Feb 1, 2010
Executives
Lynell Walton – SVP, IR Bob Jones – President & CEO Chris Wolking – Senior EVP & CFO Daryl Moore – EVP & Chief Credit Officer Barbara Murphy – Senior EVP & Chief Banking Officer
Analysts
Scott Siefers – Sandler O'Neill Mac Hodgson – SunTrust Robinson Humphrey Jon Arfstrom – RBC Capital John Rodis – Howe Barnes Stephen Geyen – Stifel Nicolaus Eileen Rooney – KBW
Operator
Welcome to the Old National Bancorp Fourth Quarter 2009 Earnings Conference Call. This call is being recorded and has been made accessible to the public in accordance with the SEC's regulation FD.
The call, along with corresponding presentation slides, will be archived for 12 months on the Investor Relations page at www.oldnational.com. A replay of the call will also be available beginning at 1:00 p.m.
Central today, through February 15. To access the replay, dial 1-800-642-1687, conference ID code 48365442.
Those participating today will be analysts and members of the financial community. At this time, all participants are in a listen-only mode.
Then we will hold a question-and-answer session and instructions will follow at that time. At this time, the call will be turned over to Lynell Walton, Director of Investor Relations for opening remarks.
Ms. Walton?
Lynell Walton
Thank you, Regina and good morning to all of you. We welcome you to our fourth quarter 2009 earnings conference call.
With me today are Old National Bancorp's management members Bob Jones, Chris Wolking, Barbara Murphy, Daryl Moore, and Joan Kissel. As noted on slide three, I would like to remind you that as we proceed, our presentation today will 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 Old National's filings with the SEC. Slide four contains our non-GAAP financial 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 to be helpful in understanding Old National's results of operations and core performance trends. If you turn to slide five, you'll see our agenda for the call today.
First, Bob will review significant events and highlights of our fourth quarter and full year 2009 performance. Daryl will then provide additional detail on our shared national credits, provide commentary on our credit quality trends and our outlook on these trends going forward.
Next, Chris will in detail items impacting our net interest margin and the specific securities, which resulted in our other-than-temporary impairment for the quarter. Bob will then close out our prepared remarks with a look-ahead at 2010.
After that time, we will be happy to open the lines and take your questions. I will now turn the call over to our CEO, Bob Jones.
Bob Jones
Thanks, Lynell and good morning to everybody on the call. As always, we appreciate you joining us.
Before I begin my commentary regarding the fourth quarter, I would be remiss if I didn’t start our call with a toast to our Indianapolis Colts and wishing them victory in the Sunday Super Bowl. I know that each of you join us in wishing the Indiana's team good luck this Sunday.
Turning to slide seven, I will begin my review of the fourth quarter. This morning, we did announce a loss for the quarter of $9.3 million or $0.11 per share.
This loss was driven by the events that we detailed in our pre-release of January 13th. To recap, those items consisted of first, a single charge-off of $12 million related to a non-real estate syndicated credit from our Indianapolis market.
I know that we spoke with those of you who called after the pre-release and answered many of your questions. We will just open items from your questions during our credit review and as always, we would be happy to answer any further questions during the Q&A.
During the quarter, we also continued to experience OTTI of $9.5 million. We were very diligent in our analysis of these portfolios in an attempt to ensure that we appropriately captured forecasted credit loss and we worked with a third party to help validate our assumptions.
To be honest though, while we feel we were conservative in our analysis, it is not possible to say we will not experience any further OTTI. As we also discussed in the pre-release, we did restructure our balance sheet in the fourth quarter, primarily in determining our higher-cost FHLB advances and sales of municipal bonds.
As Chris will discuss with you later, these actions did have a positive impact on our margin in December. Other highlights for the quarter are the continued improvement in our credit metrics with non-accruals declining quarter-over-quarter, as well as our classified loans doing the same.
These declines, coupled with the fact that our provision equaled our charge-offs for the quarter, improved our allowance to non-performing loans to 104% versus 94% last quarter. It is our opinion that we may have hit the bottom of what has been an extended negative credit cycle and while we do not see meaningful improvement in our credit trends during the near term, we also do not expect to see further significant deterioration.
Finally, for the quarter, we did see strong increases in our non-interest DDA balances. This was driven in part by the continued improvement in our sales efforts, as well as our commercial and industrial customers continuing to hold cash as they wait to see if the economic recovery is real.
The counter to that unfortunately is a continuation of very soft loan demand in our markets as our clients wait to see if the economic recovery is real. Let's turn to slide eight and you can see the highlights of what we would call a good year for Old National.
I might mention that this performance is also reflected by a recent 18th ranking in the Forbes Magazine analysis of the top 100 banks. While we are pleased, we do realize that we need to continue to work diligently to further strengthen Old National for the inevitable return to normalcy.
At the end of this presentation, I'm going to review with you some of the steps we are taking to accomplish that goal. Now, let me turn the presentation over to Daryl.
Daryl Moore
Thank you, Bob. Because the single large charge-off in the quarter was a shared national credit, I think it's appropriate to begin my segment of this morning's discussion reviewing our institution's exposure to shared national credits.
As you can see from slide 10, at the end of the year, Old National was a participant in 13 different shared national credit relationships with $141.1 million in total exposure and $73.5 million in total outstanding. All but one of these relationships is within our three-state footprint of Indiana, Kentucky, or Illinois.
Our largest exposure in this portfolio was $20 million and the portfolio has a weighted average risk rate of 1.8. To refresh your memories, we rate our commercial credits on a scale of zero to nine with zero representing the lowest risk profile of the categories.
We have monitored our shared national credit exposure closely over the last several years and continue to review our exposure in this area with our Risk Committee on a quarterly basis. At the current time, other than the remaining exposure of slightly less than $2 million on the single large credit, which was written down in the fourth quarter and a small letter of credit exposure of less than $0.5 million, there are no credits in this portfolio segment that are rated criticized or worse.
Moving to slide 11, you can see that the fourth quarter net charge-offs were significantly higher than prior quarters. Net charge-offs in the quarter were $21.8 million or 217 basis points of average loans compared to $12.7 million or 117 basis points of average loans last quarter.
Obviously, the big story in terms of charge-offs came in our C&I portfolio where losses totaled almost $17 million. Without in any way minimalizing the severity of the $12 million single credit write-down in the quarter, if you back that loss out of the C&I portfolio performance, net charge-offs in the quarter would have been roughly equal to third quarter C&I losses.
Net losses in the commercial real estate portfolio were down roughly $3.9 million from last quarter's loss levels. Reduction in net loss in this area resulted from a combination of both lower gross profits in the quarter, as well as higher recoveries on past write-downs.
Consumer loan losses were $3.6 million in the just-finished quarter, up from the $2.7 million to $2.8 million run rate over the last two quarters. While 2009 non-home equity line of credit retail portfolio losses have remained fairly constant from quarter-to-quarter, HELOC portfolio losses have shown some volatility over the same period.
All of the increase from the third to the fourth quarter came from higher HELOC losses. That having been said, delinquencies and loss rates in the HELOC portfolio are up only marginally from full-year 2008 levels.
Losses in the one-to four-family residential mortgage portfolio were higher in the quarter. The higher losses for the quarter notwithstanding, the losses remained relatively well controlled in this portfolio during 2009, but loss rate is in the 28-basis point area based on year-end outstandings.
With respect to our allowance for loan and lease losses, as you know, the provision expense for the quarter was $21.8 million, basically equal in amount to our charge-offs for the quarter. However, with changes in the portfolio outstandings and risk characteristics, we were able to increase the allowance coverage of non-accrual, underperforming, and total loans in the quarter.
For the full year, we added roughly $2.5 million to the allowance, resulting in allowance coverage of total loans as of December 31st, 2009 of 180 basis points compared to 141 basis points at the end of 2008. As slide 12 reflects non-accrual loans were lower in the quarter, falling by $6.7 million.
Non-accrual loans now comprise 131 basis points of the total portfolio compared to 180 basis points at the end of last quarter. With respect to the mix of non-accrual changes in the quarter, we observed declines in non-accrual balances in the commercial type portfolios, offset to some degree with increases in the one-to four-family residential portfolio.
Slide 13 depicts the trends in our largest non-accrual exposures at quarter's end. As you can see, we have significantly decreased the large non-accrual exposure in our company over the year with both the number of loans, as well as the total exposure related to these larger problem loans, declining by over 50% since the end of the first quarter.
With respect to the mix of commercial non-accruals, the majority of large loan exposure now originates from the C&I portfolio as opposed to the commercial real estate portfolio. While this is not a change from last quarter, it is a significant shift from year-end 2008 where the majority of our commercial type large non-accrual exposures were commercial real estate portfolio based.
As slide 14 shows, our 90-plus delinquent loans did rise by approximately $800,000 in the quarter and now stand at a yearly quarter-end high of 9 basis points of total loans. The source of the increase in this area originates chiefly from the C&I area and could be identified in a couple of loans where satisfactory resolution is expected at this time.
We continue to believe that our 90-plus day delinquent levels remain at very respectable levels given the current state of the economy. Moving to slide 15, you can see that our other real estate owned and repossessed property balances increased in the quarter, almost doubling to $8.1 million.
The great majority of this increase came in the commercial real estate and the one-to four-family residential real estate areas. We currently have only one property in our OREO portfolio with a carrying value in excess of $1 million.
Moving to slide 16, the dollar level of classified loans, which include non-accrual loans, fell slightly less than $18 million in the quarter to a level of roughly $157 million. Classified loans now stand at 4.02% of total outstandings, the lowest quarter-end level posted in 2009.
Non-investment grade securities with a book value of $161.2 million, which were categorized as classified assets, are not included in these totals. Slide 17 reflects our criticized loan trends.
Criticized loans increased roughly $9 million in the quarter and now equal 265 basis points of total loans. Until we see meaningful improvement in the economy, we would expect to see continued movement of some of the more marginal credits in our portfolio into this category with further downgrade movement of some portion of those downgrades likely.
Because 30-day delinquencies give some indication of potential for future credit issues, all banks are obviously watching them very closely. The slide 18 shows delinquency dollars and rates in our portfolio fell in the quarter, which rates just below the 90-basis point level.
Slide 19 shows by portfolio a breakout of our 30-day and greater delinquency rates. As you can see in the top half of the chart, we posted improvement in delinquency rates in all categories reflected with the exception of a slight increase in the non-HELOC related consumer loan delinquencies.
Portfolio loan type composition showed little variation in the quarter as reflected in the bottom half of the chart. Moving now to the final slide of my part of the presentation, we have again laid out information for you related to our home equity line of credit portfolio.
We have seen very little movement in the percentages reflected on this chart since the end of the last quarter. We continue to have a reasonable level of greater than 80% LTVs in the portfolio with generally higher utilization rates in the higher LTV portion of the portfolio.
Large dollar exposures continue to comprise a relatively small part of our overall exposure. In summary, I think it's very fair to say that 2009 was indeed very challenging.
As Bob said, we believe we may have seen the bottom of what has been an elongated negative credit cycle, but also expect that the recovery will be realized over an extended period. With those remarks, I'll turn the call over to Chris.
Chris Wolking
Thank you, Daryl. Bob reviewed the key drivers of our fourth quarter results at the beginning of the call.
It is important to note that our actions during the fourth quarter continued the balance sheet and net interest margin themes we have discussed in previous calls this year, which are, to maintain a strong capital base to give the company the capacity to grow through the acquisition of other banks or organically as the economy improves, to maintain an asset-sensitive balance sheet to prepare for rising short-term interest rates, and to reduce our tax-exempt income as a percentage of taxable income to slow the growth of the deferred tax asset on our balance sheet. Most of the slides in my presentation are familiar to you from previous quarterly presentations, but I have added additional information to help you understand the drivers of our lower net interest margin and the securities that generated the other-than-temporary impairment charge during this quarter.
I'll begin on slide 22. Tangible common equity declined from 8.53% in the third quarter to 8.25% in the fourth quarter.
Tangible common shareholders' equity declined from $663 million at September 30th to $643.6 million at December 31st due to the net loss in the quarter and our $0.07 per share common dividend. Tangible assets increased $34 million during the quarter.
On slide 23, note that tangible common equity, as a percentage of risk weighted assets, increased by 12 basis points from September 30th to December 31st. Risk weighted assets declined to $206.6 million during the quarter, driven primarily by the $197.2 million decline in our loan portfolio from September 30th to December 31st.
Our investment portfolio comprised 36.9% of our total assets at December 31st. Our large investment portfolio combined with our high tangible common shareholders' equity gives us a tangible common equity to risk weighted asset ratio well in excess of the average ratio of our peer group.
Moving to slide 24, note that net interest margin declined 20 basis points to 3.33% in the fourth quarter from 3.53% in the third quarter. All of the margin decline in the quarter was due to the decline in earning asset yield.
Lower asset yields caused the margin to decline 32 basis points. Yield on the investment portfolio declined from 4.90% in the third quarter to 4.26% in the fourth quarter.
Within the investment portfolio, the yield on all of our securities portfolios declined somewhat, but the yield on our treasury and agency investment portfolio dropped most significantly, declining 94 basis points. Much of what drove the decline in the treasury and agency yield was the fact that in the third quarter – late in third quarter, we invested the cash from the capital raised in the third quarter sale of our municipal tax portfolio into low-yielding, short-maturity treasury and agency securities.
Also contributing to the margin decline related asset yield, the yield in our loan portfolio declined by 6 basis points during the quarter from 5.14% in the third quarter to 5.08% in the fourth quarter. The decline in margin due to asset yield also captures the shift within the earning asset portfolio from loans to investments during the quarter.
Total average earning assets increased approximately $100 million, but average loans declined $334.6 million during the quarter and average investments increased $435.4 million during the quarter. Much of the decline in average loans in the fourth quarter was due to the lease sale in September, but commercial real estate, consumer and residential mortgage loans also declined during the quarter.
The decline in interest-bearing liability costs during the fourth quarter lifted the margin 7 basis points and offset the margin impact from lower asset yield somewhat. The cost of interest-bearing deposits declined 8 basis points during the quarter, due primarily to the 17-basis point decline in the cost of CDs under $100,000.
Borrowed funding costs declined 3 basis points during the quarter. Importantly, long-term borrowing balances decreased late in the quarter.
At September 30th, long-term borrowing totaled $808.6 million and had declines of $699.1 million by December 31st because we terminated $105 million of fixed-rate Federal Home Loan Bank advances. These advances were included in the long-term borrowings with an average rate of 3.20% and maturities of between 10 months and three and three-quarters years.
Mix/volume/other impact on margins for both assets and liabilities was minimal. As I said earlier, average earning assets increased $100 million in the fourth quarter, which contributed about 4 basis points in improved margin.
And average interest-bearing liabilities were down $89.1 million in the quarter, which lifted the margin by 1 basis point. On slide 25, you will see our monthly net interest margin during the year.
The net interest margin increased to 3.42% in December from 3.26% in November. Some of the increase in the margin was due to recovered interest from non-accrual loans that were resolved during the month, but subtracting this impact, our net interest – our December margin was 3.38%.
The December margin was positively impacted by investment sales during the month and a portion of this cash was used to retire the Federal Home Loan advances. Recall that the average yield on the terminated FHLB advances was 3.20%, while the average yield on the investment securities we sold during the month was 1.91%.
On slide 26, I've graphed our cost of interest-bearing deposits compared to the average deposit cost for peer group. We don't yet have the peer group average cost for the fourth quarter, but you will note that in the third quarter, our deposit costs were 15 basis points lower than the average deposit costs for peer group.
This compares to a 23-basis point difference in the second quarter and a 30-basis point difference in the first quarter of 2009. Clearly, our deposit pricing advantage compared to our peer group eroded somewhat in 2009.
On slide 27, note that our loan yield compared to the average yield of our peer group improved slightly in the quarter – in the third quarter. Again, fourth quarter peer data is not yet available.
The first quarter of 2009, our loan yield was 46 basis points less than the average loan yield of our peer group, but the difference had declined to 17 basis points by the third quarter. Slide 28 shows the trend in average loans and investments since first quarter of 2007.
Note particularly the decline in loans and the increase in investments during 2009. As I noted earlier in my presentation when I talked about the contributors to the decline in net interest margin during the fourth quarter, the decline in loans as a percentage of total earning assets has had a negative impact on net interest margin throughout the year.
We expect stronger loan production as the economy in our region improves. Slide 29 shows the growth in non-interest bearing deposits since first quarter of 2007.
Note the strong growth in demand deposits in 2009 and the corresponding decline in borrowed funding. Much of the decline in borrowed funding during 2009 is attributable to the $318.5 million decline in short-term borrowing since December 31st, 2008.
Because short-term borrowed funding had an average cost to us of only 27 basis points during 2009, the positive impact to the net interest margin due to the increase in non-interest bearing deposits was muted somewhat in 2009, but we believe this will be an important contributor to an improved margin as the economy improves and interest rates rise. Before I move into the slides related to the investment portfolio, I'd like to summarize the contributors to the decline in our net interest margin.
Earning assets increased, but the mix of earning assets shifted to lower-yielding investments and out of loans during the quarter and during the year. Non-interest bearing demand deposits have grown, but the full benefit of this funding won't be realized until interest rates increase.
And our balance sheet continues to be somewhat asset-sensitive and continued low short-term interest rates have impacted our margin. Future net interest margin will be dependent on our ability to grow our loan portfolio and retain our non-interest bearing demand deposits and of course, the direction of interest rates.
I think it's important to add that while we recognize we are giving up some net interest income by remaining asset-sensitive, we believe that this is a prudent strategy given unusually short-term interest rates and the scrutiny regulators are placing currently on balance sheet, liquidity, interest rate risk, and leverage. Slide 30 provides the book value and the market values of our investment portfolio by category as of December 31st.
I included the market values by category as of September 30th. So you can see the changes in the various portfolios during the quarter.
Treasury and agency securities declined during the quarter due to costs, maturities and sales. And in December, of course, we sold $217.4 million of short-term treasuries and agencies that yielded 84 basis points and a gain of approximately $881,000.
Tax-exempt muni bonds declined during the quarter, primarily due to sales in December, $38.7 million with a tax equivalent yield of 7.93% and a gain of approximately $3.7 million. Total securities gains for the quarters – for the quarter before subtracting the charge for OTTI, were approximately $6.3 million.
Taxable municipal securities increased from September 30th to December 31st. We will likely continue to shrink our nontaxable municipal bond holdings and may replace them with taxable bonds to further reduce our tax-exempt income as a percentage of taxable income.
This should reduce the growth of our federal deferred tax asset. In 2010, however, we do expect that tax-exempt income could exceed taxable income for the year and that we will recognize a tax benefit in 2010.
Slide 31 provides more detail on the securities that are included in our classified assets portfolio. Bonds must be included in classified assets if one ratings agency considers the bond is non-investment grade.
The portfolio of investments treated as classified has a book value of $161.2 million, down from $174.6 million at September 30th. We carry these bonds in classified assets at the book value of the securities, which is the original purchase price, less any OTTI and including amortization of premium or accretion of discount.
As disclosed in our 8-K released earlier this month, we charged $9.5 million to other-than-temporary impairment to earnings for the fourth quarter. Year-to-date, our OTTI charge is $24.8 million.
The $9.5 million charge for the quarter is the realized credit loss of the total impairment. The non-credit component of impairment continues to be included in other comprehensive income.
The OTTI for the fourth quarter is attributable to five of our pooled trust-preferred securities in 10 non-agency CMOs. On slide 32, I included a detailed listing of the securities that have had an OTTI charge in 2009.
Several of you had requested vintage and ratings information for the impaired bonds. We will continue to monitor our pooled trust-preferred and CMO securities closely for OTTI.
It is possible that we will have additional OTTI in future quarters. I added the effective duration of the portfolio, June 30th, September 30th, and December 31st, on slide 33.
While the duration of the entire portfolio moved up slightly from September 30th from 4.41 to 4.63, this was due primarily to the large sale in December of the very short maturity treasuries and agencies. Exclusive of the sale of the short maturity treasuries and agencies, the investment sales in the fourth quarter had an effective duration of approximately 8.6.
At 4.63 on December 31st, the portfolio effective duration is significantly lower than the 5.35 duration at June 30. We expect to continue to reduce the duration of the investment portfolio going forward.
Reducing the duration of the portfolio is consistent with our desire to continue to position our balance sheet to reduce the possible negative impact on earnings from rising interest rates. I'll now turn the call back to Bob for his final comments.
Bob Jones
Thanks, Chris. I'm going to close our presentation on slide 35 with a very high level review of a few of the actions we will be taking to further strengthen Old National during 2010.
While the economy appears to be at least slowly recovering, and we have said multiple times that has not been reflected in the demand for loans from our customers or our prospects. This slowdown has allowed us to look at ways to improve our processes, to enhance our client experience throughout the bank, with an eye towards ensuring that we are well positioned for when the demand improves.
To that end, we have multiple efforts going on in the company. Barbara Murphy and Daryl Moore are leading one effort to review our commercial lending area.
Our project manager is Dennis Heishman, our Kentucky region CEO. Early results have yielded some efficiencies as we have been able to streamline some of our processes.
Our goal is to continually focus on enhancing the client experience, improve turnaround times, and to ensure we maintain our strong credit culture. In addition, we are conducting the same review on our retail banking unit.
Identical governance structure is in place with project management being led by Jeff Speith, our Illinois market President. We have also begun an exhaustive review of our expense structure.
This is an ongoing process with the majority of the impact expected later in 2010 and into 2011. Our early results have yielded a reduction of approximately 4% of our workforce with an estimated annual reduction in expenses of close to $8 million.
I should also note that we accrued the related severance cost of $1.8 million in the fourth quarter. We are early in the process and we will continue to provide you with further updates during our quarterly calls.
It is a very interesting time to be a banker. The political winds are clearly not blowing in our direction and unfortunately, we are all being tarred with the same brush.
I do believe that there is some need for regulatory changes and I am confident that we will see some legislation passed during 2010. I can only hope that whatever passed is done with the intent of mitigating risk and not adding additional bureaucratic hurdles for banks.
The most imminent regulatory change will be Reg E. The impact is fairly significant on all banks.
We at Old National continue to work on researching product changes, as well as helping our customers better understand the effects of Reg E. More to come for each of you on this topic in future calls.
Finally, I would note that we have been very active in talking with a number of banks and looking a few deals. Our desire is still to be an active, diligent acquirer.
We have seen the pace of FDIC deals to be consistent with prior quarters, but we haven't seen any deals that either meet our target markets or meet our strategic goals. We also continue to evaluate other opportunities and believe we are well positioned for when the right deal comes along.
At this time, we will be happy to answer your questions. Operator, if you could open the lines?
Operator
(Operator Instructions). Your first question comes from the line of Scott Siefers with Sandler O'Neill.
Bob Jones
Congratulations, Scott.
Scott Siefers – Sandler O'Neill
Thank you very much. I appreciate that.
So I guess the first couple of questions are on credit. So Daryl, maybe they are best for you.
Given sort of the extended pace of recovery, I wonder when your model would allow you to begin to draw down reserve, what kind of things that you would have to see there? And then as a general credit question, what couple of metrics would you be looking at to see if the credit environment were improving more materially?
And then I guess conversely, what would you look to see if when we might be slipping into another downturn?
Daryl Moore
Yes, great questions, Scott. With respect to the drawing down the reserves, I think that we – I know that we have very spirited discussions in the organization.
I think though we are all very focused on the fact that – we have to be careful about drawing down reserves until we are absolutely convinced that the trends increasing risk in the portfolio have seized and turned the other way. And so not only do we look at our model and make sure that the model confirms where we are, but we as a management group are committed to making sure we don't get too far ahead of drawing down reserves until we are all convinced that things are turned around.
Now, with respect to that second question, I think that leads – the credit metrics that we would look at to see that – be convinced that things have turned. We monitor on a monthly basis our downgrades to upgrade ratios and we have, during 2009, continued to see a trend of our downgrades exceeding our upgrades in virtually every one of our asset quality rating categories.
If we begin to see that turn and we begin to see our delinquencies continue to improve, I think at that point in time we see kind of that first crack of light through the door and we are going to get much more enthused about the fact that we are really seeing some definitive material recovery that we can rely on.
Scott Siefers – Sandler O'Neill
Okay, perfect. Thank you.
And then Chris, I think probably next question is for you, just on the securities portfolio and I guess the possibility of any further OTTI. I guess given the kind of the review when you looked at this quarter's number, as you look for – what kind of dynamics would it take to have additional OTTIs in that portfolio?
Chris Wolking
Well, again, I kind of think I would echo Daryl's comment about spirited discussions around OTTI and it clearly is something that we look at very, very closely. I think as you see in the OTTI this quarter, Scott, we really took our first material OTTI on our CMO portfolio.
So we look very closely at our delinquency expectations and our loss expectations around those delinquencies. And I think – frankly, that's why we put a little more detail on there so that you all could take a look at those and give it your own judgment around those securities.
But as Bob mentioned, we feel like we did a nice job and we are appropriately conservative in our evaluation of delinquencies and loss expectations around those securities. So it's' a quarter-by-quarter thing.
Bob Jones
Scott, I might add to that spirited discussion. I have a broken ankle and it has nothing to do with OTTI or credit.
Scott Siefers – Sandler O'Neill
Thankful to hear that, but sorry to hear about the ankle. All right.
That – I think that should do it for me. So thank you very much.
Bob Jones
Congratulations again, Scott.
Scott Siefers – Sandler O'Neill
Thanks a lot, Bob.
Operator
(Operator Instructions). The next question comes from the line of Mac Hodgson with SunTrust Robinson Humphrey.
Bob Jones
Hey, Mac. How are you doing?
Mac Hodgson – SunTrust Robinson Humphrey
Hey, good. Good morning.
A couple of questions, maybe first – I noticed a slight decline in service charges on deposit accounts. You might have addressed this in your comments.
I was curious if that was anything unusual and I know at this point it's difficult to quantify what level of NSF-related fees will be impacted by the legislative changes, but is it possible to put a range around it?
Bob Jones
Yes, I'd be cautious in putting any range around it yet until we get further understanding, Mac. We've been diligently looking at Reg E and trying to get that number, but I'm not prepared to give you a number you can put in your models yet.
Relative to the service charge decline, it's really a more of a mechanical issue around charge-offs. We had a little higher charge-offs in the fourth quarter, which really affected that run rate.
I think if you go back to the third quarter, you will get a better idea what the run rate would be, absent any changes coming from Reg E.
Mac Hodgson – SunTrust Robinson Humphrey
Okay, great. Then Chris, on repositioning the balance sheet for a rising rate environment, can you give us any color on – I know we could see it obviously when the K comes out, but – I don't know how you all look at it, but with a increase in rates of X basis points, how would the spread income or net income adjust?
Chris Wolking
Yes, I don't have the details here in front of me, Mac. And you are right, we do spell that out pretty carefully in the K.
It – we've continued – I think as we pointed out in previous quarters, we've been maintaining an asset-sensitive balance sheet for quite a while and it's our objective not to get too far ahead of that number. So I think it's fair perhaps to look at last quarter's information and have a pretty good estimate of where we are going forward, but we clearly realize that in a steep yield curve, we are giving up some income, we don't want to go too far overboard on the asset-sensitive balance sheet, but it's a pretty important element of our AL discussions on a regular basis that we just feel like it's the right thing to do.
So you won't see us take undue leverage or interest rate risk with investment portfolio assets beyond where we are today.
Bob Jones
I might mention, Mac, if you haven't seen Vice Chairman Kohn from the Federal Reserve's testimony last week on interest rate risk, it's clear this is getting an awful attention out of Washington as well.
Mac Hodgson – SunTrust Robinson Humphrey
Yes. Yes, absolutely.
And Chris, another question on taxes. And you might not have this, but is there a way to – I mean, what was the level of tax-exempt income in the quarter?
And then it sounds like that will probably be a bit lower obviously as you shift out of some tax-exempt securities. I was trying to think about how to model – ?
Chris Wolking
How to model it, yes.
Mac Hodgson – SunTrust Robinson Humphrey
Yes.
Chris Wolking
Well, I think as I pointed out, we still expect to have higher tax-exempt income than taxable income in 2010. So that gives you some idea of what that effective rate could be and we've always maintained a relatively low effective tax rate in the course of – with this kind of information, it's effectively negative.
But I think that – I think in conjunction with that, we still want to watch the buildup of our AMT credit and we are clearly concerned, obviously – attention around our deferred tax asset, but everything is in pretty good order. We don't – I think when the SEC looks at deferred tax assets for valuations and things of that sort, they are always looking backwards at what kind of losses you've had in the previous quarters and of course your previous years, and of course we haven't had any problems with that.
So it's just a question of being cognizant of those assets and continue to do what we can to increase that taxable income as a percentage of tax-exempt total income.
Mac Hodgson – SunTrust Robinson Humphrey
Great. And one last one.
Bob, just touching on the M&A environment again, I'm curious how the company views unassisted or open bank transactions now and to the extent that aren’t a lot of FDIC assets to deal in and around your market, at what point would management feel comfortable completing a regular way type of transaction and do you see many of those on the horizon?
Bob Jones
Yes, a couple of points, Mac. One is we would get there once we can get comfortable with the mark on the credit.
That's – it's awfully tough to get comfortable in a whole-bank transaction because of those marks. So it's still in our M&A strategy, whole-bank transactions would be a distant third against FDIC and branch acquisitions.
But interestingly, as you start to see more and more companies with their stock trading below book, some interesting accounting that at least is intriguing that allows us to look at whole bank, but again that mark is just awfully tough to get past at its stage and we lay a lot of pipe and then as the world turns, hopefully we've – we can take advantage of that.
Mac Hodgson – SunTrust Robinson Humphrey
Okay, great. I appreciate the color.
Thanks.
Bob Jones
Thanks, Mac.
Operator
Your next question comes from the line of Jon Arfstrom with RBC Capital.
Bob Jones
Hey, Jon, welcome.
Jon Arfstrom – RBC Capital
Great, thanks. Good morning.
Even Archie Manning is cheering for the Colts by the way.
Bob Jones
He is not. Just give up your firstborn.
Jon Arfstrom – RBC Capital
He is. Question on OREO.
It's not a very big category and you talked about how there aren’t very many large credits in there, but how aggressive do you plan to be on moving those credits out?
Daryl Moore
Yes, Jon. This is Daryl.
We historically, and I don't see any change, have been very aggressive in trying to move them out. If you look over the long term and if you try to manage your property out of the cycle, we have found that more times not.
You just spend – end up spending more money, keeping the property up, paying the taxes, those types of things. So I think that we have the loans adequately marked to what the current market rate is or current market value is and so I would – our expectation would not be to change our philosophy of moving these out as quickly as we can.
Jon Arfstrom – RBC Capital
Maybe an unrelated question. Chris, how much more room do you think you have on deposit costs?
It looks like, according to your chart, that comes on about 8 basis points to 10 basis points per quarter and I'm curious if you think that that can keep going at that pace.
Chris Wolking
You guys are hitting all three of the spirited discussions that we have on a regular basis. I think that – when you look at our rates, particularly on the interest-bearing transaction type accounts, they are pretty low.
So we've done a good job of keeping those low and balances have continue to increase, which were very important to us. The opportunity there then becomes on CDs and the more term typed interest-bearing accounts and we continue to see some benefits there.
The question is to, given our need to continue to be asset sensitive, we don't want to give up too much duration in our core funding books. So we are – we watch it very, very closely and try to take what we can without giving up too much in the way of customer relationships or those total deposits.
Bob Jones
And I would just say there is days I feel like Dr. Phil between Barbara, Daryl and Chris.
So you hit on two of the topics between credit and deposit pricing.
Jon Arfstrom – RBC Capital
Okay, all right. Well, we'll go into loan pricing then, I guess.
Bob Jones
We've got room.
Jon Arfstrom – RBC Capital
How competitive is the environment for quality credits? I think you are obviously in the similar situation to a lot of your peers, but curious, maybe a little bit on the pipeline, a little bit on the quality of the pipeline and then a little bit on how competitive it is when something quality comes up for grab?
Barbara Murphy
This is Barbara Murphy. I'm going to take that question.
The pipeline has deteriorated through the year in terms of volume opportunities, but stabilized in the fourth quarter to where it was and at the end of the third quarter. So we've seen some of it build back up.
The pricing in our markets is very competitive and very intense. We keep compete against the lot of smaller community banks who are very aggressive with their pricing.
So guys are trying to sell relationship and the other services that we offer and not always go out on price. At times, we do concede our price, but it has to be a deep and rich relationship for us to do that now.
Jon Arfstrom – RBC Capital
Give me difference between Evansville and Indy for example.
Barbara Murphy
In terms of competitive nature?
Jon Arfstrom – RBC Capital
Yes.
Barbara Murphy
Not really. It's – Indy lasted longer in terms of the pipeline staying up, but it has fallen just as sharply now as it did in Evansville.
Jon Arfstrom – RBC Capital
And pricing would be pretty consistent between both?
Barbara Murphy
Pricing is consistent. There are lots of opportunities in the Indy for small banks.
I think there are 67 banks in the Indy. So there is no shortage of banks to compete with there.
Jon Arfstrom – RBC Capital
Okay. Thanks for the help.
Bob Jones
Great. Thanks, Jon.
Operator
Your next question comes from John Rodis with Howe Barnes.
Bob Jones
Hey, John.
John Rodis – Howe Barnes
Good morning. Good morning, guys.
Bob, I think I caught your comments on severance expense and I think you mentioned 4% cut in the workforce. Could you just go back over there?
Bob Jones
Sure. Over the last couple of weeks, we have notified about 4% of our workforce that their positions have been eliminated as I said.
On an annualized basis, that's approximately $8 million in cost reduction. The $1.8 million in severance related to those positions we did take in the fourth quarter.
Unfortunately, it's always difficult whenever you eliminate people. So obviously we have committed to you – to everyone in the third quarter that we knew we had to reduce cost and we continue to work through that process.
John Rodis – Howe Barnes
Where did most of those cuts come?
Bob Jones
Really, a lot of them in the loan and credit areas as we continue to see demand shrink. So that would be the bulk of them, geographically mostly split between Evansville and Indianapolis.
But we have seen cost reductions in virtually every area of the company as we continue to look at ways to streamline processes and reduce some of the overhead we build up as we execute the turnaround of the company.
John Rodis – Howe Barnes
Okay. And the severance cost of $1.8 million, where was that actually in the quarter?
Bob Jones
It would be in your salary and benefits line. It's a contra-expense or it's an expense that hits that number.
So – but it was slightly offset by some other reversals that we had in salaries and other areas with bonuses in that. So really from a modeling standpoint, it's almost neutral.
John Rodis – Howe Barnes
Okay, okay. And then I'm just – as far as for 2010, what do you – I mean, what do you think the efficiency ratio other than being lower?
Is there kind of a range you think it should be around?
Bob Jones
Lower. I'm not really committed, John, to get – we are continuing to try to model some of the work.
As I said, I'm very pleased with the early efforts on part of the management, but as we get a little better and a little bit more finite on our modeling, we'll give you a better idea with it, but I'd hate to commit to a number now and have to backtrack. But I can tell you, we are keenly focused on reducing overhead right now.
John Rodis – Howe Barnes
Okay, fair enough. Thanks, guys.
Bob Jones
Thanks, John.
Operator
Your next question comes from Stephen Geyen with Stifel Nicolaus.
Stephen Geyen – Stifel Nicolaus
Good morning.
Bob Jones
Hey Stephen, how are you?
Stephen Geyen – Stifel Nicolaus
I am well, thank you. This is – actually, Barbara answered one of my questions, but I got one other question for her.
Regarding CD rates, certainly industry-wide, rates have been coming down and also deposits at banks have been rising. Do you think there is more to go in CD rates?
Barbara Murphy
In terms of rates coming down?
Stephen Geyen – Stifel Nicolaus
Yes.
Barbara Murphy
I've given as blood as I'm about to give. We really have been reducing them over the last several months.
I mean, almost every month we've been reducing them. And quite frankly, I'm not seeing the attrition that we thought we would see from doing that.
Bob Jones
Yes. Stephen, our rates are clearly the lowest in the markets we are in and I wouldn't say there is a lot of room to drive that down.
We are conscious of relationships at the same time, but we work – Barbara has worked awfully hard with her team to get those rates down and we are just kind of waiting for rates to rise at this stage.
Stephen Geyen – Stifel Nicolaus
Okay, thank you.
Bob Jones
Thank you.
Operator
There is a follow-up from the question of Scott Siefers with Sandler O'Neill.
Scott Siefers – Sandler O'Neill
Hey, Bob. I was hoping you might expand a bit on one of the answers you had to one of the previous questions.
It was just on kind of the unassisted M&A environment. You made the comment about the – some of the accounting benefits that you can potentially utilize in unassisted deals.
And I guess just kind of qualitatively, if you think about those names that are trading below book, they I guess in some cases get to be sort of slippery slopes [ph]. Either they are trading there because there is a chance of failure or conversely, if they do survive, presumably they would do quite well in a recovery.
So I guess I just wonder how – kind of how those conversations go when you speak with management teams from those types of companies and then kind of how you weigh the mark given the inordinate amount of risk versus the benefits you might weigh? I guess just any color you can provide on that earlier comment would be helpful.
Bob Jones
Sure. There is a reason we haven't announced deals lately, Scott, is that we are extremely conservative as we look at those.
Conversations are interesting. I would tell you that unless a bank has gotten some regulatory restrictions or letters or whatever, their expectations are still, in my opinion, too high.
Even if they are trading below book, the boards and managements still believe that when things turn around, they are going to be okay. So I would characterize those discussions as friendly, we do a lot of them.
But there is a reason we haven't announced anything because, as I think everybody knows, we are just so darn conservative when we look at those credit marks that it's hard to get comfortable at this stage.
Scott Siefers – Sandler O'Neill
Perfect. Thank you.
Bob Jones
Thanks, Scott.
Operator
Your next question comes from Eileen Rooney with KBW.
Bob Jones
Hi, Eileen. How are you?
Eileen Rooney – KBW
Good morning, everyone. I just had one follow-up to Chris, your comments on the tax rate and I just wanted to make sure that – I know you said you would have higher tax-exempt income in 2010 than in – than non – than the taxable income.
Chris Wolking
Right.
Eileen Rooney – KBW
And under that scenario, what is your sort of tax rate range that we should assume?
Chris Wolking
It's difficult for me to give you a range. I'd have to say negative to very low positive.
Eileen, it's really difficult to look there. I – you can't really assume that our – at least our taxable to tax-exempt income ratio is going to change that dramatically early in the year from where we were in the fourth quarter.
Eileen Rooney – KBW
That's all I had.
Bob Jones
Great, Thanks, Eileen.
Operator
Your next question comes from John Rodis with Howe Barnes.
John Rodis – Howe Barnes
Hey, guys. Chris, this might be for you, real quick.
On expenses, I guess the other line item, obviously a pretty big increase over the third quarter and I know part of that from the debt extinguishment. But is there anything else in there that's sort of one-time-ish or what's kind of a good number going forward?
Chris Wolking
Yes, the big one of course was the debt extinguishment, it was $3.5 million. We had some all – some – nothing in their material, John.
We had some impairment – some intangible impairment related to some insurance business that was relatively small. We had an additional unfunded commitment provision that goes into that line item.
And I would probably say a total of $1.5 million of additional unusual items that would be considered one-timers.
John Rodis – Howe Barnes
Okay.
Chris Wolking
In addition to the $3.5 million from the extinguishment of debt.
John Rodis – Howe Barnes
Okay. So maybe a better run rates around the $6 million, $6.5 million?
Chris Wolking
Yes, what we saw in the third quarter.
Bob Jones
Third quarter would be really comparable, John.
John Rodis – Howe Barnes
Okay. Thanks, guys.
Bob Jones
Great. Thanks.
Operator
And there appear to be no further questions in queue at this time.
Bob Jones
Great. I guess in my closing remarks, just – despite Jon Arfstrom, I wish you all cheer for the Colts this Sunday and Go Colts.
So thank you very much. As always, if you have follow-up questions, give Lynell a call.
Have a great day.
Operator
This concludes 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 at www.oldnational.com.
A replay of the call will also be available by dialing 1-800-642-1687, conference ID code 48365442. This replay will be available through February 1st [ph].
If anyone has additional questions, please contact Lynell Walton at 812-464-1366. Thank you for your participation in today's conference call.