Old National Bancorp (ONB) Q4 2022 Earnings Call Transcript

Old National Bancorp (NASDAQ: ONB) Q4 2022 earnings call dated Jan. 24, 2023, 10:00 a.m. ET

Corporate Participants:

James C. Ryan — Chief Executive Officer

Brendon B. Falconer — Chief Financial Officer

James Sandgren — Chief Executive Officer, Commercial Banking

Analysts:

Ben Gerlinger — Hovde Group — Analyst

Scott Siefers — Piper Sandler — Analyst

Terry McEvoy — Stephens — Analyst

Chris McGratty — KBW — Analyst

David Long — Raymond James — Analyst

Jon Arfstrom — RBC Capital Markets — Analyst

Presentation:

Operator

Welcome to the Old National Bancorp’s Fourth Quarter 2022 Earnings Conference Call. This call is being recorded and has been made accessible to the public in accordance with 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 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 or outcomes to differ from those discussed. The company refers you to its forward-looking statements legend in the earnings release and presentation slides.

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 provide more appropriate comparisons. These non-GAAP measures are intended to assist investors understanding of performance trends. Reconciliations to these numbers are contained within the appendix of the presentation.

I’d now like to turn the call over Old National CEO, Jim Ryan, for opening remarks. Mr. Ryan, please go ahead.

James C. Ryan — Chief Executive Officer

Good morning. Earlier this morning, we reported strong fourth quarter earnings, which put an exclamation point on an incredible year for Old National. One that saw the closing of our transformational merger with First Midwest, successful completion of all related systems conversions, tremendous client growth and strong talent retention and attraction. The strength of our combined franchise is evident in the results outlined on Slide 4.

Adjusted EPS was $0.56 per common share, representing a 10% increase quarter-over-quarter with a strong adjusted ROA and ROATCE of 1.46% and 26.5%, respectively. Our efficiency ratio was a record low of 47.5%. I’m pleased to share that we achieved the quarterly expense run rate necessary to fulfill our $109 million of modeled merger expense savings.

Moving to Slide 5, we reported GAAP earnings for the entire year of $1.50 per common share. Our adjusted EPS was $1.96 per common share, representing a 13% increase over 2021. These robust quarterly annual results with peer-leading returns were driven by focused execution on our successful merger, maintaining our strong low-cost deposit franchise, growing loans with consistent strong credit standards and disciplined expense management. We were also pleased the deposit balances remained relatively flat for the year excluding the recent sale of our HSA deposits, while maintaining our deposit pricing discipline with a low 12% deposit beta cycle to date.

Another highlight in the year is our continued investment in top revenue-generating talent across our footprint. Our story resonates well with these individuals and our sales pipeline remains robust. You may have seen our recent press release last week with the official launch of our 1834 high-net worth wealth management brand. This is a fantastic opportunity to leverage our combined franchises strength and recent talent investments. We are already adding new clients for 1834. As we look forward, we feel good about 2023, and expect loan portfolio to continue to grow, albeit not at 2022 pace. In other areas, it should be more the same below peer deposit costs that drive a funding advantage, more organic growth from our wealth management client base, a continued focus on its disciplined expense management. While we don’t see anything meaningful on the horizon, it gives us cause for concern on credit. We know that our granular portfolio, attention to client selection and consistent underwriting guidelines, as well as our active approach to credit management will serve us well if the economy turns worse. In other words, we intend to stay on the offense, but we are well positioned to withstand any new challenges that lie ahead. Thank you.

I will now turn the call over to Brendon for further details.

Brendon B. Falconer — Chief Financial Officer

Thanks, Jim. Turning to the quarter’s results on Slide 6. We reported GAAP net income applicable to common shares of $197 million or $0.67 per share. Reported earnings include a $91 million pre-tax gain from the sale of our HSA business, which was partially offset by $27 million in pre-tax property optimization charges and $20 million in pre-tax merger-related charges. Excluding these items as well as debt securities losses, our adjusted earnings per share was $0.56.

Slide 7 shows the trend in total loan growth excluding PPP loans. Total loans grew $606 million, led by commercial growth of $438 million and consumer growth of $168 million. Both commercial and consumer grew an annualized 8%. The investment portfolio decreased by 1% quarter-over-quarter due to reinvestment of portfolio cash flows and supported loan growth. We expect $1.1 billion of total investment cash flows over the next 12 months.

Slide 8 provides further details of our commercial loans and pipeline. The strong fourth quarter growth was well distributed with 8% annualized growth in C&I and 7% in CRE. Q4 production put some pressure on the pipeline, but loan demand remains healthy and we expect continued organic loan growth in the mid single-digit range.

Turning briefly to pricing. New money yields on C&I increased 92 basis points from Q3, to 6.21%, with new CRE production yields up 131 basis points to 5.86%. We’ve maintained our pricing discipline throughout the rate cycle and are pleased that our spreads have remained stable.

Slide 9 shows details of our Q4 commercial production. The $2.7 billion of production with well-balanced across all product lines and major markets. In addition, all of our product segments posted quarter-over-quarter balance sheet growth. We are pleased with the contribution from our newest LPO market which contributed almost $200 million in production this quarter.

Moving to Slide 10, average deposits excluding the HSA sales were down 1% quarter-over-quarter with the mix of our noninterest-bearing deposit stable at 35%. End-of-period deposits were intact at $382 million related to the HSA sale and an additional $400 million in seasonal public fund outflows. End-of-period deposits also reflects the beginning of the mix-shift from interest-bearing transaction account into time deposits. Our loan-to-deposit ratio combined with wholesale funding capacity and asset liquidity in the form of our investment and indirect book provides us flexibility in this competitive deposit market. That said, we are actively defending deposit balances through competitive rack rates and pricing exceptions.

We are also playing offense through various deposit specials throughout our footprint. We are pleased with our execution of this strategy to date as we have been able to generate new deposits sufficient to maintain stable overall balances. Market conditions have put upward pressure on deposit rates with average total deposit costs of 22 basis points quarter-over-quarter to a still very low 34 basis points. Interest-bearing deposit costs increased to 52 basis points, resulting in an industry-leading cycle-to-date beta of 12%. Our granular low-cost deposit base should continue to give us a funding advantage throughout the remainder of this rate cycle.

Next on Slide 11, you will see details of our net interest income and margin. Both metrics exceeded expectations largely due to the outperformance of our deposit beta assumptions. Net interest margin expanded 14 basis points quarter-over-quarter to 3.85% with core margin, excluding accretion, up 30 basis points to 3.75%.

Slide 12 provides additional details on our asset liability position and projected margin range. Core margin for Q1 is expected to be in line with Q4, taking into account the 6 basis points of margin decline related to day count. Our outlook assumes deposit betas increasing from 12% to date, to a cycle-to-date beta in the first quarter of 20%. The assumptions in our outlook also including Fed funds target rate of 5% and 4% yield on 10-year treasuries at the end of the first quarter.

Specific margin guidance is challenging beyond Q1, but assuming the Fed passes in Q2 and deposit repricing persists, we would expect pressure on margin in the back half of 2023. Also, while we remain well-positioned for rising rates, we have been proactively adding down-rate protection, including an additional $400 million of new hedges this quarter with an average floor strike of 4%.

Slide 13 shows trends in adjusted noninterest income, which was $74 million for the quarter. This was generally in line with our expectations as market conditions continue to put pressure on mortgage and wealth revenues. The linked quarter decrease was also impacted by lower capital markets fees, which reflect lower demand for interest rate swap product given the rate environment. These were also impacted by one month of service charge enhancements implemented in December that were discussed last quarter. Again, we estimate approximately $5 million annual impact from service charge enhancements.

Next Slide 14 shows the trend in adjusted noninterest expenses. Adjusting for merger charges, property optimization charges impact credit amortization, noninterest expense of $230 million and our adjusted efficiency ratio was an historically low 47.5%. Expenses decreased $7 million quarter-over-quarter due to lower salaries and data processing expenses. Expenses were higher than anticipated due to $5 million quarter-over-quarter increase in incentive accruals given our strong earnings performance for the year. Excluding incentive adjustments, we are pleased to report that we have achieved a quarterly expense run rate consistent with our modeled cost synergies.

We thought it would be helpful to provide additional detail on our 2023 expense outlook. We believe $225 million quarterly run rate to build off for your 2023 models. From this $900 million annualized base, we anticipate annual impact of $14 million in tax credit amortization, a $11 million for merit, an incremental increase in FDIC expenses of $9 million, and approximately $10 million in strategic investments in both talent and technology enhancements. These investments will be partially funded with approximately $5 million of expenses from the real estate optimization actions taken in Q4.

Slide 13 shows our credit trends. Credit conditions are stable and our commercial and consumer portfolios continue to perform exceptionally well. Net charge-offs were modest 5 basis points. Our special assets team is continuing to work through our PCD loans and expect charge-off from this portfolio to increase but with variability from quarter-to-quarter. The provision expense impact from this effort should be minimal as we carry $59 million or approximately 5% reserve against the PCD book.

On Slide 15, you will see the details of our fourth quarter allowance, including reserve for unfunded commitments, which stands at $336 million, up $8 million over Q3. Note that during the quarter we reclassified both current and prior quarter allowance for for unfunded commitments from noninterest expense to provision. Allowance for credit loss totaled and metrics now include the allowance for unfunded commitments, providing a more complete view of our allowance levels. This accounting treatment is also more consistent with peers. It should aid in comparability.

Reserve build was driven primarily by strong loan growth with relatively small increases due to portfolio mix, partly offset by improvement in our economic forecast. The financial help of our clients remains strong and while credit metrics are stable, we believe it is prudent to maintain elevated reserves given the uncertainty in our base case economic outlook. Our current reserves reflect a relatively severe economic scenario, including negative GDP of 3.6% and unemployment of 7.2%, which is at the top-end of our supportable range. Unless the economic outlook deteriorates materially, 2023 provision expense should be limited to portfolio performance and loan growth. In addition to the $336 million in reserves, we also carry $102 million in acquired loan discount mark.

Slide 17 provides details on our capital position at quarter end. Capital ratios improved across-the-board. Our CET1 ratio grew to a very healthy 10% and our TCE ratio increased 36 basis points to 6.18%. Total OCI was stable quarter-over-quarter, but it’s still impacting our TCE ratio by 155 basis points. We continue to monitor our balance sheet for economic stress and feel very comfortable with our capital levels.

As I wrap up my comments, here are some key takeaways. We ended a transformational year for ONB with fantastic full year result and an even better fourth quarter. Adjusted EPS grew 10% and tangible book value per share grew 8% in the quarter. Key profitability ratios also improved from very strong Q3 results with an adjusted return on tangible common equity of 26.5% and return on average assets of 1.46%. We posted another solid quarter of quality organic loan growth and defended our deposit base well.

Net interest income improved $50 million with 30 basis points of core margin expansion, and an industry-leading cycle-to-date deposit beta of 12%. We are also pleased to have achieved a quarterly expense run rate consistent with our modeled merger cost synergies, resulting in a record low efficiency ratio of 47.5%.

Slide 18 includes thoughts on our outlook for 2023. We believe commercial sentiment in our year end pipeline supports mid single-digit loan growth in 2023. Net interest income and margin should be consistent with the guidance we outlined earlier with pressure from deposit repricing in the back-half of the year. We expect our fee businesses to continue to perform well despite headwinds with mortgage following industry patterns.

While our wealth business will be subject to market volatility, we are beginning to see revenue momentum from the strategic hires we’ve made over the last 18 months. Capital markets revenue was under pressure and should perform consistent with Q4 levels. Service changes implemented in December that are marginally consistent with industry best practice will impact full-year 2023 by approximately $5 million Our expense outlook is consistent with guidance we outlined earlier.

Turning to taxes. We expect approximately $14 million in tax credit amortization for 2023 with a corresponding full-year effective tax rate of 24% on a core FTE basis in 22% on a GAAP basis.

With those comments, I’d like to open the call for your questions. We do have the full team available, including Mark Sander, Jim Sandgren, and John Moran.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question today comes from the line of Ben Gerlinger with Hovde Group. Ben, please go ahead.

Ben Gerlinger — Hovde Group — Analyst

Hey, good morning, everyone.

James C. Ryan — Chief Executive Officer

Good morning, Ben.

Ben Gerlinger — Hovde Group — Analyst

I appreciate the guidance that you guys gave on expenses and the waterfall is really helpful. When you think about ’23, I think, obviously, everyone is a little bit more skeptical on economic outlook. When you think about hires, I know that that’s kind of a priority longer-term investment in the company, thinking decades rather than quarters. But is there any way you possibly slow because you don’t have necessarily want to hire lenders going into a recession or any type of one thing that you’re looking to win into?

James C. Ryan — Chief Executive Officer

I just think there’s great opportunities for us to tell our story. When we get those opportunities, if people are interested, I think we’re always going to have in place for top talent and mark centers set us really well. Top panel will pay for itself. So while would be thoughtful and deliberate about all of our new hires, I think when give you the opportunity to attract them, and this is really the top quartile, top decile of each of the marketplace is we’re gonna go ahead hire those folks.

But again, we’ll be thoughtful. If the economic outlook was materially different than what we look at it today, we’re going to be thoughtful about adding expenses and we’ll be diligent about looking at ways to reduce cost as well. So, but at this point in time, I just don’t see anything different than the plan which is to go ahead and attract the best possible talent we can to the organization.

Ben Gerlinger — Hovde Group — Analyst

Got you. That’s fair. And then, obviously, hires that you’re broadly speaking in terms of lenders. So when you think about fee income line items, there are a lot of moving parts and a lot of different businesses. I know the recently announced wealth management is big positive, but obviously, you guys can’t project the full-year fee income with mortgages and volatile factor on that. But when you think about it, are we out of floor in mortgage and from here you think fee income rebounds holistically.

James C. Ryan — Chief Executive Officer

Let me give you a 50,000-foot view and then I’ll have our CFO jump in. I’d like to think that mortgage doesn’t get much worse than where we’re at today, right? And a lot of the balance sheet — a lot of the production we’re doing today is our balance sheet and not the fee income line. In terms of wealth, we good news is, we’re basically taking our business and bottoming it into a couple of different businesses, and 1834 is one of those businesses, right?

There’s not a big increase needed just to staff that. And I would say that the talent we’re looking for is both on the commercial side, business banking, and — but it’s also the wealth management side. That’s a big part of where we’re heading. The good news is we have all the talent we need to get 1834 off the ground and running at a high level, so it’s not a big required investment there. But we do have high expectations that will grow kind of above our historic norms in that business despite what market conditions. The market conditions are going to be what they’re going to be, but nonetheless, we have pretty high expectations around our ability to grow that organically.

James Sandgren — Chief Executive Officer, Commercial Banking

And just before I turn over to Brendon, Ben I’ll just add to what Jim said. A number of those hires that we put on in 2022 were in wealth management. So, as we hire the dozens or 15 a quarter, probably half of those will go [Speech Overlap] So, we’re not more than sufficiently staffed to grow in wealth. Brendon?

Brendon B. Falconer — Chief Financial Officer

Probably, the only thing left to add on that, Ben, double click into mortgage. I think we have to remember, year-over-year ’22, at least in the early part of the year did include some elevated gain on sale margins. So I’d say we’re at floor in terms of production and gain on sale margins today, but we were aided in the first half of last year by elevated gain on sale margins. So that — that will impact your numbers.

James C. Ryan — Chief Executive Officer

I’d also like to think in the capital markets business, right. I mean, it was a difficult time with rates rising very quickly. But those businesses find a way to adjust and offer new products or different products, particularly if there is a different set of a view of rates emerging. So I think there’ll be opportunities to grow that business. Obviously, the fourth quarter is a tough quarter for that business overall.

Ben Gerlinger — Hovde Group — Analyst

Yeah. So if I can sneak one more in. Any appetite for potential repurchase or capital deployment? I know that you guys were historically looking to kind of support the growth, but if growth is slowing down into a recession, just overall thoughts on that?

James C. Ryan — Chief Executive Officer

Yeah, I think it’s little too early. Just don’t want to jump in that. I think we need to have more clear picture of economic outlook, any Issues related to credit out there, I think we need to have a much clearer picture before we want to jump on top of that.

Ben Gerlinger — Hovde Group — Analyst

Sounds good. Appreciate the time. I’ll get back in the queue and let Scott ask some boring deposit questions.

James C. Ryan — Chief Executive Officer

Thanks, Ben. Sure, Scott appreciates the time.

Operator

Our next question comes from Scott Siefers with Piper Sandler. Please go ahead, Scott.

Scott Siefers — Piper Sandler — Analyst

Good morning, everybody.

James C. Ryan — Chief Executive Officer

Good morning, Scott. Good to hear from you.

Scott Siefers — Piper Sandler — Analyst

Thank you. That just seems good to, it is, but I certainly have [Speech Overlap] Brendon, everyone is — probably most exciting topic I can pickup. The margin — you talked about margin pressure in the second half. Is sort of thought for order of magnitude and maybe a sense for a lower bound where the margins could settle in the event that things do start to degrade?

Brendon B. Falconer — Chief Financial Officer

It’s really hard, Scott, to pinpoint something. So much of this depends on what the Fed does. If the Fed can keep their foot on the gas, we could see maybe even marginal margin expansion, but they cause for a while and deposits continue to reprice while demand remains relatively strong. I think that would be the — kind of worst case scenario in terms of margin pressure, just hard to know where are those deposit beta fallout. But one thing we continue to talk to ourselves about is, whatever that is, I think we have a competitive advantage. Our deposit beta was half the industry last cycle and I expect we can have a significant advantage over of the industry in this cycle.

Scott Siefers — Piper Sandler — Analyst

Perfect. And I guess just for reference. When we talk about potential degradation in the second half, I know you’re hesitant to offer thoughts beyond the first quarter, but is that 368 [Phonetic] the best starting point for the margin or is something in like the low-to mid 370s [Phonetic] more appropriate? In other words, it goes down in the 1Q due largely to day count. Does it go down and stay down or would it bounce back, all else equal?

Brendon B. Falconer — Chief Financial Officer

All else equal, right? It would bounce back. And so Q2 would not have the same level of daily impact. And then what happens in the back half of the year I think is really going to come down to where do deposit costs fall.

Scott Siefers — Piper Sandler — Analyst

Yeah

James C. Ryan — Chief Executive Officer

And where is the Fed got to be heading. If the market thinks the Feds heading in the opposite direction, right? I mean, that can alleviate some pressure on deposit rates as well.

Scott Siefers — Piper Sandler — Analyst

Yeah. Perfect. Okay, good. Thank you very much.

Operator

Our next question today comes from Terry McEvoy with Stephens. Terry, please go ahead.

Terry McEvoy — Stephens — Analyst

Hi, thanks. Good morning, everyone.

James C. Ryan — Chief Executive Officer

Good to hear from you, Terry.

Terry McEvoy — Stephens — Analyst

All right. Maybe just a question. Slide 12, you’ve got the tenure at 4% by the end of this quarter versus what, 350 today, and I’m just kind of wondering how that could impact the outlook if the tenure does not change? And then maybe as a follow-ups and some on NII. Do you think even with some margin compression in the back half of this year the loan growth and the balance sheet growth can support growth and net interest income as we progress throughout 2023?

James C. Ryan — Chief Executive Officer

I don’t think — it’s not a huge impact on the tenure moving around. It will impact a little bit of our investment book and fixed-rate pricing both, but not a huge material impact. The same thing with NII. Certainly, loan growth, earning asset, remix will help support NII, but the total NII dollars, again going back to the guidance, it’s really going to come down to where deposit costs fall out and what does the Fed to in the back half of the year.

Terry McEvoy — Stephens — Analyst

And then maybe just stick with kind of the hedging strategy, added more swaps in the fourth quarter. Could you maybe talk about kind of the receive rate, duration of the additional hedges and bigger picture, what’s the strategy from here on, protecting the margin from lower rates?

James C. Ryan — Chief Executive Officer

Yeah, duration on the hedges have been roughly around three years. The average strike on that floor today is of the entire $2.2 billion is right around 3.6%. The most recent was, obviously, had striked significantly higher than that. So I think that will provide some meaningful protection. And as you think about it, as deposit costs continue to reprice up if and when the Fed starts to — starts to move, we’ve got a lot of lot of support by being able to reduce deposit costs in the back half. So as we think about positioning the balance sheet towards a more neutral position, I think we’re a long way towards that goal already.

Terry McEvoy — Stephens — Analyst

Maybe one last small question if I could. The tax rate creeping higher, that 24% core FTE, it just seems like having gone back to past presentations. It just seems like it’s kind of gotten higher the last few quarters, am I correct? And if so, what’s behind that? And if I’m not, then we can move on.

James C. Ryan — Chief Executive Officer

No, you’re correct, absolutely. We added obviously with the FMB partnership we had a lot of a earnings, but our tax credit business has not increased by double. So we’re working on a strategy to continue to invest in that business and we look to move that forward. Nothing in the near-term is going to change that. So we told you about the guidance we gave you.

Terry McEvoy — Stephens — Analyst

Okay. Thanks for taking my questions. Appreciate it.

James C. Ryan — Chief Executive Officer

Thanks, Terry.

Operator

Our next question comes from Chris McGratty with KBW. Chris, please go ahead.

Chris McGratty — KBW — Analyst

Hey, guys. Good morning.

James C. Ryan — Chief Executive Officer

Good morning, Chris.

Chris McGratty — KBW — Analyst

Brendon. Hey, good morning, Jim. Brendon or Jim, the efficiency ratio you talked about — 47.5% just been a great level. How should we be thinking about the trajectory of this of this metric? I know it’s one metric. But balancing both sides of the equation, how do we think about directionally that needs efficiency ratio were it kind of settles?

Brendon B. Falconer — Chief Financial Officer

Obviously, we’ll give you the expense outlook for 2023 where the efficiency ratio fall out will largely be a function of where revenues stand, but I can tell you that sort of this — I don’t know that we can repeat 475. But I do think for the full-year we’re going to have a really strong efficiency ratio and we continue to work on opportunities to continue to control expenses.

James C. Ryan — Chief Executive Officer

Yeah, I would just suggest that, you know, Chris, we’ve had a long history of being very disciplined around the expense base here and it’s obviously been nice to have some tailwind from the revenue side to help us out. But having said that, there’s no magic bullets or no easy wins out there, but it’s going to be a continued long-term focus on driving expenses lower. A lot of these come through just long-term enhancements through technology and business process automation which should help continue to reduce costs. So there’s not — there’s not any quick wins out there that are going to reduce this significantly, but it’s just a continued focus by our leadership and management teams to make sure that we’re driving our expense dollars more sufficiently we can.

Chris McGratty — KBW — Analyst

If I could just push on that a little bit, then the — I think in the deck you say there is $5 million of savings coming from this branch optimization. But one timer’s we call it 27. How do I wrestle with that kind of earn back math? Is there something I’m missing in that strategy? I would have expected a little bit more to fall, I guess to the bottom line.

Brendon B. Falconer — Chief Financial Officer

Yeah, I think. Most of this was from real estate, this predisposition, right? So the reality is I think it’s something less than a five-year earn-back. So still longer than we would anticipate normally. But nonetheless, we think was the right. These are properties which are problematic, around 20 pieces of property in total, about half of those were in the branch, but very small branches. So again, something like over less of a five-year earn-back, little longer than we’d like it to be but appropriate for us, particularly given the HSA gain we had to reinvest.

Chris McGratty — KBW — Analyst

Got it, great. And then maybe I could on credit. I mean, I’m getting some questions about what’s the pace of reserve builds. You guys have I think been viewed as very good on credit, FNB is history, is a little bit — a little bit more chunky, but overall, you kind of put them together pretty good credit. How do we think about, I guess two questions, the pace of build based on your economic forecast and also how you view that kind of normalized charge-offs this pro forma company?

James C. Ryan — Chief Executive Officer

I think we were in a good spot and that we really never released a lot of the excess reserves we carried in through COVID. We’re continuing to put up a pretty severe economic scenario through our model. So it’s difficult for us to sit here today to think about a more adverse scenario coming through in reality. So we think provision is limited to portfolio changes and growth. And in terms of charge-offs, I think we’ve had a good run. I don’t know what normalized charge-offs looks like in going into next year or what the economy might provide. But I do think we have significant amount of coverage on PCD, both that came over from FNB into the 2% to 5% reserve against that book. So I think that will also go a long way in offsetting incremental provision expense associated with the merger.

Chris McGratty — KBW — Analyst

That’s helpful. But the reserve at 98 bps, what’s the — I can do it, what’s the — how do you view like the fully-loaded reserve with the 5% mark on FNB. Like, what’s the real metric you guys are tracking internally as like in terms of coverage?

James C. Ryan — Chief Executive Officer

So if we think about the entire $102 million of additional discount and credit, overall, it’s a 1.4% number.

Chris McGratty — KBW — Analyst

Okay. Got it. Thank you.

Operator

Our next question comes from David Long with Raymond James. David, please go ahead.

David Long — Raymond James — Analyst

Good morning, everyone. My question first question here is related to funding loan growth and loan growth, we’ve got a pretty decent expectation for 2023 with the potential for some deposit outflows. How do you look to fund that growth? It looks like securities, you’ll get a little bit there, but that may not close fill that hole gap.

James C. Ryan — Chief Executive Officer

So we have opportunities in the mortgage book and the indirect book and asset liquidity in those forms, in addition to the investor portfolio. We also have a lot of wholesale funding capacity. And that said, we are still out there fighting hard for deposits and we’re going to — we’re going to work hard to maintain those levels and as we go through, we granted, it’s going to be a tough environment, but we’re certainly not giving up, and we’re out there playing the offense So the combination of those three items is how we’re going to fund it. We are confident we have enough liquidity to make sure we support the commercial team and the growth of that book.

Brendon B. Falconer — Chief Financial Officer

I think we are defending our deposit base quite well on the ones and getting more aggressive where we have to and you saw some of that repricing happened in this quarter, consistent with the rest of the industry. And I feel confident in our ability to raise deposits. Deposit gathering is a large component of the goals in every one of our lines of business and we’re adding net new clients in every business. And so I feel confident in our ability to raise deposits as we need them, David.

David Long — Raymond James — Analyst

Okay, alright, great. And then you gave some commentary around the deposit service charges and the changes in some of your products there. Is the fourth quarter number, its a little over $80 million, is that the right run rate? Is it fully baked in, or is there still a little bit more out of that to get to the right run rate into the first quarter?

Brendon B. Falconer — Chief Financial Officer

Yeah, the service charge line has more than just the NSF fee items in there. It is only one month of the NSF related changes baked in there. But I think if you look back at sort of a couple of quarters average is probably a better view of if you look at Q3 would be a better view of sort of more stable business and typical service charges.

David Long — Raymond James — Analyst

Okay, great. And then just to sneak one last one in here on the operating expense guide $939 million. Appreciate the color there. But you know — I know you said it depends on the revenue side of the equation, but what are you assuming or can you talk about what you’re assuming on the incentive compensation to get to that $939 million level and how that impacts the revenue side?

Brendon B. Falconer — Chief Financial Officer

So $939 million, that would include incentives really at target as opposed to above target. Obviously, we were — we benefited from a really great year this year, and so incentives were significantly higher this year relative to what we’re projecting next year.

James C. Ryan — Chief Executive Officer

It was consistent with the revenue expectations we laid out, right? So when revenue goes up significantly, then clearly we’d have some more incentive opportunity, but given the revenue outlook we provided you and the expense base are consistent with each other.

David Long — Raymond James — Analyst

Got it. Thanks a lot, guys. Appreciate it.

James C. Ryan — Chief Executive Officer

Thanks, David. Good to hear from you.

Operator

Our next question comes from Jon Arfstrom with RBC. Please go ahead, Jon.

Jon Arfstrom — RBC Capital Markets — Analyst

Hey, good morning, everyone.

James C. Ryan — Chief Executive Officer

Good morning, Jon.

Jon Arfstrom — RBC Capital Markets — Analyst

Question for you guys on loan growth. Brendon, you made a comment, I think I got it right, but some of the fourth quarter production put some pressure on the pipelines, but you still expect decent growth. What are you guys seeing in the pipeline, is it slowing? And what is your view on the cadence of growth? Do you expect continued strong first and second quarter growth and it flows later in the year? Just give us your thoughts on that.

James Sandgren — Chief Executive Officer, Commercial Banking

Well, I’ll start and Jim can add a little bit Jon. I think we feel good about certainly the pipeline coming down as a reflection of three really strong quarters of loan growth and normally is a little bit of reduction, the pipeline in Q4. So that’s the normal seasonal reduction. Certainly, we think the pipeline is at a level that can provide the growth that Brendon laid out, mid single-digits for full-year 2023 and the short-term still looks good.

I mean as much as there’s mixed signals out there in the economy, our C&I clients are still stronger. They’re a little more cautious than they were before. But there still — the business is solid and strong and then and the balance sheets are good and they are still investing. So on CRE has slowed a bit. The interest rate environment has certainly brought down the pipeline there. So we expect a less robust ’23 there.

Jim, anything you want to add?

James C. Ryan — Chief Executive Officer

I think that’s — I think that’s really well said. I think our C&I customers actually feel pretty good about things. They’re cautiously optimistic and continue to invest. So we’ll see how that plays out the rest of the year and to Mark’s comments about CRE, obviously interest rates are causing some pressure on the pipeline there, but we’ll stay close to our borrowers and have opportunities to do the right deals with the right clients.

Jon Arfstrom — RBC Capital Markets — Analyst

Okay. You also mentioned deposit pricing exceptions and deposit specials were a couple of comments you made earlier. Can you talk about how prevalent that is and kind of what you’re doing there?

James Sandgren — Chief Executive Officer, Commercial Banking

So we have special pricing and about 15% to 16% of our non-time deposit customers right now. So client by client we’re negotiating. We have given our team’s tools to to price as they need to stay market competitive and retain deposits. And as Brendon mentioned, we have a number of promotional specials in every line of business to raise deposits from money markets to CDs to the new checking account promotion.

Jon Arfstrom — RBC Capital Markets — Analyst

Okay. Brendon, one — you talked about $1 billion in cash flows on the securities portfolio over the next 12 months. What kind of a lift do you think you’re going to get on those repurchases — on the new purchases and give us an idea of what you’re interested in buying and kind of the duration on that?

Brendon B. Falconer — Chief Financial Officer

A lot of the cash flow is actually built reinvested right into the loan books that are lifted, nor can we really think about the runoff yield moving into being loan yields that are north of 6% today so meaningful uplift on those cash flows as we think about NII going forward.

Jon Arfstrom — RBC Capital Markets — Analyst

Okay. And then, Jim, you’ll love this one, but do you feel you’re done with First Midwest, both sides of the merger, things are tracking well. And any appetite whatsoever to be back in the M&A market? Thanks.

James C. Ryan — Chief Executive Officer

From a systems perspective, there’s not a — this project is officially concluded. I think the reality though is we’re continuing to look at ways to get better when we do both in the back office and front-office. And then we’re spending an awful long time on culture. Leadership team spent the last year really building a strong culture together and now we’re continuing to find ways to drive it deeper and deeper into our organization.

So that work is going to take years, Jon to continue to complete, but I feel really good about where we stand. And in fact, we joke with ourselves. I’m not sure we could have painted a better picture of how we come together as two organizations, two large organizations coming together, and so feel really good about that. Obviously, the results, we feel great about the results given all that went on this year and so that couldn’t actually feel any better.

With respect to the next opportunities to come along, we’ll continue to have active conversations and dialogs. But I can tell you it’s not top of mind for us to think about wanting to do something right now. But nonetheless, these are long-term relationship building activities, we’re going continue to engage in and those will be important to our future. At the same time, we have an obligation to our shareholders to make sure whatever we do is really disciplined and shareholder-friendly. So we’re gonna stay focused on organic growth and building out our teams with new talent and then if the right partner comes along and it’s the right fit and timing for us, we’ll take a look at it. But there’s a lot of ifs in there before we think about doing our next partnership.

Jon Arfstrom — RBC Capital Markets — Analyst

Okay. Thank you.

James C. Ryan — Chief Executive Officer

Thanks, Jon. Good to hear from you.

Operator

Our next question is a follow-up from Scott Siefers with Piper Sandler. Please go ahead, Scott.

Scott Siefers — Piper Sandler — Analyst

Hey, guys, thanks for taking the follow-up. I just wanted to go back to the expenses, just I’m kind of crystal clear on it. So the $900 million launching point, that’s a core number, but $939 million expectation includes, it looks like about $9 million of items that are not included in the starting point from that $14 million of tax credit amortization and the $5 million of property optimization, so would have more kind of apples-to-apples expectation be $930 million for 2023. In other words, if you were to hit this guide, would you call the adjusted ’23 expenses $930 million?

Brendon B. Falconer — Chief Financial Officer

We would call it, $925 million. We would exclude the entire tax credit amortization. So, $925 million would be apples-to-apples. I know the analysts treat that differently, many of them [Speech Overlap]

Scott Siefers — Piper Sandler — Analyst

Okay, so $925 million is going to underlying projection in that. I appreciate that clarification, Brendon. And then when you’re talking about 24% core FTE tax expectation for full-year ’23, does that include or exclude the tax credit benefits?

Brendon B. Falconer — Chief Financial Officer

Includes all the tax credit benefits.

Scott Siefers — Piper Sandler — Analyst

Okay, perfect. All right. Thank you guys very much.

James C. Ryan — Chief Executive Officer

Thanks, Scott.

Operator

Our next question is a follow-up from Chris McGratty with KBW. Please go ahead, Chris.

Chris McGratty — KBW — Analyst

Oh, great, thanks. Brendon the $1.1 billion that’s come off the bond book, I think you alluded that. You probably will shrink the bond portfolio and put it in the loan book. I guess, question, and how much of a remix we should think about for this year? Ultimately, I’m trying to get at two things, the level of borrowings that you’re going to have to do and your ultimate comfort with the loan-to-deposit ratio.

Brendon B. Falconer — Chief Financial Officer

Yeah, we, we’re comfortable with letting the loan-deposit ratio increase from here. I think we have plenty of room. We have plenty of wholesale funding capacity. I think how much of that and how much of the borrowing — borrowings are used for loan growth will be will be upon how effective we are at maintaining stable deposits.

Chris McGratty — KBW — Analyst

Okay. But the goal is goal roughly stable deposit, right?

Brendon B. Falconer — Chief Financial Officer

Right.

Chris McGratty — KBW — Analyst

Okay. Thank you.

James C. Ryan — Chief Executive Officer

Thanks, Chris.

Operator

[Operator Instructions] There are no further questions at this time. I’d like to turn the call back to Jim Ryan for closing remarks.

James C. Ryan — Chief Executive Officer

Well, thanks for all your attendance. Appreciate all the questions. We will be around all day long to answer any follow-up questions. Thanks, and look forward to talking to you soon.

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 866-813-9403, and the access code 104-806. This replay will be available through February 7. If anyone has any additional questions, please contact Lynell Walton at 812-464-1366. Thank you for your participation in today’s conference call.