside from the fraud-related stuff.
Are there any particular geographic areas that are experiencing more deterioration than others?
Daryl D. Moore
I would definitely say Indianapolis is our weakest market with regard to commercial real estate.
Eileen Rooney - Keefe, Bruyette & Woods
What about on the C&I side?
Daryl D. Moore
Right now the C&I side has not shown the weakness that we expected to see and so we don’t have any real pockets in the company that are showing significant weakness in that portfolio at the present time.
Eileen Rooney - Keefe, Bruyette & Woods
Jumping away from the asset quality, your personal expenses seem to pick up a little bit this quarter. I was just wondering if there’s anything unusual in there or if this is a good run rate going forward?
Robert G. Jones
It’s probably a good run rate because in the second quarter we get our merit increases that we give our employees. On average we were around 2.9% for merit increases for our associates.
Operator
Our next question is from the line of Stephen Geyen - Stifel Nicolaus & Company, Inc.
Stephen Geyen - Stifel Nicolaus & Company, Inc.
I was just wondering, in the Indianapolis region you included the $12.3 million in fraud related. How much of that is C&I and if you have any idea of time period of resolution for some of those loans?
Robert G. Jones
Daryl’s looking. Resolution Stephen would be awfully difficult because of I hate to use the word moving parts but there are so many parts moving between legal issues and working with the borrowers and getting documentation, I’d be really hesitant to give you any resolutional time.
We obviously hope to get it resolved sooner than later. We’re quite frankly a little tired of talking about it, but it’s going to take a little bit of time to work through those issues.
And Daryl may have your answer here.
Daryl D. Moore
Yes, ask the question again to make sure I’m giving you the right answer.
Stephen Geyen - Stifel Nicolaus & Company, Inc.
On the bottom of page 11 in the piece that you provided to the analysts, how much of the $12.3 million is C&I?
Daryl D. Moore
None of that is C&I.
Stephen Geyen - Stifel Nicolaus & Company, Inc.
The Toyota plant just north of town has announced some cutbacks. I guess the Tundra may be cut back.
Have you heard of any news of employment cuts at the plant?
Robert G. Jones
No employment cuts at our plant because we actually pick up the Highlander and as they do the switch over, Toyota’s guaranteed full employment for all of their associates at the plant. So really it was good news for Evansville and Princeton.
We pick up a better selling product, no employment impact at all, and it shows a commitment from the Toyota Japan to Princeton which was very good news for us.
Operator
Our next question comes from Michael Cohen - SuNOVA Capital.
Michael Cohen - SuNOVA Capital
Slide 17. Can you talk about the last maybe three quarters, Delta and the home equity 30-day delinquency?
Is that just sort of seasonality? It seems like somewhat of a larger than average jump on the HELOCs from 1Q to 2Q.
Daryl D. Moore
There is a big of an abnormality in those numbers. At the end of the first quarter we were in the 1.20% range.
There actually is about a $0.5 million account in our home equity that would be best classified as kind of a commercial workout that matured. It’s still in those home equity numbers.
It was secured by a mortgage on the individual’s residence, so it has distorted those numbers just a bit. We’re trying to work through that and resolve it.
But having said all that I would tell you that the trend of increasing delinquencies in home equities in our portfolio is a real trend and we’ll probably continue to see it rise.
Michael Cohen - SuNOVA Capital
But it’s safe to say not at that level shown quarter-over-quarter?
Daryl D. Moore
Not at that level. Yes.
Michael Cohen - SuNOVA Capital
Would it rise from the absolute level of 1.72% or are you assuming this $0.5 million somehow either migrates to another loan category or migrates off?
Daryl D. Moore
Hopefully it will migrate off. Without that specific count, the delinquencies were in the 1.53% range which is obviously still higher than where we were at the end of the quarter but I would hope that that $0.5 million would migrate off and not move to another category.
Operator
There are no further questions at this time. I would now like to turn the call back over to Mr.
Jones for any closing comments.
Robert G. Jones
The only closing comment, as always if you have further questions, please let Lynell know and again we’re interested in your input on things we can do to better provide you with the information you want. Particularly during these turbulent times we appreciate your support of Old National.
Thanks for being on the call.