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Old National Bancorp
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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 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 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?
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 stay focussed on the health and safety of our team members. We successfully executed the ONB Way transformation and we remain dedicated to serving our clients and communities.
We also continued to invest in new talents and further strengthened our clients experiences and technology. I am 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 of 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 strong efficiency and 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 recording loan production of $1.2 billion. In the 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. In the period, core deposits increased by 11% driven by checking and savings account growth. We did have a small net recovery this quarter, but maintain the overall reserve. We continue to use qualitative factors to offset improvements in the economic data, believing that there's 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 the credit metrics could worsen and losses will ultimately materialize after any stimulus and deferral programs run their course. We continue to proactively down grade 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 who 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 also [ph] lead to higher revenue from these growth initiatives.
A quick thought about 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 in somebody else's loan portfolio, but we will continue to be an active worker and a selective buyer.
With those remarks, I will now turn the call over to Brendon.
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 a trend in outstanding loans and earning asset mix, and the period loans decrease slightly quarter-over-quarter driven by payoffs of $536 million in PPP loans. Excluding the impact of PPP, and a 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're 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 the result of a few larger high credit quality clients with relatively low coupons, but strong risk adjusted returns.
The $2.1 billion quarter end pipeline reflects typical seasonal declines, as well as the unusually high pull through rates of a 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 folio also increase 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 on 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 billion in PPP related interest in fees from the forgiveness of approximately $500 million in 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 the prior quarter. Core margin excluding accretion and PPP was 2.88% in the fourth quarter compared to 2.96% in Q3. This eight 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 neutral in interest income has put additional pressure on net interest margin.
Future PPP payoffs coupled with stable deposit balances could amplify this impact in 2021. Like these pressures on margin, we expect earning asset growth to help stabilize and 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 any record into your pipeline of $361 million that is more than double 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 a 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 approvals that reflect the outstanding 2020 financial performance. Also impacting this quarter’s expenses with 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 return.
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 top safe we outlined as part of our ONB Way strategic plan. We've delivered on the $36 million in annualized expense savings we promised in 2020, including $26 million in personnel costs, and $6 million in branch/facilities expenses.
We're also beginning to see the results of our revenue initiatives, particularly in the recent above trend growth and commercial loans in capital markets revenues. Additional revenue initiatives in our wealth and treasury management segments are well underway, 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 promise, ONB Way expense savings.
With that, I will turn it over to Daryl to discuss credit [ph].
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 one half of 1% of the total portfolio. While we are still receiving deferral requests on the consumer side, we don't feel that they are outsized given the current environment. For requests 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 6100 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 5800 PPP loans for forgiveness, representing slightly more than a billion dollars in balances. Of those 5800 submissions, roughly 5300 of them totaling $636 million have been approved and paid by the SBA.
In addition of the 5800 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 three basis points, resulting in a full year 2020 charge-off rate of two basis points. Non-performing loans increased in the quarter as was expected, increases in this category continued to come in great part from the downgraded relationships that have shown weaknesses prior to the pandemic.
To put it another way, aside from loans that has reflected weakness prior to the onset of the pandemic, and other than our relatively small hotel exposure, we have not yet seen in 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 mention in substandard recurring categories as a result of the current economic challenges.
But 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 roll out 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 experienced 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 an 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 too. 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 what how quickly we can return to economic recovery.
Second, the level of 2020 growth has exceeded our market 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 crisis 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 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 improved 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.
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 $19 million decrease in reserve needs. We added a similar offsetting amount for qualitative reserves that reflects the on-going uncertainty of 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 of 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 required 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 and 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 and 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 a high level of performance in our capital markets business.
Department service charges continued to 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 only way revenue initiatives and 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 and 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've 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. We do have a full team here, including Jim Sandgren.
[Operator Instructions] The first question comes from the line of Ben [Indiscernible] with Hovde Group.
Hey good morning guys.
Good morning, Ben, how are you?
I am 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 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 [ph], 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?
I think those are all good observations Ben. And many of 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. There's some technology improvements, and particularly our treasury management business we'll continue to work on throughout the year. And we knew it was going to take the better part of 2021 to really implement those initiatives, because 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 would have anticipated executing those this year.
But having said that, big bulk of the treasure ran into commercial wealth is just, on pace and scheduled to happen throughout 2021.
Okay, great. That's, that's helpful. And then my other question, Jim came to the capital usage, I know that your stock are, call it, 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 towards Northwest Wisconsin, Minnesota and the Minnesota. I was wondering if you had any other thoughts, any geographies, you might be looking into, potential size of it difference from that $2 billion mark? And then finally, if you could talk about just a 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?
I think we continue to gravitate towards 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, 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 will just say, we're not looking at a book today and get ready to announce a transaction anytime soon. It's just -- some middle part last year was pretty hard to imagine that you could put a credit mark in somebody else's balance sheet. We're just getting more comfortable that you can define the scope of what you think the lost content may might be in, and probably closing the gap between the bid ask today than it was maybe six months ago. So we just think there are going be opportunities, they're going 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 and makes sense to continue further strengthen our company.
Got you. Thanks. That's all for me. I appreciate the time. And then congrats on a solid quarter and year.
Thanks, Ben. Appreciate it.
The next question will come from line of Scott Siefers with Piper Sandler.
Mr. Siefers, you were a little short this morning here. You got beat out.
Jim, I don't know what happened. I mean, if you're asking me, but I feel humiliated because I'm getting old.
No. But you know, that is a little bit younger. And you know you just had the edge on your…
He's coming into his own. I passed my peak. It's a sad day for me. But I'll try to be less disappointing next quarter. So I appreciate you guys taking the question. I wanted to just get some updated thoughts on loan growth. 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, et cetera. Just curious, Jim, for your updated thoughts on how much of that is just your customers and organic demand? And how much of it is market share opportunities? And where you're seeing most of that come from like geographically as well?
I'll give you my two seconds on it. And I'll let Jim up, follow up on it. A lot of that growth you saw in the fourth quarter is really all that hard work we've done in the middle part of the year. Again, as Daryl said in his remarks, and Jim will continue to reiterate, we stayed focused in on calling. Jim and I went on a lot of client calls this summer. And some of those were opportunities that we're able to steal away from larger organizations a 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 a lot of was just some existing opportunities that we had with clients. And then some of it were 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 focused 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 really stay focused and keep our underwriting going.
Yes, 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 out as well. Really, from a production standpoint, geographically, Minnesota again, led the way. We're really pleased with the continued efforts of our Minnesota RM [ph] demand 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's down a little bit seasonally, and obviously huge production in the fourth quarter feel good about. First quarter, I think our accepted categories, 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 tailwind but certainly our RMs are committed to grow in that pipeline, as we typically do at this time. So optimistic.
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, etcetera. Just I guess any top level thoughts that just be curious?
Yes, 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 that took advantage. We're also doing a lot of focus on minority owned, women owned businesses, nonprofits. So we anticipate a lot of demand, obviously, a smaller pool, and we have to show that 25% reduction in revenues, quarter 2020 over 2019. 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 far, pretty good start.
Yes. It's got to be not on average. We expect the loan balances to be relatively small. I mean, it is kept at $3 million. And so the total impact of 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 alones, 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.
Yes. All right. Perfect. Thank you guys very much. Appreciate it.
Thanks, Scott. Better luck next time.
I know, I know. Thank you again. Again, I'm sorry.
The next question comes from the line of Chris McGratty with KBW.
Good morning, Chris.
Good morning everybody. Brendon, maybe it’s 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 or the other?
Yes. Chris, if you're referencing the 2.88% that I talked about in my opening comments. Yes. That excludes both PP or PPP related interest and fees and accretion.
Okay. And so, the outlook 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?
Absolutely.
And on that, you've got a really low loan to 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, in kind of balancing the loan to deposit against the loan growth outlook?
Yes, 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.
Okay. And then, Jim, just going back to your M&A question and comments before. You talked about plan A being 10 to 20. I think in the past, you've talked about pre pandemic, the willingness to do kind of a transformational deal or more openness? Is that putting the -- I guess, play a potential MOE -- aligned. Is that something the board would consider?
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 have to consider if it was the right thing to do.
Okay, great. And then, just a couple housekeeping. Could you just provide the remaining one timers related to the ONB Way, if there are any? And then the $17 million of PPP fees? Is that just the fees? And then we should add on the 1% coupon? Or is that all in?
Chris, this is Brendon. Yes. So the PPP fees -- the $17 million, it's just the fees, does not include the interest impacts for whatever is left in Q1/Q2. Regarding ONB Way, we are wrapping up with most of the work around OMB Way. There could be some de minimis amounts coming through in Q1 and Q2, but relatively small at this point.
Okay. Awesome. Thank you.
Thanks Chris.
The next question will come from Terry McEvoy with Stephen.
Good morning, Terry.
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 of all, 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? And if it's not all in there, how should we think about growing that number? And then, same question for kind of the annual merit increase in the in the second quarter. I think last call, you may be quantified that. If you could just remind me, the best way to think about that starting in 2Q? Thanks.
Yes. We talked about $5 million impact for all the investments. And so, about a quarter of that is represented 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.
And then just my follow up here, if I look at the reserve ratio, at the end of the first quarter it was called 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? You call it day one, or it was after the first quarter ended?
Yes. 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 not meaningfully lower than we are today.
And then, just one last question. I know this came up earlier. Given the acquisition that is occurring in some of your core markets, and in some of the cost savings numbers that have publicly been talked about. Would you be interested maybe at the end of this year, and really ramping up some of your hiring, maybe 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.
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 sometimes it's difficult to serve your clients and some of those organizations. And so we'll continue to look for that. And so while we know we've kind of quantified this initial round of hire, really supporting the ONB Way initiatives, we really continue to be an optimistic hire. And I don't expect that those that hiring would have a material impact on our overall expense numbers. So we'll continue to look for those great opportunities. Minnesota continues to represent 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 for the company.
That's great. Thanks again.
Thanks, Terry.
The next question will come from one of Jon Arfstrom with RBC Capital Markets.
Good morning, Jon.
Hey, good morning. Good morning. Brendon, maybe a question for you on mortgage banking. You talked about the pipeline being twice 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? Do you expect it to fade a bit?
Yes, Jon. No real clear message other than to say we ended the year really great. So I think, 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 tailwind of the mortgage business in aggregate. I think our mortgage business continue to follow those industry trends. But I think we'll be off to a good, strong start in Q1.
I think we were finishing up last year, I mean, there's 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 [ph] forecasts show, maybe down 20% at one point in time. So, I think they're just kind of balance there. I mean, to be truthful, we're not quite sure 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, our fourth quarter ended really strong. And hopefully, we'll maintain some of the momentum going into the first quarter.
Okay, good. Fair enough. And then, 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't get your arms around the cost of that qualitative increase?
I think Jim, Daryl, and I all mentioned it. It's really the path of this virus, the vaccination roll out, and maybe more importantly, the timing of charge off, and the delayed recognition. And until we have some clarity around that it's challenging for us at this point to release reserves in any meaningful way.
Okay. 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 have you seen any other new problems or anything unexpected? And I understand the qualitative piece of it, but anything new or surprising that you're saying? Or is it just generally things are getting better?
Yes, Jon, Daryl here. No, there really isn't anything in the portfolio. We've got that slight increase in delinquencies and 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 cracked it 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 portfolios, there really is not anything at this point in time. That's surprising to us, which may in itself be surprising.
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 in what you're thinking right now, that all the stimulus that we have, and is probably yet to come flattens the losses?
Yes. I'm maybe in a little different camp. If the vaccinations can take hold, I think this next round of pain, how big it is, could not only just push out losses, they could also serve to reduce to a certain extent the loss content that we have in our portfolio. So I'm a little more bullish on that.
Which, you know, is pretty rare for Daryl.
I know. I'm shocked. But I mean you can, Daryl. I mean, you can. But I think its positive. So okay. Thanks for all the help. I appreciate it.
Thanks, Jon.
[Operator Instructions] The next question will come from the line of David Long with Raymond James.
Good morning, David.
Good morning, everyone. Thanks for taking my question. As it relates to commercial real estate, curious if you're -- what you're hearing from your customers about how much space they will need going forward as we come out of this pandemic. And that's talking about the next three 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?
Yes. I think it's -- David, its Jim Sandgren. I think it's a little too early to tell. That whole kind of work from home and office. 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. Multifamily, we've had a lot of growth there. I think we're being very opportunistic, making sure we're doing the right deals and the right markets, with the right borrowers. But, we continue to have those conversations. But 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 things going on right now. We're just kind of waiting to see how that all plays out.
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 or social by nature to get together and be more collaborative. So I think there's 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 if the virtues that everybody's been working from home and anywhere they want to work. Maybe in the Midwest, maybe different than maybe other parts of the country. But I don't think that will mean a big impact to Old National's portfolio.
Got it. Thanks, guys. Appreciate the color. That's all that I had.
Thanks, David.
[Operator Instructions]. With that, we are showing no further audio questions at this time. Did speakers have any closing remarks?
Well, Nicole, 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 everybody for joining us today.
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 6389837. This replay will be available for February 2nd. If anyone has any additional questions please contact by Lynell Walton at 812-464-1366. Thank you for your participation in today's conference call.