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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2016

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number 1-15817

 

 

OLD NATIONAL BANCORP

(Exact name of Registrant as specified in its charter)

 

 

 

INDIANA   35-1539838

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

One Main Street

Evansville, Indiana

  47708
(Address of principal executive offices)   (Zip Code)

(812) 464-1294

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for at least the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (s232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock. The Registrant has one class of common stock (no par value) with 114,352,000 shares outstanding at March 31, 2016.

 

 

 


Table of Contents

OLD NATIONAL BANCORP

FORM 10-Q

INDEX

 

         Page No.  
PART I.   FINANCIAL INFORMATION   
Item 1.   Financial Statements   
 

Consolidated Balance Sheets March 31, 2016 (unaudited), December 31, 2015, and March 31, 2015 (unaudited)

     3   
 

Consolidated Statements of Income (unaudited) Three months ended March 31, 2016 and 2015

     4   
 

Consolidated Statements of Comprehensive Income (unaudited) Three months ended March 31, 2016 and 2015

     5   
 

Consolidated Statements of Changes in Shareholders’ Equity (unaudited) Three months ended March 31, 2016 and 2015

     6   
 

Consolidated Statements of Cash Flows (unaudited) Three months ended March 31, 2016 and 2015

     7   
 

Notes to Consolidated Financial Statements (unaudited)

     8   
Item 2.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     60   
Item 3.  

Quantitative and Qualitative Disclosures About Market Risk

     84   
Item 4.  

Controls and Procedures

     84   
PART II   OTHER INFORMATION      86   

SIGNATURES

     91   

 

2


Table of Contents

OLD NATIONAL BANCORP

CONSOLIDATED BALANCE SHEETS

     March 31,     December 31,     March 31,  

(dollars and shares in thousands, except per share data)

   2016     2015     2015  
     (unaudited)           (unaudited)  

Assets

      

Cash and due from banks

   $ 153,259      $ 91,311      $ 195,970   

Money market and other interest-earning investments

     22,299        128,507        19,343   
  

 

 

   

 

 

   

 

 

 

Total cash and cash equivalents

     175,558        219,818        215,313   

Trading securities - at fair value

     3,699        3,941        3,964   

Investment securities - available-for-sale, at fair value:

      

U.S. Treasury

     12,243        12,150        25,178   

U.S. government-sponsored entities and agencies

     603,457        613,550        709,379   

Mortgage-backed securities

     990,984        1,066,361        1,090,731   

States and political subdivisions

     400,236        387,296        340,630   

Other securities

     341,523        338,864        379,552   
  

 

 

   

 

 

   

 

 

 

Total investment securities - available-for-sale

     2,348,443        2,418,221        2,545,470   

Investment securities - held-to-maturity, at amortized cost (fair value $932,590; $929,417; and $899,653, respectively)

     869,012        872,111        836,038   

Federal Home Loan Bank/Federal Reserve Bank stock, at cost

     86,146        86,146        75,068   

Loans held for sale ($22,546; $13,810; and $24,344, respectively at fair value)

     22,546        13,810        210,513   

Loans:

      

Commercial

     1,784,970        1,804,615        1,668,275   

Commercial real estate

     1,907,834        1,847,821        1,813,579   

Residential real estate

     1,634,132        1,644,614        1,625,354   

Consumer credit, net of unearned income

     1,584,735        1,543,768        1,408,491   

Covered loans, net of discount

     95,403        107,587        136,840   
  

 

 

   

 

 

   

 

 

 

Total loans

     7,007,074        6,948,405        6,652,539   

Allowance for loan losses

     (49,856     (51,296     (46,675

Allowance for loan losses - covered loans

     (844     (937     (2,203
  

 

 

   

 

 

   

 

 

 

Net loans

     6,956,374        6,896,172        6,603,661   
  

 

 

   

 

 

   

 

 

 

FDIC indemnification asset

     7,703        9,030        20,024   

Premises and equipment, net

     198,065        196,676        132,101   

Accrued interest receivable

     68,641        69,098        62,503   

Goodwill

     584,634        584,634        587,904   

Other intangible assets

     32,443        35,308        43,738   

Company-owned life insurance

     342,292        341,294        335,976   

Assets held for sale

     2,038        5,679        14,636   

Other real estate owned and repossessed personal property

     7,019        7,594        8,482   

Other real estate owned - covered

     6,503        4,904        7,084   

Other assets

     221,210        227,091        247,375   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 11,932,326      $ 11,991,527      $ 11,949,850   
  

 

 

   

 

 

   

 

 

 

Liabilities

      

Deposits:

      

Noninterest-bearing demand

   $ 2,491,767      $ 2,488,855      $ 2,553,801   

Interest-bearing:

      

NOW

     2,178,690        2,133,536        2,218,243   

Savings

     2,271,341        2,201,352        2,384,502   

Money market

     561,250        577,050        636,933   

Time

     1,085,847        1,000,067        1,134,041   
  

 

 

   

 

 

   

 

 

 

Total deposits

     8,588,895        8,400,860        8,927,520   

Short-term borrowings

     494,380        628,499        463,007   

Other borrowings

     1,167,811        1,291,747        869,123   

Accrued expenses and other liabilities

     172,597        179,251        206,929   
  

 

 

   

 

 

   

 

 

 

Total liabilities

     10,423,683        10,500,357        10,466,579   
  

 

 

   

 

 

   

 

 

 

Shareholders’ Equity

      

Preferred stock, 2,000 shares authorized, no shares issued or outstanding

     —          —          —     

Common stock, $1.00 per share stated value, 150,000 shares authorized, 114,352; 114,297; and 116,983 shares issued and outstanding, respectively

     114,352        114,297        116,983   

Capital surplus

     1,088,037        1,087,911        1,121,594   

Retained earnings

     335,839        323,759        268,936   

Accumulated other comprehensive income (loss), net of tax

     (29,585     (34,797     (24,242
  

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

     1,508,643        1,491,170        1,483,271   
  

 

 

   

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 11,932,326      $ 11,991,527      $ 11,949,850   
  

 

 

   

 

 

   

 

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

3


Table of Contents

OLD NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF INCOME (unaudited)

 

     Three Months Ended  
     March 31,  

(dollars and shares in thousands, except per share data)

   2016     2015  

Interest Income

    

Loans including fees:

    

Taxable

   $ 71,572      $ 74,959   

Nontaxable

     3,004        2,943   

Investment securities:

    

Taxable

     13,722        14,726   

Nontaxable

     6,982        5,960   

Money market and other interest-earning investments

     49        6   
  

 

 

   

 

 

 

Total interest income

     95,329        98,594   
  

 

 

   

 

 

 

Interest Expense

    

Deposits

     3,493        3,563   

Short-term borrowings

     182        96   

Other borrowings

     6,011        3,942   
  

 

 

   

 

 

 

Total interest expense

     9,686        7,601   
  

 

 

   

 

 

 

Net interest income

     85,643        90,993   

Provision for loan losses

     91        1   
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     85,552        90,992   
  

 

 

   

 

 

 

Noninterest Income

    

Wealth management fees

     8,121        8,520   

Service charges on deposit accounts

     9,639        11,045   

Debit card and ATM fees

     3,785        6,732   

Mortgage banking revenue

     2,920        2,963   

Insurance premiums and commissions

     13,121        12,113   

Investment product fees

     3,905        4,403   

Company-owned life insurance

     2,038        2,152   

Net securities gains

     1,106        2,683   

Recognition of deferred gain on sale leaseback transactions

     1,052        1,524   

Change in FDIC indemnification asset

     (655     (968

Other income

     4,419        4,128   
  

 

 

   

 

 

 

Total noninterest income

     49,451        55,295   
  

 

 

   

 

 

 

Noninterest Expense

    

Salaries and employee benefits

     56,972        69,694   

Occupancy

     12,844        14,293   

Equipment

     2,893        3,904   

Marketing

     2,486        2,236   

Data processing

     7,123        6,590   

Communication

     1,864        2,744   

Professional fees

     3,368        3,132   

Loan expense

     1,333        1,326   

Supplies

     583        684   

FDIC assessment

     1,919        1,885   

Other real estate owned expense

     424        1,161   

Amortization of intangibles

     2,647        3,081   

Other expense

     3,899        5,426   
  

 

 

   

 

 

 

Total noninterest expense

     98,355        116,156   
  

 

 

   

 

 

 

Income before income taxes

     36,648        30,131   

Income tax expense

     9,671        9,225   
  

 

 

   

 

 

 

Net income

   $ 26,977      $ 20,906   
  

 

 

   

 

 

 

Net income per common share - basic

   $ 0.24      $ 0.18   

Net income per common share - diluted

     0.24        0.18   
  

 

 

   

 

 

 

Weighted average number of common shares outstanding - basic

     113,998        118,540   

Weighted average number of common shares outstanding - diluted

     114,563        119,076   
  

 

 

   

 

 

 

Dividends per common share

   $ 0.13      $ 0.12   

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

4


Table of Contents

OLD NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)

 

     Three Months Ended  
     March 31,  

(dollars in thousands)

   2016     2015  

Net income

   $ 26,977      $ 20,906   

Other comprehensive income:

    

Change in securities available-for-sale:

    

Unrealized holding gains for the period

     17,857        18,306   

Reclassification adjustment for securities gains realized in income

     (1,106     (2,683

Income tax effect

     (6,168     (5,796
  

 

 

   

 

 

 

Unrealized gains on available-for-sale securities

     10,583        9,827   

Change in securities held-to-maturity:

    

Amortization of fair value for securities held-to-maturity previously recognized into accumulated other comprehensive income

     465        337   

Income tax effect

     (159     66   
  

 

 

   

 

 

 

Changes from securities held-to-maturity

     306        403   

Cash flow hedges:

    

Net unrealized derivative losses on cash flow hedges

     (11,130     (5,628

Reclassification adjustment for losses realized in net income

     1,273        186   

Income tax effect

     3,746        2,068   
  

 

 

   

 

 

 

Changes from cash flow hedges

     (6,111     (3,374

Defined benefit pension plans:

    

Amortization of net loss recognized in income

     700        738   

Income tax effect

     (266     (281
  

 

 

   

 

 

 

Changes from defined benefit pension plans

     434        457   
  

 

 

   

 

 

 

Other comprehensive income, net of tax

     5,212        7,313   
  

 

 

   

 

 

 

Comprehensive income

   $ 32,189      $ 28,219   
  

 

 

   

 

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

5


Table of Contents

OLD NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (unaudited)

 

                       Accumulated        
                       Other     Total  
     Common     Capital     Retained     Comprehensive     Shareholders’  

(dollars in thousands)

   Stock     Surplus     Earnings     Income (Loss)     Equity  

Balance at December 31, 2014

   $ 116,847      $ 1,118,292      $ 262,180      $ (31,555   $ 1,465,764   

Net income

     —          —          20,906        —          20,906   

Other comprehensive income

     —          —          —          7,313        7,313   

Acquisition - Founders Financial Corporation

     3,402        47,224        —          —          50,626   

Dividends - common stock

     —          —          (14,238     —          (14,238

Common stock issued

     7        90        —          —          97   

Common stock repurchased

     (3,468     (44,735     —          —          (48,203

Stock based compensation expense

     —          1,204        —          —          1,204   

Stock activity under incentive compensation plans

     195        (481     88        —          (198
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2015

   $ 116,983      $ 1,121,594      $ 268,936      $ (24,242   $ 1,483,271   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2015

   $ 114,297      $ 1,087,911      $ 323,759      $ (34,797   $ 1,491,170   

Net income

     —          —          26,977        —          26,977   

Other comprehensive income

     —          —          —          5,212        5,212   

Dividends - common stock

     —          —          (14,865     —          (14,865

Common stock issued

     8        96        —          —          104   

Common stock repurchased

     (41     (451     —          —          (492

Stock based compensation expense

     —          1,268        —          —          1,268   

Stock activity under incentive compensation plans

     88        (787     (32     —          (731
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2016

   $ 114,352      $ 1,088,037      $ 335,839      $ (29,585   $ 1,508,643   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

6


Table of Contents

OLD NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

 

     Three Months Ended  
     March 31,  

(dollars in thousands)

   2016     2015  

Cash Flows From Operating Activities

    

Net income

   $ 26,977      $ 20,906   
  

 

 

   

 

 

 

Adjustments to reconcile net income to cash provided by operating activities:

    

Depreciation

     3,527        4,140   

Amortization of other intangible assets

     2,647        3,081   

Net premium amortization on investment securities

     4,412        4,792   

Amortization of FDIC indemnification asset

     655        968   

Stock compensation expense

     1,268        1,204   

Provision for loan losses

     91        1   

Net securities gains

     (1,106     (2,683

Recognition of deferred gain on sale leaseback transactions

     (1,052     (1,524

Net gains on sales of other assets

     (792     (52

Increase in cash surrender value of company-owned life insurance

     (998     (2,062

Residential real estate loans originated for sale

     (70,754     (78,224

Proceeds from sale of residential real estate loans

     62,795        73,968   

(Increase) decrease in interest receivable

     457        (277

(Increase) decrease in other real estate owned

     (1,024     1,470   

(Increase) decrease in other assets

     3,460        (4,516

Decrease in accrued expenses and other liabilities

     (14,802     (18,072
  

 

 

   

 

 

 

Total adjustments

     (11,216     (17,786
  

 

 

   

 

 

 

Net cash flows provided by operating activities

     15,761        3,120   
  

 

 

   

 

 

 

Cash Flows From Investing Activities

    

Net cash and cash equivalents of acquired banks

     —          (37,098

Purchases of investment securities available-for-sale

     (289,184     (129,563

Purchases of Federal Home Loan Bank/Federal Reserve Bank stock

     —          (2,083

Proceeds from maturities, prepayments, and calls of investment securities available-for-sale

     298,147        132,471   

Proceeds from sales of investment securities available-for-sale

     76,650        170,265   

Proceeds from maturities, prepayments, and calls of investment securities held-to-maturity

     1,439        5,609   

Proceeds from sales of investment securities held-to-maturity

     —          855   

Reimbursements under FDIC loss share agreements

     877        —     

Net principal collected from (loans made to) loan customers

     (60,293     18,424   

Proceeds from sale of premises and equipment and other assets

     3,656        4   

Purchases of premises and equipment and other assets

     (4,928     (6,959
  

 

 

   

 

 

 

Net cash flows provided by investing activities

     26,364        151,925   
  

 

 

   

 

 

 

Cash Flows From Financing Activities

    

Net increase (decrease) in deposits and short-term borrowings:

    

Deposits

     188,035        60,200   

Short-term borrowings

     (134,119     (100,794

Payments for maturities on other borrowings

     (475,138     (227,017

Proceeds from issuance of other borrowings

     350,000        150,000   

Cash dividends paid on common stock

     (14,865     (14,238

Common stock repurchased

     (492     (48,203

Proceeds from exercise of stock options, including tax benefit

     90        260   

Common stock issued

     104        97   
  

 

 

   

 

 

 

Net cash flows used in financing activities

     (86,385     (179,695
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (44,260     (24,650

Cash and cash equivalents at beginning of period

     219,818        239,963   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 175,558      $ 215,313   
  

 

 

   

 

 

 

Supplemental cash flow information:

    

Total interest paid

   $ 11,265      $ 9,374   

Total taxes paid (net of refunds)

   $ 2,000      $ (49

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

7


Table of Contents

OLD NATIONAL BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

NOTE 1 – BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements include the accounts of Old National Bancorp and its wholly-owned affiliates (hereinafter collectively referred to as “Old National”) and have been prepared in conformity with accounting principles generally accepted in the United States of America and prevailing practices within the banking industry. Such principles require management to make estimates and assumptions that affect the reported amounts of assets, liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements and amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In the opinion of management, the consolidated financial statements contain all the normal and recurring adjustments necessary for a fair statement of the financial position of Old National as of March 31, 2016 and 2015, and December 31, 2015, and the results of its operations for the three months ended March 31, 2016 and 2015. Interim results do not necessarily represent annual results. These financial statements should be read in conjunction with Old National’s Annual Report for the year ended December 31, 2015.

All significant intercompany transactions and balances have been eliminated. Certain prior year amounts have been reclassified to conform to the 2016 presentation. Such reclassifications had no effect on net income or shareholders’ equity and were insignificant amounts.

NOTE 2 – RECENT ACCOUNTING PRONOUNCEMENTS

FASB ASC 606 – In May 2014, the FASB issued an update (ASU No. 2014-09, Revenue from Contracts with Customers) creating FASB Topic 606, Revenue from Contracts with Customers. The guidance in this update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance provides steps to follow to achieve the core principle. An entity should disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. In July 2015, the FASB approved the deferral of the amendments in this update for one year. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

FASB ASC 718 – In June 2014, the FASB issued an update (ASU No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period). Generally, an award with a performance target also requires an employee to render service until the performance target is achieved. In some cases, however, the terms of an award may provide that the performance target could be achieved after an employee completes the requisite service period. The amendments in this update require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. An entity should apply guidance in Topic 718 as it relates to awards with performance conditions that affect vesting to account for such awards. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period for which the service has already been rendered. The amendments in this update became effective for interim and annual periods beginning after December 15, 2015 and did not have a material impact on the consolidated financial statements.

FASB ASC 350 – In April 2015, the FASB issued an update (ASU No. 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement) impacting FASB ASC 350-40, Intangibles: Goodwill and Other: Internal- Use Software. This update is part of the FASB’s Simplification Initiative. The amendments in this update provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing

 

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arrangement does not include a software license, the customer should account for the arrangement as a service contract. The guidance will not change generally accepted accounting principles for a customer’s accounting for service contracts. The amendments in this update became effective for interim and annual periods beginning after December 15, 2015 and did not have a material impact on the consolidated financial statements.

FASB ASC 944 – In May 2015, the FASB issued an update (ASU No. 2015-09, Disclosures about Short-Duration Contracts). This update applies to all insurance entities that issue short-duration contracts as defined in Topic 944, Financial Services – Insurance. The amendment requires insurance entities to disclose for annual reporting periods information about the liability for unpaid claims and claim adjustment expenses, and information about significant changes in methodologies and assumptions used to calculate the liability for unpaid claims and claim adjustment expenses, including reasons for the change and the effects on the financial statements. Additionally, the amendments require insurance entities to disclose for annual and interim reporting periods a roll-forward of the liability for unpaid claims and claim adjustment expenses. The amendments in this update become effective for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

FASB ASC 805 – In September 2015, the FASB issued an update (ASU No. 2015-16, Simplifying the Accounting for Measurement-Period Adjustments). This update applies to all entities that have reported provisional amounts for items in a business combination for which the accounting is incomplete by the end of the reporting period in which the combination occurs and during the measurement period have an adjustment to provisional amounts recognized. The amendments in this update require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments in this update require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in this update require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The amendments in this update became effective for interim and annual periods beginning after December 15, 2015 and did not have a material impact on the consolidated financial statements.

FASB ASC 825 – In January 2016, the FASB issued an update (ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities). The amendments in this update impact public business entities as follows: 1) Require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. 2) Simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value. 3) Eliminate the requirement to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. 4) Require entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. 5) Require an entity to present separately in other comprehensive income the portion of the total change in fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. 6) Require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. 7) Clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

FASB ASC 842 – In February 2016, the FASB issued its new lease accounting guidance in ASU No. 2016-02, Leases (Topic 842). Under the new guidance, lessees will be required to recognize the following for all leases, with the exception of short-term leases, at the commencement date: a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset

 

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that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting in largely unchanged. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2018. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is expected to have a material impact.

FASB ASC 405 – In March 2016, the FASB issued ASU No. 2016-04, Liabilities – Extinguishments of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products. The amendments of this ASU narrowly address breakage, which is the monetary amount of the card that ultimately is not redeemed by the cardholder for prepaid stored-value products that are redeemable for monetary values of goods or services but may also be redeemable for cash. Examples of prepaid stored-value products included in this amendment are prepaid gift cards issued by specific payment networks and redeemable at network-accepting merchant locations, prepaid telecommunication cards, and traveler’s checks. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

FASB ASC 815 – In March 2016, the FASB issued ASU No. 2016-05, Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships. The amendments apply to all reporting entities for which there is a change in the counterparty to a derivative instrument that has been designated as a hedging instrument. The amendments clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument does not, in and of itself, require de-designation of that hedging relationship provided that all other hedge accounting criteria continue to be met. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

In March 2016, the FASB issued ASU No. 2016-06, Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments. The amendments apply to all entities that are issuers of or investors in debt instruments (or hybrid financial instruments that are determined to have a debt host) with embedded call (put) options. Topic 815, Derivatives and Hedging, requires that embedded derivatives be separated from the host contract and accounted for separately as derivatives if certain criteria are met. One of those criteria is that the economic characteristics and risks of the embedded derivatives are not clearly and closely related to the economic characteristics and risks of the host contract. The amendments clarify what steps are required when assessing “clearly and closely related”. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

FASB ASC 323 – In March 2016, the FASB issued ASU No. 2016-07, Investments - Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting. The amendments affect all entities that have an investment that becomes qualified for the equity method of accounting as a result of an increase in the level of ownership interest or degree of influence. The amendments eliminate the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. The amendments also require that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

 

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FASB ASC 606 – In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). The amendments relate to when another party, along with the entity, is involved in providing a good or service to a customer. Topic 606, Revenue from Contracts with Customers, requires an entity to determine whether the nature of its promise is to provide that good or service to the customer (that is, the entity is a principal) or to arrange for the good or service to be provided to the customer by the other party (that is, the entity is an agent). This determination is based upon whether the entity controls the good or the service before it is transferred to the customer. Topic 606 includes indicators to assist in this evaluation. The amendments in this update affect the guidance in ASU No. 2014-09 above, which is not yet effective. The effective date will be the same as the effective date of ASU No. 2014-09. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. The amendments clarify the following two aspects of Topic 606: identifying performance obligations, and the licensing implementation guidance. Before an entity can identify its performance obligations in a contract with a customer, the entity first identifies the promised goods or services in the contract. The amendments in this update are expected to reduce the cost and complexity of applying the guidance on identifying promised goods or services. To identify performance obligations in a contract, an entity evaluates whether promised goods and services are distinct. Topic 606 includes two criteria for assessing whether promises to transfer goods or services are distinct. One of those criteria is that the promises are separately identifiable. This update will improve the guidance on assessing that criterion. Topic 606 also includes implementation guidance on determining whether as entity’s promise to grant a license provides a customer with either a right to use the entity’s intellectual property, which is satisfied at a point in time, or a right to access the entity’s intellectual property, which is satisfied over time. The amendments in this update are intended to improve the operability and understandability of the licensing implementation guidance. The amendments in this update affect the guidance in ASU No. 2014-09 above, which is not yet effective. The effective date will be the same as the effective date of ASU No. 2014-09. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

FASB ASC 718 – In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Shared-Based Payment Accounting. The amendments are intended to improve the accounting for employee shared-based payments and affects all organizations that issue share-based payment awards to their employees. Several aspects of the accounting for share-based payment award transactions are simplified, including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

NOTE 3 – ACQUISITION AND DIVESTITURE ACTIVITY

Acquisitions

Founders Financial Corporation

On July 28, 2014, Old National announced that it had entered into an agreement to acquire Grand Rapids, Michigan-based Founders Financial Corporation (“Founders”) through a stock and cash merger. The acquisition was completed effective January 1, 2015 (the “Closing Date”). Founders was a bank holding company with Founders Bank & Trust as its wholly-owned subsidiary and operated four full-service banking centers in Kent County. Old National believes that it will be able to achieve cost savings by integrating the two companies and combining accounting, data processing, retail and lending support, and other administrative functions after the merger, which will enable Old National to achieve economies of scale in these areas.

The total purchase price for Founders was $91.7 million, consisting of $41.0 million of cash and the issuance of 3.4 million shares of Old National Common Stock valued at $50.6 million. This acquisition was accounted for under the acquisition method of accounting. Accordingly, the Company recognized amounts for identifiable assets acquired and liabilities assumed at their estimated acquisition date fair values. Through December 31, 2015, transaction and integration costs of $4.9 million associated with the acquisition had been expensed.

 

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As of December 31, 2015, the Company finalized its valuation of all assets and liabilities acquired, resulting in no material change to purchase accounting adjustments. A summary of the final purchase price allocation is as follows (in thousands):

 

Cash and cash equivalents

   $ 3,978   

Investment securities

     75,383   

Federal Home Loan Bank stock

     1,810   

Loans held for sale

     3,473   

Loans

     339,569   

Premises and equipment

     3,604   

Accrued interest receivable

     1,260   

Other real estate owned

     674   

Company-owned life insurance

     8,297   

Other assets

     8,804   

Deposits

     (376,656

Other borrowings

     (39,380

Accrued expenses and other liabilities

     (1,307
  

 

 

 

Net tangible assets acquired

     29,509   

Definite-lived intangible assets acquired

     5,515   

Loan servicing rights

     664   

Goodwill

     56,014   
  

 

 

 

Purchase price

   $ 91,702   
  

 

 

 

The portion of the purchase price allocated to goodwill will not be deductible for tax purposes and is included in the “Banking” segment, as described in Note 21 of these consolidated financial statement footnotes.

The components of the estimated fair value of the acquired identifiable intangible assets are in the table below. These intangible assets will be amortized on an accelerated basis over their estimated lives and are included in the “Banking” segment.

 

     Estimated
Fair Value
(in millions)
     Estimated
Useful Lives (Years)
 

Core deposit intangible

   $ 2.9         7   

Trust customer relationship intangible

   $ 2.6         12   

Acquired loan data for Founders can be found in the table below:

 

(in thousands)

   Fair Value
of Acquired Loans
at Acquisition Date
     Gross Contractual
Amounts Receivable
at Acquisition Date
     Best Estimate at
Acquisition Date of
Contractual Cash
Flows Not Expected
to be Collected
 

Acquired receivables subject to ASC 310-30

   $ 6,607       $ 11,103       $ 2,684   

Acquired receivables not subject to ASC 310-30

   $ 332,962       $ 439,031       $ 61,113   

Insurance Acquisitions

Effective February 1, 2015, Old National acquired certain assets from Mutual Underwriters Insurance (“Mutual Underwriters”). The total purchase price of the assets was $3.7 million, consisting of $2.6 million of customer business relationship intangibles and $1.1 million of goodwill, both of which are included in our “Insurance” segment. The customer business relationship intangibles will be amortized using an accelerated method over an estimated useful life of 10 years.

 

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On May 8, 2015, the Company issued cash consideration of $0.1 million to purchase a book of business. The acquisition terms call for further cash consideration of approximately $0.1 million if certain operating targets are met. The fair value of these payments was booked at acquisition and added $0.2 million of customer business relationships intangibles, which is included in the “Insurance” segment. The customer business relationship intangibles will be amortized using an accelerated method over an estimated useful life of 10 years.

Divestitures

On August 14, 2015, the Company completed its previously announced branch sales. The Company divested its southern Illinois region (twelve branches) along with four branches in eastern Indiana and one in Ohio. At closing, the purchasers assumed loans of $193.6 million and deposits of $555.8 million. The Company recorded a net pre-tax gain of $15.6 million in connection with the divestitures, which included a deposit premium of $19.3 million, goodwill allocation of $3.8 million, and $0.9 million of other transaction expenses.

In addition, the Company consolidated 23 branches throughout the Old National franchise during 2015 based on an ongoing assessment of our service and delivery network and on our goal to continue to move our franchise into stronger growth markets.

Pending Acquisitions at March 31, 2016

On January 12, 2016, Old National announced that it had entered into an agreement to acquire Madison, Wisconsin-based Anchor BanCorp Wisconsin Inc. (“Anchor”) through a stock and cash merger. Anchor is a savings and loan holding company with AnchorBank, fsb (“AnchorBank”) as its wholly-owned subsidiary. AnchorBank operates 46 banking centers, including 32 banking centers in the Madison, Milwaukee and Fox Valley triangle. At March 31, 2016, AnchorBank reported total assets of $2.231 billion and $1.816 billion of deposit liabilities. Pursuant to the merger agreement, shareholders of Anchor could elect to receive either 3.5505 shares of Old National common stock or $48.50 in cash for each share of Anchor they held, subject to no more than 40% of the outstanding shares of Anchor could receive cash. The transaction closed on May 1, 2016. Based on Old National’s closing share price of $13.40 on May 1, 2016, this represents a total transaction value of approximately $460 million. Due to the timing of the acquisition, the Company is continuing to determine the preliminary fair values of the assets and liabilities assumed and the purchase price allocation. The Company expects to finalize the analysis of the acquired assets and liabilities over the next few months and within one year of the acquisition.

 

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NOTE 4 – NET INCOME PER SHARE

The following table reconciles basic and diluted net income per share for the three months ended March 31, 2016 and 2015:

 

     Three Months Ended  
     March 31,  

(dollars and shares in thousands, except per share data)

   2016      2015  

Basic Earnings Per Share

     

Net income

   $ 26,977       $ 20,906   

Weighted average common shares outstanding

     113,998         118,540   

Basic Earnings Per Share

   $ 0.24       $ 0.18   
  

 

 

    

 

 

 

Diluted Earnings Per Share

     

Net income

   $ 26,977       $ 20,906   

Weighted average common shares outstanding

     113,998         118,540   

Effect of dilutive securities:

     

Restricted stock (1)

     526         438   

Stock options (2)

     39         98   
  

 

 

    

 

 

 

Weighted average shares outstanding

     114,563         119,076   

Diluted Earnings Per Share

   $ 0.24       $ 0.18   
  

 

 

    

 

 

 

 

(1) 4 thousand shares of restricted stock and restricted stock units at March 31, 2016 were not included in the computation of net income per diluted share because the effect would be antidilutive. There were no antidilutive shares excluded from the computation at March 31, 2015.
(2) Options to purchase 0.8 million shares and 0.9 million shares outstanding at March 31, 2016 and 2015, respectively, were not included in the computation of net income per diluted share because the exercise price of these options was greater than the average market price of the common shares and, therefore, the effect would be antidilutive.

 

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NOTE 5 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table summarizes the changes within each classification of accumulated other comprehensive income (loss) (“AOCI”) net of tax for the three months ended March 31, 2016 and 2015:

 

    

Unrealized Gains
and Losses on

Available-for-Sale

    Unrealized Gains
and Losses on
Held-to-Maturity
    Gains and
Losses on
Cash Flow
    Defined
Benefit
Pension
       

(dollars in thousands)

   Securities     Securities     Hedges     Plans     Total  

Three Months Ended March 31, 2016

          

Balance at January 1, 2016

   $ (3,806   $ (14,480   $ (9,276   $ (7,235   $ (34,797

Other comprehensive income (loss) before reclassifications

     11,282        —          (6,900     —          4,382   

Amounts reclassified from accumulated other comprehensive income (loss) (a)

     (699     306        789        434        830   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net other comprehensive income (loss)

     10,583        306        (6,111     434        5,212   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2016

   $ 6,777      $ (14,174   $ (15,387   $ (6,801   $ (29,585
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended March 31, 2015

          

Balance at January 1, 2015

   $ (748   $ (15,776   $ (5,935   $ (9,096   $ (31,555

Other comprehensive income (loss) before reclassifications

     11,515        —          (3,489     —          8,026   

Amounts reclassified from accumulated other comprehensive income (loss) (a)

     (1,688     403        115        457        (713
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net other comprehensive income (loss)

     9,827        403        (3,374     457        7,313   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2015

   $ 9,079      $ (15,373   $ (9,309   $ (8,639   $ (24,242
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(a) See table below for details about reclassifications.

 

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The following table summarize the significant amounts reclassified out of each component of AOCI for the three months ended March 31, 2016 and 2015:

 

     Amount Reclassified     Affected Line Item in the

Details about AOCI Components

   from AOCI    

Statement of Income

     Three Months Ended      
     March 31,      

(dollars in thousands)

   2016     2015      

Unrealized gains and losses on available-for-sale securities

   $ 1,106      $ 2,683      Net securities gains
     (407     (995   Income tax (expense) benefit
  

 

 

   

 

 

   
   $ 699      $ 1,688      Net income
  

 

 

   

 

 

   

Unrealized gains and losses on held-to-maturity securities

   $ (465   $ (337   Interest income/(expense)
     159        (66   Income tax (expense) benefit
  

 

 

   

 

 

   
   $ (306   $ (403   Net income
  

 

 

   

 

 

   

Gains and losses on cash flow hedges Interest rate contracts

   $ (1,273   $ (186   Interest income/(expense)
     484        71      Income tax (expense) benefit
  

 

 

   

 

 

   
   $ (789   $ (115   Net income
  

 

 

   

 

 

   

Amortization of defined benefit pension items

      

Actuarial gains/(losses)

   $ (700   $ (738   Salaries and employee benefits
     266        281      Income tax (expense) benefit
  

 

 

   

 

 

   
   $ (434   $ (457   Net income
  

 

 

   

 

 

   

Total reclassifications for the period

   $ (830   $ 713      Net income
  

 

 

   

 

 

   

 

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NOTE 6 – INVESTMENT SECURITIES

The following table summarizes the amortized cost and fair value of the available-for-sale and held-to-maturity investment securities portfolio at March 31, 2016 and December 31, 2015 and the corresponding amounts of unrealized gains and losses therein:

 

     Amortized      Unrealized      Unrealized     Fair  

(dollars in thousands)

   Cost      Gains      Losses     Value  

March 31, 2016

          

Available-for-Sale

          

U.S. Treasury

   $ 11,966       $ 277       $ —        $ 12,243   

U.S. government-sponsored entities and agencies

     600,938         2,578         (59     603,457   

Mortgage-backed securities - Agency

     980,374         13,812         (3,202     990,984   

States and political subdivisions

     387,916         12,931         (611     400,236   

Pooled trust preferred securities

     17,192         —           (9,205     7,987   

Other securities

     339,148         2,481         (8,093     333,536   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total available-for-sale securities

   $ 2,337,534       $ 32,079       $ (21,170   $ 2,348,443   
  

 

 

    

 

 

    

 

 

   

 

 

 

Held-to-Maturity

          

U.S. government-sponsored entities and agencies

   $ 142,045       $ 2,455       $ —        $ 144,500   

Mortgage-backed securities - Agency

     14,604         578         —          15,182   

States and political subdivisions

     712,363         60,545         —          772,908   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total held-to-maturity securities

   $ 869,012       $ 63,578       $ —        $ 932,590   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2015

          

Available-for-Sale

          

U.S. Treasury

   $ 11,968       $ 190       $ (8   $ 12,150   

U.S. government-sponsored entities and agencies

     615,578         1,495         (3,523     613,550   

Mortgage-backed securities - Agency

     1,065,936         10,970         (10,545     1,066,361   

States and political subdivisions

     375,671         11,960         (335     387,296   

Pooled trust preferred securities

     17,320         —           (9,420     7,900   

Other securities

     337,590         1,151         (7,777     330,964   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total available-for-sale securities

   $ 2,424,063       $ 25,766       $ (31,608   $ 2,418,221   
  

 

 

    

 

 

    

 

 

   

 

 

 

Held-to-Maturity

          

U.S. government-sponsored entities and agencies

   $ 142,864       $ 2,899       $ —        $ 145,763   

Mortgage-backed securities - Agency

     16,042         562         —          16,604   

States and political subdivisions

     713,205         53,848         (3     767,050   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total held-to-maturity securities

   $ 872,111       $ 57,309       $ (3   $ 929,417   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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Proceeds from sales or calls of available-for-sale investment securities, the resulting realized gains and realized losses, and other securities gains or losses were as follows for the three months ended March 31, 2016 and 2015:

 

     Three Months Ended  
     March 31,  

(dollars in thousands)

   2016      2015  

Proceeds from sales of available-for-sale securities

   $ 76,650       $ 170,265   

Proceeds from calls of available-for-sale securities

     124,311         51,594   
  

 

 

    

 

 

 

Total

   $ 200,961       $ 221,859   
  

 

 

    

 

 

 

Realized gains on sales of available-for-sale securities

   $ 1,660       $ 2,481   

Realized gains on calls of available-for-sale securities

     244         168   

Realized losses on sales of available-for-sale securities

     (446      (25

Realized losses on calls of available-for-sale securities

     (87      (3

Other securities gains (losses) (1)

     (265      62   
  

 

 

    

 

 

 

Net securities gains

   $ 1,106       $ 2,683   
  

 

 

    

 

 

 

 

(1) Other securities gains (losses) includes net realized gains or losses associated with trading securities and mutual funds.

During the three months ended March 31, 2015, the Company sold a municipal bond that was classified as held-to-maturity due to credit deterioration. Proceeds from the sale were $0.8 million and resulted in a gain of $52 thousand.

Trading securities, which consist of mutual funds held in a trust associated with deferred compensation plans for former Monroe Bancorp directors and executives, are recorded at fair value and totaled $3.7 million at March 31, 2016 and $3.9 million at December 31, 2015.

All of the mortgage-backed securities in the investment portfolio are residential mortgage-backed securities. The amortized cost and fair value of the investment securities portfolio are shown by expected maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Weighted average yield is based on amortized cost.

 

     At March 31, 2016  
(dollars in thousands)           Weighted  
     Amortized      Fair      Average  

Maturity

   Cost      Value      Yield  

Available-for-Sale

        

Within one year

   $ 28,446       $ 28,505         1.58

One to five years

     508,313         512,104         1.78   

Five to ten years

     344,286         339,730         2.61   

Beyond ten years

     1,456,489         1,468,104         2.60   
  

 

 

    

 

 

    

 

 

 

Total

   $ 2,337,534       $ 2,348,443         2.41
  

 

 

    

 

 

    

 

 

 

Held-to-Maturity

        

Within one year

   $ 11,984       $ 12,154         6.29

One to five years

     32,840         34,392         4.14   

Five to ten years

     214,165         222,378         3.67   

Beyond ten years

     610,023         663,666         5.48   
  

 

 

    

 

 

    

 

 

 

Total

   $ 869,012       $ 932,590         5.00
  

 

 

    

 

 

    

 

 

 

 

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The following table summarizes the investment securities with unrealized losses at March 31, 2016 and December 31, 2015 by aggregated major security type and length of time in a continuous unrealized loss position:

 

     Less than 12 months     12 months or longer     Total  
     Fair      Unrealized     Fair      Unrealized     Fair      Unrealized  

(dollars in thousands)

   Value      Losses     Value      Losses     Value      Losses  

March 31, 2016

               

Available-for-Sale

               

U.S. government-sponsored entities and agencies

   $ 38,400       $ (59   $ —         $ —        $ 38,400       $ (59

Mortgage-backed securities - Agency

     151,882         (357     162,982         (2,845     314,864         (3,202

States and political subdivisions

     44,889         (458     5,151         (153     50,040         (611

Pooled trust preferred securities

     —           —          7,987         (9,205     7,987         (9,205

Other securities

     96,543         (1,865     111,346         (6,228     207,889         (8,093
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total available-for-sale

   $ 331,714       $ (2,739   $ 287,466       $ (18,431   $ 619,180       $ (21,170
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

December 31, 2015

               

Available-for-Sale

               

U.S. Treasury

   $ 6,505       $ (8   $ —         $ —        $ 6,505       $ (8

U.S. government-sponsored entities and agencies

     160,751         (1,492     122,581         (2,031     283,332         (3,523

Mortgage-backed securities - Agency

     256,359         (3,444     239,047         (7,101     495,406         (10,545

States and political subdivisions

     38,373         (161     5,137         (174     43,510         (335

Pooled trust preferred securities

     —           —          7,900         (9,420     7,900         (9,420

Other securities

     156,604         (2,717     126,661         (5,060     283,265         (7,777
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total available-for-sale

   $ 618,592       $ (7,822   $ 501,326       $ (23,786   $ 1,119,918       $ (31,608
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Held-to-Maturity

               

States and political subdivisions

   $ 2,026       $ (3   $ —         $ —        $ 2,026       $ (3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total held-to-maturity

   $ 2,026       $ (3   $ —         $ —        $ 2,026       $ (3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. The investment securities portfolio is evaluated for OTTI by segregating the portfolio into two general segments and applying the appropriate OTTI model. Investment securities classified as available-for-sale or held-to-maturity are generally evaluated for OTTI under FASB ASC 320 (SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities). However, certain purchased beneficial interests, including non-agency mortgage-backed securities, asset-backed securities, and collateralized debt obligations, that had credit ratings at the time of purchase of below AA are evaluated using the model outlined in FASB ASC 325-10 (EITF Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests that Continue to be Held by a Transfer in Securitized Financial Assets).

In determining OTTI under the FASB ASC 320 (SFAS No. 115) model, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time. The second segment of the portfolio uses the OTTI guidance provided by FASB ASC 325-10 (EITF 99-20) that is specific to purchased beneficial interests that, on the purchase date, were rated below AA. Under the FASB ASC 325-10 model, we compare the present value of the remaining cash flows as estimated at the preceding evaluation date to the current expected remaining cash flows. An OTTI is deemed to have occurred if there has been an adverse change in the remaining expected future cash flows.

When other-than-temporary impairment occurs under either model, the amount of the other-than-temporary impairment recognized in earnings depends on whether an entity intends to sell the security or more likely than not

 

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will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the other-than-temporary impairment shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. Otherwise, the other-than-temporary impairment shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total other-than-temporary impairment related to other factors shall be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the other-than-temporary impairment recognized in earnings shall become the new amortized cost basis of the investment.

We did not record other-than-temporary-impairments during the three months ended March 31, 2016 or 2015.

As of March 31, 2016, Old National’s securities portfolio consisted of 1,719 securities, 132 of which were in an unrealized loss position. The unrealized losses attributable to our U.S. government-sponsored entities and agencies, our agency mortgage-backed securities, and our other securities are the result of fluctuations in interest rates. Our pooled trust preferred securities are discussed below.

Pooled Trust Preferred Securities

At March 31, 2016, our securities portfolio contained three pooled trust preferred securities with a fair value of $8.0 million and unrealized losses of $9.2 million. One of the pooled trust preferred securities in our portfolio falls within the scope of FASB ASC 325-10 (EITF 99-20) and has a fair value of $0.2 million with an unrealized loss of $3.1 million at March 31, 2016. This security was rated A3 at inception, but is rated D at March 31, 2016. The issuers in this security are banks. We use the OTTI evaluation model to compare the present value of expected cash flows to the previous estimate to determine whether an adverse change in cash flows has occurred during the quarter. The OTTI model considers the structure and term of the collateralized debt obligation (“CDO”) and the financial condition of the underlying issuers. Specifically, the model details interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities. Assumptions used in the model include expected future default rates and prepayments. We assume no recoveries on defaults and a limited number of recoveries on current or projected interest payment deferrals. In addition, we use the model to “stress” this CDO, or make assumptions more severe than expected activity, to determine the degree to which assumptions could deteriorate before the CDO could no longer fully support repayment of Old National’s note class. For the three months ended March 31, 2016 and 2015, our model indicated no other-than-temporary-impairment losses on this security. At March 31, 2016, we had no intent to sell any securities that were in an unrealized loss position nor is it expected that we would be required to sell any securities.

Two of our pooled trust preferred securities with a fair value of $7.7 million and unrealized losses of $6.1 million at March 31, 2016 are not subject to FASB ASC 325-10. These securities are evaluated using collateral-specific assumptions to estimate the expected future interest and principal cash flows. For the three months ended March 31, 2016 and 2015, our analysis indicated no OTTI on these securities.

 

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The table below summarizes the relevant characteristics of our pooled trust preferred securities as well as our single issuer trust preferred securities that are included in the “other securities” category in this footnote. Each of the pooled trust preferred securities support a more senior tranche of security holders. All three pooled trust preferred securities have experienced credit defaults. However, two of these securities have excess subordination and are not other-than-temporarily-impaired as a result of their class hierarchy, which provides more loss protection.

 

                                              Actual     Expected     Excess  
                                              Deferrals     Defaults as     Subordination  
                                        # of Issuers     and Defaults     a % of     as a % of  
Trust preferred securities         Lowest                 Unrealized     Realized     Currently     as a % of     Remaining     Current  
March 31, 2016         Credit     Amortized     Fair     Gain/     Losses     Performing/     Original     Performing     Performing  

(dollars in thousands)

  Class     Rating (1)     Cost     Value     (Loss)     2016     Remaining     Collateral     Collateral     Collateral  

Pooled trust preferred securities:

  

               

Reg Div Funding 2004

    B-2        D      $ 3,305      $ 244      $ (3,061   $ —          23/39        33.3     7.5     0.0

Pretsl XXVII LTD

    B        B        4,422        2,304        (2,118     —          34/45        20.4     3.5     51.6

Trapeza Ser 13A

    A2A        BBB        9,465        5,439        (4,026     —          50/57        8.9     5.0     47.4
     

 

 

   

 

 

   

 

 

   

 

 

         
        17,192        7,987        (9,205     —             

Single Issuer trust preferred securities:

  

               

Fleet Cap Tr V (BOA)

      BB+        3,391        2,713        (678     —             

JP Morgan Chase Cap XIII

      BBB-        4,759        3,940        (819     —             

NB-Global

      BB+        772        780        8        —             

Chase Cap II

      BBB-        811        775        (36     —             
     

 

 

   

 

 

   

 

 

   

 

 

         
        9,733        8,208        (1,525     —             

Total

      $ 26,925      $ 16,195      $ (10,730   $ —             
     

 

 

   

 

 

   

 

 

   

 

 

         

 

(1) Lowest rating for the security provided by any nationally recognized credit rating agency.

The following table details the remaining securities with other-than-temporary-impairment, their credit rating at March 31, 2016, and the related life-to-date credit losses recognized in earnings:

 

                          Amount of OTTI  
                          recognized in earnings  
            Lowest             Three Months Ended         
            Credit      Amortized      March 31,      Life-to  

(dollars in thousands)

   Vintage      Rating (1)      Cost      2016      2015      date  

Reg Div Funding

     2004         D       $ 3,305       $ —         $ —         $ 5,685   

 

(1) Lowest rating for the security provided by any nationally recognized credit rating agency.

NOTE 7 – LOANS HELD FOR SALE

Mortgage loans held for immediate sale in the secondary market were $22.5 million at March 31, 2016, compared to $13.8 million at December 31, 2015. Residential loans that Old National has originated with a commitment to sell are recorded at fair value in accordance with FASB ASC 825-10 (SFAS No. 159 – The Fair Value Option for Financial Assets and Financial Liabilities). Beginning with the inception of an in-house servicing unit in the third quarter of 2014, conventional mortgage production is sold on a servicing retained basis. Certain loans, such as government guaranteed mortgage loans are sold on servicing released basis.

During the fourth quarter of 2014, $197.9 million of loans were reclassified to loans held for sale at the lower of cost or fair value. When the branch divestitures closed during the third quarter of 2015, these loans were valued at $193.6 million, resulting in a gain of $0.1 million. At March 31, 2016, there were no loans held for sale under this arrangement.

 

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NOTE 8 – LOANS AND ALLOWANCE FOR CREDIT LOSSES

Old National’s finance receivables consist primarily of loans made to consumers and commercial clients in various industries including manufacturing, agribusiness, transportation, mining, wholesaling, and retailing. Most of Old National’s lending activity occurs within our principal geographic markets of Indiana, Kentucky, and Michigan. Old National has no concentration of commercial loans in any single industry exceeding 10% of its portfolio.

The composition of loans by lending classification was as follows:

 

     March 31,      December 31,  

(dollars in thousands)

   2016      2015  

Commercial (1)

   $ 1,784,970       $ 1,804,615   

Commercial real estate:

     

Construction

     202,278         185,449   

Other

     1,705,556         1,662,372   

Residential real estate

     1,634,132         1,644,614   

Consumer credit:

     

Heloc

     347,776         359,954   

Auto

     1,109,883         1,050,336   

Other

     127,076         133,478   

Covered loans

     95,403         107,587   
  

 

 

    

 

 

 

Total loans

     7,007,074         6,948,405   

Allowance for loan losses

     (49,856      (51,296

Allowance for loan losses - covered loans

     (844      (937
  

 

 

    

 

 

 

Net loans

   $ 6,956,374       $ 6,896,172   
  

 

 

    

 

 

 

 

(1) Includes direct finance leases of $13.4 million at March 31, 2016 and $14.4 million at December 31, 2015.

The risk characteristics of each loan portfolio segment are as follows:

Commercial

Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate

These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts, and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be adversely affected by conditions in the real estate markets or in the general economy. The properties securing Old National’s commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, Old National avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

Included with commercial real estate are construction loans, which are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates, and financial analysis of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of

 

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substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from Old National until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions, and the availability of long-term financing.

Residential

With respect to residential loans that are secured by 1-4 family residences and are generally owner occupied, Old National typically establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in residential property values. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

Consumer

Home equity loans are typically secured by a subordinate interest in 1-4 family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in residential property or other collateral values. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

Covered loans

Covered loans represent loans acquired from the FDIC that are subject to loss share agreements whereby Old National is indemnified against 80% of losses up to $275.0 million, losses in excess of $275.0 million up to $467.2 million at 0% reimbursement, and 80% of losses in excess of $467.2 million. Our losses will not exceed $275.0 million. See Note 9 to the consolidated financial statements for further details on our covered loans.

Allowance for loan losses

The allowance for loan losses is maintained at a level believed adequate by management to absorb probable losses incurred in the consolidated loan portfolio. Management’s evaluation of the adequacy of the allowance is an estimate based on reviews of individual loans, pools of homogeneous loans, assessments of the impact of current and anticipated economic conditions on the portfolio, and historical loss experience. The allowance is increased through a provision charged to operating expense. Loans deemed to be uncollectible are charged to the allowance. Recoveries of loans previously charged-off are added to the allowance.

We utilize a probability of default (“PD”) and loss given default (“LGD”) model as a tool to determine the adequacy of the allowance for loan losses for performing commercial and commercial real estate loans. The PD is forecast using a transition matrix to determine the likelihood of a customer’s asset quality rating (“AQR”) migrating from its current AQR to any other status within the time horizon. Transition rates are measured using Old National’s own historical experience. The model assumes that recent historical transition rates will continue into the future. The LGD is defined as credit loss incurred when an obligor of the bank defaults. The sum of all net charge-offs for a particular portfolio segment are divided by all loans that have defaulted over a given period of time. The expected loss derived from the model considers the PD, LGD, and exposure at default. Additionally, qualitative factors, such as changes in lending policies or procedures, and economic business conditions are also considered.

We use historic loss ratios adjusted for economic conditions to determine the appropriate level of allowance for residential real estate and consumer loans.

No allowance was brought forward on any of the acquired loans as any credit deterioration evident in the loans was included in the determination of the fair value of the loans at the acquisition date. Purchased credit impaired

 

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(“PCI”) loans are not considered impaired until after the point at which there has been a degradation of cash flows below our expected cash flows at acquisition. Impairment on PCI loans would be recognized in the current period as provision expense.

Old National’s activity in the allowance for loan losses for the three months ended March 31, 2016 and 2015 is as follows:

 

           Commercial                           

(dollars in thousands)

   Commercial     Real Estate     Residential     Consumer     Unallocated      Total  

Three Months Ended March 31, 2016

             

Balance at January 1, 2016

   $ 26,347      $ 15,993      $ 2,051      $ 7,842      $ —         $ 52,233   

Charge-offs

     (1,527     (279     (140     (1,996     —           (3,942

Recoveries

     818        840        26        634        —           2,318   

Provision

     (517     (783     (188     1,579        —           91   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at March 31, 2016

   $ 25,121      $ 15,771      $ 1,749      $ 8,059      $ —         $ 50,700   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Three Months Ended March 31, 2015

             

Balance at January 1, 2015

   $ 20,670      $ 17,348      $ 2,962      $ 6,869      $ —         $ 47,849   

Charge-offs

     (548     413        (374     (1,604     —           (2,113

Recoveries

     1,774        464        28        875        —           3,141   

Provision

     2,807        (4,418     303        1,309        —           1   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at March 31, 2015

   $ 24,703      $ 13,807      $ 2,919      $ 7,449      $ —         $ 48,878   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

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The following table provides Old National’s recorded investment in financing receivables by portfolio segment at March 31, 2016 and December 31, 2015 and other information regarding the allowance:

 

            Commercial                              

(dollars in thousands)

   Commercial      Real Estate      Residential      Consumer      Unallocated      Total  

March 31, 2016

                 

Allowance for loan losses:

                 

Individually evaluated for impairment

   $ 7,016       $ 3,468       $ —         $ —         $ —         $ 10,484   

Collectively evaluated for impairment

     17,523         12,110         1,729         7,846         —           39,208   

Noncovered loans acquired with deteriorated credit quality

     192         193         13         77         —           475   

Covered loans acquired with deteriorated credit quality

     390         —           7         136         —           533   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total allowance for loan losses

   $ 25,121       $ 15,771       $ 1,749       $ 8,059       $ —         $ 50,700   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans and leases outstanding:

                 

Individually evaluated for impairment

   $ 53,022       $ 41,022       $ —         $ —         $ —         $ 94,044   

Collectively evaluated for impairment

     1,737,377         1,843,821         1,634,184         1,629,730         —           6,845,112   

Loans acquired with deteriorated credit quality

     674         24,431         86         3,564         —           28,755   

Covered loans acquired with deteriorated credit quality

     1,915         13,480         15,726         8,042         —           39,163   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans and leases outstanding

   $ 1,792,988       $ 1,922,754       $ 1,649,996       $ 1,641,336       $ —         $ 7,007,074   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2015

                 

Allowance for loan losses:

                 

Individually evaluated for impairment

   $ 7,467       $ 4,021       $ —         $ —         $ —         $ 11,488   

Collectively evaluated for impairment

     18,295         11,439         2,038         7,614         —           39,386   

Noncovered loans acquired with deteriorated credit quality

     247         533         13         70         —           863   

Covered loans acquired with deteriorated credit quality

     338         —           —           158         —           496   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total allowance for loan losses

   $ 26,347       $ 15,993       $ 2,051       $ 7,842       $ —         $ 52,233   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans and leases outstanding:

                 

Individually evaluated for impairment

   $ 60,959       $ 41,987       $ —         $ —         $ —         $ 102,946   

Collectively evaluated for impairment

     1,750,397         1,779,062         1,644,631         1,590,288         —           6,764,378   

Loans acquired with deteriorated credit quality

     691         28,499         127         3,925         —           33,242   

Covered loans acquired with deteriorated credit quality

     2,893         19,424         16,577         8,945         —           47,839   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans and leases outstanding

   $ 1,814,940       $ 1,868,972       $ 1,661,335       $ 1,603,158       $ —         $ 6,948,405   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Credit Quality

Old National’s management monitors the credit quality of its financing receivables in an on-going manner. Internally, management assigns an asset quality rating (“AQR”) to each non-homogeneous commercial and commercial real estate loan in the portfolio. The primary determinants of the AQR are based upon the reliability of the primary source of repayment and the past, present, and projected financial condition of the borrower. The AQR also reflects current economic and industry conditions. Major factors used in determining the AQR can vary based on the nature of the loan, but commonly include factors such as debt service coverage, internal cash flow, liquidity, leverage, operating performance, debt burden, FICO scores, occupancy, interest rate sensitivity, and expense burden. Old National uses the following definitions for risk ratings:

Criticized. Special mention loans that have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Classified – Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Classified – Nonaccrual. Loans classified as nonaccrual have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection in full, on the basis of currently existing facts, conditions, and values, in doubt.

Classified – Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as nonaccrual, with the added characteristic that the weaknesses make collection in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Pass rated loans are those loans that are other than criticized, classified – substandard, classified - nonaccrual or classified – doubtful.

As of March 31, 2016 and December 31, 2015, the risk category of commercial and commercial real estate loans, excluding covered loans, by class of loans is as follows:

 

(dollars in thousands)                  Commercial      Commercial  
            Real Estate -      Real Estate -  
Corporate Credit Exposure    Commercial      Construction      Other  
Credit Risk Profile by    March 31,      December 31,      March 31,      December 31,      March 31,      December 31,  
Internally Assigned Grade    2016      2015      2016      2015      2016      2015  

Grade:

                 

Pass

   $ 1,656,554       $ 1,668,667       $ 196,052       $ 179,543       $ 1,540,250       $ 1,491,750   

Criticized

     54,746         54,606         3,251         3,300         72,951         74,992   

Classified - substandard

     24,004         23,806         2,293         1,857         49,347         49,029   

Classified - nonaccrual

     47,774         55,067         682         749         34,044         39,164   

Classified - doubtful

     1,892         2,469         —           —           8,964         7,437   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,784,970       $ 1,804,615       $ 202,278       $ 185,449       $ 1,705,556       $ 1,662,372   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Old National considers the performance of the loan portfolio and its impact on the allowance for loan losses. For residential and consumer loan classes, Old National also evaluates credit quality based on the aging status of the loan and by payment activity. The following table presents the recorded investment in residential and consumer loans based on payment activity as of March 31, 2016 and December 31, 2015, excluding covered loans:

 

(dollars in thousands)

   Residential      Consumer  
            Heloc      Auto      Other  

March 31, 2016

           

Performing

   $ 1,619,917       $ 345,630       $ 1,108,568       $ 126,106   

Nonperforming

     14,215         2,146         1,315         970   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,634,132       $ 347,776       $ 1,109,883       $ 127,076   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2015

           

Performing

   $ 1,629,661       $ 357,585       $ 1,048,763       $ 132,222   

Nonperforming

     14,953         2,369         1,573         1,256   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,644,614       $ 359,954       $ 1,050,336       $ 133,478   
  

 

 

    

 

 

    

 

 

    

 

 

 

Impaired Loans

Large commercial credits are subject to individual evaluation for impairment. Retail credits and other small balance credits that are part of a homogeneous group are not tested for individual impairment unless they are modified as a troubled debt restructuring. A loan is considered impaired when it is probable that contractual interest and principal payments will not be collected either for the amounts or by the dates as scheduled in the loan agreement. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported net, at the present value of estimated cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Old National’s policy, for all but purchased credit impaired loans, is to recognize interest income on impaired loans unless the loan is placed on nonaccrual status.

 

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The following table shows Old National’s impaired loans, excluding covered loans, as of March 31, 2016 and December 31, 2015, respectively. Of the loans purchased without FDIC loss share coverage, only those that have experienced subsequent impairment since the date acquired are included in the table below.

 

            Unpaid         
     Recorded      Principal      Related  

(dollars in thousands)

   Investment      Balance      Allowance  

March 31, 2016

        

With no related allowance recorded:

        

Commercial

   $ 28,921       $ 30,140       $ —     

Commercial Real Estate - Construction

     —           —           —     

Commercial Real Estate - Other

     27,351         30,593         —     

Residential

     1,342         1,363         —     

Consumer

     838         998         —     

With an allowance recorded:

        

Commercial

     20,188         20,198         6,784   

Commercial Real Estate - Construction

     231         231         1   

Commercial Real Estate - Other

     13,441         13,523         3,467   

Residential

     1,016         1,016         51   

Consumer

     2,776         2,776         139   
  

 

 

    

 

 

    

 

 

 

Total

   $ 96,104       $ 100,838       $ 10,442   
  

 

 

    

 

 

    

 

 

 

December 31, 2015

        

With no related allowance recorded:

        

Commercial

   $ 40,414       $ 41,212       $ —     

Commercial Real Estate - Construction

     —           —           —     

Commercial Real Estate - Other

     26,998         30,264         —     

Residential

     1,383         1,422         —     

Consumer

     1,201         1,305         —     

With an allowance recorded:

        

Commercial

     16,377         16,483         7,111   

Commercial Real Estate - Construction

     237         237         6   

Commercial Real Estate - Other

     14,752         14,802         4,015   

Residential

     985         985         49   

Consumer

     2,525         2,525         126   
  

 

 

    

 

 

    

 

 

 

Total

   $ 104,872       $ 109,235       $ 11,307   
  

 

 

    

 

 

    

 

 

 

 

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The average balance of impaired loans, excluding covered loans, and interest income recognized on impaired loans during the three months ended March 31, 2016 and 2015 are included in the table below.

 

     Average      Interest  
     Recorded      Income  

(dollars in thousands)

   Investment      Recognized (1)  

Three Months Ended March 31, 2016

     

With no related allowance recorded:

     

Commercial

   $ 34,085       $ 28   

Commercial Real Estate - Construction

     —           —     

Commercial Real Estate - Other

     27,149         95   

Residential

     1,362         —     

Consumer

     1,019         2   

With an allowance recorded:

     

Commercial

     18,283         13   

Commercial Real Estate - Construction

     234         —     

Commercial Real Estate - Other

     14,097         48   

Residential

     1,001         38   

Consumer

     2,651         38   
  

 

 

    

 

 

 

Total

   $ 99,881       $ 262   
  

 

 

    

 

 

 

Three Months Ended March 31, 2015

     

With no related allowance recorded:

     

Commercial

   $ 26,849       $ 42   

Commercial Real Estate - Construction

     2,250         3   

Commercial Real Estate - Other

     38,801         85   

Residential

     747         —     

Consumer

     731         1   

With an allowance recorded:

     

Commercial

     11,516         48   

Commercial Real Estate - Construction

     166         —     

Commercial Real Estate - Other

     10,728         1   

Residential

     1,475         61   

Consumer

     1,492         20   
  

 

 

    

 

 

 

Total

   $ 94,755       $ 261   
  

 

 

    

 

 

 

 

(1) The Company does not record interest on nonaccrual loans until principal is recovered.

For all loan classes, a loan is generally placed on nonaccrual status when principal or interest becomes 90 days past due unless it is well secured and in the process of collection, or earlier when concern exists as to the ultimate collectibility of principal or interest. Interest accrued during the current year on such loans is reversed against earnings. Interest accrued in the prior year, if any, is charged to the allowance for loan losses. Cash interest received on these loans is applied to the principal balance until the principal is recovered or until the loan returns to accrual status. Loans may be returned to accrual status when all the principal and interest amounts contractually due are brought current, remain current for six months and future payments are reasonably assured.

Loans accounted for under FASB ASC Topic 310-30 accrue interest, even though they may be contractually past due, as any nonpayment of contractual principal or interest is considered in the periodic re-estimation of expected cash flows and is included in the resulting recognition of current period covered loan loss provision or prospective yield adjustments. Similar to noncovered loans, covered loans accounted for outside FASB ASC Topic 310-30 are classified as nonaccrual when, in the opinion of management, collection of principal or interest is doubtful. Information for covered loans accounted for both under and outside FASB ASC Topic 310-30 is included in the table below in the row labeled covered loans.

 

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Old National’s past due financing receivables as of March 31, 2016 and December 31, 2015 are as follows:

 

                   Recorded                       
                   Investment >                       
     30-59 Days      60-89 Days      90 Days and             Total         

(dollars in thousands)

   Past Due      Past Due      Accruing      Nonaccrual      Past Due      Current  

March 31, 2016

                 

Commercial

   $ 1,625       $ 58       $ —         $ 49,666       $ 51,349       $ 1,733,621   

Commercial Real Estate:

                 

Construction

     693         —           —           682         1,375         200,903   

Other

     4,231         27         80         43,008         47,346         1,658,210   

Residential

     8,608         40         150         14,215         23,013         1,611,119   

Consumer:

                 

Heloc

     1,093         75         —           2,146         3,314         344,462   

Auto

     2,792         372         100         1,315         4,579         1,105,304   

Other

     495         99         27         970         1,591         125,485   

Covered loans

     734         —           —           5,864         6,598         88,805   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 20,271       $ 671       $ 357       $ 117,866       $ 139,165       $ 6,867,909   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2015

                 

Commercial

   $ 802       $ 100       $ 565       $ 57,536       $ 59,003       $ 1,745,612   

Commercial Real Estate:

                 

Construction

     —           —           —           749         749         184,700   

Other

     438         135         —           46,601         47,174         1,615,198   

Residential

     9,300         2,246         114         14,953         26,613         1,618,001   

Consumer:

                 

Heloc

     283         402         —           2,369         3,054         356,900   

Auto

     3,804         730         202         1,573         6,309         1,044,027   

Other

     830         165         25         1,256         2,276         131,202   

Covered loans

     809         312         10         7,336         8,467         99,120   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 16,266       $ 4,090       $ 916       $ 132,373       $ 153,645       $ 6,794,760   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loan Participations

Old National has loan participations, which qualify as participating interests, with other financial institutions. At March 31, 2016, these loans totaled $314.5 million, of which $173.8 million had been sold to other financial institutions and $140.7 million was retained by Old National. The loan participations convey proportionate ownership rights with equal priority to each participating interest holder, involve no recourse (other than ordinary representations and warranties) to, or subordination by, any participating interest holder, all cash flows are divided among the participating interest holders in proportion to each holder’s share of ownership and no holder has the right to pledge the entire financial asset unless all participating interest holders agree.

Troubled Debt Restructurings

Old National may choose to restructure the contractual terms of certain loans. The decision to restructure a loan, versus aggressively enforcing the collection of the loan, may benefit Old National by increasing the ultimate probability of collection.

Any loans that are modified are reviewed by Old National to identify if a troubled debt restructuring (“TDR”) has occurred, which is when for economic or legal reasons related to a borrower’s financial difficulties, the Bank grants a concession to the borrower that it would not otherwise consider. Terms may be modified to fit the ability of the borrower to repay in line with its current financial status. The modification of the terms of such loans include one or a combination of the following: a reduction of the stated interest rate of the loan, an extension of the maturity date at a stated rate of interest lower than the current market rate of new debt with similar risk, or a permanent reduction of the recorded investment of the loan.

 

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Table of Contents

Loans modified in a TDR are typically placed on nonaccrual status until we determine the future collection of principal and interest is reasonably assured, which generally requires that the borrower demonstrate a period of performance according to the restructured terms for six months.

If we are unable to resolve a nonperforming loan issue, the credit will be charged off when it is apparent there will be a loss. For large commercial type loans, each relationship is individually analyzed for evidence of apparent loss based on quantitative benchmarks or subjectively based upon certain events or particular circumstances. Old National charges off small commercial loans scored through our small business credit center with contractual balances under $250,000 that have been placed on nonaccrual status or became 90 days or more delinquent, without regard to the collateral position. For residential and consumer loans, a charge off is recorded at the time foreclosure is initiated or when the loan becomes 120 to 180 days past due, whichever is earlier.

For commercial TDRs, an allocated reserve is established within the allowance for loan losses for the difference between the carrying value of the loan and its computed value. To determine the value of the loan, one of the following methods is selected: (1) the present value of expected cash flows discounted at the loan’s original effective interest rate, (2) the loan’s observable market price, or (3) the fair value of the collateral value, if the loan is collateral dependent. The allocated reserve is established as the difference between the carrying value of the loan and the collectable value. If there are significant changes in the amount or timing of the loan’s expected future cash flows, impairment is recalculated and the valuation allowance is adjusted accordingly.

When a residential or consumer loan is identified as a troubled debt restructuring, the loan is written down to its collateral value less selling costs.

The following table presents activity in TDRs for the three months ended March 31, 2016 and 2015:

 

           Commercial                    

(dollars in thousands)

   Commercial     Real Estate     Residential     Consumer     Total  

Three Months Ended March 31, 2016

          

Balance at January 1, 2016

   $ 23,354      $ 14,602      $ 2,693      $ 3,602      $ 44,251   

(Charge-offs)/recoveries

     (826     62        32        (18     (750

Payments

     (3,565     (1,106     (348     (309     (5,328

Additions

     1,542        9,476        133        385        11,536   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2016

   $ 20,505      $ 23,034      $ 2,510      $ 3,660      $ 49,709   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended March 31, 2015

          

Balance at January 1, 2015

   $ 15,205      $ 15,226      $ 2,063      $ 2,459      $ 34,953   

(Charge-offs)/recoveries

     586        248        (15     (11     808   

Payments

     (2,198     (1,608     (33     (164     (4,003

Additions

     1,741        1,573        352        174        3,840   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2015

   $ 15,334      $ 15,439      $ 2,367      $ 2,458      $ 35,598   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Approximately $35.7 million of the TDRs at March 31, 2016 were included with nonaccrual loans, compared to $30.0 million at December 31, 2015. Old National has allocated specific reserves to customers whose loan terms have been modified in TDRs totaling $4.4 million at March 31, 2016 and $2.3 million at December 31, 2015. As of March 31, 2016, Old National had committed to lend an additional $2.8 million to customers with outstanding loans that are classified as TDRs.

 

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The pre-modification and post-modification outstanding recorded investments of loans modified as TDRs during the three months ended March 31, 2016 and 2015 are the same except for when the loan modifications involve the forgiveness of principal. The following table presents loans by class modified as TDRs that occurred during the three months ended March 31, 2016:

 

            Pre-modification      Post-modification  
     Number      Outstanding Recorded      Outstanding Recorded  

(dollars in thousands)

   of Loans      Investment      Investment  

Troubled Debt Restructuring:

        

Commercial

     10       $ 1,542       $ 990   

Commercial Real Estate - Other

     7         9,476         9,476   

Residential

     1         133         133   

Consumer

     8         385         385   
  

 

 

    

 

 

    

 

 

 

Total

     26       $ 11,536       $ 10,984   
  

 

 

    

 

 

    

 

 

 

The TDRs described above increased the allowance for loan losses by $0.2 million and resulted in $0.6 million of charge-offs during the three months ended March 31, 2016.

The following table presents loans by class modified as TDRs that occurred during the three months ended March 31, 2015:

 

            Pre-modification      Post-modification  
     Number      Outstanding Recorded      Outstanding Recorded  

(dollars in thousands)

   of Loans      Investment      Investment  

Troubled Debt Restructuring:

        

Commercial

     11       $ 1,741       $ 1,741   

Commercial Real Estate - Construction

     5         1,187         1,187   

Commercial Real Estate - Other

     5         385         385   

Residential

     2         366         366   

Consumer

     6         161         161   
  

 

 

    

 

 

    

 

 

 

Total

     29       $ 3,840       $ 3,840   
  

 

 

    

 

 

    

 

 

 

The TDRs described above resulted in immaterial changes in the allowance for loan losses and charge-offs during the three months ended March 31, 2015.

A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms.

There were four commercial loans and three commercial real estate loans totaling $0.6 million that were modified as TDRs within the preceding twelve months, and for which there was a payment default during the three months ended March 31, 2016.

There were three commercial loans and one commercial real estate loan totaling $0.3 million that were modified as TDRs within the preceding twelve months, and for which there was a payment default during the three months ended March 31, 2015.

The terms of certain other loans were modified during the three months ended March 31, 2016 that did not meet the definition of a TDR. It is our process to review all classified and criticized loans that, during the period, have been renewed, have entered into a forbearance agreement, have gone from principal and interest to interest only, or have extended the maturity date. In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on its debt in the foreseeable future without the modification. The evaluation is performed under our internal underwriting policy. We also evaluate whether a concession has been granted or if we were adequately compensated through a market interest rate, additional collateral or a bona fide guarantee. We also consider whether the modification was insignificant relative to the other terms of the agreement or if the delay in a payment was 90 days or less.

 

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PCI loans are not considered impaired until after the point at which there has been a degradation of cash flows below our expected cash flows at acquisition. If a PCI loan is subsequently modified, and meets the definition of a TDR, it will be removed from PCI accounting and accounted for as a TDR only if the PCI loan was being accounted for individually. If the purchased credit impaired loan is being accounted for as part of a pool, it will not be removed from the pool. As of March 31, 2016, it has not been necessary to remove any loans from PCI accounting.

In general, once a modified loan is considered a TDR, the loan will always be considered a TDR, and therefore impaired, until it is paid in full, otherwise settled, sold or charged off. However, recent guidance also permits for loans to be removed from TDR status when subsequently restructured under these circumstances: (1) at the time of the subsequent restructuring, the borrower is not experiencing financial difficulties, and this is documented by a current credit evaluation at the time of the restructuring, (2) under the terms of the subsequent restructuring agreement, the institution has granted no concession to the borrower; and (3) the subsequent restructuring agreement includes market terms that are no less favorable than those that would be offered for a comparable new loan. For loans subsequently restructured that have cumulative principal forgiveness, the loan should continue to be measured in accordance with ASC 310-10, “Receivables – Overall”. However, consistent with ASC 310-40-50-2, “Troubled Debt Restructurings by Creditors, Creditor Disclosure of Troubled Debt Restructurings,” the loan would not be required to be reported in the years following the restructuring if the subsequent restructuring meets both of these criteria: (1) has an interest rate at the time of the subsequent restructuring that is not less than a market interest rate; and (2) is performing in compliance with its modified terms after the subsequent restructuring.

Purchased Impaired Loans (noncovered loans)

Purchased loans acquired in a business combination are recorded at estimated fair value on their purchase date with no carryover of the related allowance for loan and lease losses. In determining the estimated fair value of purchased loans, management considers a number of factors including, among others, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, and net present value of cash flows expected to be received. Purchased loans are accounted for in accordance with guidance for certain loans acquired in a transfer (ASC 310-30), when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition that the acquirer will not collect all contractually required principal and interest payments. The difference between contractually required payments and the cash flows expected to be collected at acquisition is referred to as the non-accretable difference. Subsequent decreases to the expected cash flows will generally result in a provision for loan and lease losses. Subsequent increases in expected cash flows will result in a reversal of the provision for loan losses to the extent of prior charges and then an adjustment to accretable yield, which would have a positive impact on interest income.

Old National has purchased loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. For these noncovered loans that meet the criteria of ASC 310-30 treatment, the carrying amount is as follows:

 

     March 31,      December 31,  

(dollars in thousands)

   2016      2015  

Commercial

   $ 674       $ 691   

Commercial real estate

     24,431         28,499   

Residential

     86         127   

Consumer

     3,564         3,925   
  

 

 

    

 

 

 

Carrying amount

     28,755         33,242   

Allowance for loan losses

     (475      (863
  

 

 

    

 

 

 

Carrying amount, net of allowance

   $ 28,280       $ 32,379   
  

 

 

    

 

 

 

The outstanding balance of noncovered loans accounted for under ASC 310-30, including contractual principal, interest, fees and penalties, was $105.0 million at March 31, 2016 and $107.1 million at December 31, 2015.

 

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The accretable difference on purchased loans acquired in a business combination is the difference between the expected cash flows and the net present value of expected cash flows with such difference accreted into earnings using the effective yield method over the term of the loans. Accretion recorded as loan interest income totaled $2.5 million during the three months ended March 31, 2016 and $2.9 million during the three months ended March 31, 2015. Improvement in cash flow expectations has resulted in a reclassification from nonaccretable difference to accretable yield.

Accretable yield of noncovered purchased credit impaired loans, or income expected to be collected, is as follows:

 

           Integra                                      

(dollars in thousands)

   Monroe     Noncovered     IBT     Tower     United     LSB     Founders     Total  

Balance at January 1, 2016

   $ 2,023      $ 1,708      $ 9,486      $ 3,713      $ 2,812      $ 4,971      $ 2,812      $ 27,525   

Accretion of income

     (563     (99     (737     (209     (242     (229     (396     (2,475

Reclassifications from (to) nonaccretable difference

     (511     47        270        347        196        333        411        1,093   

Disposals/other adjustments

     627        126        8        —          10        —          —          771   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2016

   $ 1,576      $ 1,782      $ 9,027      $ 3,851      $ 2,776      $ 5,075      $ 2,827      $ 26,914   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Included in Old National’s allowance for loan losses is $0.5 million related to the purchased loans disclosed above at March 31, 2016, compared to $0.9 million at December 31, 2015.

At acquisition, purchased loans, both covered and noncovered, for which it was probable at acquisition that all contractually required payments would not be collected were as follows:

 

           Integra                                

(dollars in thousands)

   Monroe     Bank (1)     IBT     Tower     United     LSB     Founders  

Contractually required payments

   $ 94,714      $ 921,856      $ 118,535      $ 22,746      $ 15,483      $ 24,493      $ 11,103   

Nonaccretable difference

     (45,157     (226,426     (53,165     (5,826     (5,487     (9,903     (2,684
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows expected to be collected at acquisition

     49,557        695,430        65,370        16,920        9,996        14,590        8,419   

Accretable yield

     (6,971     (98,487     (11,945     (4,065     (1,605     (2,604     (1,812
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fair value of acquired loans at acquisition

   $ 42,586      $ 596,943      $ 53,425      $ 12,855      $ 8,391      $ 11,986      $ 6,607   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes covered and noncovered.

Income would not be recognized on certain purchased loans if Old National could not reasonably estimate cash flows to be collected. Old National had no purchased loans for which it could not reasonably estimate cash flows to be collected.

 

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NOTE 9 – COVERED LOANS

Covered loans represent loans acquired from the FDIC that are subject to loss share agreements. The carrying amount of covered loans was $95.4 million at March 31, 2016, compared to $107.6 million at December 31, 2015. The composition of covered loans by lending classification was as follows:

 

     At March 31, 2016  
     Loans Accounted for      Loans Excluded from         
     Under ASC 310-30      ASC 310-30 (1)         
     (Purchased Credit      (Not Purchased      Total Covered  

(dollars in thousands)

   Impaired)      Credit Impaired)      Purchased Loans  

Commercial

   $ 1,915       $ 6,103       $ 8,018   

Commercial real estate

     13,480         1,440         14,920   

Residential

     15,726         138         15,864   

Consumer

     8,042         48,559         56,601   
  

 

 

    

 

 

    

 

 

 

Covered loans

     39,163         56,240         95,403   

Allowance for loan losses

     (533      (311      (844
  

 

 

    

 

 

    

 

 

 

Covered loans, net

   $ 38,630       $ 55,929       $ 94,559   
  

 

 

    

 

 

    

 

 

 

 

(1) Includes loans with revolving privileges which are scoped out of FASB ASC 310-30 and certain loans which Old National elected to treat under the cost recovery method of accounting.

Loans were recorded at fair value in accordance with FASB ASC 805, Business Combinations. No allowance for loan losses related to the acquired loans is recorded on the acquisition date as the fair value of the loans acquired incorporates assumptions regarding credit risk. Loans acquired are recorded at fair value in accordance with the fair value methodology prescribed in FASB ASC 820, exclusive of the loss share agreements with the FDIC. The fair value estimates associated with the loans include estimates related to expected prepayments and the amount and timing of undiscounted expected principal, interest, and other cash flows.

The outstanding balance of covered loans accounted for under ASC 310-30, including contractual principal, interest, fees and penalties, was $202.4 million at March 31, 2016 and $214.4 million at December 31, 2015.

 

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The following table is a roll-forward of acquired impaired loans accounted for under ASC 310-30 for the three months ended March 31, 2016 and 2015:

 

     Contractual     Nonaccretable     Accretable     Carrying  

(dollars in thousands)

   Cash Flows (1)     Difference     Yield     Amount (2)  

Three Months Ended March 31, 2016

        

Balance at January 1, 2016

   $ 69,857      $ (4,729   $ (17,785   $ 47,343   

Principal reductions and interest payments

     (13,403     (270     —          (13,673

Accretion of loan discount

     —          —          6,186        6,186   

Changes in contractual and expected cash flows due to remeasurement

     1,305        334        (1,777     (138

Removals due to foreclosure or sale

     (1,944     135        270        (1,539

Loans removed from loss share coverage

     323        (6     134        451   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2016

   $ 56,138      $ (4,536   $ (12,972   $ 38,630   
  

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended March 31, 2015

        

Balance at January 1, 2015

   $ 124,809      $ (12,014   $ (35,742   $ 77,053   

Principal reductions and interest payments

     (9,566     (702     —          (10,268

Accretion of loan discount

     —          —          3,344        3,344   

Changes in contractual and expected cash flows due to remeasurement

     (498     3,695        (3,132     65   

Removals due to foreclosure or sale

     (433     133        (129     (429
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2015

   $ 114,312      $ (8,888   $ (35,659   $ 69,765   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) The balance of contractual cash flows includes future contractual interest and is net of amounts charged off and interest collected on nonaccrual loans.
(2) Carrying amount for this table is net of allowance for loan losses.

Over the life of the acquired loans, we continue to estimate cash flows expected to be collected on individual loans or on pools of loans sharing common risk characteristics which were treated in the aggregate when applying various valuation techniques. We evaluate at each balance sheet date whether the present value of loans determined using the effective interest rates has decreased and if so, recognize a provision for loan losses. For any increases in cash flows expected to be collected, we adjust the amount of accretable yield recognized on a prospective basis over the loan’s or pool’s remaining life. Eighty percent of the prospective yield adjustments are offset as Old National will recognize a corresponding change in cash flows expected from the indemnification asset prospectively in a similar manner. The indemnification asset is adjusted over the shorter of the life of the underlying investment or the indemnification agreement.

At March 31, 2016, the $7.7 million loss sharing asset is comprised of a $6.2 million FDIC indemnification asset and a $1.5 million FDIC loss share receivable. The loss share receivable represents actual incurred losses where reimbursement has not yet been received from the FDIC. The indemnification asset represents future cash flows we expect to collect from the FDIC under the loss sharing agreements and the amount related to the estimated improvements in cash flow expectations that are being amortized over the same period for which those improved cash flows are being accreted into income. At March 31, 2016, $4.3 million of the FDIC indemnification asset is related to expected indemnification payments and $1.9 million is expected to be amortized and reported in noninterest income as an offset to future accreted interest income. At March 31, 2015, $8.1 million of the FDIC indemnification asset was related to expected indemnification payments and $8.5 million was expected to be amortized and reported in noninterest income as an offset to future accreted interest income.

For covered loans, we remeasure contractual and expected cash flows on a quarterly basis. When the quarterly re-measurement process results in a decrease in expected cash flows due to an increase in expected credit losses, impairment is recorded. As a result of this impairment, the indemnification asset is increased to reflect anticipated future cash flows to be received from the FDIC. Consistent with the loss sharing agreements between Old National and the FDIC, the amount of the increase to the indemnification asset is measured at 80% of the resulting impairment.

 

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Alternatively, when the quarterly re-measurement results in an increase in expected future cash flows due to a decrease in expected credit losses, the nonaccretable difference decreases and the effective yield of the related loan portfolio is increased. As a result of the improved expected cash flows, the indemnification asset would be reduced first by the amount of any impairment previously recorded and, second, by increased amortization over the remaining life of the related loss sharing agreements or the remaining life of the indemnified asset, whichever is shorter.

The following table shows a detailed analysis of the FDIC loss sharing asset for the three months ended March 31, 2016 and 2015:

 

(dollars in thousands)

   2016      2015  

Balance at January 1,

   $ 9,030       $ 20,603   

Adjustments not reflected in income:

     

Cash received from the FDIC

     (877      —     

Other

     205         389   

Adjustments reflected in income:

     

(Amortization) accretion

     (497      (1,986

Higher (lower) loan loss expectations

     (33      —     

Impairment/(recovery) of value and net (gain)/loss on sales of other real estate

     (125      1,018   
  

 

 

    

 

 

 

Balance at March 31,

   $ 7,703       $ 20,024   
  

 

 

    

 

 

 

Old National has applied with the FDIC to terminate its loss sharing agreements. If agreed upon, the termination of the agreements would result in the elimination of the FDIC indemnification asset and all future gains and losses associated with the covered assets would then be recognized entirely by Old National since the FDIC would no longer be sharing in these gains and losses.

NOTE 10 – OTHER REAL ESTATE OWNED

The following table presents activity in other real estate owned for the three months ended March 31, 2016 and 2015:

 

     Other Real Estate      Other Real Estate  

(dollars in thousands)

   Owned (1)      Owned, Covered  

Three Months Ended March 31, 2016

     

Balance at January 1, 2016

   $ 7,594       $ 4,904   

Additions

     736         1,830   

Sales

     (1,125      (81

(Impairment)/recovery of value

     (186      (150
  

 

 

    

 

 

 

Balance at March 31, 2016

   $ 7,019       $ 6,503   
  

 

 

    

 

 

 

Three Months Ended March 31, 2015

     

Balance at January 1, 2015

   $ 7,241       $ 9,121   

Additions

     1,906         360   

Sales

     (428      (2,556

(Impairment)/recovery of value

     (237      159   
  

 

 

    

 

 

 

Balance at March 31, 2015

   $ 8,482       $ 7,084   
  

 

 

    

 

 

 

 

(1) Includes repossessed personal property of $0.3 million at March 31, 2016 and $0.2 million at March 31, 2015.

At March 31, 2016, foreclosed residential real estate property included in the table above totaled $0.9 million. At March 31, 2016, consumer mortgage loans collateralized by residential real property that were in the process of foreclosure totaled $5.2 million.

 

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Covered OREO expenses and valuation write-downs are recorded in the noninterest expense section of the consolidated statements of income. Under the loss sharing agreements, the FDIC will reimburse us for 80% of expenses and valuation write-downs related to covered assets up to $275.0 million, losses in excess of $275.0 million up to $467.2 million at 0%, and 80% of losses in excess of $467.2 million. Our losses will not exceed $275.0 million. The reimbursable portion of these expenses is recorded in the FDIC indemnification asset. Changes in the FDIC indemnification asset are recorded in the noninterest income section of the consolidated statements of income.

NOTE 11 – GOODWILL AND OTHER INTANGIBLE ASSETS

The following table shows the changes in the carrying amount of goodwill by segment for the three months ended March 31, 2016 and 2015:

 

(dollars in thousands)

   Banking      Insurance      Total  

Three Months Ended March 31, 2016

        

Balance at January 1, 2016

   $ 543,671       $ 40,963       $ 584,634   

Goodwill acquired during the period

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Balance at March 31, 2016

   $ 543,671       $ 40,963       $ 584,634   
  

 

 

    

 

 

    

 

 

 

Three Months Ended March 31, 2015

        

Balance at January 1, 2015

   $ 490,972       $ 39,873       $ 530,845   

Goodwill acquired during the period

     55,969         1,090         57,059   
  

 

 

    

 

 

    

 

 

 

Balance at March 31, 2015

   $ 546,941       $ 40,963       $ 587,904   
  

 

 

    

 

 

    

 

 

 

Goodwill is reviewed annually for impairment. Old National completed its most recent annual goodwill impairment test as of August 31, 2015 and concluded that, based on current events and circumstances, it is not more likely than not that the carrying value of goodwill exceeds fair value. Additionally, the Company evaluated the impact of the sale of its southern Illinois franchise in August of 2015 and concluded that no impairment charge was necessary. See Note 3 to the consolidated financial statements for detail regarding goodwill associated with this divestiture.

See Note 3 to the consolidated financial statements for detail regarding goodwill recorded in 2015 associated with acquisitions.

The gross carrying amount and accumulated amortization of other intangible assets at March 31, 2016 and December 31, 2015 were as follows:

 

     Gross      Accumulated      Net  
     Carrying      Amortization      Carrying  

(dollars in thousands)

   Amount      and Impairment      Amount  

March 31, 2016

        

Amortized intangible assets:

        

Core deposit

   $ 60,103       $ (45,502    $ 14,601   

Customer business relationships

     30,570         (23,800      6,770   

Customer trust relationships

     16,547         (6,210      10,337   

Customer loan relationships

     4,413         (3,678      735   
  

 

 

    

 

 

    

 

 

 

Total intangible assets

   $ 111,633       $ (79,190    $ 32,443   
  

 

 

    

 

 

    

 

 

 

December 31, 2015

        

Amortized intangible assets:

        

Core deposit

   $ 60,103       $ (43,982    $ 16,121   

Customer business relationships

     30,787         (23,341      7,446   

Customer trust relationships

     16,547         (5,286      11,261   

Customer loan relationships

     4,413         (3,933      480   
  

 

 

    

 

 

    

 

 

 

Total intangible assets

   $ 111,850       $ (76,542    $ 35,308   
  

 

 

    

 

 

    

 

 

 

 

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Other intangible assets consist of core deposit intangibles and customer relationship intangibles and are being amortized primarily on an accelerated basis over their estimated useful lives, generally over a period of 5 to 15 years. During the first quarter of 2016, Old National decreased customer business relationships by $0.2 million. These adjustments related to final contingency payments on acquired insurance books of business that occurred in prior years. The adjustments are included in the “Insurance” segment. See Note 21 to the consolidated financial statements for a description of the Company’s operating segments.

Old National reviews other intangible assets for possible impairment whenever events or changes in circumstances indicate that carrying amounts may not be recoverable. No impairment charges were recorded during the three months ended March 31, 2016 or 2015. Total amortization expense associated with intangible assets was $2.6 million for the three months ended March 31, 2016 and $3.1 million for the three months ended March 31, 2015.

Estimated amortization expense for future years is as follows:

 

(dollars in thousands)

      

2016 remaining

   $ 7,232   

2017

     7,581   

2018

     5,799   

2019

     4,317   

2020

     3,036   

Thereafter

     4,478   
  

 

 

 

Total

   $ 32,443   
  

 

 

 

NOTE 12 – LOAN SERVICING RIGHTS

Loan servicing rights were assumed in Old National’s acquisitions of United on July 31, 2014, LSB on November 1, 2014, and Founders on January 1, 2015.

At March 31, 2016, loan servicing rights derived from loans sold with servicing retained totaled $10.5 million and were included in other assets in the consolidated balance sheet, compared to $10.5 million at December 31, 2015. Loans serviced for others are not reported as assets. The principal balance of loans serviced for others was $1.270 billion at March 31, 2016, compared to $1.263 billion at December 31, 2015. Approximately 96% of the loans serviced for others at March 31, 2016 were residential mortgage loans. Custodial escrow balances maintained in connection with serviced loans were $6.4 million at March 31, 2016 and $3.0 million at December 31, 2015.

The following table summarizes the carrying values and activity related to loan servicing rights and the related valuation allowance for the three months ended March 31, 2016 and 2015:

 

(dollars in thousands)

   2016      2015  

Balance at January 1,

   $ 10,502       $ 9,584   

Additions

     481         956   

Amortization

     (447      (518
  

 

 

    

 

 

 

Balance before valuation allowance at March 31,

     10,536         10,022   
  

 

 

    

 

 

 

Valuation allowance:

     

Balance at January 1,

     (34      (50

(Additions)/recoveries

     32         (437
  

 

 

    

 

 

 

Balance at March 31,

     (2      (487
  

 

 

    

 

 

 

Loan servicing rights, net

   $ 10,534       $ 9,535   
  

 

 

    

 

 

 

At March 31, 2016, the fair value of servicing rights was $11.0 million, which was determined using a discount rate of 11% and a weighted average prepayment speed of 175% PSA. At December 31, 2015, the fair value of servicing rights was $11.3 million, which was determined using a discount rate of 11% and a weighted average prepayment speed of 166% PSA.

 

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NOTE 13 – SHORT-TERM BORROWINGS

The following table presents the distribution of Old National’s short-term borrowings and related weighted-average interest rates as of March 31, 2016:

 

                 American        
     Federal     Repurchase     Financial        
     Funds     Agreements /     Exchange        

(dollars in thousands)

   Purchased     Sweeps     Borrowings (1)     Total  

2016

        

Outstanding at March 31, 2016

   $ 155,320      $ 329,060      $ 10,000      $ 494,380   

Average amount outstanding

     104,774        336,044        5,604        446,422   

Maximum amount outstanding at any month-end

     155,320        346,695        20,000     

Weighted average interest rate:

        

During the three months ended March 31, 2016

     0.43     0.07     0.81     0.16

At March 31, 2016

     0.49        0.07        0.57        0.21   

 

(1) In 2015, the Company joined the American Financial Exchange, which is an overnight source of borrowings. No collateral was pledged on these funds.

The following table presents the contractual maturity of our secured borrowings and class of collateral pledged:

 

     At March 31, 2016  
     Remaining Contractual Maturity of the Agreements  
     Overnight and      Up to             Greater Than         

(dollars in thousands)

   Continuous      30 Days      30-90 Days      90 days      Total  

Repurchase Agreements:

              

U.S. Treasury and agency securities

   $ 329,060       $ —         $ —         $ —         $ 329,060   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 329,060       $ —         $ —         $ —         $ 329,060   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The fair value of securities pledged to secure repurchase agreements may decline. The Company has pledged securities valued at 108% of the gross outstanding balance of repurchase agreements at March 31, 2016 to manage this risk.

REVOLVING LOAN

Subsequent to quarter end, the Company entered into a $75.0 million revolving line of credit agreement. The 364 day revolving loan has a variable rate of interest priced at the one-month LIBOR plus 200 basis points. Currently, $50.0 million is outstanding on the loan.

 

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NOTE 14 – FINANCING ACTIVITIES

The following table summarizes Old National’s and its subsidiaries’ other borrowings at March 31, 2016 and December 31, 2015:

 

     March 31,      December 31,  

(dollars in thousands)

   2016      2015  

Old National Bancorp:

     

Senior unsecured bank notes (fixed rate 4.125%) maturing August 2024

   $ 175,000       $ 175,000   

Unamortized debt issuance costs related to Senior unsecured bank notes

     (1,299      (1,338

Junior subordinated debentures (variable rates of 1.97% to 2.39%) maturing March 2035 to June 2037

     45,000         45,000   

ASC 815 fair value hedge and other basis adjustments

     (4,327      (4,442

Old National Bank:

     

Securities sold under agreements to repurchase (fixed rates 2.47% to 2.50%) maturing January 2017 to January 2018

     50,000         50,000   

Federal Home Loan Bank advances (fixed rates 0.56% to 6.76% and variable rates 0.70% to 0.78%) maturing April 2016 to January 2025

     897,645         1,022,766   

Capital lease obligation

     4,019         4,036   

ASC 815 fair value hedge and other basis adjustments

     1,773         725   
  

 

 

    

 

 

 

Total other borrowings

   $ 1,167,811       $ 1,291,747   
  

 

 

    

 

 

 

Contractual maturities of other borrowings at March 31, 2016 were as follows:

 

(dollars in thousands)

      

Due in 2016

   $ 417,338   

Due in 2017

     95,744   

Due in 2018

     195,308   

Due in 2019

     2,867   

Due in 2020

     50,091   

Thereafter

     410,316   

ASC 815 fair value hedge, unamortized debt issuance costs, and other basis adjustments

     (3,853
  

 

 

 

Total

   $ 1,167,811   
  

 

 

 

SENIOR NOTES

In August 2014, Old National issued $175.0 million of senior unsecured notes with a 4.125% interest rate. These notes pay interest on February 15 and August 15. The notes mature on August 15, 2024.

FEDERAL HOME LOAN BANK

Federal Home Loan Bank (“FHLB”) advances had weighted-average rates of 0.96% at March 31, 2016 and 0.72% at December 31, 2015. These borrowings are collateralized by investment securities and residential real estate loans up to 140% of outstanding debt.

JUNIOR SUBORDINATED DEBENTURES

Junior subordinated debentures related to trust preferred securities are classified in “other borrowings”. These securities qualify as Tier 1 capital for regulatory purposes, subject to certain limitations.

 

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In 2007, Old National acquired St. Joseph Capital Trust II in conjunction with its acquisition of St. Joseph Capital Corporation. Old National guarantees the payment of distributions on the trust preferred securities issued by St. Joseph Capital Trust II. St. Joseph Capital Trust II issued $5.0 million in preferred securities in March 2005. The preferred securities have a variable rate of interest priced at the three-month London Interbank Offered Rate (“LIBOR”) plus 175 basis points, payable quarterly and maturing on March 17, 2035. Proceeds from the issuance of these securities were used to purchase junior subordinated debentures with the same financial terms as the securities issued by St. Joseph Capital Trust II.

In 2011, Old National acquired Monroe Bancorp Capital Trust I and Monroe Bancorp Statutory Trust II in conjunction with its acquisition of Monroe Bancorp. Old National guarantees the payment of distributions on the trust preferred securities issued by Monroe Bancorp Capital Trust I and Monroe Bancorp Statutory Trust II. Monroe Bancorp Capital Trust I issued $3.0 million in preferred securities in July 2006. The preferred securities have a variable rate of interest priced at the three-month LIBOR plus 160 basis points. Proceeds from the issuance of these securities were used to purchase junior subordinated debentures with the same financial terms as the securities issued by Monroe Bancorp Capital Trust I. Monroe Bancorp Statutory Trust II issued $5.0 million in preferred securities in March 2007. The preferred securities have a variable rate of interest priced at the three-month LIBOR plus 160 basis points. Proceeds from the issuance of these securities were used to purchase junior subordinated debentures with the same financial terms as the securities issued by Monroe Bancorp Statutory Trust II.

In 2012, Old National acquired Home Federal Statutory Trust I in conjunction with its acquisition of Indiana Community Bancorp. Old National guarantees the payment of distributions on the trust preferred securities issued by Home Federal Statutory Trust I. Home Federal Statutory Trust I issued $15.0 million in preferred securities in September 2006. The preferred securities carry a variable rate of interest priced at the three-month LIBOR plus 165 basis points. Proceeds from the issuance of these securities were used to purchase junior subordinated debentures with the same financial terms as the securities issued by Home Federal Statutory Trust I.

On April 25, 2014, Old National acquired Tower Capital Trust 2 and Tower Capital Trust 3 in conjunction with its acquisition of Tower Financial Corporation. Old National guarantees the payment of distributions on the trust preferred securities issued by Tower Capital Trust 2 and Tower Capital Trust 3. Tower Capital Trust 2 issued $8.0 million in preferred securities in December 2005. The preferred securities carry a variable rate of interest priced at the three-month LIBOR plus 134 basis points. Proceeds from the issuance of these securities were used to purchase junior subordinated debentures with the same financial terms as the securities issued by Tower Capital Trust 2. Tower Capital Trust 3 issued $9.0 million in preferred securities in December 2006. The preferred securities carry a variable rate of interest priced at the three-month LIBOR plus 169 basis points. Proceeds from the issuance of these securities were used to purchase junior subordinated debentures with the same financial terms as the securities issued by Tower Capital Trust 3.

Old National, at any time, may redeem the junior subordinated debentures at par and thereby cause a redemption of the trust preferred securities in whole or in part.

SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

Securities sold under agreements to repurchase are secured borrowings. The Company pledges investment securities to secure these borrowings. The fair value of securities pledged to secure repurchase agreements may decline. The Company has pledged securities valued at 118% of the gross outstanding balance of repurchase agreements at March 31, 2016 to manage this risk.

CAPITAL LEASE OBLIGATION

On January 1, 2004, Old National entered into a long-term capital lease obligation for a branch office building in Owensboro, Kentucky, which extends for 25 years with one renewal option for 10 years. The economic substance of this lease is that Old National is financing the acquisition of the building through the lease and accordingly, the building is recorded as an asset and the lease is recorded as a liability. The fair value of the capital lease obligation was estimated using a discounted cash flow analysis based on Old National’s current incremental borrowing rate for similar types of borrowing arrangements.

 

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At March 31, 2016, the future minimum lease payments under the capital lease were as follows:

 

(dollars in thousands)

      

2016 remaining

   $ 307   

2017

     410   

2018

     410   

2019

     430   

2020

     430   

Thereafter

     8,406   
  

 

 

 

Total minimum lease payments

     10,393   

Less amounts representing interest

     6,374   
  

 

 

 

Present value of net minimum lease payments

   $ 4,019   
  

 

 

 

NOTE 15 – EMPLOYEE BENEFIT PLANS

RETIREMENT PLAN

Old National maintains a funded noncontributory defined benefit plan (the “Retirement Plan”) that was frozen as of December 31, 2005. Retirement benefits are based on years of service and compensation during the highest paid five years of employment. The freezing of the plan provides that future salary increases will not be considered. Old National’s policy is to contribute at least the minimum funding requirement determined by the plan’s actuary. Old National does not expect to contribute cash payments to the Retirement Plan in 2016.

Old National also maintains an unfunded pension restoration plan (the “Restoration Plan”) which provides benefits for eligible employees that are in excess of the limits under Section 415 of the Internal Revenue Code of 1986, as amended, that apply to the Retirement Plan. The Restoration Plan is designed to comply with the requirements of ERISA. The entire cost of the plan, which was also frozen as of December 31, 2005, is supported by contributions from the Company.

Old National contributed $10 thousand to cover benefit payments from the Restoration Plan during the three months ended March 31, 2016. Old National expects to contribute an additional $29 thousand to cover benefit payments from the Restoration Plan during the remainder of 2016.

The net periodic benefit cost and its components were as follows for the three months ended March 31:

 

     Three Months Ended  
     March 31,  

(dollars in thousands)

   2016      2015  

Interest cost

   $ 440       $ 415   

Expected return on plan assets

     (442      (512

Recognized actuarial loss

     494         531   

Settlement loss

     206         206   
  

 

 

    

 

 

 

Net periodic benefit cost

   $ 698       $ 640   
  

 

 

    

 

 

 

In March 2016, we sent to participants and beneficiaries a Notice of Intent to Terminate the Employee Retirement Plan effective May 15, 2016. The complete distribution of the trust fund during the fourth quarter of 2016 is expected to result in a pre-tax charge of $11 million to $14 million and relieve Old National of all future obligations and expense.

NOTE 16 – STOCK-BASED COMPENSATION

At March 31, 2016, Old National had 5.0 million shares remaining available for issuance under the Company’s Amended and Restated 2008 Incentive Compensation Plan. The granting of awards to key employees is typically in the form of restricted stock awards or units.

 

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Restricted Stock Awards

The Company granted 67 thousand time-based restricted stock awards to certain key officers during the three months ended March 31, 2016, with shares vesting over a thirty-six month period. Compensation expense is recognized on a straight-line basis over the vesting period. Shares are subject to certain restrictions and risk of forfeiture by the participants. As of March 31, 2016, unrecognized compensation expense was estimated to be $3.4 million for unvested restricted stock awards.

Old National recorded expense of $0.3 million, net of tax, during the three months ended March 31, 2016, compared to $0.2 million, net of tax, during the three months ended March 31, 2015 related to the vesting of restricted stock awards.

Restricted Stock Units

The Company granted 270 thousand shares of performance based restricted stock units to certain key officers during the three months ended March 31, 2016, with shares vesting at the end of a thirty-six month period based on the achievement of certain targets. For certain awards, the level of performance could increase or decrease the percentage of shares earned. Compensation expense is recognized on a straight-line basis over the vesting period. Shares are subject to certain restrictions and risk of forfeiture by the participants. As of March 31, 2016, unrecognized compensation expense was estimated to be $5.3 million.

Old National recorded stock based compensation expense, net of tax, related to restricted stock units of $0.5 million during the three months ended March 31, 2016 and 2015.

Stock Options

Old National has not granted stock options since 2009. However, Old National did acquire stock options through prior year acquisitions. Old National did not record any stock based compensation expense related to these stock options during the three months ended March 31, 2016 or 2015.

Stock Appreciation Rights

Old National has never granted stock appreciation rights. However, Old National did acquire stock appreciation rights through a prior year acquisition. Old National did not record any incremental expense associated with the conversion of these stock appreciation rights. At March 31, 2016, 81 thousand stock appreciation rights remained outstanding.

NOTE 17 – INCOME TAXES

Following is a summary of the major items comprising the differences in taxes from continuing operations computed at the federal statutory rate and as recorded in the consolidated statements of income for the three months ended March 31:

 

     Three Months Ended  
     March 31,  

(dollars in thousands)

   2016     2015  

Provision at statutory rate of 35%

   $ 12,827      $ 10,546   

Tax-exempt income

     (4,168     (3,852

State income taxes

     583        1,277   

Interim period effective rate adjustment

     (148     1,506   

Other, net

     577        (252
  

 

 

   

 

 

 

Income tax expense

   $ 9,671      $ 9,225   
  

 

 

   

 

 

 

Effective tax rate

     26.4     30.6
  

 

 

   

 

 

 

 

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In accordance with ASC 740-270, Accounting for Interim Reporting, the provision for income taxes was recorded at March 31, 2016 and 2015 based on the current estimate of the effective annual rate.

The lower effective tax rate during the three months ended March 31, 2016 when compared to the three months ended March 31, 2015 is the result of a decrease in the forecasted effective tax rate for 2016 as compared to 2015. In addition, in the first quarter of 2015, the valuation of the state deferred tax asset was reduced due to a change in state apportionment estimates related to the acquisition of Founders, resulting in a higher state income tax expense in 2015.

No valuation allowance was recorded at March 31, 2016 or 2015 because, based on current expectations, Old National believes it will generate sufficient income in future years to realize deferred tax assets.

Unrecognized Tax Benefits

The Company and its subsidiaries file a consolidated U.S. federal income tax return, as well as filing various state returns. Unrecognized state income tax benefits are reported net of their related deferred federal income tax benefit.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

 

(dollars in thousands)

   2016      2015  

Balance at January 1,

   $ 124       $ 77   

Additions based on tax positions related to the current year

     14         11   
  

 

 

    

 

 

 

Balance at March 31,

   $ 138       $ 88   
  

 

 

    

 

 

 

If recognized, approximately $0.1 million of unrecognized tax benefits, net of interest, would favorably affect the effective income tax rate in future periods.

NOTE 18 – DERIVATIVE FINANCIAL INSTRUMENTS

As part of our overall interest rate risk management, Old National uses derivative instruments, including interest rate swaps, caps and floors. The notional amount of these derivative instruments was $761.5 million at March 31, 2016 and December 31, 2015. The March 31, 2016 balances consist of $36.5 million notional amount of receive-fixed, pay-variable interest rate swaps on certain of its FHLB advances and $725.0 million notional amount of pay-fixed, receive-variable interest rate swaps on certain of its FHLB advances. During the first quarter of 2016, $50.0 million notional amount of receive-fixed, pay-variable interest rate swaps on certain commercial loans was terminated resulting in an immaterial gain. The December 31, 2015 balances consist of consist of $36.5 million notional amount of receive-fixed, pay-variable interest rate swaps on certain of its FHLB advances, $675.0 million notional amount of pay-fixed, receive-variable interest rate swaps on certain of its FHLB advances and $50.0 million notional amount of receive-fixed, pay-variable interest rate swaps on certain of its commercial loans. These hedges were entered into to manage interest rate risk. Derivative instruments are recognized on the balance sheet at their fair value and are not reported on a net basis.

In addition, commitments to fund certain mortgage loans (interest rate lock commitments) and forward commitments for the future delivery of mortgage loans to third party investors are considered derivatives. At March 31, 2016, the notional amount of the interest rate lock commitments was $49.1 million and forward commitments were $59.5 million. At December 31, 2015, the notional amount of the interest rate lock commitments was $30.4 million and forward commitments were $33.3 million. It is our practice to enter into forward commitments for the future delivery of residential mortgage loans to third party investors when interest rate lock commitments are entered into in order to economically hedge the effect of changes in interest rates resulting from our commitment to fund the loans.

Old National also enters into derivative instruments for the benefit of its customers. The notional amounts of these customer derivative instruments and the offsetting counterparty derivative instruments were $437.4 million and $437.4 million, respectively, at March 31, 2016. At December 31, 2015, the notional amounts of the customer derivative instruments and the offsetting counterparty derivative instruments were $428.4 million and $428.4 million, respectively. These derivative contracts do not qualify for hedge accounting. These instruments include

 

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interest rate swaps, caps and collars. Commonly, Old National will economically hedge significant exposures related to these derivative contracts entered into for the benefit of customers by entering into offsetting contracts with approved, reputable, independent counterparties with substantially matching terms.

Credit risk arises from the possible inability of counterparties to meet the terms of their contracts. Old National’s exposure is limited to the replacement value of the contracts rather than the notional, principal or contract amounts. There are provisions in our agreements with the counterparties that allow for certain unsecured credit exposure up to an agreed threshold. Exposures in excess of the agreed thresholds are collateralized. In addition, we minimize credit risk through credit approvals, limits, and monitoring procedures.

Amounts reported in AOCI related to cash flow hedges will be reclassified to interest income or interest expense as interest payments are received or paid on the Company’s derivative instruments. During the next 12 months, the Company estimates that $0.3 million will be reclassified to interest income and $7.6 million will be reclassified to interest expense.

On the balance sheet, asset derivatives are included in other assets, and liability derivatives are included in other liabilities. The following table summarizes the fair value of derivative financial instruments utilized by Old National:

 

     March 31, 2016      December 31, 2015  
     Asset      Liability      Asset      Liability  

(dollars in thousands)

   Derivatives      Derivatives      Derivatives      Derivatives  

Derivatives designated as hedging instruments

           

Interest rate contracts

   $ 4,858       $ 25,720       $ 3,794       $ 15,554   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total derivatives designated as hedging instruments

   $ 4,858       $ 25,720       $ 3,794       $ 15,554   
  

 

 

    

 

 

    

 

 

    

 

 

 

Derivatives not designated as hedging instruments

           

Interest rate contracts

   $ 16,817       $ 16,938       $ 11,296       $ 11,414   

Mortgage contracts

     1,390         94         835         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total derivatives not designated as hedging instruments

   $ 18,207       $ 17,032       $ 12,131       $ 11,414   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 23,065       $ 42,752       $ 15,925       $ 26,968   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The effect of derivative instruments on the consolidated statements of income for the three months ended March 31, 2016 and 2015 are as follows:

 

          Three Months Ended  
          March 31,  

(dollars in thousands)

        2016      2015  

Derivatives in

Fair Value Hedging

Relationships

  

Location of Gain or (Loss)

Recognized in Income on

Derivative

   Amount of Gain or (Loss)
Recognized in Income on
Derivative
 

Interest rate contracts (1)

  

Interest income / (expense)

   $ (1,043    $ 23   

Interest rate contracts (2)

  

Other income / (expense)

     50         59   
     

 

 

    

 

 

 

Total

      $ (993    $ 82   
     

 

 

    

 

 

 

Derivatives in

Cash Flow Hedging

Relationships

  

Location of Gain or (Loss)

Recognized in Income on

Derivative

   Amount of Gain or (Loss)
Recognized in Income on
Derivative
 

Interest rate contracts (1)

  

Interest income / (expense)

   $ 86       $ 166   
     

 

 

    

 

 

 

Total

      $ 86       $ 166   
     

 

 

    

 

 

 

Derivatives Not Designated

as Hedging Instruments

  

Location of Gain or (Loss)

Recognized in Income on

Derivative

   Amount of Gain or (Loss)
Recognized in Income on
Derivative
 

Interest rate contracts (3)

  

Other income / (expense)

   $ (3    $ —     

Mortgage contracts

  

Mortgage banking revenue

     461         788   
     

 

 

    

 

 

 

Total

      $ 458       $ 788   
     

 

 

    

 

 

 

 

(1) Amounts represent the net interest payments as stated in the contractual agreements.
(2) Amounts represent ineffectiveness on derivatives designated as fair value hedges.
(3) Includes the valuation differences between the customer and offsetting counterparty swaps.

NOTE 19 – COMMITMENTS AND CONTINGENCIES

LITIGATION

In the normal course of business, Old National Bancorp and its subsidiaries have been named, from time to time, as defendants in various legal actions. Certain of the actual or threatened legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages.

Old National contests liability and/or the amount of damages as appropriate in each pending matter. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases where claimants seek substantial or indeterminate damages or where investigations and proceedings are in the early stages, Old National cannot predict with certainty the loss or range of loss, if any, related to such matters, how or if such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, or other relief, if any, might be. Subject to the foregoing, Old National believes, based on current knowledge and after consultation with counsel, that the outcome of such pending matters will not have a material adverse effect on the consolidated financial condition of Old National, although the outcome of such matters could be material to Old National’s operating results and cash flows for a particular future period, depending on, among other things, the level of Old National’s revenues or income for such period. Old National will accrue for a loss contingency if (1) it is probable that a future event will occur and confirm the loss and (2) the amount of the loss can be reasonably estimated.

In November 2010, Old National was named in a class action lawsuit in Vanderburgh Circuit Court challenging our checking account practices associated with the assessment of overdraft fees. The theory set forth by plaintiffs in this case is similar to other class action complaints filed against other financial institutions in recent years and settled for substantial amounts. On May 1, 2012, the plaintiff was granted permission to file a First Amended Complaint which named additional plaintiffs and amended certain claims. The plaintiffs seek damages, and other relief, including treble damages, attorneys’ fees and costs pursuant to the Indiana Crime Victim’s Relief Act. On June 13, 2012, Old National filed a motion to dismiss the First Amended Complaint, which was subsequently denied by the Court. On September 7, 2012, the plaintiffs filed a motion for class certification, which was granted on March 20, 2013, and

 

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provides for a class of “All Old National Bank customers in the State of Indiana who had one or more consumer accounts and who, within the applicable statutes of limitation through August 15, 2010, incurred an overdraft fee as a result of Old National Bank’s practice of sequencing debit card and ATM transactions from highest to lowest.”

Old National sought an interlocutory appeal on the issue of class certification on April 2, 2013, which was subsequently denied. On June 11, 2013, Old National moved for summary judgment asserting the law as applied to the material facts not in dispute should result in judgment in favor of Old National. On September 16, 2013, a hearing was held on the summary judgment motion and the Motion was denied by the Circuit Court on April 14, 2014. Subsequently, Old National sought and was granted leave to appeal the denial of its Motion for Summary Judgment. On July 11, 2014, the Indiana Court of Appeals accepted the appeal and the parties fully briefed the matter as of February 23, 2015. On April 23, 2015, the Court of Appeals affirmed in part and reversed in part the Circuit Court’s denial of Old National’s Motion for Summary Judgment and remanded the case to the Circuit Court for further proceedings. Specifically, the Court of Appeals rejected Old National’s contention that all of plaintiffs’ claims were preempted by federal law but did agree that plaintiffs’ state law claims of conversion, unconscionability and unjust enrichment were unsupported under Indiana law. The dismissal of these claims removes any claims which would entitle plaintiffs to treble damages. The Court of Appeals determined Old National had not negated plaintiffs’ state law claim for breach of a duty of good faith and fair dealing as to the deposit account agreement and remanded that claim back to the Circuit Court. On May 22, 2015, Old National filed a Petition to Transfer the Case to the Indiana Supreme Court in which it asked the Court to accept an appeal of the remaining count.

On July 23, 2015, the Indiana Supreme Court declined to accept transfer of the case. Thereafter, the case returned to the trial court for further proceedings on the sole remaining count.

The trial court set the case for trial on May 9, 2016 along with various other case management deadlines. On January 11, 2016, Old National filed its second Motion for Summary Judgment addressing the issues discussed in the Court of Appeals opinion. Simultaneously, other deadlines relating to, among other things, witness and exhibit disclosures and expert disclosures were approaching which presented the parties an opportunity to evaluate the pending case. On April 5, 2016, Old National entered into a settlement agreement with plaintiffs providing for a cash payment from Old National in the amount of $4,750,000 in exchange for a full release and dismissal of plaintiffs’ complaint. By entering into the settlement agreement, Old National has not admitted any liability with respect to the lawsuit. The settlement amount had previously been accrued for in the December 31, 2015 financial statements.

On April 14, 2016, the Circuit Court preliminarily approved the settlement agreement, entered an order authorizing notice of the settlement to the class participants, and vacated the May 9, 2016 trial date. Following notice of the settlement to the class participants, the settlement agreement will be subject to final Circuit Court approval which is scheduled for June 13, 2016. Although Old National cannot guarantee that the Circuit Court will approve the settlement agreement, Old National believes it is reasonably likely that the settlement agreemen