KBRA Places Ratings for Bremer Financial Corporation on Watch Upgrade Following Merger Announcement

KBRA places the long-term ratings of St. Paul, MN-based privately held Bremer Financial Corporation (“Bremer” or “the company”) on Watch Upgrade, including the senior unsecured debt rating of BBB+ and the subordinated debt rating of BBB following the recently proposed merger announcement with Old National Bancorp (NASDAQ: ONB) (“Old National”). In addition, KBRA affirms Bremer’s short-term debt rating of K2. KBRA also places the ratings of Bremer’s subsidiary, Bremer Bank, National Association, on Watch Upgrade, including the deposit and senior unsecured debt ratings of A-, the subordinated unsecured debt rating of BBB+, and the short-term deposit and debt ratings of K2.

Key Credit Considerations

On November 25, 2024, Old National Bancorp and privately held Bremer Financial Corporation jointly announced the signing of a definitive merger agreement, in which the companies will combine in a part-stock / part-cash (78% and 22%, respectively) transaction that is expected to close in middle of 2025. Bremer is expected to merge with and into Old National, and Bremer’s subsidiary, Bremer Bank, National Association will merge with and into Old National’s subsidiary, Old National Bank. The transaction was valued at $1.4 billion, or 1.0x price to TBV, at the merger announcement. In conjunction with the deal, ONB announced the pricing of a forward sale common equity raise (~19 million shares for $384 million of net proceeds; assuming the underwriters do not exercise their option to purchase additional 2.9 million shares), in which ONB’s management team has the option to exercise any time over the next 12 months, though likely will be completed near the closing of the merger. KBRA has a favorable view of the deal structure from the creditor perspective of ONB, as the transaction was essentially an all-stock consideration with the cash component being largely offset by the net proceeds of the common stock offering. There are no changes to the executive leadership team anticipated following the close of the merger, though the Board of Directors is expected to add one member from the Otto Bremer Trust.

Headquartered in Evansville, IN, Old National Bancorp is a $54 billion in total assets bank holding company for Old National Bank. Founded in 1824 (as Evansville National Bank), Old National Bank offers traditional banking services as well as wealth management services (total AUM of $31 billion, as of 3Q24) through 288 branches primarily in the Midwest region of the U.S. The loan portfolio is relatively balanced by segment, in our view, including a manageable investor CRE exposure (241% of total risk-based capital as of 3Q24). Moreover, ONB’s growth strategy has been acquisitive, with the most meaningful whole bank merger with First Midwest Bancorp completed in 1Q22, essentially doubling its size. However, the company completed a smaller-scale transaction of CapStar Financial Holdings, Inc. in 1Q24, which added $3 billion in assets and expanded ONB into the Nashville market.

Old National’s operating footprint encompasses a mixture of high-growth markets as well as more rural regions in the Midwest. Bremer has long-running ties to the local economy, especially within the Twin Cities region. From a strategic perspective, although dependent upon the successful execution of the merger, KBRA's view is that the combined entity creates a premier regional bank in the Midwest region by adding Bremer’s relatively strong deposit base in the Twin Cities MSA and a more granular deposit franchise in the upper Midwest region. Moreover, the combined deposit base is expected to reflect a solid mix, including 24% in NIB accounts, as well as a below average deposit costs. In addition, the combination delivers significant scale with platform for strategic investments, including the ability to leverage larger balance sheet and product suite across Bremer’s relatively diversified commercial and wealth management businesses.

In terms of earnings performance, both banks have exhibited relatively solid profitability over the years, supported by respectable margins and meaningful proportions of fee income. Moreover, both banks reported ROA around 1% during 3Q24, which we view as solid in this challenging interest rate environment. With respect to pro forma earnings, the combined institution is projected to reflect an ROA of approximately 1.3%, which includes expected cost-savings of ~30% of Bremer’s 2025 estimated noninterest expense run-rate (~$111 million pre-tax), realizing 25% in 2024 and 100% in 2025 and thereafter. However, there will be meaningful one-time merger expenses, which are estimated to be $194 million on a pre-tax basis. Both banks’ fee income sources are considered diversified and consist of durable items that are non-credit related and not generally affected by the overall interest rate environment. Moreover, we believe that ONB’s earnings are favorable on a risk-adjusted basis, which demonstrates the management team’s ability to generate solid returns while effectively managing credit risks through a relatively conservative loan portfolio composition.

Despite the meaningful decrease in core capital expected following the closing of the merger, it appears that the enhanced earnings profile of the combined institution will allow for a fast rebuild of the capital position, with management anticipating 180 bps of CET1 growth over an 18-month period. Rebuilding to a CET1 ratio near 12.0% would better align with the higher rating category, and return the institution to a comfortable position especially in the context of ONB’s and Bremer’s favorable credit performance over a long period of time.

In addition, KBRA favorably views management’s plan to sell up to $2.4 billion of CRE loans post-merger. According to management, the plan is to maintain the CRE to total RBC ratio below 250% by selling mostly non-relationship, non-core type loans out of Bremer’s investor CRE book.

Rating Sensitivities

The Watch Upgrade for Bremer’s ratings assumes that the transaction receives the required regulatory, shareholder, and other approvals to close in a timely manner and recognizes that Bremer will be merging with and into a larger and more diversified institution. Moreover, the basis for the Watch Upgrade also stems from the fact that Old National, while not rated by KBRA, would represent around 75% of the post-merger consolidated total assets, and would likely be rated in the category one notch higher than Bremer, as a result of solid earnings profile (above 1% in ROAA space since 2020), a diversified, higher quality revenue stream from the substantial wealth management business, favorable long-term credit performance and the granularity of the loan portfolio, adequate capitalization in the context of the business model, and a conservatively managed balance sheet footing (average loans to average earnings assets of 74% as of 3Q24). Moreover, the Watch Upgrade also assumes effective integration for the combined company and the achievement of earnings and capital targets, which is likely given ONB’s strong track-record with respect to M&A, and the similar operating strategy and lending philosophy. As such, once the merger closes, Bremer’s ratings would likely be upgraded one notch from the current levels. Conversely, if the transaction were to be terminated, Bremer’s ratings would likely to be maintained at current levels with a Stable Outlook, assuming the transaction did not present any undue burden on the overall financial performance.

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