Old National Bancorp Stock: Earnings Likely To Remain Flat

Earnings of Old National Bancorp (NASDAQ: ONB) will likely remain mostly flattish in 2022 as provision normalization will likely negate the benefit from the merger of equals. The merger with First Midwest Bancorp (FMBI) will likely lead to significant cost savings for the combined company. Moreover, a rising interest-rate environment will benefit the top line as the balance sheets of both Old National and First Midwest are quite sensitive to rate changes. Overall, I am expecting Old National Bancorp to report earnings of $1.65 per share in 2022, down from $1.67 per share for 2021. The year-end target price suggests a modest upside from the current market price. Therefore, I’m adopting a bullish rating on Old National Bancorp.

Substantial Cost Savings are the Biggest Benefit of the Combination

The merger of equals between Old National Bancorp and First Midwest Bancorp was originally scheduled to close in the fourth quarter of 2021. However, due to delays in regulatory approvals, the closing will likely now happen during the first quarter of 2022. The management mentioned in the conference call that it is awaiting Federal Reserve approval and that it is expecting to hear positive news this quarter. Additionally, the management now expects the system conversion to get completed by July 2022.

Following the system conversion, the management expects to achieve substantial cost savings. As mentioned in the conference call, the management has identified opportunities to save around $109 million annually, and it expects to achieve 50% of the modeled savings in 2022 and 100% thereafter. These estimated annual savings are quite considerable considering First Midwest reported quarterly expenses of $120.9 million in the fourth quarter of 2021, as mentioned in its earnings release.

On the other hand, pressures on salary due to a high inflationary environment will likely pressurize the non-interest expenses. Considering the management’s guidance and the inflationary environment, I’m expecting Old National’s efficiency ratio to improve to 52.9% by the last quarter of 2022 from 61.8% in 2021. First Midwest’s efficiency ratio has been quite similar to Old National’s ratio in the past.

Organic Loan Growth, Rising Interest Rate Environment to Support the Top Line

First Midwest’s loans totaled $14.5 billion at the end of December 2021. Therefore, the merger of equals will more than double Old National’s loan portfolio at the time of the transaction closing. Apart from acquired growth, organic growth will remain at a satisfactory level for the combined company. The nationwide improvement in the economy will likely drive credit demand. Further, the forgiveness of Paycheck Protection Program (“PPP”) loans is mostly behind us. Old National’s PPP loan portfolio made up just 1.2% of total loans at the end of December 2021, as mentioned in the earnings presentation. Further, First Midwest’s PPP loan portfolio made up just 2.2% of total loans at the end of the last quarter, as mentioned in its earnings release. I’m expecting these remaining PPP loans to get forgiven in early 2022.

Considering these factors, I’m expecting the loan portfolio to surge by 110% in 2022. Other interest-earning assets and deposits will likely grow in tandem with loans. The following table shows my balance sheet estimates.

	FY17	FY18	FY19	FY20	FY21	FY22E
Financial Position
Net Loans	11,068	12,188	12,063	13,655	13,495	28,346
Growth of Net Loans	23.5%	10.1%	(1.0)%	13.2%	(1.2)%	110.1%
Securities	4,082	4,815	5,615	6,527	8,357	16,879
Deposits	12,606	14,350	14,553	17,037	18,659	36,746
Borrowings and Sub-Debt	2,578	2,494	2,745	2,677	2,575	2,861
Common equity	2,154	2,690	2,852	2,973	3,012	5,752
Book Value Per Share ($)	15.55	17.18	16.52	17.89	18.15	19.48
Tangible BVPS ($)	15.55	10.07	10.16	11.37	11.69	15.85
Source: SEC Filings, Author’s Estimates (In USD million unless otherwise specified)

Apart from organic growth, the combined company’s top line will also benefit from the rising interest-rate environment. As mentioned in Old National’s third-quarter 10-Q filing, the management’s interest-rate sensitivity analysis shows that a 100-basis points increase in interest rates can boost the interest income by 5.92% over twelve months. Further, a 100-basis points increase in interest rates can boost the net interest income of First Midwest Bancorp by 7.5% over twelve months, as mentioned in First Midwest’s third-quarter 10-Q filing. Overall, I’m expecting the net interest margin to increase by 4 basis points in 2022 for the combined company.

On the other hand, the top line of the combined company will suffer from the absence of PPP fees. Both Old National and First Midwest have small PPP balances outstanding that are likely to get forgiven in early 2022.

Considering the outlook on organic loan growth, margin expansion, and PPP fees, I’m expecting Old National to report a net interest income of $1,160 million in 2022. This is slightly below the sum of the Old National and First Midwest net interest income for 2021, as shown below.

	ONB	FMBI	Combined
Earnings for 2021
Net Interest Income	596	569	1,166
Provisions	(29)	3	(26)
Non-Interest Income	214	182	396
Non-Interest Expense	501	477	977
Net Income	278	182	459
Source: Earnings Releases of ONB and FMBI (In USD million)

Provision Expense Normalization Likely After a Year of Reserve Releases

Both Old National and First Midwest released a substantial amount of loan loss reserves in the last quarter of 2021. As the allowances are now no longer at excessive levels, I’m not expecting further reserve releases. Old National’s allowances made up 0.79% of total loans, while its nonperforming loans made up 0.92% of total loans at the end of December 2021, as mentioned in the presentation. First Midwest was much better as its allowances made up 1.4% of total loans, while its non-performing loans made up just 0.7% of total loans at the end of December 2021.

Further, the organic loan growth will likely drive the normalization of the provision expense in 2022. Overall, I’m expecting the provision expense to make up around 0.04% of total loans in 2022, which is in line with the 2016 to 2019 average of 0.03%.

Expecting Flattish Earnings for 2022

Earnings will likely remain flat to slightly down this year as the anticipated normalization of provision expense will likely counter the impact of cost savings, organic loan growth, and margin expansion. As consideration for the merger of equals, I’m estimating Old National to issue 129 million new shares to First Midwest Bancorp’s shareholders. Overall, I’m expecting Old National to report earnings of $1.65 per share in 2022, down front $1.67 per share for 2021. The following table shows my income statement estimates.

	FY17	FY18	FY19	FY20	FY21	FY22E
Income Statement
Net interest income	437	538	604	596	596	1,160
Provision for loan losses	3	7	5	38	(29)	12
Non-interest income	183	195	199	239	214	357
Non-interest expense	449	517	508	541	501	911
Net income – Common Sh.	96	191	238	226	278	487
EPS – Diluted ($)	0.69	1.22	1.38	1.36	1.67	1.65
Source: SEC Filings, Author’s Estimates (In USD million unless otherwise specified)

Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic, especially the Omicron Variant.

Decent Price Upside Justifies a Bullish Rating

Old National is offering a dividend yield of 2.9% at the current quarterly dividend rate of $0.14 per share. The earnings and dividend estimates suggest a payout ratio of 34% for 2022, which is below the five-year average of 46%. Nevertheless, I’m not expecting an increase in the dividend level this year because Old National does not often change its dividend level.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Old National Bancorp. The stock has traded at an average P/TB ratio of 1.51 in the past, as shown below.

	FY19	FY20	FY21	Average
T. Book Value per Share ($)	10.2	11.4	11.7
Average Market Price ($)	17.1	14.8	17.9
Historical P/TB	1.68x	1.30x	1.53x	1.51x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/TB multiple with the forecast tangible book value per share of $15.9 gives a target price of $23.9 for the end of 2022. This price target implies a 23.8% upside from the January 19 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

P/TB Multiple	1.41x	1.46x	1.51x	1.56x	1.61x
TBVPS – Dec 2022 ($)	15.9	15.9	15.9	15.9	15.9
Target Price ($)	22.3	23.1	23.9	24.7	25.4
Market Price ($)	19.3	19.3	19.3	19.3	19.3
Upside/(Downside)	15.6%	19.7%	23.8%	27.9%	32.1%
Source: Author’s Estimates

The stock has traded at an average P/E ratio of around 11.5x in the past, as shown below.

	FY19	FY20	FY21	Average
Earnings per Share ($)	1.4	1.4	1.7
Average Market Price ($)	14.8	17.9	17.9
Historical P/E	10.7x	13.2x	10.7x	11.5x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/E multiple with the forecast earnings per share of $1.65 gives a target price of $19.0 for the end of 2022. This price target implies a 1.4% downside from the January 19 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

P/E Multiple	11.4x	11.5x	11.5x	11.6x	11.6x
EPS 2022 ($)	1.65	1.65	1.65	1.65	1.65
Target Price ($)	18.8	18.9	19.0	19.1	19.2
Market Price ($)	19.3	19.3	19.3	19.3	19.3
Upside/(Downside)	(2.2)%	(1.8)%	(1.4)%	(0.9)%	(0.5)%
Source: Author’s Estimates

Equally weighting the target prices from the two valuation methods gives a combined target price of $21.4, which implies an 11.2% upside from the current market price. Adding the forward dividend yield gives a total expected return of 14.1%. Hence, I’m adopting a bullish rating on Old National Bancorp.