Old National Bancorp

NASDAQ:ONB

Earnings Call Transcript 2020-Q1

[Operator]

Welcome to the Old National Bancorp First Quarter 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.

Before turning the call over, management would like to remind everyone that as noted on Slide 2, certain statements on today’s call maybe 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 its SEC filings. In addition, certain slides contain non-GAAP measures, which management believes provides more appropriate comparisons. These non-GAAP measures are intended to assist investors understanding of performance trends. Reconciliation for 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.

[Jim Ryan, Chief Executive Officer]

Thank you, Dorothy. Good morning, everyone. I hope this call finds all of you and your families safe and healthy. While we are pleased with our first quarter core fundamental trends and the implementation of the ONB Way strategic initiatives, our commitment and focus today is on supporting our clients, team members, and communities. I would also like to thank our team members for their hard work and dedication to serving our clients and communities during this difficult time.

Starting on Slide 3, our first quarter net income was $22.6 million, including $31.2 million in ONB Way charges. Adjusted net income was higher at $42.1 million, which includes higher loan loss provisions for the first quarter adoption of CECL. As you review our results, you will see that our core margin was down due to the Fed fund rate cuts and the challenging yield curve. We were able to lower total deposit costs by 9 basis points to 34 basis points. Our commercial production of $647 million was seasonally higher. As a result of the good production, lower payoffs, and some higher quality line usage, commercial loans grew over 13% annualized.

We recorded $17 million in provision expense during the quarter related to the adoption of CECL. I suspect you will see wide variances in CECL provision this quarter for midsized banks as we all adapted to this new standard and the multiple economic forecast. Once we determined the accounting relief from CECL was very temporary and the regulatory capital relief was extended, it made sense for us to proceed with adopting as of January 1. The depth of this crisis is yet to be known. I won’t even speculate on future losses or provision needs, but the impact is clearly very broad-based. The Midwest hasn’t felt the same impact as other parts of the country and we are hopeful that relief programs we have put in place coupled with the various governmental programs will ultimately blunt the economic impact to our clients.

Old National is celebrating our 186th year in business. As you know, we pride ourselves on being a basic foreign bank. Our loan portfolio is diverse, it’s granular, and overall as strong that’s ever been heading into this crisis, but we will need more time to better understand the magnitude of the economic impacts before truly understanding future losses. We have run and shared with our Board of Directors multiple economic forecasts and various stress tests. As a result, we are still open for business and extending new credit. We manage for the long-term. Our balance sheet and capital are strong, our markets are diverse, and our experienced team will help manage us through this challenging time. I am confident that we will emerge even stronger on the other side.

We were successful in making the organizational changes we revealed last quarter and we made significant progress on the efficiency initiatives under the ONB Way. Brendon will provide all the details, but we are on track to deliver $22 million in cost savings in 2020 and achieved the full $40 million run-rate for 2021 as we discussed on last quarter’s call. We continue to make progress on the revenue initiatives, but admittedly some of them have been reprioritized given the pressing need for investments in the various government relief programs and our own internal relief programs. On the capital front, we did repurchase 4.9 million shares during the quarter at an average price of $16.05. We did suspend our program given the uncertain economic conditions. After reviewing the various stress tests with our Board, we don’t anticipate any other capital actions and we expect to maintain our current dividend.

Moving to Slide 4, we detailed our COVID-19 response for clients, team members, and communities. The health and safety of our team members and clients is paramount. We granted additional sick time for team members along with additional paid time off for all team members to assist with unforeseen personal needs. We also expanded family and medical leave benefits to those who are at risk or will have an at-risk person in their household. We have enabled many team members to work remotely. Daily, we have more than 1,000 team members working from home. And lastly, we expanded our ONe Wish program for team members with unforeseen financial needs. All our branches are opened via drive-through with lobbies by appointment only. We have provided information on digital banking options and change in our service delivery model via oldnational.com, e-mails, direct mail, and social media platforms.

We have definitely seen healthy increases on our mobile and online platforms. We are providing clients relief by approving payment extensions, not reporting payment deferrals to credit bureaus, and waiving or a refunding overdraft and monthly service charges for clients impacted by COVID-19. We continue to lend to qualified businesses for working capital and general business purposes. We’ve helped nearly 5,200 clients with the SBA Payment Protection Program, and we are proactively reaching out to our clients and approving loan payment extensions. Today, I’m pleased that we announced a $1.2 million commitment to immediate and near-term relief efforts, $600,000 for immediate needs with an emphasis on low-to-moderate income communities, and $600,000 for our foundation with a focus on long-term restoration.

As you can see on Slide 5, the COVID-19 impact to the states in our footprint has been less impactful than other parts of the country. Michigan has some of the highest reported cases in our footprint with almost 80% concentrated in the [audio gap] where we have no branches. In our footprint, business and governmental leaders are talking about safe ways to open businesses and return to work. I’m optimistic that the Midwest will be among the earliest to reopen. Scott Evernham, our Chief Risk Officer; and Daryl Moore, our Chief Credit Executive are joining us on the call today. Both are experienced in their roles and have many of the same leaders on their teams from the 2008 financial crisis. We are fortunate to have Daryl’s experience in this environment, given he has been with Old National for more than 40 years. He was really hoping he would finish his career by never having to present slides on our earnings conference call again, but I’m glad to have his experience today, and I will now turn the call over to Daryl.

[Daryl Moore]

Thank you, Jim. Slide 6 gives us a high level overview of the composition of both our commercial and consumer portfolios. While there’s no denying that most industry segments have been negatively impacted by the COVID-19 outbreak, we have outlined in the top chart for you the commercial industries that many believe will suffer disproportionately in this crisis. Over the years, we’ve tried to identify those industry segments that are most volatile and do not perform well in a cycle, and for the most part have attempted to either not participate in those segments or participate with appropriate structure and risk mitigation in place. We certainly will not be immune to difficulties in these segments, but as you can see the size of our exposure to these most vulnerable industries appears to be well managed going into the cycle. With respect to our consumer loan book, you can see in the chart in the bottom-left quadrant of the slide, a breakout of the size and average FICO scores of the different product types within our consumer portfolio going into the cycle. There is no doubt that because of the significant increase in unemployment, we will experience difficulties in this portfolio that none of us would have anticipated when we originated these loans. But again, looking at the FICO scores and the fact that less than 2.5% of the portfolio could be considered sub-prime, we believe that we are fairly well positioned to address any developing difficulties in this portfolio.

Just a couple of comments about line utilization, as reflected on the chart in the lower right-hand quadrant, we have seen an increase in commercial line utilization predominantly from clients with stronger asset quality ratings. Commercial line utilization at March 31 was 35.2% compared to 32.6% at the end of the prior quarter. We’ve also seen an increase in HELOC applications within the last 45 days with the quality of those applications generally being very strong. While we are not able to definitively determine why we are seeing an uptick in this particular loan category, we suspect that many of our consumer borrowers are following the lead of our commercial clients wanting the liquidity backed up if the economy continues to be stressed for a more lengthy time period.

Next, we wanted to give you an idea of the volume of the loan deferral approvals we have granted and have laid out those along with some Paycheck Protection Program information on Slide 7. On the commercial side, we have approved roughly 900 requests from borrowers totaling $1.1 billion, representing 14% of total commercial outstandings. While 62% of the deferrals we have booked to-date are in the CRE loan category. We expect to see this percentage drop as we continue to book approved requests as a proportion of CRE requests appears to have been higher early on in the deferral application process. As you might suspect, while the number of loan deferrals is higher in the consumer area, the dollar amount of those deferrals and the portfolio penetration numbers are lower than in the commercial area. As shown on the right hand side of the slide, to the exhaustive work of many of our team members, we have helped provide $1.3 billion in Paycheck Protection Program assistance to roughly 5,200 borrowers.

Slide 8 provides recap of credit trends for the first quarter results. Both non-performing and underperforming loans fell slightly in the quarter to levels lower than we have posted at any quarter end in 2019 and lower than any year-end level in the past 3 years. Charge-offs were higher in the quarter related to two particular credits. We chose to take an additional write-down prior to the end of the quarter on the relationship that was the subject of our larger 2019 fourth quarter charge-offs. Being concerned about collateral values in this new economic environment, we commissioned new appraisals and felt an additional write-down of $2.1 million was appropriate. The other larger charge-off in the quarter was a $3.8 million action on a credit we have been working with for an extended time period waiting on the investment of outside capital that had been promised by the borrower.

As we were not entirely certain that this capital investment would be made, we chose to fully impair the loan for loan loss reserve purposes back in 2019. When it became apparent that the investment would not materialize by the end of the quarter and given the change in the economy, we determined that a complete write-off of the exposure was appropriate. We will continue to pursue collection efforts on this relationship going forward. At this point in time, we do not feel these write-downs are reflective of any general pre-COVID-19 credit issues in the portfolio, but represent isolated credit events that occur over time in any portfolio.

Just a couple of comments before I end my part of this discussion about our approach to this newly changing environment. Over the years, we have dealt with numerous economic cycles. It has become apparent that an intentional clearly communicated plan with respect to how we will approach the challenge at hand is important to minimizing losses. What we have found is the first item at hand is for everyone to recognize that economic conditions have changed. In this current environment, the pace and the breadth of this change, is unparalleled. While this sounds obvious and simple to accomplish, we have to remember that just 60 days ago, most banks were in full new loan production mode getting team members to switch for production call mode to when necessary, having tough conversations with clients about the new economic realities is vitally important and has to be accomplished quickly for the benefit of both the client and the bank.

In this new environment, we are emphasizing at minimum we must evaluate a borrower’s liquidity, capital adequacy and availability and loan structure every time we touch a credit. Liquidity is the first concern of the bank and most borrowers in such times as these without the ability to continue to fund the basic necessities of the business and otherwise resourceful enterprise can’t survive. What is different about this downturn is the infusion of liquidity that the government is making through the Paycheck Protection Program and other offerings. While we are hopeful it is yet to be seen whether the amounts our borrowers are able to draw under these programs are going to be at levels sufficient to bridge them through this challenge.

The adequacy and availability of capital is the next concern we talked with our borrowers about to remember that – or to remind them that capital is a reserve that they have to cover unanticipated setbacks. If we do not believe that our borrowers have sufficient balance sheet capital to get them through the current setbacks, we challenge them as to what outside resources they may have at their disposal to raise needed capital and encourage them to begin to line up those resources. As a final point, we require a review of the current loan structure and collateral support. We are emphasizing that opportunities to strengthen structures in terms of guarantees and covenants must be considered and the acquisition of additional collateral if available has to be on the table in our discussion with our borrowers.

We are also beginning to think about how the current challenges of shelter in place might have an impact on collateral values and ultimately loss given the false assumptions. Foreclosures have been put on hold. Auto auction houses are not currently in operation in many locations. Courts are closed and I could go on. It’s a time proven fact that in most instances collateral does not get more valuable with the passage of time in an economic downturn. Our collateral values and liquidation strategies play out has yet to be seen given the pent-up demand may play a role in stopping the risk associated with this potential issue. I outlined these fairly obvious items, because I believe that a bank’s discipline around these very basic fundamentals can make a difference to the ultimate performance of its portfolios.

Finally, I think it’s important to reaffirm that the bank embraces the vital role it needs to play in supporting each of our communities’ recovery efforts. While focusing on the basic credit fundamentals I have addressed is critically important in this environment, we also understand our obligation to provide credit at every responsible opportunity to help our clients and this country to get back on our feet. My belief is that banks that understand how to properly balance these two imperatives will have every opportunity to be very successful as we come out of the cycle.

With that, I will turn the call over to Brendon.

[Brendon Falconer]

Thank you, Daryl. Before turning to the quarterly financials, we would like to provide some additional color on our CECL allowance on Slide 9. Our day 1 CECL reserve of $96 million was $41.3 million over our year end reserve and right in the middle of our projected range. The relatively large day 2 increase in reserves and $17 million provision expense for the quarter were primarily driven by projected economic impact of the coronavirus. The macroeconomic variables used in our models were derived from the Moody’s critical pandemic forecast scenario published on March 20. The scenario assumes a sharp decline in GDP in Q2 and a return to growth by year end. The immediate increase in unemployment is less severe than current expectations, but does remain elevated through 2023. The slide also outlines the key economic variables and portfolio inputs used in our model.

In addition to the quantitative inputs, we also considered several qualitative factors in our final reserve assessment, including the risk that the economic decline, specifically unemployment and GDP, prove to be more severe and work for long than our baseline forecast. We also took into consideration the mitigating impact of the unprecedented fiscal stimulus, including direct payments individuals, enhanced unemployment benefits as well as the various government sponsored loan programs, which we expect will provide relief to consumer and commercial borrowers.

Lastly, as Daryl reviewed, we considered a relatively low exposure to the industry as expected, to be most vulnerable to this crisis. The future severity of the economic fallout from this virus is yet unknown as is the ultimate effectiveness of the government response on providing a bridge for the individuals and businesses impacted. As times goes on, we will have more clarity on both and will adjust our reserve levels accordingly. As said, we believe our current reserve level reflects our best estimate of the credit losses in the portfolio today.

Turning to the quarter on Slide 10, our GAAP earnings per share was $0.13 and our adjusted earnings per share, was $0.25. Adjusted earnings per share, excludes $31.2 million in ONB Way related charges as well as $5.2 million in debt securities gains. Moving to Slide 11, our quarterly adjusted pre-tax pre-provision net revenue was 3% higher year-over-year and 5% higher over prior quarter. This result was driven by increased fee income led by our mortgage and capital markets businesses as well as a reduction in adjusted operating expenses resulting from our progress towards achieving the expected savings from the ONB Way initiative. Despite the challenging operating environment, we improved operating leverage by 102 basis points year-over-year. We believe our strong pre-tax pre-provision net revenue will provide a buffer against future provision needs.

Slide 12 shows the trend in outstanding loans. End of period loans increased $274 million quarter-over-quarter largely in our commercial and commercial real estate loan categories. The increase was driven by solid commercial loan production of $647 million, slowing prepayment fees and higher line utilization. The 2.6% increase in line utilization was concentrated in our highest quality borrowers. Commercial activity was high during the first quarter, which resulted in a sizable increase in our pipeline, which currently stands at $2.7 billion. But given the current economic uncertainty, we would expect pull-through rates to be lower than recent quarters. The full impact of the December rate cut on existing loans, coupled with lower coupons on new production, drove overall portfolio yields lower. We expect the dramatic shift in the yield curve will continue to put pressure on asset yields in 2020.

Moving to Slide 13, both period-end and average deposits decreased during the quarter due to seasonal declines in public fund operating accounts and modest CD realm. Our total cost of deposits declined 9 basis points quarter-over-quarter to 34 basis points. We quickly reacted to the emergency rate cuts in March and ended the month at a very low 21 basis points in total deposit costs. Bank deposit rates averaged 1.34% during the quarter, but with approximately three quarters of our CD book maturing in the next 12 months, our interest expense should continue to decline. We are pleased with the results for deposit pricing strategy that has resulted in a meaningful reduction in deposit costs, while maintaining our core client base.

Slide 14 shows our first quarter earning asset mix and quarter-over-quarter change in loan mix. Strong commercial loan growth this quarter supports our goal of remixing our balance sheet to more productive commercial and commercial real estate loans. The investment portfolio yield was down just 3 basis points quarter-over-quarter to 2.71% with new purchases yielding 2.42%.

Next, on Slide 15, you will see the detailed changes in our first quarter net interest income and corresponding margin. Strong earning asset growth contributed to our net interest income and we are pleased with the performance of the margin given the challenges of the interest rate environment. Net interest margin, excluding accretion, was slightly lower than our expectations at 3.16% compared to 3.25% last quarter. However, adjusting for the day impact and lower interest collected on non-accrual loans, core margin was down just 2 basis points. The reduction in core earning asset yields, which were down 10 basis points, was nearly offset by reductions in our funding costs. Active re-pricing of our deposit book and balance sheet strategies continue to help mitigate the negative impact on margin.

Slide 16 shows trends in adjusted non-interest income. Our first quarter adjusted non-interest income increased $5 million. The quarter-over-quarter change was a result of an increase in mortgage banking revenue, which was driven by strong production and healthy gain on sale margins but also benefited from a $4.8 million change in our pipeline valuation. We did take a $1.5 million impairment charge to our MSR portfolio this quarter that is netted against our mortgage revenue. The capital markets line of business continues to be a bright spot as interest rate swaps continue to be very attractive to clients. Other fee categories were generally stable but will likely come under pressure in the second quarter. Also included on this slide is a summary of our mortgage activities for the quarter, which shows $361 million in production. Low interest rates continue to support strong refi activity in the quarter, which accounted for 48% of our production.

Next, Slide 17 shows a trend in adjusted non-interest expenses, which reflects our ongoing focus on expense management. One-time charges were $31.2 million this quarter, which is slightly better than the $34 million we projected. Adjusting for these one-time charges and tax credit amortization, non-interest expense was down almost $3.6 million quarter-over-quarter, and we remain on track to realize the expected savings from our ONB Way strategic plan. It’s also worth noting that our Q1 non-interest expense included a CECL-related day-two adjustment to our allowance for unfunded commitments of $1.7 million. Our adjusted efficiency ratio for the quarter is a low 59.3%, representing 166 basis point improvement over Q4 of 2019.

As I wrap up my discussion on the quarter, here are some key takeaways. We are pleased with our overall performance as the fundamentals of our core business were strong as demonstrated by our improved pre-tax pre-provision net revenue. We posted 9% annualized loan growth in the quarter without compromising on credit. We defended the margin well in an increasingly challenging rate environment. Our fee businesses posted healthy revenue growth, particularly in mortgage and capital markets, and we delivered on the promised expense savings we outlined last quarter.

Slide 18 includes our thoughts on our outlook for the remainder of 2020. The COVID-19 virus will have a meaningful impact on our 2020 performance. Commercial loan activity was strong in the quarter and we ended the second quarter with a healthy pipeline. However, near-term economic uncertainty is expected to have a negative impact on pull-through rates and may mute future loan growth. PPP loans are expected to add $1.35 billion to our outstandings in Q2, but there is some uncertainty that how long these loans will stay on our balance sheet. We have meaningfully mitigated the impact on our net interest margins and short end of the curve, but historically low long-term rates will continue to put pressure on asset yields as our loan and investment portfolios re-priced at lower coupons. After re-pricing, our deposit book has been a key component of our margin defense. And while there is room to move deposit cost lower, particularly within the CD portfolio, most of the transaction account rate reductions are now behind us. PPP loans will also impact our margin going forward. These loans carry a 1% coupon and an average fee of approximately 3% that will be accretive through margin on a level yield over their two-year terms. As loans are paid off early, any remaining fees will be accretive to income immediately.

Several fee items will also likely come under pressure from the economic slowdown. Our wealth management and investment businesses have seen a decline in the evaluation of our assets under management that will impact fees in the near-term. Overdraft fees and interchange income were down sharply in the last week of March as consumers began to comply with shelter in place orders and limited their spending to essential services. Although we’ve seen a pickup in activity in early April, we are likely to stay at the low trend until the economy is reopened.

As I mentioned earlier, the mortgage pipeline ended at record highs. We could see – but we could see increased fallout in the weeks to come. A large driver of the mortgage revenue this quarter was related to our pipeline build. That revenue typically reverses in the fourth quarter as pipelines decline. So given the disruption in the housing market, it may reverse more quickly. We expect the remainder of 2020 to reflect the expense reductions associated with ONB Ways that we communicated last quarter net of merit increases beginning in Q2. We are now estimating total one-time charges in 2020 related to ONB Way to be $39 million, which is a decrease from the original estimate of $42 million. All of our expense initiatives remained on track, including the planned closure of 31 branches by April 24.

We would also like to give you an update on our current capital position and outlook. We ended the quarter with a healthy CET1 ratio of 11.4%. And in abundance of caution, we have suspended our buyback program temporarily with any future use of the authorization depending on the facts and circumstances present later in the year. I would also reiterate that based on our current capital levels and our outlook of 2020 performance, we believe we have the capacity to maintain our dividend. We have also recently updated our stress test model. And under the CCAR severely adverse scenario, we remained well capitalized at the lowest point in the 9-quarter horizon. Our liquidity position also remains very strong with our low loan-to-deposit ratio of 87%, strong cash and unencumbered security positions and various other sources of liquidity, we have plenty of flexibility to respond to funding needs.

Lastly, we have provided some guidance on our full year 2020 tax rate, which is expected to be approximately 19.5% on an FTE basis and 14.5% on a GAAP basis. The effective tax rate includes $6 million in tax credits primarily related to the historic tax credit project, which was placed in service in Q1. This project generated a majority of the $5.5 million in tax credit amortization included in our operating expenses this quarter. Project delays caused by COVID-19 have impacted the timing of our other historic tax credit projects that were included in our last quarter estimates. Please remove any additional tax credit amortization you have in your model other than the actual amount from Q1. We will update you next quarter regarding the timing of the remaining projects. As a reminder, the tax credit amortization is recognized through expenses in the quarter that corresponds with the placement service date while the tax benefit is spread over the full year though the tax line.

With that, we are happy to answer any questions that you may have and we do have the full team here, including Jim Sandgren and Scott Evernham.

[Operator]

[Operator Instructions] Your first question comes from the line of Scott Siefers with Piper Sandler.

[Jim Ryan, Chief Executive Officer]

Good morning, Scott.

[Scott Siefers, Piper Sandler]

Good morning, guys. Hey, how is everyone doing?

[Jim Ryan, Chief Executive Officer]

We are doing fine. Hope, you are doing well too.

[Scott Siefers, Piper Sandler]

We are. We are. Thank you very much for asking. I appreciate you taking the questions. First ones that I wanted to ask was just on credit, so first maybe just sort of a second on the 86 basis point reserve to loan ratio and basically what that means in a CECL world, maybe just kind of a refresher there just in terms of adequacy. And then you noted that you guys had updated your stress scenario and still remain well capitalized even at the low point, just curious how the existing reserve compares to what you guys might consider sort of stress losses in that scenario?

[Jim Ryan, Chief Executive Officer]

Yes, sure. Scott, I will start off and Daryl can chime in. So just as a reminder, so we started the reserve at $55 million at year end. We are now sitting at $106 million, and the $67 million of March still remains outstanding on those loans. As far as the stress test concerns, we ran the most recent portfolio through our stress test models and come out with cumulative net charge-offs that are roughly in line with great recession totals at 2.5% to 3% range. So that would be the right comparable to our 86 basis points in losses [ph].

[Scott Siefers, Piper Sandler]

Okay, perfect. Thank you. And then I had another question on the PPP loans, maybe just I guess a little bit of a tutorial on how you plan to account for them in addition to what you put in the guidance slide. So first of all, those – everything that you guys approved, that actually gets funded right based on what you guys have in the outlook? And then the origination fees, those it looks like will all flow through the margin as well. So I guess we could see kind of the PPP be dilutive to the margin here in the immediate term, but presuming they are forgiven as planned, then you would sort of accelerate so you’d get a bump up in the margin as they payoff, is that the right way to think about it?

[Jim Ryan, Chief Executive Officer]

Exactly right, Scott. That’s how we are seeing it.

[Scott Siefers, Piper Sandler]

Okay, perfect. Alright. Thank you guys very much.

[Jim Ryan, Chief Executive Officer]

Thanks, Scott.

[Operator]

Your next question comes from the line of Chris McGratty with KBW.

[Jim Ryan, Chief Executive Officer]

Good morning, Chris.

[Chris McGratty, KBW]

Hey, good morning everyone. Just want to go back to Scott’s question on the PPP loans. I think a lot of the programs are much shorter than I think the 2 years that you laid out in the slide. For modeling purposes, I mean we bumped up the loan growth in the second quarter by the amount of $1.3 billion. My sense is most of that will come -- kind of unwind over the next 6 months. Is that a reasonable base case with how you are doing it and how you are structuring it?

[Brendon Falconer]

That’s our expectation too, Chris, but initially, you have to set these things up to amortize over the life of the loans. But – so if they are all forgiven within Q2, then you’d see a bump there, but if it does -- if they are not forgiven till Q3, it would be dilutive to the margin in Q2.

[Daryl Moore]

Chris, I would just add, there is still a lot of details to be determined about how we verify compliance with the forgiveness rules that are yet to being written or published. So, it could take a couple of quarters for this to kind of all unwind. I think we are all hopeful it unwinds quickly, but the reality is since we don’t know the rules to play by, it’s going to be difficult to determine exactly how fast these loans are going to get forgiven.

[Chris McGratty, KBW]

Okay. And then the expectation is to either fund them with the balance sheet flexibility you have with loan-to-deposit or through some of the government programs that you expect to qualify, is that right?

[Brendon Falconer]

Yes. We are actively planning to participate with the Federal Reserve’s or the Treasury department’s program.

[Chris McGratty, KBW]

Okay, I appreciate that. Just one more, I am trying to map Slides 6 and 7, the deferrals and the vulnerable industries. I think in your prepared remarks, you talked about CRE being a big piece of the deferral. Any color on maybe the restaurant book or some of the other portfolios that might be – you might be working with in terms of trying to extend some terms for your stress clients?

[Daryl Moore]

Yes. Chris, this is Daryl. Certainly, within those deferrals, there have – there is a fair amount of request from restaurants, and we have been working with those clients. I would – I don’t think that we will see them come back again until we get through at least the 90 days and see where we are. On the hotels, the very little hotel exposure that we have -- most of those have been asking for deferrals as you might imagine. And on the CRE piece, much of that comes from either multifamily that have retail associated with it where the retail has been closed down. Some just apartments early on we’re concerned about ability of their tenants to pay rent. We looked at a little bit of that, and then anything kind of retail, strip mall, those types of things were also heavy requestors early on in the deferral approval process.

[Chris McGratty, KBW]

And Daryl, as you are going through this process with your borrower, what kind of conversations are you having in terms of having them put more kind of skin in the game to work with you and to make sure you are not on the hook?

[Daryl Moore]

Yes. Chris, so early on, we had some conversations with those clients, but mostly just given the uncertainty and the fact that we knew they are going to have cash strains, we did a lot of these deferrals. Just look back on their operating history, if they hadn’t had problems before, look to see what we thought was reasonable and then just moved on. As we hit to the end of the 90 days, on those that we did 90 days, we will – we are going to be asking for updated financial information on sponsors and I have to sit down and have in some cases some tough conversations if this hasn’t turned around. Some borrowers, we did 180-day extensions on, because it made sense to do that. All of our relationship matters will be out in 90 days talking with those clients beginning to understand how deeply they have been impacted and start to gather financial information, start to have those conversations about additional capital or collateral or how we are going to work through this. It is so fluid right now.

[Chris McGratty, KBW]

Thank you very much.

[Operator]

Your next question comes from the line of Terry McEvoy with Stephens.

[Jim Ryan, Chief Executive Officer]

Good morning, Terry.

[Terry McEvoy, Stephens]

Hi, good morning. Maybe could you start – just provide some insight into the accounting for the commercial and consumer deferrals, did you keep accruing but the yield is now lower? And if so could you talk about what type of impact that could have and I would assume it’s built into your projections and outlook today?

[Brendon Falconer]

No change in, Terry, to how we accrue for them. Obviously, there is a cash flow impact on that, but relatively minor, but we will continue to accrue those as we normally would.

[Terry McEvoy, Stephens]

Okay. And then maybe could you expand on the CD pricing over the next, well I think you just said 6 or 12 months kind of average rates today on the balance sheet what current market rates are?

[Brendon Falconer]

Yes. So as I said, we are sitting at 1.34%. Three quarters of that book will re-price over the next 12 months. And depending on the maturity and the tenor, I am not giving you a specific number on that, but they will be meaningfully lower than they are today.

[Terry McEvoy, Stephens]

Maybe just one last quick one, can you just talk about the impact on fee income in the first quarter from some of the actions you took to help your clients? And maybe just some color on what happened in March or late in the quarter to help us on a year-over-year basis kind of model out some of those transactional revenue lines?

[Jim Ryan, Chief Executive Officer]

Yes. I would say the first quarter impact from some of the fee waivers was de minimis with all kind of coming in the middle part of March and so really didn’t have a meaningful impact. I think, as Brendon pointed out though, I think everybody is seeing the spend slowdown, right and everybody saw service charges, I think across the industry be lower. It’s just hard for us to get a handle on how permanent – we have already seen a better pickup in April. And so it’s just really hard for us to have a pickup for – a view on how long this lasts and what the exact impact is going to be.

[Terry McEvoy, Stephens]

Understood. Thank you.

[Jim Ryan, Chief Executive Officer]

Thanks, Terry.

[Operator]

Your next question comes from the line of Jon Arfstrom with RBC Capital Markets.

[Jim Ryan, Chief Executive Officer]

Good morning, Jon.

[Jon Arfstrom, RBC Capital Markets]

Hey, thanks. Good morning. I just wanted to follow-up on a couple of things. Can you talk about the magnitude? I think Brendon you talked about it in your comments and Jim, you just alluded to just the magnitude of the increase in consumer activity. Is it meaningful at all or is it just very, very early?

[Brendon Falconer]

I think it’s just very, very early. I will tell you – and Jon you are in the Midwest, so you understand. I mean, I see a lot of people still buying food for restaurants and out and about, but clearly, card spend is down and that’s going to have an impact on, I think the entire industry. But I think it’s just too early to understand what the exact impact is. I guess, what I am optimistic is, I know our state is having a lot of great conversations about return to work. And I am very optimistic that by the end of April, we will start the economy back up here in the Midwest. And I think hopefully card spend and other things will return back to kind of normal. I know it’s going to take some time to get fully back up to speed, but I am optimistic that the Midwest will start to restart and maybe some of the earliest in the whole country.

[Jon Arfstrom, RBC Capital Markets]

A question for you guys as well on the loan demand today, you talked about the big pipeline that may not all pull through, but what does the loan demand today look like compared to maybe what it was 2 or 3 or 4 weeks ago? It looks like it was line draws initially, but what does it look like today and what are the areas where you are seeing the demand?

[James Sandgren, President and Chief Operating Officer]

Yes. Jon, this is Jim Sandgren. I would say the pipeline is down a little bit. The breakdown of that pipeline is still kind of 50% commercial real estate and balance C&I. I think everyone is kind of taking a step back to see how this is all going to impact their particular industries. Of the pipeline typically when we look at the accepted category, it’s about 90% to 95% likelihood. We are going to close those deals. After reviewing with our commercial segment leaders, I think that number drops to closer to 75%, still a lot of deals I think to be booked, but there is certainly going to be some borrowers, they are going to be a little cautious and projects or investments may get delayed a quarter or two, so kind of a wait and see.

[Jim Ryan, Chief Executive Officer]

Jon, I might add. This is a little bit longer term view, but I think manufacturers are looking at their supply chain today and saying how much of this could be done onshore versus offshore. And I am optimistic that Midwest might see some increased investment over the coming year or two and expect people think about those critical suppliers in their supply chain and how much of that really should be produced here in the U.S. versus someplace else. And so I think the Midwest can be a long-term beneficiary of that kind of new view of the supply chain dynamics.

[Jon Arfstrom, RBC Capital Markets]

I could keep going with questions, but I have a couple of more follow-ups I guess. Maybe Daryl or Scott, you talked about the increase in CRE deferrals and I am curious areas where you expect to see deferral increases from here? And if you have any shot at what percentage of book do you think could be deferred I don’t view that as a negative. I guess I am just curious as to how far you think this could go?

[Daryl Moore]

Yes, Jon. This is Daryl. I think we have most of the deferral requests behind us. It has slowed considerably now, maybe pick back up after the PPP. But I just don’t think that you’re going to see significant increases or changes going forward.

[Jon Arfstrom, RBC Capital Markets]

And then one more, Daryl, for you, just maybe more of an industry observation, I’m curious. The PPP, I don’t want to say loan quality, but any assessment of the business, health of the businesses that are in the PPP program we should think about that longer term?

[Daryl Moore]

Yes. Jon, that’s really interesting. So, if you think about the program, none of the review of what we did on any PPP loans had anything to do with the financial strength of those businesses was verification now. Anecdotally, as we all work through those, it goes the gamut, right? We’ve got some very strong borrowers who we’re not concerned about at all that took advantage of this program, and then we also have some very small businesses who I’m sure have very little cash. And I know just by talking to some of them that they are asking when does this money come? So, it is really all across the board.

[Jon Arfstrom, RBC Capital Markets]

These are things we will eventually find out and you think a quarter or two when we will know more on that?

[Daryl Moore]

Yes. The PPP program is a program that is meant to bridge these borrowers through to keep people employed. And to the extent that as Jim suggested at least in our markets, so we can begin to open things up fairly quickly, I think we’ll have a really positive impact with respect to being able to get these businesses started up again. The longer it goes, the more risk we have that these programs won’t be as effective as well they’ll be.

[Jon Arfstrom, RBC Capital Markets]

Alright. Thanks for taking my question.

[Jim Ryan, Chief Executive Officer]

Thanks, Jon.

[Operator]

[Operator Instructions] Your next question comes from the line of David Long with Raymond James.

[Jim Ryan, Chief Executive Officer]

Good morning, David.

[David Long, Raymond James]

Good morning, everyone. Thank you for taking my question. I appreciate the color you provided with the Moody’s critical pandemic forecast. But curious if you could tell me – tell us what the specific economic inputs may have been that you built into your reserving as far as it relates to unemployment in GDP?

[Brendon Falconer]

Yes. So, David, what we did is, we look at every one of the Moody’s forecast from the 10th, the 20th and the 27th. We run all of them through our models and sensitized the model. So we did consider all of the economic forecasts. The one we actually went through and put through as a baseline for a model and then did qualitative adjustments on top was the one on the 20th. And unemployment in there is – it goes up about 6% and then stays elevated at around that level for an extended period of time. GDP comes down pretty sharply, I think 6%, 7% and then starts to rebound in a V-shaped manner in Q4, starts growth again in 2021, kind of growth at the same pace it was prior. Those are the two key critical inputs into the model.

[David Long, Raymond James]

Got it. Thank you. And how frequently have they been providing you with updates?

[Brendon Falconer]

They’re – so, through the quarter end, the last one we ran through our models was the one on the 27, but I believe there was another one April 10 that came out. But that’s not the one that we run through our model.

[Jim Ryan, Chief Executive Officer]

And just as a reminder, we only expected to receive one forecast per quarter. So, interesting timing of having multiple forecasts come out throughout the quarter, especially if this is the first quarter we adopted.

[Daryl Moore]

Yes. I would assume that this is obviously new to them. But hopefully we can get it to one per quarter at some point here in the future but...

[David Long, Raymond James]

Okay. I appreciate the color. Thanks, guys.

[Jim Ryan, Chief Executive Officer]

David, I will also add. Our sense is, as we’ve obviously compared a lot of notes with a lot of different banks and a lot of different banks used a bunch of different forecasts, a bunch of different management overlays. And so, I think you’re just going to see, as I said in my prepared comments, just kind of a wide variance of how we look at this. And every day makes a difference of how you view this, the future economics around the pandemic. And so, we thought we put in place a very supportable forecast that made sense for us at the time. But every day, you have better optics and we’re going to continue to wait and see and adjust as necessary.

[David Long, Raymond James]

Got it. Thank you, Jim.

[Jim Ryan, Chief Executive Officer]

Thanks, David.

[Operator]

And there are no further questions at this time. Are there any closing remarks?

[Jim Ryan, Chief Executive Officer]

We appreciate everybody’s support. Please stay safe and healthy. And as usual, we are here for any follow-up questions. Thank you very much.

[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 1855-859-2056, conference ID code 9178738. This replay will be available through May 4. If anyone has additional questions, please contact Lynell Walton at 812-464-1366. Thank you for your participation on today’s conference call.