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Old National Bancorp (NASDAQ:ONB)
Q4 2020 Earnings Call
Jan 19, 2021, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to the Old National Bancorp Fourth Quarter and Full Year 2020 Earnings Conference Call. This call is being recorded and has been made accessible to the public in accordance with the SEC's Regulation FD. Corresponding presentation slides can be found on the Investor Relations page at oldnational.com and will be archived there for 12 months.

Management would like to remind everyone that as noted on Slide 2, certain statements on today's call may be forward-looking in nature and are subject to certain risks, uncertainties and other factors that could cause actual results to differ from those discussed. The Company's risk factors are fully disclosed and discussed within the SEC filings.

In addition, certain slides contain non-GAAP measures, which management believes provide more appropriate comparisons. These non-GAAP measures are intended to assist investors' understanding of performance trends. Reconciliations of these numbers are contained within the appendix of the presentation.

I would now like to turn the call over to Jim Ryan for opening remarks. Mr. Ryan?

James C. Ryan -- Chairman and Chief Executive Officer

Good morning and Happy New Year. I hope this call finds all of you and your families safe and healthy. We are really pleased with our fourth quarter and full year 2020 results. Despite all the challenges that came our way this last year; we stayed focused on the health and safety of our team members, we successfully executed the ONB Way transformation and, we remained dedicated to serving our clients and communities.

We also continued to invest in new talents and further strengthened our client experience as a technology. I'm pleased to say that we've delivered on the run rate savings we promised from the ONB Way. As a result of the ONB Way, FTEs and branches are lower by 16% each, and we were able to reduce other overhead cost.

We were also able to achieve better than trend line growth from our commercial segment in 2020, and we plan to execute additional ideas in 2021 to drive higher revenue. Starting on Slide 3, our 2020 highlights include earnings per share of $1.36. When adjusted for the ONB Way charges, earnings per share were $1.50. Adjusted return on average tangible common equity was 14.6%. Adjusted operating leverage improved by 460 basis points and our adjusted efficiency ratio was 55.6%.

We also set several new records during 2020 including the following: Record commercial loan production, record mortgage production, record capital markets revenue and, obviously we had a strong efficiency in core deposit growth. Next on Slide 4, our fourth quarter earnings per share was $0.44 per share. Adjusted EPS was $0.46.

I was particularly pleased with our quarterly loan production of $1.2 billion. End of period commercial loans excluding PPP loans increased 22% on an annualized basis. The loan growth was split equally between C&I and CRE. Growing our loan portfolio and improving our earning asset mix will help us preserve net interest income. End of period core deposits increased by 11% driven by checking and savings account growth. We did have a small net recovery in this quarter, but maintained the overall reserve.

We continue to use [Phonetic] qualitative factors to offset improvements in the economic data believing that there is still a fair amount of uncertainty with the economy and the pandemic. Net interest income excluding PPP increased because of the loan growth and better mix. Non-interest income was down slightly due to seasonal declines in mortgage, but held up better than previous fourth quarters.

Most of our reported credit quality metrics were relatively benign during the quarter, but as we have previously stated, we expect that credit metrics could worsen and losses will ultimately materialize after any stimulus and deferral programs run their course. We continue to proactively downgrade some of the most pandemic exposed loans into the watch asset quality ratings and are still meeting weekly to review credit quality loan-by-loan. We continue to believe that our historically strong and consistent underwriting practices, our diverse and granular loan portfolios and our Midwest footprint should help us weather the impact better than most. I'm really excited about the team members we've hired during 2020.

We continue to have a good pipeline of opportunities too. We have a great story to tell and we have strong interest from people wanting to join our team. We have hired and expect to hire more in Wealth Management, Private Banking, Commercial, Treasury Management and key support team members. As we disclosed last quarter, these hires will cost us approximately $5 million year-over-year, but should ultimately lead to higher revenue from these growth initiatives.

A quick thought about our capital. We plan to maintain our buyback authorization throughout the year. We will balance the benefits of buybacks versus M&A opportunities. I suspect there will be M&A opportunities that will present themselves during the year. We are getting more comfortable that we could put a credit mark on somebody else's loan portfolio, but we will continue to be an active looker and a selective buyer.

With those remarks, I'll now turn the call over to Brendon.

Brendon B. Falconer -- Chief Financial Officer

Thank you, Jim. Turning to the quarter on Slide 5. Our GAAP earnings per share was $0.44 and our adjusted earnings per share was $0.46. Adjusted earnings excludes $3.6 million in ONB Way related charges. Moving to Slide 6. We are pleased with our full year adjusted pre-tax, pre-provision net revenue, which was 10% higher year-over-year. And despite the challenging 2020 operating environment, we generated 460 basis points of positive operating leverage.

Slide 7 shows the trend in outstanding loans and earning asset mix. End of period loans decreased slightly quarter-over-quarter driven by pay off of $536 million in PPP loans. Excluding the impact of PPP, end of period commercial loans increased $473 million, driven by record commercial production of $1.2 billion. The strong commercial growth this quarter was aided by higher than average pull-through rates and funding levels.

We are also pleased with our loan growth mix this quarter, which is well balanced between C&I and CRE. Production yields were slightly lower quarter-over-quarter, which was a result of a few larger high credit quality clients with relatively low coupons, with strong risk-adjusted returns. The $2.1 billion quarter-end pipeline reflects typical seasonable declines as well as the unusually high pull-through rates of our record third quarter pipeline.

We believe the current pipeline with over $560 million in the accepted category should lead to another good quarter of production. The investment portfolio also increased in the quarter as deposit growth outpaced loan growth. We are taking a disciplined approach to putting excess liquidity to work, including adding some protection if rates were to rise. Lower rates on new purchases continue to impact our total portfolio yield, which is down 14 basis points to 2.31%.

Moving to Slide 8. Period-end and average deposits increased during the quarter by 9% and 13% respectively. Growth was largely concentrated in our existing personal checking accounts, but we were also continuing to win new deposit relationships in the business and public segments that added meaningfully to this quarter's growth.

Turning to pricing, our total cost of deposits declined from 13 basis points in the fourth quarter to 9 basis points in Q4. Both time deposits and borrowing costs were meaningfully lower in the quarter and will continue to fall, but at a moderate pace. Overall, we are pleased with our deposit repricing efforts that have resulted in a significant reduction in deposit costs, while maintaining our core client base.

Next on Slide 9, you will see details of our net interest income and margin. Net interest income increased $16 million quarter-over-quarter, largely due to an increase of $14 million in PPP related interest and fees from the forgiveness of approximately $500 million of loans. Excluding the impact of PPP, net interest income increased $2 million quarter-over-quarter due to strong commercial loan growth and active management of our funding costs.

The net interest margin also benefited from PPP fees, adding an additional 31 basis points over prior quarter. Core margin excluding accretion and PPP was 2.88% in the fourth quarter compared to 2.96% in Q3. This 8 basis point decline was in line with our expectations and was partly the result of the lower new business rates, I referenced earlier.

However, we also experienced a significant uptick in liquidity and that while neutralizing [Phonetic] net interest income has put additional pressure on net interest margin. Future PPP pay-offs coupled with stable deposit balances could amplify this impact in 2021. Like these pressures on margin, we expect earning asset growth to help stabilize net interest income.

Slide 10 shows trends in adjusted non-interest income. Adjusted non-interest income of $58 million in the fourth quarter was slightly lower than the $60 million we recorded in Q3. The $2 million decline was primarily driven by seasonal factors in our mortgage business. Despite the slight decline, mortgage revenues outperformed our expectations with a record fourth quarter production of $531 million and a record end of year pipeline of $361 million that has more than doubled the year end 2019 level.

Our capital markets also had another strong quarter posting $7 million in revenues, a $2 million increase over prior quarter. Next, Slide 11 shows the trend in adjusted non-interest expenses. Adjusting for ONB Way related charges and tax credit amortization, non-interest expense was $129 million. The increase in expenses was largely driven by incentive accruals that reflect the outstanding 2020 financial performance.

Also impacting this quarter's expenses was the timing of miscellaneous professional fees and community investments. Several smaller items make up the remainder of the quarter-over-quarter variance and are not expected to recur. Given the number of moving parts, this quarter we thought it would be helpful to provide additional details on our Q1 expense expectations. Reductions in incentives and other expenses, along with the typical adjustments for seasonal payroll taxes should result in non-interest expense of approximately $118 million in the first quarter.

Merit increases will go into effect in April and will not impact expenses until Q2. We also want to provide a brief recap on the cost saves we outlined as part of our ONB Way strategic plan. We have delivered on the $36 million in annualized expense saves we promised in 2020, including $26 million in personnel costs and $6 million in branch and facilities expenses.

We are also beginning to see the results of our revenue initiatives, particularly in the recent above trend growth in commercial loans and capital markets revenues. Additional revenue initiatives in our wealth and treasury management segments are well under way and we look forward to discussing the results of these projects as they progress.

As I wrap up my comments, here are some key takeaways. We are very pleased with the results of the quarter and the full-year. Record commercial loan production led to significant earning asset growth. Our mortgage and capital markets businesses finished their record-breaking years with a strong fourth quarter and we delivered on the promised ONB Way expense savings.

With that, I will turn it over to Daryl to discuss credit.

Daryl D. Moore -- Chief Credit Executive

Thank you, Brendon. First update I would like to provide this morning is likely our last update around the first round of our client relief programs as they continue to wind down. With respect to deferrals, we have previously reported that we granted some type of deferral on slightly less than $1.3 billion in loans, which represented approximately 10% of the portfolio. At the end of this most recent quarter, the dollar amount of loans, still in deferral mode had dropped to $64 million, which represents roughly 0.5% of the total portfolio.

While we are still receiving deferral request on the consumer side, we don't feel they are outsized given the current environment. Deferral request on the commercial side has slowed to a trickle especially after the announcement of the new stimulus aid package. As you know, we were very successful in securing round one PPP funds for our clients having originated just short of 10,000 loans with balances in excess of $1.5 billion. As of year-end we had roughly 6,100 PPP loans with a balance of $960 million remaining on the books from round one of the program.

As of late last week we had submitted over 5,800 PPP loans for forgiveness representing slightly more than $1 billion in balances. Of those 5,800 submissions, roughly 5,300 of them totaling $636 million have been approved and paid by the SBA. In addition, of the 5,800 forgiveness submissions, 73 of those represented loans greater than $2 million. In total, we originated only 116 of these higher dollar loans and it is encouraging to note that we did receive our first approval for forgiveness for this particular set of loans last week.

Remaining fees on PPP loans not yet taken into income totaled $17 million. Slide 13 lays out trends in the most significant credit quality indicator categories. Delinquencies fell in the quarter to 15 basis points of the total portfolio. Increases in both our C&I and residential mortgage portfolios were noted in the quarter, while we continue to see a somewhat increasing trend in our indirect auto portfolio delinquencies.

With respect to charge-offs, we posted a net recovery in the quarter of 3 basis points resulting in a full year of 2020 charge-off rate of 2 basis points. Non-performing loans increased in the quarter as was expected. The increases in this category continue to come in great part from the downgrade of relationships that had shown weaknesses prior to the pandemic. To put it in another way, aside from loans that had reflected weaknesses prior to the onset of the pandemic and other than our relatively small hotel exposure, we have not yet seen a meaningful migration of other credit relationships into our non-performing category.

The first round of stimulus payments certainly helped in this regard and we expect the second round to also provide assistance. I do want to be clear though that we are obviously seeing the migration of credits that were not in a significantly weakened position coming into the year into the special mentioned and substandard accruing categories as a result of the current economic challenges.

What this might lead us to summarize is that the rate of future inflows of credits into the non-performing category may likely be highly dependent upon both the ability of the U.S. to rollout vaccinations in an efficient and timely manner, as well as the length of time it will take U.S. consumers to return to their pre-pandemic spending routines. Obviously, the longer it takes to get back to pre-pandemic state, the more room our borrowers will have to experience financial difficulties.

We believe that in the near-term, a continuing increase in risk assets is certainly a possibility. Slide 14 sets out those industries we have identified as deserving extra level of attention in this current economic environment. There has been nominal change in our exposure to these industries which remains at roughly 7% of total loans.

As we mentioned last quarter, while there is merit in acknowledging that these industries as a whole may be suffering disproportionately in the current environment, it is important to note that we will originate new credits in these categories to the right borrowers and for the appropriate purposes.

Chart at the bottom of Slide 14 shows the breakout of our consumer portfolio along with corresponding FICO -- average FICO scores. This portfolio has shown little change as well since our last presentation to you. We do continue to watch our consumer portfolio closely. We will persist in our endeavors to work with borrowers who have lost their jobs during the pandemic and we believe that the new round of financial stimulus should help us in that regard.

As a final comment, I think it is fair to admit that the results which we posted over the last few quarters are not what we had feared they might be back in March. First of all, our expectations were that we would have seen a much more significant downward migration of loans into the non-performing category.

I think that the combination of government stimulus programs, cost cutting efforts by our borrowers and creative retooling by many of our clients have been key to keeping more borrowers from financial default. While the impacts of the pandemic are lasting longer than any of us may have initially anticipated, we are hopeful that the second round of stimulus will go a long way to bridging our borrowers through to the end of the pandemic.

How and when losses manifest themselves in 2021 remains very uncertain. We expect that loss rates will be higher in 2021, but the magnitude of those increases again has much to do with how quickly we can return to economic recovery. Second, the level of 2020 growth has exceeded our marked expectations as well. I think that some of that growth may have to do with the quality of our loan book going into the recession which allowed us to not have to solely focus on the immediate prices at hand, but take a longer view with respect to working with clients, both existing and new.

The sudden nature of this downturn and the likelihood that the recovery will be speedy once the vaccine -- or vaccines have taken hold, has permitted us to work with borrowers with an eye on post-recovery prospects. If we had -- had to have been more inwardly focused on cleaning up a big share of our book at the outset of the downturn, I suspect that our success levels in generating new loans would have been much diminished.

I believe that in 2020 we continue to underwrite loans in a prudent fashion and that we did not take on extraordinary risk in order to generate the loans we have -- loan growth we have posted.

With that, I'll turn the call back over to Brendon.

Brendon B. Falconer -- Chief Financial Officer

Thank you, Daryl. On Slide 15 you will see the details of our fourth quarter allowance of $131 million which was unchanged from Q3. The improving economic forecasts derived from Moody's baseline led to a $90 million decrease in reserve needs. We added a similar opening amount for qualitative reserve that reflects the ongoing uncertainty at the economy and the charge-off timing. Although the economic outlook continues to improve, we believe it's prudent to maintain a reserve level until we have more clarity on the path of the virus, vaccination rollout and the efficacy of the latest stimulus package.

Excluding PPP balances, our allowance to loan ratio was 102 basis points and is an appropriately conservative estimate of the credit risk in our portfolio today. I would also like to remind you that we continue to carry $51 million in unamortized marks from our acquired portfolios. While these marks will not directly offset charge offs, any remaining mark will accrete through margin upon resolution.

Slide 16 includes thoughts on our outlook for 2021. We ended the quarter with a healthy, albeit, seasonally lower $2 billion commercial pipeline, which includes $560 million in the accepted category. Expected core earning asset growth and reduced funding costs should lead to stable net interest income. But net interest margin could come under pressure from additional excess liquidity. The PPP loan forgiveness process continues to go well and we expect run-off and the recognition of the related $17 million in unamortized fees will be concentrated in the first half of 2021.

We expect our fee businesses to continue to perform well. We are encouraged by the great momentum in mortgage evidenced by the strong year-end pipeline, but performance will still be subject to industry trends. The strong commercial activity and rate environment should help maintain the high level of performance in our capital markets business.

The deposit service charges continue to lag historical levels and the promise of additional stimulus could further delay the return of this revenue. Other fee lines are expected to be stable in the near-term as our ONB Way revenue initiatives in wealth and treasury management take shape later in the year.

We provided guidance on Q1 expenses of $118 million, which includes the investments in talent we discussed last quarter in our wealth and commercial segments as well as some additional marketing and technology spend. Lastly, a brief update on taxes. As we previously reported, a couple of large historic tax credit projects were placed in service in Q4.

These projects accounted for most of the increase in tax credit amortization in the quarter with a net income benefit of approximately $1 million. Regarding 2021, we expect a reduction in the volatility caused by our tax credits as we worked through the last of the remaining one-year historical tax credit commitments.

In total, we are expecting approximately $5 million in tax credit amortization for the year with a corresponding full year effective tax rate of approximately 20%. With that, we are happy to answer any questions that you may have, and we do have the full team here including Jim Sandgren.

Questions and Answers:

Operator

[Operator Instructions]. The first question will come from the line of Ben Gerlinger with Hovde Group.

Ben Gerlinger -- Hovde Group -- Analyst

Hey, good morning guys.

James C. Ryan -- Chairman and Chief Executive Officer

Good morning, Ben. How are you?

Ben Gerlinger -- Hovde Group -- Analyst

I'm doing well. You guys seem to have a pretty solid 2020, so congratulations on that. I was wondering if you guys could take a step back and look at a little bit of a bigger picture on the ONB Way. 2020 was largely focused on expense management and you guys did a lot of heavy lifting throughout the year, and then 2021 was kind of scheduled to have a lot more of that revenue growth. Granted, when you guys released the plan, a lot of events have taken place since then around the world. So I was wondering if you guys could just talk around potential timing of when things could come to fruition in terms of revenue? And any opportunities that you might see now that there has been some disruption in the market that you guys currently have your footprint in?

James C. Ryan -- Chairman and Chief Executive Officer

I think those are all good observations Ben, and maybe the commercial treasury wealth management initiatives are just kind of full steam ahead. It's really about putting the right talent in place to go out and execute those. And there are some technology improvements and particularly in our treasury management business that we'll continue to work out throughout the year. And we knew it was going to take a better part of 2021 to really implement those initiatives, get those people on board, hired and trained up. And there are some initiatives around small business and some consumer initiatives that quite frankly we're not quite ready to put in place, but we continue to build the technology to support those initiatives.

So those are a little bit longer runway than we anticipated. If we had a more normal economy, we would have anticipated executing those this year. But having said that, big bulk of the treasury management and commercial wealth is just on pace and scheduled to happen throughout 2021.

Ben Gerlinger -- Hovde Group -- Analyst

Okay, great, that's helpful. And then my other question Jim came to the capital usage. I know that your stocks have got 45% or so since the lows in like September-October. Obviously, in your prepared remarks, you said that M&A is much more of an opportunity, and like obviously -- the math does work better with a better currency.

So, I was curious on if you had any potential remarks about something going forward. I know your past three acquisitions have been around $2 billion or so and they've been drifting toward the Northwest with Wisconsin, Minnesota -- and the Minnesota. I was wondering if you had any other thoughts on any geographies you might be looking into potential size as it differs from that $2 billion mark.

And then finally, if you thought about just the loan portfolio itself of that acquired bank, is there any concentrations you might want to bulk up or is it a little agnostic to their loan portfolio?

James C. Ryan -- Chairman and Chief Executive Officer

I think we continue to gravitate toward banks that have a similar business mix and model that we have. We continue to be very comfortable in the Midwest, obviously. And, in terms of size, you know, those Plan A opportunities continue to be that kind of 10% to 20% of assets, but as we've always said, we're willing to think about other things if it strikes the right balance between shareholder accretion, strengthening our Company further. I think all those things are going to be important to us.

And I would just say, you know, we're not looking at our book today and getting ready to announce a transaction anytime soon. It's just -- some middle part of last year was pretty hard to imagine that you could put a credit mark at somebody else's balance sheet. We're just getting more comfortable that you can define the scope of what you think the lost content might be and probably closing the gap between the bid ask today than it was maybe six months ago.

So we just think there's going to be opportunities that are going to present themselves throughout the year and we're going to be in a position to take advantage of those opportunities and continue to do deals like we've done in the past that we think makes sense for our shareholders, that make sense to continue to further strengthen our Company.

Ben Gerlinger -- Hovde Group -- Analyst

Got you. Thanks. That's all from me. I appreciate the time and then congrats on a solid quarter and year.

James C. Ryan -- Chairman and Chief Executive Officer

Thanks, Ben. Appreciate it.

Operator

The next question will come from the line of Scott Siefers with Piper Sandler.

James C. Ryan -- Chairman and Chief Executive Officer

Mr. Siefers, you're a little short this morning here, you got beat out.

Scott Siefers -- Piper Sandler -- Analyst

Jim, I don't know what happened. I mean, if you're asking am I -- do I feel humiliated, because I'm getting old...

James C. Ryan -- Chairman and Chief Executive Officer

No, but you know, Ben is a little bit younger and you know, he just had the edge on you this morning.

Scott Siefers -- Piper Sandler -- Analyst

He's -- he's coming into a zone, I've past my peak, it's a sad day for me. I'll try to be less disappointing next quarter. But I appreciate you guys taking the question. I wanted to just get some updated thoughts on loan growth. If we back out the PPP and it's just -- I mean it's extraordinarily strong relative to what we're seeing out of the HA data, a lot of competitors, etc.

Just curious Jim for your updated thoughts on how much of that is just your customer's organic demand and how much of it is market share opportunities and where are you seeing most of that come from like geographically as well?

Brendon B. Falconer -- Chief Financial Officer

I'll give you, mic [Phonetic] -- two seconds on it, and then I'll let Jim maybe follow up on it. You know, a lot of the growth we saw in the fourth quarter is really all the hard work we've done in the middle part of the year. Again as Daryl said on his remarks, and Jim will continue to reiterate, we stayed focused in on calling -- you know, and Jim and I went on a lot of client calls this summer and some of those were opportunities that we were able to steal away from larger organizations that quite frankly, made some policy changes that caught up some of their best clients.

And so we walked through those doors and some real long term clients, and the live [Phonetic] was just some existing opportunities that we had with clients and then some of it new. I mean it was really a mixture of all, but I'll let Jim kind of follow-up. But we were really pleased that we really stayed focus throughout the whole year on those clients. And because I think of our historically strong underwriting practices we weren't scared that we were going to have some big mess to deal with. We were able to real stay focused and keep our underwriting going.

James C. Ryan -- Chairman and Chief Executive Officer

Yeah, I think that's well said. I think the commitment through the ONB Way to commit to segments and to really align our skill sets with what our customers need certainly helped that as well. Really from a production standpoint, geographically Minnesota again led the way. We're really pleased with the continued efforts of our Minnesota RMs and then continue to see strong growth from Louisville and Indianapolis among others.

So again, a lot of the growth was throughout the footprint, but kind of concentrated in those two areas. And while the pipeline is down a little bit seasonally and obviously huge production in the fourth quarter, feel good about first quarter, I think our accepted category is about $200 million higher than it was at this time last year. Plus, we do have a number of commercial construction advances over $800 million that are still left to be advanced off.

So, I feel like we have some tailwinds, but certainly our RMs are committed to grow in that pipeline as we typically do at this time. So, optimistic.

Scott Siefers -- Piper Sandler -- Analyst

Perfect. Okay, good. Thank you for that color. And then separately, I know we're still very early in this new round of PPP program. But just curious what kind of demand are you guys seeing for it? What role do you expect you guys will play, etc.? Just I guess any top level thoughts, I'd just be curious.

James C. Ryan -- Chairman and Chief Executive Officer

Yeah, Scott. Right now, we're really seeing some nice demand. So we did a soft opening with our portal on Friday. Already we've seen over 600 applications, average loan size about $150,000, our RMs are doing a lot of very proactive outreach to our round one clients who took advantage. We're also doing a lot of focus on minority-owned, women-owned businesses, non-profit. So we anticipate a lot of demand, obviously a smaller pool and we have to show that 25% reduction in revenues, quarter '20 over '19.

That being said, I think we're going to see a lot of opportunities not only to help our customers, but to bring in some new clients to the bank. So -- so far, pretty good start.

Brendon B. Falconer -- Chief Financial Officer

Yeah. Scott, I mean, on average, we expect the loan balances to be relatively small. I mean it is capped at $3 million. And so the total impact to our organization will be much smaller than the initial round. But as Jim said, in terms of shared numbers of loans, I think there'll be a fair amount of numbers of loans, but the dollar size of those loans will be relatively small. And the overall income impact will be much, much smaller in 2021 than it was in 2020.

Scott Siefers -- Piper Sandler -- Analyst

Yeah. All right, perfect. Thank you guys very much appreciate it.

James C. Ryan -- Chairman and Chief Executive Officer

Thanks Scott. Better luck next time.

Scott Siefers -- Piper Sandler -- Analyst

I know, I know. Thank you again, and again, I'm sorry.

Operator

The next question will come from the line of Chris McGratty with KBW.

James C. Ryan -- Chairman and Chief Executive Officer

Good morning, Chris.

Christopher McGratty -- Keefe, Bruyette & Woods -- Analyst

Hey, good morning, everybody. Brendon maybe just a clarifying question on the net interest income guide. Is that excluding, can you tell me is that excluding both accretion and the PPP impact, or is that one of the other?

Brendon B. Falconer -- Chief Financial Officer

Yeah, Chris, as you're referencing the 2.88% that I talked about in my opening comments, yes, that excludes both PPP -- all PPP related interest and fees and accretion.

Christopher McGratty -- Keefe, Bruyette & Woods -- Analyst

Okay. And so, the outlook, the comment that suggested a little bit of pressure on margins but stable net interest income, is that kind of the core, core excluding both accretion and PPP?

Brendon B. Falconer -- Chief Financial Officer

Yes.

Christopher McGratty -- Keefe, Bruyette & Woods -- Analyst

Okay. [Speech Overlap]. And on that, you've got a really low loan deposit ratio and you've had a lot of success with deposit growth, how do I think about the borrowings that are on your balance sheet? The need to keep them on the balance sheet this year and kind of balancing that -- the loan to deposit against the loan growth outlook.

Brendon B. Falconer -- Chief Financial Officer

Yeah, Chris. Great question. We are looking for opportunities to continue to optimize the funding side of our balance sheet. There are some levers we can pull, but I would not expect that number to change materially over the next several quarters.

Christopher McGratty -- Keefe, Bruyette & Woods -- Analyst

Okay. Okay. And then, Jim, just going back to your M&A question and comments before. You talked about Plan A being 10%-20% I think in the past you've talked about pre-pandemic, the willingness to do what -- a kind of a transformational deal or more openness, is that put into, I guess play a potential MOE if the stars are aligned? Is that something the Board would consider?

Brendon B. Falconer -- Chief Financial Officer

Look, we have to do our fiduciary job. If it makes sense for the shareholders, and we think we can create long-term value out of it, we will absolutely consider it. We need to be open to those things, but we know how difficult they are, and they're going to have a higher bar for us given the execution risk around that. But the Board and management would absolutely consider if it was the right thing to do.

Christopher McGratty -- Keefe, Bruyette & Woods -- Analyst

Okay, great. And then just a couple of housekeeping, could you just provide the remaining one-timers related to the ONB Way, if there are any? And then the $70 million of PPP fees, is that just the fees and then we should add on the 1% coupon, or is that all in revenues?

Brendon B. Falconer -- Chief Financial Officer

Chris, this is Brendon. Yeah, so the PPP fees or -- the $70 million is just the fees. It does not include the interest impact for whatever is left in Q1, Q2. Regarding ONB Way, we are wrapping up with most of the work around ONB Way. There could be some de minimis amounts coming through in Q1 and Q2, but relatively small at this point.

Christopher McGratty -- Keefe, Bruyette & Woods -- Analyst

Okay, awesome. Thank you.

James C. Ryan -- Chairman and Chief Executive Officer

Thanks, Chris.

Operator

The next question will come from the line of Terry McEvoy with Stephens.

James C. Ryan -- Chairman and Chief Executive Officer

Good morning, Terry.

Terry McEvoy -- Stephens Inc. -- Analyst

Good morning, everyone. I'm used to coming after Scott, so nothing new on my end this morning. But thanks for taking my questions. First off, I just want to make sure I understand the expense commentary. I mean, pretty straightforward, the $118 million for the first quarter. So I guess my question is how much of that $5 million year-over-year increase from the new hires is in that $118 million and if it's not all in there, how should we think about growing that number?

And then, same question for the kind of the annual merit increase in the second quarter. I think last call you maybe quantified that, if you could just remind me the best way to think about that starting in 2Q. Thanks.

James C. Ryan -- Chairman and Chief Executive Officer

Yeah. We talked about the $5 million impact for all the investments, and so about a quarter of that is represented in your -- in your Q1 number. So the remainder of that will happen over the course of the year. And in terms of merit, it's about $1.2 million, $1.5 million per quarter beginning in Q2.

Terry McEvoy -- Stephens Inc. -- Analyst

And then just my follow up here. If I look at the reserve ratio at the -- end of the first quarter was call it 86 basis points, now over 1% ex-PPP loans. Once you have a little bit more clarity and certainty about the economic outlook and just feel more comfortable there, do you think that ratio goes back to where it was, call it day one, or it was after the first quarter ended?

James C. Ryan -- Chairman and Chief Executive Officer

Yeah, Terry, I don't think it goes back to day one. I think the economic outlook that we'll experience at the end of this crisis will probably not be as rosy as it was back in January 1st, when we put it together. So, my guess is we ended a level higher than day one, but probably meaningfully lower than we are today.

Terry McEvoy -- Stephens Inc. -- Analyst

And then, I guess one last question, I know this came up earlier, given the acquisition that is occurring in some of your core markets, in some of the cost savings number that have publicly been talked about, would you be interested maybe at the end of this year in really ramping up some of your hiring may be in excess of what you were thinking about before that news happened? And if so, maybe what markets do you think present the best opportunity for that? Thank you.

James C. Ryan -- Chairman and Chief Executive Officer

Yes, we will continue to be an opportunistic place to hire folks for, and we have feelers out in all of our markets, trying to look for the best possible talent, there's still a fair amount of disruption from the largest banks in our footprint. And it's -- sometimes it's difficult to serve your clients in some of those organizations. And so we'll continue to look for that.

And so, while we know we kind of quantified this initial round of hire, really supporting the ONB Way initiatives, we really continue to be an opportunistic hire. And I don't expect that those that hiring would have a material impact on our overall expense number. So, and so we'll continue to look for those great opportunities. Minnesota continues to represent [Phonetic] great opportunities for us, Michigan continues to represent great opportunities for us. Louisville, places like that continue to represent great opportunities. So we're absolutely willing to go off and hire in excess of our original plans if it makes sense for long-term growth of the Company.

Terry McEvoy -- Stephens Inc. -- Analyst

That's great. Thanks again.

James C. Ryan -- Chairman and Chief Executive Officer

Thanks, Terry.

Operator

The next question will come from the line of Jon Arfstrom with RBC Capital Markets.

James C. Ryan -- Chairman and Chief Executive Officer

Good morning, Jon.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Hey, good morning. Good morning. Brendon, maybe a question for you on mortgage banking. You talked about the pipeline being twice of what it was a year ago, but what's the message you're sending on some of the near-term mortgage trends? Can you keep pace with the kinds of numbers you put up in the fourth quarter, or do you expect that to fade a bit?

Brendon B. Falconer -- Chief Financial Officer

Yeah, Jon. No real clear message other than to say, we ended the year really great. So typically we should be able to outperform the Q1 of last year, just given the year-end pipeline. But we will not be immune to the headwinds and tailwinds of the mortgage business in aggregate. I think our mortgage business will continue to follow those industry trends, but I think we'll be off to a good strong start in Q1.

James C. Ryan -- Chairman and Chief Executive Officer

You know, as I think we are finishing up last year, I mean there is a fair amount of uncertainty, can 2021 be as robust as 2020, and I think many of the models out there had really strong 2021 in terms of mortgage fee income where the MBA forecast showed maybe down 20% at one point in time.

So I think there's just kind of balance there. I mean, it'd be triple, we're not quite sure of what mortgage volumes will look like. We were anticipating a down year, but we've been calling that down year for the last few years to be honest with you. So it's hard to know. We were just really pleased that our fourth quarter ended really strong, and hopefully we'll maintain some of the momentum going into the first quarter.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Okay, good. Fair enough. And then the back on the reserve, just a follow-up, the qualitative piece of it, just curious if you could help us think through that, what are maybe the top couple qualitative factors that maybe you can get your arms around that caused that qualitative increase?

Brendon B. Falconer -- Chief Financial Officer

I think, Jim, Daryl, and I all mentioned it. It's really the path of this -- the virus, the vaccination rollout and maybe more importantly, the timing of charge-offs, and the delayed recognition. And still we have some clarity around that, it's challenging for us at this point to release reserves in a meaningful way.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Okay. And that kind of leads to my last one here, the follow-up. You talked a little bit about indirect auto delinquencies up a little bit and I guess that's maybe understandable with kind of the stimulus pause, but are you seeing any other new problems or anything unexpected? And I understand the qualitative piece of it, but so anything new or surprising that you're seeing or is it just generally things are getting better?

Daryl D. Moore -- Chief Credit Executive

Yeah, Jon, Daryl here. No, there really isn't anything in the portfolio. We've got that slight increase in delinquencies in the indirect. If I had to search and search the only thing that is remotely surprising to us in our consumer portfolio is the defaults related to deaths. And I don't think it's COVID related necessarily, but we've tracked that over the last several years and at least in our portfolio we have some defaults related to that. But as we look through the rest of the portfolio there really is not anything at this point in time that's surprising to us which may in itself be surprising.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Right. Okay. And the general view is that new stimulus generally helps to push out losses. Do you think Daryl that all the stimulus and what we're seeing and what you're thinking right now, that all the stimulus that we have and is probably yet to come flattens the losses?

Daryl D. Moore -- Chief Credit Executive

Yeah, on -- may be in a little different camp, if the vaccinations can't take hold, I think this next round depending on how big it is, could not only just push out losses, it could also serve to reduce to a certain extent the lost content that we have in our portfolio. So I'm a little more bullish on that.

James C. Ryan -- Chairman and Chief Executive Officer

Which you know is pretty rare for Daryl.

Jon Arfstrom -- RBC Capital Markets -- Analyst

I know, I'm shocked. But, I mean you can -- you can, but I think it's positive. So, OK, thanks for all the help. I appreciate it.

James C. Ryan -- Chairman and Chief Executive Officer

Thanks, Jon.

Operator

[Operator Instructions]. The next question will come from the line of David Long with Raymond James.

James C. Ryan -- Chairman and Chief Executive Officer

Good morning, David.

David Long -- Raymond James -- Analyst

Good morning everyone, thanks for taking my question. You know, as it relates to commercial real estate, curious if you're -- what you're hearing from your customers about how much -- how much space they will need going forward as we come out of this pandemic. I'm not talking about the next three months to six months, but just over the course of the next couple of years, if you're getting any insights as to customers needing to expand to create space or are they going to be looked to be cutting space because more people are going to be working in at home. Just curious on anything you're picking up in your discussions with your customers right now.

James A. Sandgren -- President and Chief Operating Officer

Yeah, I think, I think it's -- Dave, this is Jim Sandgren, this -- I think it's a little early to tell. You know, that whole kind of work from home and office, are -- we don't have a huge exposure to office. And we've been very cautious about that as we go into it. But continue to keep a close eye on retail, multi-family, we've had a lot of growth there. I think we're being very opportunistic making sure we're doing the right deals in the right markets with the right borrowers. But we continue to have those conversations. But I think it's -- I think it's still too early to tell exactly what that trend is going to be for businesses and work from home and how much office space you're going to need. We've also heard the other side, if a lot of people are working from home, people may say, hey, we still need office space, but we may need more office space for less people. So again, a lot of -- a lot of things going on right now. We're just kind of wait and see how that all plays out.

James C. Ryan -- Chairman and Chief Executive Officer

David, I would just share anecdotal conversations I've had with CEOs across our footprint and while everybody was talking about the virtues of working from home last year, I think as the year started closing out, there was a lot of CEOs that had some fatigue around the work from home and the productivity around the work from home and maybe while it worked really early on, it's been more challenging here as of late. And just the desire for people who are social by nature to get together and be more collaborative. So I think there is balance in the conversation today. I agree with Jim, it's too early to tell about what happens to our portfolio. But I don't think that the virtues that everyone is going to be working from home and anywhere they want to work maybe in the Midwest may be different than maybe other parts of the country.

But I don't think that that will mean a big impact to Old National's portfolio.

David Long -- Raymond James -- Analyst

Got it. Thanks guys. I appreciate the color. That's all I had.

James C. Ryan -- Chairman and Chief Executive Officer

Thanks, David.

Operator

[Operator Instructions]. With that, we are showing no further audio questions at this time, do the speakers have any closing remarks?

James C. Ryan -- Chairman and Chief Executive Officer

Well, Nichole, thank you for your hosting today and thanks to everybody for joining us. As always, we are here and available to take further follow-up questions. Happy New Year and thanks for everybody for joining us today.

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-6389837. This replay will be available through February 2nd. If anyone has any additional questions, please contact Lynell Walton at (812) 464-1366. Thank you for your presentation -- participation in today's conference call.

Duration: 44 minutes

Call participants:

James C. Ryan -- Chairman and Chief Executive Officer

Brendon B. Falconer -- Chief Financial Officer

Daryl D. Moore -- Chief Credit Executive

James A. Sandgren -- President and Chief Operating Officer

Ben Gerlinger -- Hovde Group -- Analyst

Scott Siefers -- Piper Sandler -- Analyst

Christopher McGratty -- Keefe, Bruyette & Woods -- Analyst

Terry McEvoy -- Stephens Inc. -- Analyst

Jon Arfstrom -- RBC Capital Markets -- Analyst

David Long -- Raymond James -- Analyst

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