Jan 28, 2013
Executives
Lynell J. Walton - Senior Vice President and Director of Investor Relations Christopher A.
Wolking - Chief Financial Officer and Senior Executive Vice President Daryl D. Moore - Chief Credit Officer and Executive Vice President Robert G.
Jones - Chief Executive Officer, President and Director James A. Sandgren - Region Chief Executive Officer of Old National Bank
Analysts
R. Scott Siefers - Sandler O'Neill + Partners, L.P., Research Division Stephen G.
Geyen - Stifel, Nicolaus & Co., Inc., Research Division Emlen B. Harmon - Jefferies & Company, Inc., Research Division Christopher McGratty - Keefe, Bruyette, & Woods, Inc., Research Division Jon G.
Arfstrom - RBC Capital Markets, LLC, Research Division Mac Hodgson - SunTrust Robinson Humphrey, Inc., Research Division
Operator
Welcome to the Old National Bancorp Fourth Quarter 2012 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 oldnational.com. A replay of the call will also be available beginning at 1 p.m.
Central today through February 11. To access the replay, dial 1 (855) 859-2056, conference ID code 85748760.
Those participating today will be analysts and members of the financial community. [Operator Instructions] At this time, the call will be turned over to Lynell Walton, Director of Investor Relations, for opening remarks.
Ms. Walton?
Lynell J. Walton
Thank you, Jackie, and good morning, everyone. Joining me today on Old National Bancorp's Fourth Quarter 2012 Earnings Conference Call are Bob Jones; Chris Wolking; Daryl Moore and Joan Kissel.
I would like to remind you that our comments today may 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. Please refer to the forward-looking statement disclosure contained on Slide 3, as well as our SEC filings for a full discussion of the company's risk factors.
Additionally, as you review Slide 4, certain non-GAAP financial measures will be discussed on this conference call. References to such non-GAAP measures are only provided to assist you in understanding Old National's results and performance trends and should not be relied upon as a financial measure of actual results.
Reconciliations for such non-GAAP measures are appropriately referenced and included within the presentation. At the conclusion of our prepared remarks, we'll be happy to open the line and take your questions.
But before I turn over the call, I'd like to begin our fourth quarter and full year performance review with Slide 5. As I'm pleased to announce Old National reported fourth quarter earnings this morning of $23 million or $0.23 per share.
This net income represents a 17% increase over third quarter 2012 net income of $19.7 million, and is a 4% increase over fourth quarter 2011 earnings. There were several positive highlights of the quarter, the first being the increase of 18% we experienced in total revenue.
In part, the increase in revenue is a result of the continuation of loan growth in our core Commercial portfolio, which we've experienced now for the past 8 -- 3 quarters, as this portfolio increased $42.9 million during the quarter. This increase represents the largest quarterly improvement this year.
Also contributing to the increase in total revenue is the positive results of our successful acquisitions and corresponding increase in our net interest margin. As important during the quarter were the positive results in credit with declines in our highest risk grades, as well as continued low delinquency and charge-off levels.
Turning to Slide 6. You'll see a list of other items that were included in our fourth quarter results that impacted the quarter in either a positive or negative way.
The first 2 items on the left impacted our total revenue with the change in indemnification asset resulting in positive $0.7 million and securities gains of $4.5 million. The third item on the left is actually a negative expense as we reversed $2.1 million in provision for unfunded commitments.
The listing on the right side of the slide relates to various noninterest expense items, some associated with our expense initiatives or our recent acquisition and other items that may not occur in future quarters. Moving to Slide 7.
We've laid out Old National's strong 2012 earnings performance of $91.7 million or $0.95 per share, which represents increases of 26% over 2011, and 140% over 2010 net income. The $91.7 million earned in 2012 also represents our highest net income since 2002.
Driving these strong yearly results is the benefit we've seen from our well-executed acquisitions over the last 2 years, as well as the organic growth we've experienced in our non-covered loan portfolio during 2012 of almost 7%. We've also experienced strong improvement in credit costs with lower levels of both net charge-offs and provision expense.
In addition, we continue to work on improving internal processes, which should benefit our clients' experience and should improve efficiencies, both this quarter, as well as in future quarters. Now to provide more detail on the call, I'll turn it over to Chris.
Christopher A. Wolking
Thanks, Lynell. Lynell shared with you the company's earnings highlights for the fourth quarter and for the full year of 2012.
I'd like to add that we are all pleased with our 2012 performance. We believe it shows steady progress in our basic banking strategy.
In 2012, we reduced core operating expenses, successfully executed the acquisition of Indiana Community Bancorp and announced our acquisition of branches in Northern Indiana and Southwest Michigan, a new market for us. Additionally, credit costs declined and we grew core loans and core deposits.
We still have work to do, but it is gratifying for all of the associates who have worked so hard at the company to have a successful year behind us. Lynell's slide listed a number of items that affected fourth quarter earnings, including $4.5 million in securities gains and $1.9 million in charges associated with debt extinguishment.
I'd like to add a little color to our investment portfolio transactions. The securities we sold included approximately $26 million of long maturity municipal bonds.
We feel it is prudent to manage the duration of the investment portfolio towards the low end of our historical portfolio duration. We finished the year with a duration of approximately 3.71.
Since 2008, our investment portfolio has had a duration of between 5.66 and 3.33. A full review of the investment portfolio was included in the appendix.
We used a portion of these security gains to terminate $50 million of Federal Home Loan advances, which would have had an average cost of approximately 7% in 2013. I will begin with Slide 9.
You can see that our pretax pre-provision income without securities gains and merger and integration expenses increased to $34 million in the fourth quarter, from $28.2 million in the third quarter. Fourth quarter includes a full quarter's earnings contribution from Indiana Community Bancorp.
Pretax pre-provision income not attributable to accretion income was impacted by several unusual income and expense items in the fourth quarter. If I subtract the impact of the branch optimization, debt extinguishment and charitable contributions expense and add back the reversal of the unfunded commitment expense, pretax pre-provision income not attributable to accretion would have been $19.7 million.
Total pretax pre-provision income then would have increased to $38.7 million for the fourth quarter if these items did not occur. As we have discussed for several quarters, accretion income resulting from our recent acquisitions continues to lift net interest income.
Accretion income from ICB contributed $5.8 million in the fourth quarter. Without the ICB accretion in Q4, accretion income would have been $13.2 million, slightly higher than the third quarter.
We did have accretion income from Integra assets in Q4 -- we did have higher accretion income from Integra assets in Q4 compared to Q3, but our outlook is that accretion income from our Monroe and Integra purchases should continue to diminish over time. We continue to stay focused on reducing operating expenses and increasing organic revenue to offset declining accretion income.
On Slide 10, I've illustrated our progress with the impaired assets acquired in the Monroe, Integra and Indiana Community transactions. This is a graphical depiction of the performance of only the impaired assets and does not reflect the acquired performing loans.
In the fourth quarter, loan interest income related to Monroe impaired assets was $1.1 million, about the same as in the third quarter. We've owned Monroe for a full 2 years, and you can see that since the second quarter of this year, our projection of the non-accretable component of the impaired asset discount has remained relatively stable.
We believe that the quarterly accretion income from these assets should stay relatively consistent with the third and fourth quarters of 2012, at least through the first half of 2013. Loan interest income from Integra impaired assets was $14.7 million during the fourth quarter, up about $2.4 million from the third quarter.
Integra accretion income was slightly higher than anticipated due largely to the successful remediation of several impaired assets late in the fourth quarter. I've added the chart for Indiana Community Bancorp.
We recognized $2.1 million of accretion income from these assets in the fourth quarter, and our expectation is that $16.1 million of the original discount will be recognized as income over the life of these assets. The non-accretable discounts declined $6.9 million from our original expectation.
On Slide 11, I've provided data for Indiana Community Bancorp for the fourth quarter. At 12/31/2012, ICB loans net of discount totaled $407.2 million, and noninterest-bearing demand deposits totaled $99.2 million.
One-time charges related to the integration of ICB were $2 million for the quarter, and as I noted earlier, ICB assets generated $5.8 million of accretion income for the quarter. We continue to expect the EPS accretion from ICB to be in excess of the $0.06 to $0.08 per share we provided you on our original model for the first full year of earnings.
I will update you further on ICB performance at our first quarter call in April. Moving to Slide 12.
You will see that average loans increased significantly in the fourth quarter. The ICB transaction closed in mid-September 2012, so the total reflects a full quarter of ICB average loans.
Excluding purchase loans, total average loans increased $85.1 million from the third quarter of 2012, and are up $254.1 million from the fourth quarter of 2011. This continues the steady quarterly increase in core average loans we first saw in the second quarter of this year.
Monroe purchase loans are stable over the third quarter, while Integra loans continue to decline. ICB loans averaged $447.9 million for the quarter but stood at $407.2 million at the end of 2012.
So we did see a decline in ICB loans. [Audio Gap] Slide 13 shows graphs with several Commercial loan production statistics.
Commercial line utilization increased to 36.9% in the fourth quarter 2012, from 36.3%, and has remained relatively stable during 2012 in the range of 36% to 37%. We are still under our 2007 to 2008 average utilization of 39.9%.
The commercial loan pipeline declined to $396 million in the fourth quarter, but we saw strong production and funding in the quarter. The chart on the lower right of the slide shows fourth quarter Commercial loan production of $241 million, which is the highest production we saw all year.
We consider production the face amount of the loans closing, and the loans may not fully fund at closing. I believe the smaller pipeline we saw in the last half of 2012 reflects the strong production we experienced in the third and fourth quarters of 2012, and does not imply a lack of opportunity or a poor outlook for loan growth in our markets.
We expect that the total pipeline will increase in the first quarter of 2013, particularly as our new loan producers in the ICB markets become productive. I added a line in the production graph that shows the Commercial loan pay downs we experienced in 2012.
This line reflects all pay downs except the pay downs of assets covered by FDIC loss share. By retaining more quality existing commercial relationships, we may have an opportunity to increase Commercial loan growth further.
Keeping existing quality credit relationships is an important focus of credit and lending in 2013. Slide 14 is another look at our Commercial loan pipeline.
We believe it is important to show the individual components of our pipeline. Pipeline is broken down into loans in the discussion phase, loan proposals and loans that have been accepted.
While the total pipeline declined by $70 million from the third quarter, loans in the proposal and accepted stages of the pipeline only declined $19 million. We believe this shows that the near-term outlook for Commercial loan production is good even after the strong production in Q4.
We expect that loans in the discussion phase will increase in early 2013. It's also important to note the overall trend of the pipeline in 2012 compared to 2011.
As you can see on the chart, comparing each quarter in 2012 to the same quarter in 2011, in every case, the pipeline was higher in 2012. This is another reason to be optimistic for loans in 2013.
On Slide 15, I've provided a graph of the trends in noninterest income. ICB contributed to quarterly increases in mortgage banking and wealth management revenue.
Service charges on deposits only increased $100,000 over the third quarter even though ICB deposit accounts contributed $1 million in new deposit service charge income in the quarter. Service charges have been flat during 2012 at the company and were lower than we had forecasted at the beginning of 2012.
The primary contributor to the increase in other income for the quarter was the change in the amortization of the FDIC indemnification asset from the third quarter. In the fourth quarter, the change in the indemnification asset resulted in income of $700,000 compared to an expense of $4.9 million in Q3.
We would expect to see quarterly amortization expense as the IA continues to shrink like the expense we saw in Q2 and Q3. As I noted earlier, total average Integra loans outstanding in the fourth quarter were $464.5 million, down from $726.2 million in the fourth quarter of 2011.
In the fourth quarter of 2012, however, we took a charge of $5.2 million to reduce the carrying value of Integra-related other real estate-owned. Because this is a larger expected loss on this asset, the FDIC should absorb 80% of this loss when it is realized.
This caused us to increase the FDIC indemnification asset by 80% of the expected loss or approximately $4.14 million. Without the increase in the IA due to the write-down of the Integra OREO, our amortization expense for the quarter would have been approximately $3.3 million, slightly lower than Q3 expense.
As of December 31, 2012, the indemnification asset on the balance sheet was $115.7 million, down from $167.7 million as of 12/31/2011. Total noninterest expenses shown on Slide 16 were $99.4 million compared to $89 million in the third quarter.
As you saw on Lynell's slides, we had several expenses in the fourth quarter that we would not expect in future quarters. We incurred the $5.2 million in Integra OREO expenses and $6.5 million in other expenses, all of which are listed on the slide below the chart.
Finally, we incurred $2 million in expenses related to ICB integration in the fourth quarter. Core expenses increased to $85.7 million and included ICB operating expenses for the quarter.
Our reported efficiency ratio for the quarter was 72.2%, obviously short of our 65% target. However, if I exclude all but the OREO expense from our results in the quarter, our efficiency ratio would have been 66% for the fourth quarter 2012.
I didn't exclude the OREO charge because there is an offsetting revenue item reflecting the 80% FDIC loss share. We realize that the 66% efficiency ratio does include significant accretion revenue for the quarter, but it demonstrates progress to our near-term objective of 65% efficiency.
In the right-hand margin on Slide 16, I've noted estimated impacts we should see or begin to see in the first quarter. Our largest remaining cost of $2.5 million from our BSA/AML project should be expensed in Q1.
This cost is for professional fees incurred for the project and are not considered ongoing costs. We should also begin seeing more benefit to core operating cost from our branch optimization program in Q1.
The final branch sales should be completed in February, and I expect that the personnel cost savings from the consolidations in November should be fully phased in by March 31. When the branch consolidations and closures are fully recognized, we should see $6.5 million to $7.5 million in annual expense savings.
Moving to Slide 17. I provided a breakdown of our net interest margin in the fourth quarter and the trends we've experienced over the last 18 months.
Net interest margin on a fully taxable equivalent basis was 4.34% for the fourth quarter of 2012, up from 4.09% in the third quarter. The net interest income generated by the accretion of purchase accounting discounts translated to an estimated 94 basis points of margin for the fourth quarter when they're annualized.
Accretion of ICB discount accounted for 29 basis points of margin. Accretion of discount from Integra accounted for 55 basis points of margin, and accretion for Monroe accounted for 10 basis points of margin.
ICB accretion of $5.8 million for the quarter was slightly higher than forecast. Our estimate is that Integra fourth quarter accretion income was approximately $3.5 million higher for the quarter than expected, although contribution from the purchased assets will likely continue to be somewhat variable in 2013, we continue to expect that the Monroe and Integra accretion income will decline significantly in 2013, but that this decline in revenues should be offset by income from the newly acquired ICB portfolio.
Core interest margin declined more than we expected in the fourth quarter although some of this can be attributed to higher average earning assets in Q4 compared to Q3 than forecast. Core net interest margin was 3.40% in the fourth quarter compared to 3.47% in the third quarter.
Most of this decline was from a lower yield on our investment portfolio. Portfolio yield declined due to growth in the portfolio, the sale of the higher yielding securities I discussed earlier and lower reinvestment yields.
Also the growth in core loans contributed to the lower margin as well because new loans were booked at a lower rate than we had forecast. Our forecast indicates that first quarter core margin could decline by another 3 to 5 basis points.
Slide 18 shows our trend in tangible book value per share. Our tangible book value per share ended the quarter at $8.17, up from $8.09 per share at the end of the third quarter.
The decline in third quarter tangible book value per share was driven by the 6.6 million shares issued for the purchase of ICB plus the goodwill and intangibles added to the balance sheet with the ICB purchase. The trend in tangible book value per share shows an upward trend in tangible book value from the first quarter of 2011 when we purchased Monroe through the fourth quarter of 2012.
Significantly higher accretion income over this period has helped us recover tangible book value relatively quickly after each purchase. We believe this shows that these were acquisitions that were priced appropriately and have been managed well.
We have stated previously that our priorities for using capital are organic balance sheet growth, attractive acquisitions and the return of capital to shareholders in the form of dividends or stock buybacks. As you saw with our announcements in January, we continue to try to balance these priorities to take advantage of opportunities as they are available.
Early this month, we announced the acquisition of 24 branches from Bank of America. We believe this is a low-cost, low-risk opportunity to build our franchise in Northern Indiana, and to enter a new market, Southwest Lower Michigan, in a meaningful way.
Additionally, last week, we announced our intention to increase our quarterly dividend by $0.01 per share to $0.10, and reestablished our authorization to buy up to 2 million common shares during 2013. In the last quarter of 2012, we repurchased approximately 250,000 shares under our 2012 authorization.
One final point before I turn the call over to Daryl. Our effective tax rate for the fourth quarter increased to 32.4% from 22.9% in the third quarter due to increases in pretax income while tax-exempt income remained relatively stable.
In addition, the company completed its 2011 tax return in the third quarter and lowered tax expense to adjust to the actual tax return results. Also we reversed $292,000 of tax expense in the third quarter related to the uncertain tax positions.
We expect our effective tax rate to be in the range of 27% to 28% in 2013. I'll now turn the call over to Daryl Moore.
Daryl D. Moore
Thank you, Chris. I'd like to begin my remarks this morning on Slide 20 where we show a trailing 8-quarter summary of net charge-offs for our core portfolio, as well as for our 3 most recently purchased portfolios.
As you can see, the ONB core portfolio continues to perform very well with roughly $1 million in net losses representing 10 basis points of net charge-offs in the quarter. With respect to the Monroe portfolio, we posted net losses of approximately $200,000, which represents 30 basis points of loss, down from the 75 basis points on losses last quarter.
Integra portfolio continues to be a little lumpy with losses in the fourth quarter of $400,000 or 35 basis points of the total portfolio. $600,000 in losses were recognized in the Indiana Community Bank portfolio in the first full quarter holdings representing 50 basis points of loss.
On a consolidated basis, you can see that net charge-offs in the fourth quarter on an annualized basis were $2.2 million or 17 basis points of average loans. Within that $2.2 million total, we took write-downs of approximately $750,000 associated with our regulators' guidance on performing borrowers who had obviously filed Chapter 7 bankruptcy but who had not reaffirmed our debt within that bankruptcy.
Full 2012 net charge-offs were $8.3 million, also representing 17 basis points of average loans, compared to net charge-offs of $21.7 million or 49 basis points of average loans to the full year 2011. The 17 basis point level was the lowest level of charge-offs posted by the bank since 1999.
Moving to Slide 21. We can see that excluding covered Monroe and Indiana Community loans, the allowance coverage of non-performing assets fell 4 basis points in the quarter to 50%.
You can see that ONB non-covered consolidated percentages now reflect a 29% coverage, up slightly from last quarter's coverage level with the improvement coming from the decline in non-performing assets in those portfolios. I would remind you that these numbers do not take into consideration the $17.4 million currently outstanding mark on the Monroe portfolio or the $61 million mark on the Indiana Community Bank portfolio.
As we move to Slide 22, you can see that we have laid out for you what the combined allowance for loan losses and loan marks look like as a percent of the pre-marked loan portfolio for each of our differently tracked portfolios. As you would expect, the combined ALLL and mark and to the pre-mark loan balance percentages appear to appropriately rank and reserve for the risk levels in each of the portfolios with the Integra portfolio remaining the most troubled portfolio followed by the most recently acquired Indiana Community Bank portfolio.
You can see that combined allowance and marks represent slightly more than 6% of the pre-mark Monroe portfolio, roughly 13% of the Indiana Community Bank portfolio and close to 27% of the Integra portfolio. Keep in mind that the majority of the Integra portfolio is also subject to our loss share agreement with the FDIC.
On a combined basis, the allowance for loan losses and loan marks as a percent of the pre-mark loan portfolio is now 5.13%. On Slide 23, we lay out for you trends and fourth quarter results with respect to our portfolio delinquency levels.
At 66 basis points, 30-day or greater non-covered delinquencies remain relatively flat from last quarter end levels. The 66 basis point level compares favorably with fourth quarter 2011 levels and continues to compare very favorably with peer results.
As you can see in the chart at the bottom of the slide, 90-plus-day non-covered loan delinquencies continue at very low levels with this quarter's results at 2 basis points. These results continue to be at a level considerably lower than that of our peers whose average trailing quarter results stood at 58 basis points.
Moving to Slide 24. You can see that within the non-covered portfolio, we halted the prior 2 quarter trend of increasing criticized loans with significant decreases in this category in the fourth quarter.
Non-covered criticized loans fell $22 million in the quarter landing at roughly $113.3 million at December 31. Excluding the Indiana Community portfolio, non-covered criticized loans fell to $98 million.
Classified loans also fell in the quarter as shown on Slide 25. Non-covered classified loans declined $15.4 million in the quarter to stand at $83.1 million.
Excluding the Indiana Community Bank outstandings, classified loans were at $59.2 million. At Slide 26 reflects non-covered net non-accrual exposure fell by $11.2 million in the quarter.
What I find interesting in this chart is you can clearly see the spikes in non-accrual assets associated with our acquisitions followed by improving trends until the time of our next acquisition. Assuming we continue to resolve the non-accruals at levels equal to or better than what those loans were marked to on day 1, trends like these on a go-forward basis should prove beneficial for the bank.
If you combine the results for the last 3 slides and look at the progress we have made in improving embedded risk in our loan portfolio as measured by trends in criticized and classified loans, you will see that exclusive of the additions associated with the Indiana Community Bank acquisition in September, we reduced criticized and classified loans by over $136 million from a beginning level of $507.5 million at December 31, 2011, to a level of $370.9 million at the end of 2012. In summary, I look forward to the period where we can take a view over a longer timeframe and not see more than a few things potentially lingering on the horizon that could reverse any positive momentum we're experiencing in our economic recovery.
We hope that with the most recent quarter's results, coupled with what seems to be less pessimism in the business community, we are at the beginning of the period of sustained trends and improving credit quality. As a final thought, in my view, the banking industry is in a period now that we need to be very mindful of when it comes underwriting credits, especially commercial-type credits.
With the increasing pressure to add earning assets in anticipation of an improving economy, we need to be thoughtful about how we underwrite and structure credits. The consequences of poor underwriting and structuring are fresh in our minds and apparent.
Consequences of too conservative underwriting at our institution will sacrifice potential loyal and profitable client relationships over periods to come. With those comments, I'll turn the call back over to Bob.
Robert G. Jones
Great. Thank you, Daryl.
Beginning on Slide 29, I wanted to briefly shift our focus from 2012 to 2013 by providing you with our perspective on the upcoming year, both on a macro level and specifically as it pertains to Old National. Our clients are expressing more optimism about the economy.
This was especially true following the gymnastics around the fiscal cliff. Many are reporting increased business demand, and this is happening across multiple sectors, as well as multiple geographies.
It is interesting to note that a good portion of those clients have even expressed frustrations with their ability to hire trained workers. While I would not say we are in a robust expansion mode, the steady economic expansion may have picked up slightly, and our clients are beginning to see the benefits.
While our clients are expressing more optimism with the economy, they continue to be frustrated with the lack of clarity and leadership coming out of Washington. Whether it was the fiscal cliff resolution or the proposed debt ceiling discussions, it is as Yogi Berra famously said, déjà vu all over again.
We continue to kick the can down the road and have truly not made the decisions with the clarity or decisiveness that is necessary to provide the stability our clients are looking for in our economy. Our fear as we look forward is that the next round of discussions on the debt ceiling and the continuing resolutions necessary to meet the spending needs of the federal government will cause more uncertainty and potentially slow the recovery.
We can only hope that our leaders will realize the country's need for economic stability outweighs politics, and that this will be their central focus. Moving to the overall economy.
We are projecting a GDP in our markets in the range of 2.75% to 2.9%, and believe that unemployment will continue on its slow trajectory downward. A more critical element for all banks will be the interest rate environment.
We do not see any movement in the short end based on the assumptions I just laid out for growth. And while we have seen some movement in the long end of the yield curve recently, we do not view this as sustainable and expect interest rates through 2013 to be very similar to where we are today.
I believe this will be one of the big hurdles that the industry will face with regards to the impact on our net interest margins and the potential risk if banks begin to search for yield in their investment portfolio. Indiana and now Michigan probably have the strongest economies in our markets, followed by Kentucky and then Illinois.
Indiana's recent unemployment numbers and the budget surplus are encouraging, and it's our expectations that are more the same upward trajectory under our new governor, Mike Pence. From our time in Michigan in recent weeks, we are impressed with the local economies in our new markets, and we heard many positive remarks regarding Governor Snyder and his policies.
Now I'd like to get a little more granular about 2013 as it pertains to Old National. I will begin by outlining our team's focus for the new year as affirmed recently by our board with their support of our bank's strategy.
In 2013, we will continue to focus on many of the same tactics that led to our success in 2012. Consistency is one of our key strategic imperatives.
Those tactics are to continue to focus on improving our core net income. This is important as a means of offsetting the continued reduction in accretion income from Monroe and Integra.
While sounding very basic, it serves as a good reminder to all of you that we continue to understand both the volatility and the life cycle of accretion. An important element of driving our core net income will be our focus on revenue.
All of our company knows the importance of revenue, and we are all committed to continuing the positive trends we have seen in banking, insurance, wealth management and investments. An important element of our revenue growth will be profitable core loan growth.
By continuing the trends of the last 4 quarters with a corporate-wide focus on loan growth, driven by loans that meet our credit standards and are within our pricing metrics. We will not sacrifice quality for growth, but we will continue to take advantage of market share in our new markets to drive this growth.
Finally, as a key element to increasing our core net income, we will continue to focus on improving our efficiency ratio. As Chris said, our core efficiency ratio we estimate at approximately 66%.
Make no mistake about it. We are still focused on achieving our 65% target, and as just as a reminder, this is not a stopping point but part of a continual effort to reduce the complexity and cost within our organization.
While we are all disappointed we were not able to achieve our 65% aspirational goal this year, I am proud of the efforts we have put forward. Our view remains the same.
We want to achieve a sustainable ratio and are not looking at expense reductions as a programmatic effort, but rather one that becomes cultural. While not excuses, our efforts to remediate our BSA/AML programs, as well as a slight diversion of effort caused by our merger activity and a delay in implementation of actions like our branch divestitures and other items, did have an impact on our target.
But as I said, we offer no excuses, and our management team's incentives as it relates to the efficiency ratio, reflect that miss. To that end, our 2013 short-term incentives has the same 3 measurements as 2012: achieve our 2013 net income goal, achieve our net charge off target and achieving our efficiency ratio target.
Our 2013 efforts will also continue to focus on mergers and acquisitions as a key tool to improving shareholder value. The M&A markets continue to show promise.
Chatter amongst advisors and banks has increased slightly in recent weeks, and both inbound and outbound calls have increased. We think this is due to a number of items.
With the completion of the 2013 budgets, many companies have realized that challenges remain in growing both revenue and net income. While reduced credit costs have helped in recent times, they may not be sustainable.
And when coupled with low interest rate, we suspect the budget discussions at many banks have been enlightening. This, along with the regulatory challenges, we believe will cause an increase in opportunities.
Our target markets remain the same: Indiana, Southwest Lower Michigan and Kentucky. While M&A is still our first desire for our use of excess capital because we feel it provides our investors with the best return, we are also cognizant that the dividend and buyback are important components as well.
And as we increase our earnings, I can assure you that our board reviews all elements of capital management with our investors' interest always coming first. Let me close with a few words in our most recent M&A activity.
Our branch acquisition with Bank of America is off to a great start. After meeting with our soon-to-be new associates, visiting the markets we'll be entering and working with the BofA divestiture team, we are more excited about the potential of this partnership.
I was very impressed with the associates. They're extremely well trained and have a great strong focus on client service.
They also displayed excellent leadership skills during the announcement period and beyond. And as I said earlier, the economic activity in our new markets is encouraging and reinforces our belief that our community banking model will work well in these new markets.
We also have been very impressed with the quality team we'll be working with at BofA to orchestrate this transaction. Our previously announced divestitures went well.
As a reminder, we sold 7 branches in January, and we have one more sale in February of 2 branches with the total combined deposits of slightly less than $150 million. Our 19 consolidations also went well last quarter.
Client disruption and attrition were minimal and well within our expectations. These combined efforts will have an estimated effect of reducing our annual noninterest expense by $6.5 million to $7.5 million, and we'll have an annual positive $3 million to $4 million pretax dollar impact on our net income.
Those conclude our remarks. Jackie, we'll be glad to take questions at this time.
Operator
[Operator Instructions] Your first question comes from the line of Scott Siefers with Sandler O’Neill.
R. Scott Siefers - Sandler O'Neill + Partners, L.P., Research Division
Bob, I think kind of between you and Chris and Daryl, it sounded like the overall loan growth outlook is pretty constructive. Just I guess in addition to the color that you already gave, maybe if you wouldn't mind kind of venturing I guess on how robust the strength of growth would be in 2013?
I guess one of the other things that I'm kind of interested in is you still do have at least some runoffs from the covered loans that I would anticipate would continue. So I guess in the aggregate, what kind of core loan growth would you be looking for this year?
Robert G. Jones
Boy, Scott, hard to put a number on it just based on the IBT and based on the covered loan portfolio. But I will say that the activity level over the last 2 to 3 quarters continues to increase.
While you saw a little decline in the pipeline over the last couple of quarters, we've had some strong closings. So I think easiest way to answer is the activity levels are slightly better than what we've had, and again that all depends on our experience at IBT to give you some number.
But I can also tell you that from our directors down to everyone in the company, we're all focused on it. We had actually a director that referred over $40 million in loans to us over the last couple of weeks.
So we're encouraged.
R. Scott Siefers - Sandler O'Neill + Partners, L.P., Research Division
Okay. That's perfect.
Definitely appreciate that. And then, Chris, just want to make sure that I understood your comments correctly.
Appreciate the color you've given on the, I guess, the actual purchase accounting accretion you've had and then the expectations as we look into 2013 because I think you guys had right around $57.5 million as you detailed in the release in accretion income in 2012. So it sounds like pretty similar expectation ahead as we look into 2013, just with kind of an anticipated change in the complexion of that.
Christopher A. Wolking
Exactly, Scott. I think we still believe that what we've got from the ICB transaction kind of looking forward will offset what we'll give up in 2013.
I think it's important that we continue to make you all aware of those numbers, and the fact that it is kind of transitory, and we'd expect that Monroe and Integra accretion to continue to come down.
R. Scott Siefers - Sandler O'Neill + Partners, L.P., Research Division
Okay, perfect. And then I guess finally, just on the core margin, you gave some color on the first quarter expectation.
When or I guess will there be kind of a stabilization in the core margin in your pure estimation. Just at some point seemingly the re-pricing risk in the securities portfolio will kind of play itself out.
Do you think that's only going to happen this year or is maybe a few basis points a quarter out as we look beyond the first quarter in terms of compression for the core margins. Is that a fair presumption?
Christopher A. Wolking
I think we've talked about the benefit we still expect to see from our liability re-pricing, particularly on our CDs. I think I tried to make clear that in the fourth quarter we had a pretty significant increase in earning assets, which may have driven the core margin.
And it really depends on how the loan growth continues and how much of those cash flows from the investment portfolio we can steer to better quality earning assets. I'm not willing to add duration to the book, the investment portfolio.
I just don't feel like it's appropriate to take more risk there even though we can squeeze a few basis points of yield out of the portfolio. So we'll just have to play it by ear.
But like I said, I think a large part of that fourth quarter compression was due to higher-than-anticipated growth in earning assets. And some of that did come from the portfolio albeit very short term in duration.
Operator
Your next question comes from the line of Stephen Geyen with Stifel, Nicolaus.
Stephen G. Geyen - Stifel, Nicolaus & Co., Inc., Research Division
Maybe just a follow on question. The change in the movement discussed and post the loans in the pipeline ticks up over the last few quarters, I'm just curious if you could talk just a bit about the success you'd had in moving the loans through the pipeline and how that's changed over the last couple of quarters.
Robert G. Jones
In years past, Stephen, our regional CEOs were great folks at kind of postponing closings to make themselves look better the following year. And so Barbara and I did a pretty significant push to say cut the whatever, and let's get them closed.
So I think that's part of it. And again I go back to the -- we've got everybody in the company really focused on loan growth.
And maybe we're not at 8 cylinders, but I'd say we're at 7 pushing towards 8. A conversation doesn't go by when I'm not with our regional CEOs, our Commercial Banking managers, when you don't talk about how's loan growth?
What can we do? Daryl and I are working on credits, just the 2 of us.
No, he doesn't like getting that broad end so far, but I think it's just more a -- the continual effort to make sure we get stuff on the balance sheet before the year end.
Stephen G. Geyen - Stifel, Nicolaus & Co., Inc., Research Division
Okay. And maybe just some thoughts on the runoff of the core portfolio.
Just kind of curious how you look -- how things kind of work their way out through 2012, and what the impact might be in 2013 and just the type of credits that you've seen leaving the bank. Has it been because of pricing?
It's been mostly because of pay downs? What's been driving the runoff?
Robert G. Jones
Yes, a couple of things. As you look at the third quarter '12 to fourth quarter '12, the jump there, the 2 primary drivers are really Indiana Community.
Any time you acquire a new bank and you change credit standards, you're going to have some good core loans that unfortunately somebody's going to come in and make some structural changes that we lose that opportunity. So as Chris said, we went from an average of 4.47 to 4.04 in our ICB.
So you can see we've had some pay downs there. I will say we've got a completely new commercial banking team in there.
They've built their pipeline. We're encouraged by what we see, but it's natural.
Actually if you go back and you look over the Monroe loan trends, they're not dissimilar. And again, I think we're in very good shape in Bloomington.
The other thing you get, Stephen, at the end of the year, is you got some seasonal pay downs either people flushed with cash, they want to pay down or some other things that happened. But if we lose a credit these days, it's generally going to be to structure more so than pricing.
We're competitive on the pricing standpoint because of our good core funding. But as Chris or as Daryl alluded to in his comments, when people start to reach for growth, structure's the first thing that's going to go.
And we are seeing some markets where people have short memories. But fortunately Daryl has got a very long memory, and I sleep pretty well with that.
Stephen G. Geyen - Stifel, Nicolaus & Co., Inc., Research Division
Okay. And the -- you made a comment about the $6.5 million to $7.5 million in branch optimization saves in 2013.
I just want to make sure, is that off the base of 4Q level?
Robert G. Jones
It would be off of the 4Q level, but that's an annualized number. So you assume that we closed -- consolidated the ones in the fourth quarter the sales will happen late January, early February.
So I think for models, I'd give us 10/12 of that as you're building your models.
Stephen G. Geyen - Stifel, Nicolaus & Co., Inc., Research Division
Okay, all right. That's helpful.
And last question on Slide 10, just curious what prompted the change in the not-accretable difference -- or excuse me, actually one different question. You had mentioned in one of the slides about the adjustment in the pension, and I was just curious what exactly prompted that?
Was it change in the discount rate or was there some other factor?
Christopher A. Wolking
Oh, thank you, Stephen. I just had to ask Joan Kissel to help me with that.
We had lump-sum distributions and that -- all those things can come up kind of suddenly from retirements.
Operator
Your next question comes from the line of Emlen Harmon with Jefferies & Company.
Emlen B. Harmon - Jefferies & Company, Inc., Research Division
I was hoping we could hit on the forward expense run rate a little bit. Just a lot going on this quarter, and as we think about kind of the forward expense run rate, is it reasonable?
Because there are a couple of items in there, right? Well, and it sounds like the pension really is kind of truly a onetime or just based on your last comment, where we wouldn't necessarily expect that in the first quarter.
But just kind of like, what's the normal level of charitable contributions, anything else in that pension line that may run through and how should we really be thinking about kind of the expense run rate starting in the first quarter?
Robert G. Jones
Yes, the $85.7 million is a good starting point. What we don't have really fully into the $85.7 million, Emlen and others, is we really need another full quarter of IBT to give you their exact.
We're still investing in those markets. I've got to add some people in wealth management.
We've added some other staffing, but the $85.7 million is probably the best place to start with a little bit of additional expense for IBT. But the contributions really is a payment to our foundation.
That's a onetime expense that happens. Most of the other ones, as Lynell said, are ones we wouldn't anticipate.
But I'd start your miles at the $85.7 million and we'll add a little bit it in there for IBT as we go forward.
Christopher A. Wolking
Emlen, I might add too that we should begin to see those benefits from the branch optimization as well. That we won't see all of that obviously probably until the second quarter.
Robert G. Jones
So I would focus on the blue line there. And again, the only thing that we anticipate at this time being unusual in the first quarter will be the last of our consulting fees or we hope the last of our consulting fees for BSA/AML.
Emlen B. Harmon - Jefferies & Company, Inc., Research Division
As the BSA/AML, that's all going to be a onetime expense in the first quarter. There wasn't anything I guess enough in the fourth quarter in terms of accruals for that?
Robert G. Jones
No, we can't accrue it because we haven't gotten -- I'm not an expert on accounting but this really revolves -- it really involves the look backs that we have to do with the last portion of our consent order, and we can't pay that bill until we actually have the completion of the look back. So it revolves around the folks that are helping us with that.
So it is truly a onetime expense, and we had no accrual in the fourth quarter for it.
Emlen B. Harmon - Jefferies & Company, Inc., Research Division
Got you. And then I was surprised that we didn't see maybe more of an increase in the service charges this quarter with Indiana Community coming over.
Could you talk a little bit about how your fee structure kind of lines up with their previous fee structure and whether there's any opportunity to kind of push some of that into the new franchise.
Robert G. Jones
Yes, we actually changed the fee structure at IBT early on, Emlen. So what you're seeing is our fee structure on their clients.
And we were clearly a little more costly than they were for clients. And we saw the natural attrition we normally see.
I think actually, we're a little better than we thought. We're as frustrated as anybody with service charges.
We're just not seeing the presentments we've historically seen. We're in the midst of reviewing our complete service charge structure as we speak because obviously, flat quarter-over-quarter's not good enough, and we need to find ways to drive more noninterest income.
So I think the number as you see it is probably a good run rate until we make some adjustments.
Emlen B. Harmon - Jefferies & Company, Inc., Research Division
Got you. Okay.
And then last question for me, in terms of -- appreciate the stack rank of kind of how you're thinking about your different economies in terms of -- or different geographies in terms of economic performance. Kind of where the markets that you're in, in Michigan where would they kind of fall into that stack rank or just in terms of how you're thinking about just kind of the growth opportunities in some of those markets?
Robert G. Jones
Great question. I fell in love with Kalamazoo.
I got to tell you, if you've not been to Kalamazoo and you know Grand Rapids, Kalamazoo is a mini Grand Rapids. It's got a strong medical base, just a vibrant corporate leadership, not a lot of local banks.
The ones they do have are very strong in Kalamazoo, but their unemployment was less than 7%. I mean, going by memory, I think it was 6.5% or 6.7% on unemployment.
Battle Creek is much the same. But even Paw Paw, I'll be honest with you.
We kind of all laughed about Paw Paw, Michigan. I thought I was going to pull up to a -- well, I wasn't sure what I was going to get.
But the visit to Paw Paw was -- it's not a huge economy. But you get outside of Detroit, and I think what we're seeing in Michigan is very encouraging.
So -- but clearly the gem is Kalamazoo. That's where we have our largest presence of branches, and we've just got some wonderful associates in the Kalamazoo market as well.
Operator
Your next question comes from the line of Chris McGratty with Keefe, Bruyette and Woods.
Christopher McGratty - Keefe, Bruyette, & Woods, Inc., Research Division
Chris, on the balance sheet side, obviously with the liquidity coming with BofA, can you help us on the size of the securities book. I think it's around 2 7 [ph] today maybe either on a dollar amount or percent of earning assets as the year progresses.
Christopher A. Wolking
Right, and I don't have our -- my Bank of America slides in front of me. But that model all -- is really driven by largely increases in investment securities to offset the deposits.
So we know that number will go up. And frankly, some of what we did in the fourth quarter was a little bit in anticipation of that.
Logically, you'd expect that with the branch sales, we would have maybe managed down the book in the fourth quarter. But I'm purposefully keeping that up a little bit, I think.
As we go -- get closer to the acquisition date, I want to take advantage of the movements in rates when we have it. But I would tell you that we're not expecting -- I would expect that the duration after we're done with those investments on the average -- the average duration of the portfolio will go down because we'll continue to invest in pretty short-term securities in that book, Chris.
So we'll go up kind of probably in lockstep with what we see in terms of ultimately the total deposit transaction. But we would hope that, that wouldn't be sustained and that we could move that pretty quickly into loan assets.
Robert G. Jones
Chris, just to follow on as a little bit of color, the model, when we talked to you a couple of weeks about BofA, was really based, as Chris said, taking that full deposits and putting them in investments. But in anticipation of closing, we're already looking to put an indirect lenders up in the Southwest Michigan market to work with the auto dealers.
We're already out to look for some wealth management, trust folks and commercial bankers. So we're gearing up in anticipation of that $700-plus million in deposits.
And I've got to tell you again the quality of the folks of BofA, and I think their reputation in the market, we're very encouraged that we can start lending here fairly quickly.
Christopher McGratty - Keefe, Bruyette, & Woods, Inc., Research Division
Great, and then the capital targets, I think 8.25 [ph], was kind of the pro forma. One, is that still the case, and then two, Bob, can you talk about deal appetite going forward?
Michigan's a new market, but it sounds like an important market. Is there a size that you guys are targeting for your next deal and then whether you think it would be Michigan in '13.
Robert G. Jones
Well, the 8.25 [ph] I think still stands as a post transaction. Obviously, our earnings over the first couple of quarters could change that or some other changes.
Obviously, I would say as an exact science, M&A is not. Our focus would really like to get, as we've said on the call, we're kind of half pregnant with our $10 billion mark.
We need to get above that in a fairly, not large way, but we've got to get a couple of billion above that to be able to take care of Dodd-Frank and the impact. But -- so our ideal deal is $1 billion plus.
But if I've got a great opportunity to $600 million, $700 million in any of the markets we like, we still love Northern Indiana, we love Southwest Michigan, Louisville continues to a market we're intrigued with, as well as other parts of Kentucky. So if I could tell Jim exactly where I wanted to be then I wouldn't need Jim.
But I think the reality is we're going to have to deal with a -- our nature, Chris, is we really want a willing seller and somebody that's made that leap of faith. And once we get to that phase, it really helps to make the transition much better.
Christopher McGratty - Keefe, Bruyette, & Woods, Inc., Research Division
Great. One last one for Chris.
On the liability of the restructuring, is there anything else entering '13 that you can do on your liability side to help the margin?
Christopher A. Wolking
We continue to look at opportunities to restructure. So we don't have much in the way of wholesale funding left.
We've still got some old trust preferred issues out there. So we're looking at every opportunity, Chris.
But I think probably our biggest benefit will still come from the core deposits re-pricing. In the slides, you'll see that whole spill out of the CD book I think it's on Slide 46, 46.
So that's probably our best benefit. But sometimes these opportunities come up.
And our treasury group is pretty good about looking at ways to reduce funding costs. So I'm encouraged.
I was encouraged by the transaction we did in the fourth quarter. That's one that they worked really hard to identify.
So I'll keep you posted as those things come up.
Operator
Your next question comes from the line of Jon Arfstrom with RBC Capital Markets.
Jon G. Arfstrom - RBC Capital Markets, LLC, Research Division
Daryl, are you there? Just a couple of questions, probably start with you, Daryl.
But you've touched a bit on pricing on new loans, and you mentioned the word structure in your prepared comments. So just curious what you're seeing in terms of is it rational?
Are you starting to see irrationality float into it in terms of pricing and structure?
Daryl D. Moore
Honestly, it's really interesting because, as Bob and Chris both mentioned, we've really got a lot of emphasis on, not only new loan production, but keeping what we have on the book, the loans that we want to. And we went through a couple of weeks ago and just took a sampling of the loans that had paid off in the bank.
And what we're seeing really are 2 phenomena. One is, the first one is on the very largest of loans where we compete against the large banks, the Chases, the Fifth Thirds, where we seem to potentially lose some of those larger deals is in the structure around personal guarantees.
Those larger banks don't feel that that's probably as important as may be a mid-sized bank, our size bank. And up to this point in time, we just decided not to compromise on many of those loans.
So we lose some of those loans, some of those types of loans on guarantees to larger banks. We do lose some loans to smaller banks and not necessarily on the guarantees, but more particularly on the covenants.
Because we have a particular set of covenants that we like to use on loans of certain sizes and many of the smaller banks are now beginning to back off those covenants. And they don't feel it's important as we do.
So it's not back to where we were in 2006, 2007. But up to this point in time, we've just simply said, you know what that strategy of holding to our credit quality, to our principles, to our structure really served us well over that last cycle.
And we're going to stay with that here, but we are beginning to see some of those things begin to creep back into the market.
Robert G. Jones
Jon, I might -- for the benefit of others, we've got Jim Sandgren with us who's our regional CEO, runs our largest markets in Southern Indiana. Let me have him add a little color just as the guy that's facing off with it every day.
James A. Sandgren
Yes, I think what Daryl said is absolutely right. We're really not compromising on structure.
We are having a daily call every morning with Daryl and his top credit folks, as well as the regional CEOs and our chief banking officer and we're talking about these deals. And so if there are issues with structure, we're escalating those to the proper level of management, and we're working through those deals.
And sometimes we get to a point where we're not comfortable with that additional risk, but we're also finding ways and maybe different options to do some of those deals. So the fact that we've got a lot of folks on the call every morning talking about these deals and moving them through the pipeline, I think has helped.
Pricing, what we talked about earlier on the call, I think is something that I think we compete very well with today. And so we're probably more willing to give a little bit, a few basis points here or there.
And with our market share that we have in so many of our markets, we're able to get a little bit higher pricing because of the relationships that we have. But what we really haven't done too much of at all is compromise on structure, and I would confirm what Daryl says there.
But still getting a lot of at-bats and talking a lot about these deals and as you've seen prior quarters, we're getting them through the pipeline.
Jon G. Arfstrom - RBC Capital Markets, LLC, Research Division
Okay, good. And then, Bob, maybe just one question for you, a little bit different question.
But is there, in your view, a difference in the economic or business climate between say Northwest Indiana or Northern Indiana and Southwest Michigan?
Robert G. Jones
Jon, it's a great question. I would tell you they're almost identical.
If anything, I would say Southwest Michigan's maybe a little more vibrant only because of, again, remember we run South Bend to Fort Wayne. Elkhart is coming back, they're doing well.
The mobile home and RVs are doing much better, but still somewhat challenged. But what we've found in Southwest Michigan was a little more service based than people realized and probably a little more vibrancy than people realized.
It's -- we were very encouraged just -- Jim and I spent time, not only with the BofA folks, but we talked to economic development professionals, and there's a lot of good things going on up there. So we're encouraged.
It looks a lot more like South Bend than it does anywhere else.
Operator
Your next question comes from the line of Mac Hodgson with SunTrust Robinson.
Mac Hodgson - SunTrust Robinson Humphrey, Inc., Research Division
Most of the questions have been asked and answered. Just, Chris, just one kind of summary question on the -- on net interest income or accretion.
I think before in the third quarter, you guys had said a decline of maybe $20 million to $25 million related to Monroe and Integra. And then I think on this call, you think that'll be offset by Indiana Community.
So it seems like maybe you're expecting a run rate, quarterly run rate on Indiana Community in the $7 million to $8 million range. Is that the right way to think of it or is maybe your expectation on the decline in Monroe and Integra changed a little bit?
Christopher A. Wolking
I'd truly feel better about talking about that after we get through another quarter, Mac. Like I said I think in my comments, it was a little bit higher than we had anticipated.
And as Bob pointed out, we saw some pay downs of some non-impaired assets in the quarter that were a little bit higher than we, frankly, thought they'd be. So I'd like to see a second quarter before I -- a second full quarter, so that would be the first quarter this year, before I talk more about that.
I think our forecast still indicated that -- indicate that one will be offset by the other going forward.
Operator
At this time, you have no further questions.
Robert G. Jones
Super. Well again, everybody, thank you so much.
And as always, any follow-up questions, give Lynell a call, and I guarantee we'll get right back to you. Appreciate your interest, and 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, oldnational.com.
A replay of the call will also be available by dialing 1 (855) 859-2056, conference ID code 85748760. This replay will be available through February 11.
If anyone has additional questions, please contact Lynell Walton at (812) 464-1366. Thank you for your participation in today's conference call.
You may now disconnect.