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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 September 30, 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 134,985,000 shares outstanding at September 30, 2016.

 

 

 


Table of Contents

OLD NATIONAL BANCORP

FORM 10-Q

INDEX

 

         Page
No.
 

PART I.

 

FINANCIAL INFORMATION

  

Item 1.

 

Financial Statements

  
 

Consolidated Balance Sheets
September 30, 2016 (unaudited), December 31, 2015, and September 30, 2015 (unaudited)

     3   
 

Consolidated Statements of Income (unaudited)
Three and nine months ended September 30, 2016 and 2015

     4   
 

Consolidated Statements of Comprehensive Income (unaudited)
Three and nine months ended September 30, 2016 and 2015

     5   
 

Consolidated Statements of Changes in Shareholders’ Equity (unaudited)
Nine months ended September 30, 2016 and 2015

     6   
 

Consolidated Statements of Cash Flows (unaudited)
Nine months ended September 30, 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

     63   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     87   

Item 4.

 

Controls and Procedures

     88   

PART II

 

OTHER INFORMATION

     88   

SIGNATURE

     90   

 

2


Table of Contents

OLD NATIONAL BANCORP

CONSOLIDATED BALANCE SHEETS

 

     September 30,     December 31,     September 30,  

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

   2016     2015     2015  
     (unaudited)           (unaudited)  

Assets

      

Cash and due from banks

   $ 224,893      $ 91,311      $ 157,919   

Money market and other interest-earning investments

     36,147        128,507        15,491   
  

 

 

   

 

 

   

 

 

 

Total cash and cash equivalents

     261,040        219,818        173,410   

Trading securities - at fair value

     4,973        3,941        3,827   

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

      

U.S. Treasury

     9,265        12,150        12,239   

U.S. government-sponsored entities and agencies

     473,070        613,550        641,780   

Mortgage-backed securities

     1,483,840        1,066,361        1,136,352   

States and political subdivisions

     449,578        387,296        390,103   

Other securities

     342,925        338,864        339,419   
  

 

 

   

 

 

   

 

 

 

Total investment securities - available-for-sale

     2,758,678        2,418,221        2,519,893   

Investment securities - held-to-maturity, at amortized cost (fair value $922,311; $929,417; and $902,176, respectively)

     850,803        872,111        851,051   

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

     101,716        86,146        86,146   

Loans held for sale, at fair value

     60,465        13,810        18,783   

Loans:

      

Commercial

     1,836,380        1,804,615        1,740,394   

Commercial real estate

     3,092,575        1,847,821        1,845,889   

Residential real estate

     2,105,232        1,644,614        1,640,289   

Consumer credit, net of unearned income

     1,870,798        1,543,768        1,507,287   

Covered loans, net of discount

     —          107,587        114,039   
  

 

 

   

 

 

   

 

 

 

Total loans

     8,904,985        6,948,405        6,847,898   

Allowance for loan losses

     (51,547     (51,296     (49,515

Allowance for loan losses - covered loans

     —          (937     (1,711
  

 

 

   

 

 

   

 

 

 

Net loans

     8,853,438        6,896,172        6,796,672   
  

 

 

   

 

 

   

 

 

 

FDIC indemnification asset

     —          9,030        8,905   

Premises and equipment, net

     333,266        196,676        130,341   

Accrued interest receivable

     77,689        69,098        65,485   

Goodwill

     655,210        584,634        584,634   

Other intangible assets

     40,918        35,308        38,124   

Company-owned life insurance

     351,431        341,294        339,352   

Net deferred tax assets

     169,466        109,984        117,374   

Loan servicing rights

     25,920        10,468        10,283   

Assets held for sale

     4,217        5,679        4,744   

Other real estate owned and repossessed personal property

     23,719        7,594        9,282   

Other real estate owned - covered

     —          4,904        4,423   

Other assets

     130,122        106,639        151,057   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 14,703,071      $ 11,991,527      $ 11,913,786   
  

 

 

   

 

 

   

 

 

 

Liabilities

      

Deposits:

      

Noninterest-bearing demand

   $ 2,944,331      $ 2,488,855      $ 2,388,854   

Interest-bearing:

      

NOW

     2,486,190        2,133,536        2,001,077   

Savings

     2,963,637        2,201,352        2,201,066   

Money market

     687,895        577,050        1,043,135   

Time

     1,564,655        1,000,067        987,193   
  

 

 

   

 

 

   

 

 

 

Total deposits

     10,646,708        8,400,860        8,621,325   

Short-term borrowings

     422,924        628,499        474,894   

Other borrowings

     1,600,175        1,291,747        1,118,949   

Accrued expenses and other liabilities

     198,807        179,251        222,616   
  

 

 

   

 

 

   

 

 

 

Total liabilities

     12,868,614        10,500,357        10,437,784   
  

 

 

   

 

 

   

 

 

 

Shareholders’ Equity

      

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

     —          —          —     

Common stock, $1.00 per share stated value, 300,000 shares authorized, 134,985; 114,297; and 114,523 shares issued and outstanding, respectively

     134,985        114,297        114,523   

Capital surplus

     1,343,740        1,087,911        1,090,381   

Retained earnings

     374,561        323,759        305,478   

Accumulated other comprehensive income (loss), net of tax

     (18,829     (34,797     (34,380
  

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

     1,834,457        1,491,170        1,476,002   
  

 

 

   

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 14,703,071      $ 11,991,527      $ 11,913,786   
  

 

 

   

 

 

   

 

 

 

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     Nine Months Ended  
     September 30,     September 30,  

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

   2016      2015     2016      2015  

Interest Income

          

Loans including fees:

          

Taxable

   $ 94,866       $ 81,881      $ 252,965       $ 233,419   

Nontaxable

     3,004         2,832        8,999         8,593   

Investment securities:

          

Taxable

     14,612         14,293        41,919         43,311   

Nontaxable

     7,208         6,661        21,309         18,888   

Money market and other interest-earning investments

     23         4        93         18   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total interest income

     119,713         105,671        325,285         304,229   
  

 

 

    

 

 

   

 

 

    

 

 

 

Interest Expense

          

Deposits

     4,819         3,474        12,566         10,568   

Short-term borrowings

     324         141        916         349   

Other borrowings

     6,767         4,952        19,017         13,118   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total interest expense

     11,910         8,567        32,499         24,035   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net interest income

     107,803         97,104        292,786         280,194   

Provision for loan losses

     1,306         167        2,716         2,439   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net interest income after provision for loan losses

     106,497         96,937        290,070         277,755   
  

 

 

    

 

 

   

 

 

    

 

 

 

Noninterest Income

          

Wealth management fees

     8,572         8,290        26,048         26,253   

Service charges on deposit accounts

     11,054         11,010        31,130         33,333   

Debit card and ATM fees

     4,330         3,887        12,586         17,694   

Mortgage banking revenue

     7,718         3,170        15,841         10,395   

Insurance premiums and commissions

     132         9,938        20,375         32,223   

Investment product fees

     5,038         4,427        13,667         13,549   

Company-owned life insurance

     2,163         2,195        6,281         6,540   

Net securities gains

     1,647         861        4,609         4,056   

Recognition of deferred gain on sale leaseback transactions

     235         1,417        2,325         4,409   

Gain on sale of ONB Insurance Group, Inc.

     —           —          41,864         —     

Net gain on branch divestitures

     —           15,355        —           15,355   

Change in FDIC indemnification asset

     —           (6,582     233         (9,091

Other income

     6,354         5,776        15,120         15,302   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total noninterest income

     47,243         59,744        190,079         170,018   
  

 

 

    

 

 

   

 

 

    

 

 

 

Noninterest Expense

          

Salaries and employee benefits

     60,861         58,151        180,548         187,093   

Occupancy

     12,944         13,009        39,356         41,443   

Equipment

     3,564         2,977        9,773         10,327   

Marketing

     3,528         2,727        11,125         8,641   

Data processing

     8,242         6,622        24,041         21,289   

Communication

     2,755         2,301        7,154         7,480   

Professional fees

     3,252         2,435        11,801         8,948   

Loan expense

     2,213         1,420        5,669         4,562   

Supplies

     799         445        1,980         1,710   

FDIC assessment

     2,149         1,733        6,098         5,590   

Other real estate owned expense

     728         584        3,251         2,221   

Amortization of intangibles

     3,233         2,872        9,245         8,930   

Other expense

     3,794         7,341        17,848         20,229   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total noninterest expense

     108,062         102,617        327,889         328,463   
  

 

 

    

 

 

   

 

 

    

 

 

 

Income before income taxes

     45,678         54,064        152,260         119,310   

Income tax expense

     10,969         16,395        51,452         34,579   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income

   $ 34,709       $ 37,669      $ 100,808       $ 84,731   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income per common share - basic

   $ 0.25       $ 0.33      $ 0.80       $ 0.73   

Net income per common share - diluted

     0.25         0.33        0.80         0.73   
  

 

 

    

 

 

   

 

 

    

 

 

 

Weighted average number of common shares outstanding - basic

     134,492         114,590        125,366         116,272   

Weighted average number of common shares outstanding - diluted

     135,011         115,153        125,839         116,800   
  

 

 

    

 

 

   

 

 

    

 

 

 

Dividends per common share

   $ 0.13       $ 0.12      $ 0.39       $ 0.36   

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     Nine Months Ended  
     September 30,     September 30,  

(dollars in thousands)

   2016     2015     2016     2015  

Net income

   $ 34,709      $ 37,669      $ 100,808      $ 84,731   

Other comprehensive income (loss):

        

Change in securities available-for-sale:

        

Unrealized holding gains for the period

     3,428        14,509        33,956        6,581   

Reclassification adjustment for securities gains realized in income

     (1,647     (861     (4,609     (4,056

Income tax effect

     (693     (5,021     (10,670     (1,101
  

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized gains on available-for-sale securities

     1,088        8,627        18,677        1,424   

Change in securities held-to-maturity:

        

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

     439        455        1,370        1,222   

Income tax effect

     (150     (155     (468     (236
  

 

 

   

 

 

   

 

 

   

 

 

 

Changes from securities held-to-maturity

     289        300        902        986   

Cash flow hedges:

        

Net unrealized derivative gains (losses) on cash flow hedges

     3,133        (10,278     (12,480     (12,349

Reclassification adjustment for losses realized in net income

     1,865        902        4,723        1,527   

Income tax effect

     (1,899     3,563        2,948        4,112   
  

 

 

   

 

 

   

 

 

   

 

 

 

Changes from cash flow hedges

     3,099        (5,813     (4,809     (6,710

Defined benefit pension plans:

        

Amortization of net loss recognized in income

     503        917        1,933        2,380   

Income tax effect

     (191     (349     (735     (905
  

 

 

   

 

 

   

 

 

   

 

 

 

Changes from defined benefit pension plans

     312        568        1,198        1,475   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss), net of tax

     4,788        3,682        15,968        (2,825
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 39,497      $ 41,351      $ 116,776      $ 81,906   
  

 

 

   

 

 

   

 

 

   

 

 

 

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)

 

(dollars in thousands)

   Common
Stock
    Capital
Surplus
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Shareholders’
Equity
 

Balance at December 31, 2014

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

Net income

     —          —          84,731        —          84,731   

Other comprehensive loss

     —          —          —          (2,825     (2,825

Acquisition of Founders Financial Corporation

     3,402        47,224        —          —          50,626   

Dividends - common stock

     —          —          (41,817     —          (41,817

Common stock issued

     21        271        —          —          292   

Common stock repurchased

     (6,080     (78,165     —          —          (84,245

Stock based compensation expense

     —          3,517        —          —          3,517   

Stock activity under incentive compensation plans

     333        (758     384        —          (41
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2015

   $ 114,523      $ 1,090,381      $ 305,478      $ (34,380   $ 1,476,002   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2015

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

Net income

     —          —          100,808        —          100,808   

Other comprehensive income

     —          —          —          15,968        15,968   

Acquisition of Anchor BanCorp Wisconsin Inc.

     20,415        253,150        —          —          273,565   

Dividends - common stock

     —          —          (49,962     —          (49,962

Common stock issued

     24        272        —          —          296   

Common stock repurchased

     (146     (1,759     —          —          (1,905

Stock based compensation expense

     —          5,070        —          —          5,070   

Stock activity under incentive compensation plans

     395        (904     (44     —          (553
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2016

   $ 134,985      $ 1,343,740      $ 374,561      $ (18,829   $ 1,834,457   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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)

 

     Nine Months Ended  
     September 30,  

(dollars in thousands)

   2016     2015  

Cash Flows From Operating Activities

    

Net income

   $ 100,808      $ 84,731   
  

 

 

   

 

 

 

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

    

Depreciation

     11,399        10,865   

Amortization of other intangible assets

     9,245        8,930   

Net premium amortization on investment securities

     14,331        14,023   

Amortization of and net gains on termination of FDIC indemnification asset

     (458     9,091   

Stock compensation expense

     5,070        3,517   

Provision for loan losses

     2,716        2,439   

Net securities gains

     (4,609     (4,056

Recognition of deferred gain on sale leaseback transactions

     (2,325     (4,409

Gain on sale of ONB Insurance Group, Inc.

     (41,864     —     

Net gain on branch divestitures

     —          (15,355

Net gains on sales of other assets

     (6,019     (5,021

Increase in cash surrender value of company-owned life insurance

     (2,859     (5,438

Residential real estate loans originated for sale

     (447,191     (278,850

Proceeds from sale of residential real estate loans

     416,208        283,971   

Increase in interest receivable

     (1,283     (3,910

Decrease in other real estate owned

     7,022        3,331   

(Increase) decrease in other assets

     22,153        (35,009

Decrease in accrued expenses and other liabilities

     (11,059     (1,416
  

 

 

   

 

 

 

Total adjustments

     (29,523     (17,297
  

 

 

   

 

 

 

Net cash flows provided by operating activities

     71,285        67,434   
  

 

 

   

 

 

 

Cash Flows From Investing Activities

    

Cash portion of bank purchase price, net of cash acquired

     (62,532     (37,098

Proceeds from sale of ONB Insurance Group, Inc.

     91,771        —     

Payments related to branch divestitures

     —          (333,095

Purchases of investment securities available-for-sale

     (1,281,062     (716,510

Purchases of investment securities held-to-maturity

     —          (44,479

Purchases of Federal Home Loan Bank/Federal Reserve Bank stock

     (10,974     (21,872

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

     1,043,014        601,586   

Proceeds from sales of investment securities available-for-sale

     157,819        296,841   

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

     16,324        32,049   

Proceeds from sales of investment securities held-to-maturity

     —          855   

Proceeds from sales of Federal Home Loan Bank/Federal Reserve Bank stock

     —          8,711   

Reimbursements under FDIC loss share agreements

     10,000        3,555   

Net principal collected from (loans made to) loan customers

     (322,876     (185,891

Proceeds from sale of premises and equipment and other assets

     6,332        7,709   

Purchases of premises and equipment and other assets

     (117,899     (14,259
  

 

 

   

 

 

 

Net cash flows used in investing activities

     (470,083     (401,898
  

 

 

   

 

 

 

Cash Flows From Financing Activities

    

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

    

Deposits

     393,135        309,793   

Short-term borrowings

     (208,707     (88,907

Payments for maturities on other borrowings

     (592,927     (227,503

Proceeds from issuance of other borrowings

     900,000        400,000   

Cash dividends paid on common stock

     (49,962     (41,817

Common stock repurchased

     (1,905     (84,245

Proceeds from exercise of stock options, including tax benefit

     90        298   

Common stock issued

     296        292   
  

 

 

   

 

 

 

Net cash flows provided by financing activities

     440,020        267,911   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     41,222        (66,553

Cash and cash equivalents at beginning of period

     219,818        239,963   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 261,040      $ 173,410   
  

 

 

   

 

 

 

Supplemental cash flow information:

    

Total interest paid

   $ 33,394      $ 25,470   

Total taxes paid (net of refunds)

   $ 25,900      $ 8,784   

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

 

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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 September 30, 2016 and 2015, and December 31, 2015, and the results of its operations for the three and nine months ended September 30, 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 606In 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, 2017. We do not expect the new standard to result in a material change from our current accounting for revenue, but it will result in new disclosure requirements.

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 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.

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

 

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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.

In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. The amendments do not change the core revenue recognition principle in Topic 606. The amendments provide clarifying guidance in certain narrow areas and add some practical expedients.

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.

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.

FASB ASC 350In 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 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 944In 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.

 

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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 842In 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 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 is largely unchanged. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2018. Based on leases outstanding as of September 30, 2016, we do not expect the new standard to have a material impact on our income statement, but anticipate a $140 million to $200 million increase in our assets and liabilities. Decisions to repurchase, modify or renew leases prior to the implementation date will impact this level of materiality.

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.

 

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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.

FASB ASC 326In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The main objective of this amendment is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The amendment requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to enhance their credit loss estimates. The amendment requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2019. Early adoption will be permitted beginning after December 15, 2018. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements.

FASB ASC 230In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230). This update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice of how certain cash receipts and cash payments are presented and classified in the statement of cash flow. Adopting the new guidance will not have a material impact on Old National. The amendments in this update are effective for fiscal years and interim periods beginning after December 15, 2017; however early adoption is permitted.

 

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FASB ASC 740In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. Current guidance prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. This prohibition on recognition is an exception to the principle of comprehensive recognition of current and deferred income taxes in generally accepted accounting principles. The exception has led to diversity in practice and is a source of complexity in financial reporting. FASB decided that an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Consequently, the amendments in this update eliminate the exception for an intra-entity transfer of an asset other than inventory. The amendments in this update do not include new disclosure requirements; however, existing disclosure requirements might be applicable when accounting for the current and deferred income taxes for an intra-entity transfer of an asset other than inventory. For public business entities, the amendments in this update are effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within those annual reporting periods. The amendments in this update should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. 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.

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.

 

     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   

Anchor BanCorp Wisconsin Inc.

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. The acquisition was completed effective May 1, 2016 (the “Closing Date”). Anchor was a savings and loan holding company with AnchorBank, fsb (“AnchorBank”) as its wholly-owned subsidiary. AnchorBank operated 46 banking centers, including 32 banking centers in the Madison, Milwaukee and Fox Valley triangle. 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.

 

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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 a maximum of 40% of the purchase price in cash. The total purchase price for Anchor was $459.8 million, consisting of $186.2 million of cash and the issuance of 20.4 million shares of Old National Common Stock valued at $273.6 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 September 30, 2016, transaction and integration costs of $14.1 million associated with the acquisition have been expensed and remaining integration costs will be expensed in future periods as incurred.

Under the acquisition method of accounting, the total estimated purchase price is allocated to net tangible and intangible assets based on their current estimated fair values on the date of acquisition. Based on management’s preliminary valuation of the fair value of tangible and intangible assets acquired and liabilities assumed, which are based on assumptions that are subject to change, the purchase price for the Anchor acquisition is allocated as follows (in thousands):

 

Cash and cash equivalents

   $ 123,657   

Investment securities

     235,240   

Federal Home Loan Bank stock

     4,596   

Loans held for sale

     9,334   

Loans

     1,637,106   

Premises and equipment

     35,721   

Accrued interest receivable

     7,308   

Other real estate owned

     18,243   

Company-owned life insurance

     7,278   

Other assets

     125,825   

Deposits

     (1,852,713

Other borrowings

     (3,255

Accrued expenses and other liabilities

     (36,958
  

 

 

 

Net tangible assets acquired

     311,382   

Definite-lived intangible assets acquired

     21,559   

Loan servicing rights

     15,274   

Goodwill

     111,539   
  

 

 

 

Purchase price

   $ 459,754   
  

 

 

 

Prior to the end of the one year measurement period for finalizing the purchase price allocation, if information becomes available which would indicate adjustments are required to the purchase price allocation, such adjustments will be included in the purchase price allocation in the reporting period in which the adjustment amounts are determined.

The portion of the purchase price allocated to goodwill will not be deductible for tax purposes.

The estimated fair value of the core deposit intangible is $21.6 million and will be amortized over an estimated useful life of 7 years.

Acquired loan data for Anchor 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

   $ 20,174       $ 29,544       $ 6,153   

Acquired receivables not subject to ASC 310-30

   $ 1,616,932       $ 2,143,532       $ 274,155   

 

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Summary of Unaudited Pro-forma Information

The unaudited pro-forma information below for the periods ended September 30, 2016 and 2015 gives effect to the Anchor acquisition as if it had occurred on January 1, 2015. The pro-forma financial information is not necessarily indicative of the results of operations if the acquisition had been effective as of this date.

 

     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  

(dollars in thousands)

   2016      2015      2016      2015  

Revenue (1)

   $ 155,046       $ 182,855       $ 526,523       $ 529,177   

Income before income taxes

   $ 51,165       $ 74,442       $ 187,800       $ 141,796   

 

(1) Net interest income plus noninterest income.

2016 supplemental pro-forma earnings were adjusted to exclude $5.5 million and $14.1 million of acquisition-related costs incurred during the three and nine months ended September 30, 2016, respectively. 2015 supplemental pro-forma earnings were adjusted to include these charges.

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. The customer business relationship intangibles were originally scheduled to be amortized using an accelerated method over an estimated useful life of 10 years.

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. The customer business relationship intangibles were originally scheduled to 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.

On May 31, 2016 the Company completed its previously announced sale of its insurance operations, ONB Insurance Group, Inc. (“ONI”). The Company received approximately $91.8 million in cash resulting in a pre-tax gain of $41.9 million and an after-tax gain of $17.6 million. See Note 19 to the consolidated financial statements for further details on the income tax impact of this sale. Goodwill and intangible assets of approximately $47.5 million were eliminated as part of this transaction. ONI was an ancillary business and did not meet the criteria to be treated as a discontinued operation as defined in Accounting Standards Update 2014-08 “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity”.

 

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NOTE 4 - NET INCOME PER SHARE

The following table reconciles basic and diluted net income per share for the three and nine months ended September 30, 2016 and 2015:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 

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

   2016      2015      2016      2015  

Basic Earnings Per Share

           

Net income

   $ 34,709       $ 37,669       $ 100,808       $ 84,731   

Weighted average common shares outstanding

     134,492         114,590         125,366         116,272   

Basic Earnings Per Share

   $ 0.25       $ 0.33       $ 0.80       $ 0.73   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted Earnings Per Share

           

Net income

   $ 34,709       $ 37,669       $ 100,808       $ 84,731   

Weighted average common shares outstanding

     134,492         114,590         125,366         116,272   

Effect of dilutive securities:

           

Restricted stock

     465         477         432         435   

Stock options (1)

     54         86         41         93   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding

     135,011         115,153         125,839         116,800   

Diluted Earnings Per Share

   $ 0.25       $ 0.33       $ 0.80       $ 0.73   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Options to purchase 0.9 million shares outstanding at September 30, 2016 and 2015 were not included in the computation of net income per diluted share for the three months ended September 30, 2016 and 2015 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. Options to purchase 0.8 million shares and 0.9 million shares outstanding at September 30, 2016 and 2015, respectively, were not included in the computation of net income per diluted share for the nine months ended September 30, 2016 and 2015, respectively, 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 and nine months ended September 30, 2016 and 2015:

 

(dollars in thousands)

   Unrealized Gains
and Losses on
Available-for-Sale
Securities
    Unrealized Gains
and Losses on
Held-to-Maturity
Securities
    Gains and
Losses on
Cash Flow
Hedges
    Defined
Benefit
Pension
Plans
    Total  

Three Months Ended September 30, 2016

  

       

Balance at July 1, 2016

   $ 13,783      $ (13,867   $ (17,184   $ (6,349   $ (23,617

Other comprehensive income (loss) before reclassifications

     2,094        —          1,943        —          4,037   

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

     (1,006     289        1,156        312        751   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net other comprehensive income (loss)

     1,088        289        3,099        312        4,788   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2016

   $ 14,871      $ (13,578   $ (14,085   $ (6,037   $ (18,829
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended September 30, 2015

  

       

Balance at July 1, 2015

   $ (7,951   $ (15,090   $ (6,832   $ (8,189   $ (38,062

Other comprehensive income (loss) before reclassifications

     9,171        —          (6,373     —          2,798   

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

     (544     300        560        568        884   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net other comprehensive income (loss)

     8,627        300        (5,813     568        3,682   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2015

   $ 676      $ (14,790   $ (12,645   $ (7,621   $ (34,380
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nine Months Ended September 30, 2016

          

Balance at January 1, 2016

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

Other comprehensive income (loss) before reclassifications

     21,584        —          (8,446     —          13,138   

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

     (2,907     902        3,637        1,198        2,830   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net other comprehensive income (loss)

     18,677        902        (4,809     1,198        15,968   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2016

   $ 14,871      $ (13,578   $ (14,085   $ (6,037   $ (18,829
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nine Months Ended September 30, 2015

          

Balance at January 1, 2015

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

Other comprehensive income (loss) before reclassifications

     3,982        —          (7,657     —          (3,675

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

     (2,558     986        947        1,475        850   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net other comprehensive income (loss)

     1,424        986        (6,710     1,475        (2,825
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2015

   $ 676      $ (14,790   $ (12,645   $ (7,621   $ (34,380
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(a) See table below for details about reclassifications.

 

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The following table summarizes the significant amounts reclassified out of each component of AOCI for the three months ended September 30, 2016 and 2015:

 

Details about AOCI Components

   Amount Reclassified
from AOCI
    

Affected Line Item in the

Statement of Income

     Three Months Ended
September 30,
      

(dollars in thousands)

   2016      2015       

Unrealized gains and losses on available-for-sale securities

   $ 1,647       $ 861       Net securities gains
     (641      (317    Income tax (expense) benefit
  

 

 

    

 

 

    
   $ 1,006       $ 544       Net income
  

 

 

    

 

 

    

Unrealized gains and losses on held-to-maturity securities

   $ (439    $ (455    Interest income/(expense)
     150         155       Income tax (expense) benefit
  

 

 

    

 

 

    
   $ (289    $ (300    Net income
  

 

 

    

 

 

    

Gains and losses on cash flow hedges Interest rate contracts

   $ (1,865    $ (902    Interest income/(expense)
     709         342       Income tax (expense) benefit
  

 

 

    

 

 

    
   $ (1,156    $ (560    Net income
  

 

 

    

 

 

    

Amortization of defined benefit pension items

        

Actuarial gains/(losses)

   $ (503    $ (917    Salaries and employee benefits
     191         349       Income tax (expense) benefit
  

 

 

    

 

 

    
   $ (312    $ (568    Net income
  

 

 

    

 

 

    

Total reclassifications for the period

   $ (751    $ (884    Net income
  

 

 

    

 

 

    

 

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The following table summarizes the significant amounts reclassified out of each component of AOCI for the nine months ended September 30, 2016 and 2015:

 

Details about AOCI Components

   Amount Reclassified
from AOCI
    

Affected Line Item in the

Statement of Income

     Nine Months Ended
September 30,
      

(dollars in thousands)

   2016      2015       

Unrealized gains and losses on available-for-sale securities

   $ 4,609       $ 4,056       Net securities gains
     (1,702      (1,498   

Income tax (expense) benefit

  

 

 

    

 

 

    
   $ 2,907       $ 2,558      

Net income

  

 

 

    

 

 

    

Unrealized gains and losses on held-to-maturity securities

   $ (1,370    $ (1,222    Interest income/(expense)
     468         236      

Income tax (expense) benefit

  

 

 

    

 

 

    
   $ (902    $ (986   

Net income

  

 

 

    

 

 

    

Gains and losses on cash flow hedges Interest rate contracts

   $ (4,723    $ (1,527    Interest income/(expense)
     1,086         580      

Income tax (expense) benefit

  

 

 

    

 

 

    
   $ (3,637    $ (947   

Net income

  

 

 

    

 

 

    

Amortization of defined benefit pension items

        

Actuarial gains/(losses)

   $ (1,933    $ (2,380   

Salaries and employee benefits

     735         905      

Income tax (expense) benefit

  

 

 

    

 

 

    
   $ (1,198    $ (1,475   

Net income

  

 

 

    

 

 

    

Total reclassifications for the period

   $ (2,830    $ (850   

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 September 30, 2016 and December 31, 2015 and the corresponding amounts of unrealized gains and losses therein:

 

(dollars in thousands)

   Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
     Fair
Value
 

September 30, 2016

           

Available-for-Sale

           

U.S. Treasury

   $ 8,960       $ 305       $ —         $ 9,265   

U.S. government-sponsored entities and agencies

     470,516         3,029         (475      473,070   

Mortgage-backed securities - Agency

     1,468,624         17,855         (2,639      1,483,840   

States and political subdivisions

     433,795         16,413         (630      449,578   

Pooled trust preferred securities

     17,007         —           (10,233      6,774   

Other securities

     336,271         4,412         (4,532      336,151   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $ 2,735,173       $ 42,014       $ (18,509    $ 2,758,678   
  

 

 

    

 

 

    

 

 

    

 

 

 

Held-to-Maturity

           

U.S. government-sponsored entities and agencies

   $ 140,391       $ 1,008       $ —         $ 141,399   

Mortgage-backed securities - Agency

     11,843         486         —           12,329   

States and political subdivisions

     698,569         70,016         (2      768,583   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total held-to-maturity securities

   $ 850,803       $ 71,510       $ (2    $ 922,311   
  

 

 

    

 

 

    

 

 

    

 

 

 

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 and nine months ended September 30, 2016 and 2015:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 

(dollars in thousands)

   2016      2015      2016      2015  

Proceeds from sales of available-for-sale securities

   $ 50,368       $ 100,257       $ 157,819       $ 296,841   

Proceeds from calls of available-for-sale securities

     160,805         108,790         525,114         321,792   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 211,173       $ 209,047       $ 682,933       $ 618,633   
  

 

 

    

 

 

    

 

 

    

 

 

 

Realized gains on sales of available-for-sale securities

   $ 1,062       $ 1,315       $ 4,213       $ 4,112   

Realized gains on calls of available-for-sale securities

     477         99         848         479   

Realized losses on sales of available-for-sale securities

     (2      (373      (450      (420

Realized losses on calls of available-for-sale securities

     (15      —           (103      (15

Other securities gains (losses) (1)

     125         (180      101         (100
  

 

 

    

 

 

    

 

 

    

 

 

 

Net securities gains

   $ 1,647       $ 861       $ 4,609       $ 4,056   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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

During the nine months ended September 30, 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 trusts associated with deferred compensation plans for former directors and executives, are recorded at fair value and totaled $5.0 million at September 30, 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 September 30, 2016  
(dollars in thousands)           Weighted  
     Amortized      Fair      Average  

Maturity

   Cost      Value      Yield  

Available-for-Sale

        

Within one year

   $ 33,986       $ 34,080         1.68

One to five years

     338,607         343,626         2.09   

Five to ten years

     351,830         359,712         2.76   

Beyond ten years

     2,010,750         2,021,260         2.35   
  

 

 

    

 

 

    

 

 

 

Total

   $ 2,735,173       $ 2,758,678         2.36
  

 

 

    

 

 

    

 

 

 

Held-to-Maturity

        

Within one year

   $ 7,433       $ 7,519         3.82 % 

One to five years

     52,130         55,239         4.94   

Five to ten years

     237,605         249,104         3.87   

Beyond ten years

     553,635         610,449         5.52   
  

 

 

    

 

 

    

 

 

 

Total

   $ 850,803       $ 922,311         5.01 % 
  

 

 

    

 

 

    

 

 

 

 

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The following table summarizes the investment securities with unrealized losses at September 30, 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  

(dollars in thousands)

   Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
 

September 30, 2016

               

Available-for-Sale

               

U.S. Treasury

   $ 2,000       $ —        $ —         $ —        $ 2,000       $ —     

U.S. government-sponsored entities and agencies

     92,525         (475     —           —          92,525         (475

Mortgage-backed securities - Agency

     167,158         (1,551     61,689         (1,088     228,847         (2,639

States and political subdivisions

     35,316         (542     5,472         (88     40,788         (630

Pooled trust preferred securities

     —           —          6,774         (10,233     6,774         (10,233

Other securities

     2,746         (29     148,194         (4,503     150,940         (4,532
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total available-for-sale

   $ 299,745       $ (2,597   $ 222,129       $ (15,912   $ 521,874       $ (18,509
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Held-to-Maturity

               

States and political subdivisions

   $ 1,813       $ (2   $ —         $ —        $ 1,813       $ (2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total held-to-maturity

   $ 1,813       $ (2   $ —         $ —        $ 1,813       $ (2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

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.

 

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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 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 nine months ended September 30, 2016 or 2015.

As of September 30, 2016, Old National’s securities portfolio consisted of 1,732 securities, 102 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 September 30, 2016, our securities portfolio contained three pooled trust preferred securities with a fair value of $6.8 million and unrealized losses of $10.2 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 $2.9 million at September 30, 2016. This security was rated A3 at inception, but is rated D at September 30, 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 nine months ended September 30, 2016 and 2015, our model indicated no other-than-temporary-impairment losses on this security. At September 30, 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 $6.6 million and unrealized losses of $7.3 million at September 30, 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 nine months ended September 30, 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.

 

Trust preferred securities

September 30, 2016

(dollars in thousands)

  Class     Lowest
Credit
Rating (1)
    Amortized
Cost
    Fair
Value
    Unrealized
Gain/
(Loss)
    Realized
Losses
2016
    # of Issuers
Currently
Performing/
Remaining
    Actual
Deferrals
and Defaults
as a % of
Original
Collateral
    Expected
Defaults as
a % of
Remaining
Performing
Collateral
    Excess
Subordination
as a % of
Current
Performing
Collateral
 

Pooled trust preferred securities:

  

               

Reg Div Funding 2004

    B-2        D      $ 3,111      $ 211      $ (2,900   $ —          23/39        33.3     7.3     0.0

Pretsl XXVII LTD

    B        B        4,422        2,035        (2,387     —          35/44        16.7     4.1     47.5

Trapeza Ser 13A

    A2A        BBB        9,474        4,528        (4,946     —          50/56        5.9     4.9     46.6
     

 

 

   

 

 

   

 

 

   

 

 

         
        17,007        6,774        (10,233     —             

Single Issuer trust preferred securities:

  

             

Fleet Cap Tr V (BOA)

      BB+        3,395        2,993        (402     —             

JP Morgan Chase Cap XIII

      BBB-        4,764        4,175        (589     —             

NB-Global

      BB+        781        868        87        —             

Chase Cap II

      BBB-        819        880        61        —             
     

 

 

   

 

 

   

 

 

   

 

 

         
        9,759        8,916        (843     —             

Total

      $ 26,766      $ 15,690      $ (11,076   $ —             
     

 

 

   

 

 

   

 

 

   

 

 

         

 

(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 $60.5 million at September 30, 2016, compared to $13.8 million at December 31, 2015. Residential loans that Old National has originated with the intent 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 September 30, 2016, there were no loans held for sale under this arrangement.

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, Michigan, and Wisconsin. Old National has no concentration of commercial or commercial real estate loans in any single industry exceeding 10% of its portfolio.

 

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The composition of loans by lending classification was as follows:

 

     September 30,      December 31,  

(dollars in thousands)

   2016      2015  

Commercial (1)

   $ 1,836,380       $ 1,804,615   

Commercial real estate:

     

Construction

     574,476         185,449   

Other

     2,518,099         1,662,372   

Residential real estate

     2,105,232         1,644,614   

Consumer credit:

     

Home equity

     481,995         359,954   

Auto

     1,146,594         1,050,336   

Other

     242,209         133,478   

Covered loans

     —           107,587   
  

 

 

    

 

 

 

Total loans

     8,904,985         6,948,405   

Allowance for loan losses

     (51,547      (51,296

Allowance for loan losses - covered loans

     —           (937
  

 

 

    

 

 

 

Net loans

   $ 8,853,438       $ 6,896,172   
  

 

 

    

 

 

 

 

(1) Includes direct finance leases of $11.7 million at September 30, 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. 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 independent appraisal reviews, sensitivity analysis of absorption and lease rates, financial analysis of the developers and property owners, and feasibility studies, if available. 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 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.

 

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The acquisition of Anchor on May 1, 2016 added $926.2 million of commercial real estate loans to our portfolio. At 178%, Old National Bank’s commercial real estate loans as a percentage of its risk-based capital remained well below the regulatory guideline limit of 300% at September 30, 2016.

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. We assumed student loans in the acquisition of Anchor in May 2016. As of September 30, 2016, student loans totaled $80.5 million and are guaranteed by the government from 97% to 100%. 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

Old National entered into an agreement with the FDIC on June 22, 2016 to terminate its loss share agreements. As a result of the termination of the loss share agreements, the remaining loans that were covered by the loss share arrangements were reclassified to noncovered loans effective June 22, 2016. All future gains and losses associated with covered loans will be recognized entirely by Old National.

Prior to the termination of the loss share agreements, certain loans acquired from the FDIC were classified as covered loans. Covered loans were subject to loss share agreements whereby Old National was indemnified against 80% of losses up to $275.0 million, an amount which we never reached. 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.

 

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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. An allowance for loan losses will be established for any subsequent credit deterioration or adverse changes in expected cash flows.

Old National’s activity in the allowance for loan losses for the three and nine months ended September 30, 2016 and 2015 is as follows:

 

(dollars in thousands)

   Commercial     Commercial
Real Estate
    Residential     Consumer     Unallocated      Total  

Three Months Ended September 30, 2016

  

          

Balance at July 1, 2016

   $ 24,156      $ 18,208      $ 1,459      $ 7,981      $ —         $ 51,804   

Charge-offs

     (1,681     (1,378     (140     (1,320     —           (4,519

Recoveries

     594        1,548        2,174        (1,360     —           2,956   

Provision

     1,461        (1,033     (1,963     2,841        —           1,306   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at September 30, 2016

   $ 24,530      $ 17,345      $ 1,530      $ 8,142      $ —         $ 51,547   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Three Months Ended September 30, 2015

  

          

Balance at July 1, 2015

   $ 23,434      $ 16,325      $ 2,581      $ 7,851      $ —         $ 50,191   

Charge-offs

     (223     (733     (313     (1,239     —           (2,508

Recoveries

     1,088        1,422        74        792        —           3,376   

Provision

     1,219        (950     (317     215        —           167   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at September 30, 2015

   $ 25,518      $ 16,064      $ 2,025      $ 7,619      $ —         $ 51,226   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Nine Months Ended September 30, 2016

  

          

Balance at January 1, 2016

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

Charge-offs

     (3,640     (2,440     (360     (4,698     —           (11,138

Recoveries

     2,288        2,935        2,387        126        —           7,736   

Provision

     (465     857        (2,548     4,872        —           2,716   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at September 30, 2016

   $ 24,530      $ 17,345      $ 1,530      $ 8,142      $ —         $ 51,547   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Nine Months Ended September 30, 2015

  

          

Balance at January 1, 2015

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

Charge-offs

     (2,644     (834     (709     (4,337     —           (8,524

Recoveries

     3,652        2,895        161        2,754        —           9,462   

Provision

     3,840        (3,345     (389     2,333        —           2,439   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at September 30, 2015

   $ 25,518      $ 16,064      $ 2,025      $ 7,619      $ —         $ 51,226   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

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The following table provides Old National’s recorded investment in financing receivables by portfolio segment at September 30, 2016 and December 31, 2015 and other information regarding the allowance:

 

(dollars in thousands)

  Commercial     Commercial
Real Estate
    Residential     Consumer     Unallocated     Total  

September 30, 2016

           

Allowance for loan losses:

           

Individually evaluated for impairment

  $ 6,979      $ 4,459      $ —        $ —        $ —        $ 11,438   

Collectively evaluated for impairment

    17,422        12,712        1,517        7,886        —          39,537   

Loans acquired with deteriorated credit quality

    129        174        13        256        —          572   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total allowance for loan losses

  $ 24,530      $ 17,345      $ 1,530      $ 8,142      $ —        $ 51,547   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans and leases outstanding:

           

Individually evaluated for impairment

  $ 49,815      $ 57,801      $ —        $ —        $ —        $ 107,616   

Collectively evaluated for impairment

    1,785,010        2,987,280        2,091,020        1,861,647        —          8,724,957   

Loans acquired with deteriorated credit quality

    1,555        47,494        14,212        9,151        —          72,412   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans and leases outstanding

  $ 1,836,380      $ 3,092,575      $ 2,105,232      $ 1,870,798      $ —        $ 8,904,985   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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   

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 will also consider current 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 September 30, 2016 and December 31, 2015, the risk category of commercial and commercial real estate loans by class of loans is as follows:

 

(dollars in thousands)                  Commercial      Commercial  
            Real Estate -      Real Estate -  
     Commercial      Construction      Other  
Corporate Credit Exposure Credit Risk Profile by
Internally Assigned Grade
   September 30,
2016
     December 31,
2015 (1)
     September 30,
2016
     December 31,
2015 (1)
     September 30,
2016
     December 31,
2015 (1)
 

Grade:

                 

Pass

   $ 1,703,363       $ 1,672,672       $ 560,891       $ 182,701       $ 2,338,786       $ 1,508,309   

Criticized

     53,092         55,570         10,949         3,300         61,799         75,477   

Classified - substandard

     30,573         24,723         1,258         1,857         45,089         49,091   

Classified - nonaccrual

     45,716         58,469         1,378         830         62,513         39,521   

Classified - doubtful

     3,636         3,506         —           —           9,912         7,886   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,836,380       $ 1,814,940       $ 574,476       $ 188,688       $ 2,518,099       $ 1,680,284   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)    Includes loans previously covered by loss share agreements with the FDIC.

       

     

Commercial loans as of September 30, 2016 in the table above include loans attributable to the acquisition of Anchor totaling $0.2 million in the classified – substandard category and $0.7 million in the classified – nonaccrual category. There were no construction commercial real estate loans in the criticized or classified categories attributable to the acquisition of Anchor as of September 30, 2016. Other commercial real estate as of September 30, 2016 in the table above includes loans attributable to the acquisition of Anchor totaling $16.6 million in the criticized category, $4.2 million in the classified – substandard category, and $25.4 million in the classified – nonaccrual category.

 

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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 September 30, 2016 and December 31, 2015:

 

(dollars in thousands)    Residential      Consumer  
            Home
Equity
     Auto      Other  

September 30, 2016

           

Performing

   $ 2,088,694       $ 478,810       $ 1,145,140       $ 235,057   

Nonperforming

     16,538         3,185         1,454         7,152   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,105,232       $ 481,995       $ 1,146,594       $ 242,209   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2015 (1)

           

Performing

   $ 1,645,293       $ 410,243       $ 1,048,763       $ 138,031   

Nonperforming

     16,042         3,051         1,573         1,497   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,661,335       $ 413,294       $ 1,050,336       $ 139,528   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes loans previously covered by loss share agreements with the FDIC.

Other consumer loans as of September 30, 2016 in the table above includes loans attributable to the acquisition of Anchor totaling $5.7 million in the nonperforming category, the majority of which are student loans that are guaranteed by the government from 97% to 100%.

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 as of September 30, 2016 and December 31, 2015, respectively. Only purchased loans that have experienced subsequent impairment since the date acquired are included in the table below.

 

(dollars in thousands)

   Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
 

September 30, 2016

        

With no related allowance recorded:

        

Commercial

   $ 34,050       $ 34,803       $ —     

Commercial Real Estate - Other

     40,601         43,981         —     

Residential

     1,113         1,134         —     

Consumer

     852         983         —     

With an allowance recorded:

        

Commercial

     15,765         16,573         6,979   

Commercial Real Estate - Other

     17,200         17,717         4,459   

Residential

     1,094         1,094         55   

Consumer

     1,984         1,984         99   
  

 

 

    

 

 

    

 

 

 

Total

   $ 112,659       $ 118,269       $ 11,592   
  

 

 

    

 

 

    

 

 

 

December 31, 2015 (1)

        

With no related allowance recorded:

        

Commercial

   $ 40,414       $ 41,212       $ —     

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   
  

 

 

    

 

 

    

 

 

 

 

(1) Does not include $4.2 million of loans that were previously covered by loss share agreements with the FDIC.

 

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The average balance of impaired loans during the three and nine months ended September 30, 2016 and 2015 are included in the table below.

 

     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  

(dollars in thousands)

   2016      2015 (1)      2016      2015 (1)  

Average Recorded Investment

           

With no related allowance recorded:

           

Commercial

   $ 35,513       $ 33,128       $ 37,581       $ 29,878   

Commercial Real Estate - Construction

     —           1,122         —           1,475   

Commercial Real Estate - Other

     40,971         33,235         37,937         32,440   

Residential

     1,233         999         1,270         873   

Consumer

     878         836         865         728   

With an allowance recorded:

           

Commercial

     17,334         29,978         16,072         16,090   

Commercial Real Estate - Construction

     —           331         119         171   

Commercial Real Estate - Other

     15,119         12,656         15,977         13,109   

Residential

     1,099         1,330         1,072         1,264   

Consumer

     2,385         1,775         2,515         1,886   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 114,532       $ 115,390       $ 113,408       $ 97,914   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Does not include $4.4 million of loans that were previously covered by loss share agreements with the FDIC.

The Company does not record interest on nonaccrual loans until principal is recovered. Interest income recognized on impaired loans during the three and nine months ended September 30, 2016 and 2015 was immaterial.

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 a prescribed period, 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 loan loss provision or prospective yield adjustments.

 

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Old National’s past due financing receivables as of September 30, 2016 and December 31, 2015 are as follows:

 

(dollars in thousands)

   30-59 Days
Past Due
     60-89 Days
Past Due
     Recorded
Investment >
90 Days and
Accruing
     Nonaccrual      Total
Past Due
     Current  

September 30, 2016

                 

Commercial

   $ 577       $ 262       $ —         $ 49,352       $ 50,191       $ 1,786,189   

Commercial Real Estate:

                 

Construction

     —           —           —           1,378         1,378         573,098   

Other

     835         445         —           72,425         73,705         2,444,394   

Residential

     14,228         1,911         152         16,538         32,829         2,072,403   

Consumer:

                 

Home equity

     1,741         1,749         46         3,185         6,721         475,274   

Auto

     3,931         915         154         1,454         6,454         1,140,140   

Other

     3,090         2,118         91         7,152         12,451         229,758   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 24,402       $ 7,400       $ 443       $ 151,484       $ 183,729       $ 8,721,256   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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:

                 

Home equity

     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 September 30, 2016, these loans totaled $473.0 million, of which $259.1 million had been sold to other financial institutions and $213.9 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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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 typically written down to its collateral value less selling costs.

The following table presents activity in TDRs for the nine months ended September 30, 2016 and 2015:

 

(dollars in thousands)

   Commercial     Commercial
Real Estate
    Residential     Consumer     Total  

Nine Months Ended September 30, 2016

          

Balance at January 1, 2016

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

(Charge-offs)/recoveries

     (1,098     148        42        (27     (935

Payments

     (17,517     (6,050     (482     (1,273     (25,322

Additions

     12,367        10,581        335        385        23,668   

Other

     1,569        523        —          —          2,092   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2016

   $ 18,675      $ 19,804      $ 2,588      $ 2,687      $ 43,754   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nine Months Ended September 30, 2015

          

Balance at January 1, 2015

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

(Charge-offs)/recoveries

     89        825        (40     (6     868   

Payments

     (13,064     (4,709     (614     (1,035     (19,422

Additions

     29,956        3,774        792        1,797        36,319   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2015

   $ 32,186      $ 15,116      $ 2,201      $ 3,215      $ 52,718   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Approximately $29.9 million of the TDRs at September 30, 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 $6.2 million at September 30, 2016 and $2.3 million at December 31, 2015. As of September 30, 2016, Old National had committed to lend an additional $4.5 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 nine months ended September 30, 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 nine months ended September 30, 2016 and 2015:

 

(dollars in thousands)

   Number
of Loans
     Pre-modification
Outstanding Recorded
Investment
     Post-modification
Outstanding Recorded
Investment
 

Nine Months Ended September 30, 2016

        

Troubled Debt Restructuring:

        

Commercial

     17       $ 12,367       $ 11,815   

Commercial Real Estate - Other

     9         10,581         10,581   

Residential

     3         335         335   

Consumer

     8         385         385   
  

 

 

    

 

 

    

 

 

 

Total

     37       $ 23,668       $ 23,116   
  

 

 

    

 

 

    

 

 

 

Nine Months Ended September 30, 2015

        

Troubled Debt Restructuring:

        

Commercial

     25       $ 29,956       $ 29,956   

Commercial Real Estate - Construction

     5         1,162         1,162   

Commercial Real Estate - Other

     21         2,612         2,612   

Residential

     8         792         792   

Consumer

     26         1,797         1,797   
  

 

 

    

 

 

    

 

 

 

Total

     85       $ 36,319       $ 36,319   
  

 

 

    

 

 

    

 

 

 

The TDRs that occurred during the nine months ended September 30, 2016 decreased the allowance for loan losses by $0.3 million due to a change in collateral position on a large commercial loan and resulted in $0.8 million of charge-offs during the nine months ended September 30, 2016. The TDRs that occurred during the nine months ended September 30, 2015 increased the allowance for loan losses by $0.6 million and resulted in immaterial charge-offs during the nine months ended September 30, 2015.

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

There were 6 commercial loans and 1 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 nine months ended September 30, 2016.

There were 3 commercial loans and 6 commercial real estate loans totaling $2.1 million that were modified as TDRs within the preceding twelve months, and for which there was a payment default during the nine months ended September 30, 2015.

The terms of certain other loans were modified during the nine months ended September 30, 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 the delay in a payment.

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

 

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Table of Contents

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 September 30, 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, 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 Credit Impaired Loans (“PCI”)

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 loans that meet the criteria of ASC 310-30 treatment, the carrying amount is as follows:

 

(dollars in thousands)

   September 30,
2016
     December 31,
2015 (1)
 

Commercial

   $ 1,555       $ 3,584   

Commercial real estate

     47,494         47,923   

Residential

     14,212         16,704   

Consumer

     9,151         12,870   
  

 

 

    

 

 

 

Carrying amount

     72,412         81,081   

Allowance for loan losses

     (572      (1,359
  

 

 

    

 

 

 

Carrying amount, net of allowance

   $ 71,840       $ 79,722   
  

 

 

    

 

 

 

 

(1) Includes loans previously covered by loss share agreements with the FDIC.

The outstanding balance of loans accounted for under ASC 310-30, including contractual principal, interest, fees and penalties, was $312.8 million at September 30, 2016 and $321.5 million at December 31, 2015.

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 $18.2 million during the nine months ended September 30, 2016 and $28.8 million during the nine months ended September 30, 2015. Improvement in cash flow expectations has resulted in a reclassification from nonaccretable difference to accretable yield as shown in the table below.

 

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Table of Contents

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

 

(dollars in thousands)

   Acquisitions
Prior to
2015 (1)
     Founders (2)      Anchor (2)      Total  

Balance at January 1, 2016

   $ 42,498       $ 2,812       $ —         $ 45,310   

New loans purchased

     —           —           3,217         3,217   

Accretion of income

     (16,765      (618      (819      (18,202

Reclassifications from (to) nonaccretable difference

     7,104         434         —           7,538   

Disposals/other adjustments

     889         —           72         961   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at September 30, 2016

   $ 33,726       $ 2,628       $ 2,470       $ 38,824   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes loans previously covered by loss share agreements with the FDIC.
(2) Old National acquired Founders effective January 1, 2015 and Anchor effective May 1, 2016.

Included in Old National’s allowance for loan losses is $0.6 million related to the purchased loans disclosed above at September 30, 2016, compared to $1.4 million at December 31, 2015.

PCI loans purchased during the nine months ended September 30, 2016 and 2015 for which it was probable at acquisition that all contractually required payments would not be collected were as follows:

 

(dollars in thousands)

   Founders      Anchor  

Contractually required payments

   $ 11,103       $ 29,544   

Nonaccretable difference

     (2,684      (6,153
  

 

 

    

 

 

 

Cash flows expected to be collected at acquisition

     8,419         23,391   

Accretable yield

     (1,812      (3,217
  

 

 

    

 

 

 

Fair value of acquired loans at acquisition

   $ 6,607       $ 20,174   
  

 

 

    

 

 

 

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.

NOTE 9 – COVERED LOANS

Old National entered into an agreement with the FDIC on June 22, 2016 to terminate its loss share agreements. As a result of the termination of the loss share agreements, the remaining loans that were covered by the loss share arrangements were reclassified to noncovered loans effective June 22, 2016. All future gains and losses associated with covered loans will be recognized entirely by Old National.

Prior to the termination of the loss share agreements, certain loans acquired from the FDIC were classified as covered loans. Covered loans were subject to loss share agreements. Under the early termination agreement, the FDIC made a final payment of $8.7 million to Old National as consideration for the early termination. After the elimination of the remaining FDIC indemnification asset and the payment of settlement charges, Old National realized a pre-tax gain of $0.2 million during the three months ended June 30, 2016.

 

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Table of Contents

The following table is a roll-forward of covered acquired impaired loans accounted for under ASC 310-30 for the nine months ended September 30, 2016 and 2015. As a result of the termination of the loss share agreements, the remaining loans that were covered by the loss share arrangements were reclassified to noncovered loans effective June 22, 2016.

 

(dollars in thousands)

   Contractual
Cash Flows (1)
     Nonaccretable
Difference
     Accretable
Yield
     Carrying
Amount (2)
 

Nine Months Ended September 30, 2016

           

Balance at January 1, 2016

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

Principal reductions and interest payments

     (18,195      (347      —           (18,542

Accretion of loan discount

     —           —           7,196         7,196   

Changes in contractual and expected cash flows due to remeasurement

     4,431         631         (4,927      135   

Removals due to foreclosure or sale

     (1,948      136         263         (1,549

Loans removed from loss share coverage

     (54,145      4,309         15,253         (34,583
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at September 30, 2016

   $ —         $ —         $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Nine Months Ended September 30, 2015

           

Balance at January 1, 2015

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

Principal reductions and interest payments

     (34,842      (1,430      —           (36,272

Accretion of loan discount

     —           —           17,850         17,850   

Changes in contractual and expected cash flows due to remeasurement

     (4,218      6,821         (2,505      98   

Removals due to foreclosure or sale

     (1,020      376         (182      (826

Loans removed from loss share coverage

     (6,027      236         618         (5,173
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at September 30, 2015

   $ 78,702       $ (6,011    $ (19,961    $ 52,730   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(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.

Prior to the termination of the loss share agreements, we estimated the 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 evaluated at each balance sheet date whether the present value of loans determined using the effective interest rates had decreased and if so, recognized a provision for loan losses. For any increases in cash flows expected to be collected, we adjusted 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 were offset as Old National would recognize a corresponding change in cash flows expected from the indemnification asset prospectively in a similar manner. The indemnification asset was adjusted over the shorter of the life of the underlying investment or the indemnification agreement.

The loss share receivable represented actual incurred losses where reimbursement had not yet been received from the FDIC. The indemnification asset represented future cash flows we expected to collect from the FDIC under the loss sharing agreements and the amount related to the estimated improvements in cash flow expectations that were being amortized over the same period for which those improved cash flows were being accreted into income.

 

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The following table shows a detailed analysis of the FDIC loss sharing asset for the nine months ended September 30, 2016 and 2015. As a result of the termination of the loss share agreements on June 22, 2016, the table below reflects the write-off of the remaining FDIC loss sharing asset.

 

(dollars in thousands)

   2016      2015  

Balance at January 1,

   $ 9,030       $ 20,603   

Adjustments not reflected in income:

     

Cash received from the FDIC

     (10,000      (3,555

Other

     512         948   

Adjustments reflected in income:

     

(Amortization) accretion

     (816      (10,587

Higher (lower) loan loss expectations

     (13      109   

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

     1,062         1,387   

Gain as a result of the early termination agreement with the FDIC, effective June 22, 2016

     225         —     
  

 

 

    

 

 

 

Balance at September 30,

   $ —         $ 8,905   
  

 

 

    

 

 

 

As a result of the termination of the loss share agreements, all future gains and losses associated with covered assets will be recognized entirely by Old National since the FDIC will 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 nine months ended September 30, 2016 and 2015:

 

(dollars in thousands)

   Other Real Estate
Owned (1)
     Other Real Estate
Owned, Covered
 

Nine Months Ended September 30, 2016

     

Balance at January 1, 2016

   $ 7,594       $ 4,904   

Additions (2)

     22,244         2,093   

Sales

     (9,049      (1,454

(Impairment)/recovery of value

     (741      (1,872

Reclassification due to termination of the loss share agreements, effective June 22, 2016

     3,671         (3,671
  

 

 

    

 

 

 

Balance at September 30, 2016

   $ 23,719       $ —     
  

 

 

    

 

 

 

Nine Months Ended September 30, 2015

     

Balance at January 1, 2015

   $ 7,241       $ 9,121   

Additions

     5,665         880   

Sales

     (2,807      (5,291

(Impairment)/recovery of value

     (817      (287
  

 

 

    

 

 

 

Balance at September 30, 2015

   $ 9,282       $ 4,423   
  

 

 

    

 

 

 

 

(1) Includes repossessed personal property of $0.2 million at September 30, 2016 and 2015.
(2) Includes other real estate owned of $18.2 million acquired from Anchor in May 2016.

At September 30, 2016, foreclosed residential real estate property included in the table above totaled $1.6 million. At September 30, 2016, consumer mortgage loans collateralized by residential real property that were in the process of foreclosure totaled $2.4 million.

Old National entered into an agreement with the FDIC on June 22, 2016 to terminate its loss share agreements. As a result of the termination of the loss share agreements, the remaining other real estate owned that was covered by the loss share arrangements were reclassified to noncovered other real estate owned effective June 22, 2016.

 

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Prior to the termination of the loss share agreements, covered OREO expenses and valuation write-downs were recorded in the noninterest expense section of the consolidated statements of income. Under the loss sharing agreements, the FDIC would have reimbursed us for 80% of expenses and valuation write-downs related to covered assets up to $275.0 million, an amount which we never reached. The reimbursable portion of these expenses was recorded in the FDIC indemnification asset. Changes in the FDIC indemnification asset were recorded in the noninterest income section of the consolidated statements of income. As a result of the termination of the loss share agreements, all future gains and losses associated with covered assets will be recognized entirely by Old National since the FDIC will no longer be sharing in these gains and losses.

NOTE 11 – PREMISES AND EQUIPMENT

The composition of premises and equipment was as follows:

 

(dollars in thousands)

   September 30,
2016
     December 31,
2015
 

Land

   $ 57,904       $ 41,604   

Buildings

     230,192         111,982   

Furniture, fixtures, and equipment

     107,555         94,819   

Leasehold improvements

     28,497         33,111   
  

 

 

    

 

 

 

Total

     424,148         281,516   

Accumulated depreciation

     (90,882      (84,840
  

 

 

    

 

 

 

Premises and equipment, net

   $ 333,266       $ 196,676   
  

 

 

    

 

 

 

During the third quarter of 2016, the Company purchased the corporate office and 2 bank properties that it had previously leased for an aggregate purchase price of approximately $98.4 million, resulting in the recognition of $0.8 million of pre-tax losses.

Depreciation expense was $3.9 million for the three months ended September 30, 2016 and $11.4 million for the nine months ended September 30, 2016, compared to $3.1 million for the three months ended September 30, 2015 and $10.9 million for the nine months ended September 30, 2015.

Operating Leases

Old National rents certain premises and equipment under operating leases, which expire at various dates. Many of these leases require the payment of property taxes, insurance premiums, maintenance, and other costs. In some cases, rentals are subject to increase in relation to a cost-of-living index. The leases have original terms ranging from less than one year to twenty-four years, and Old National has the right, at its option, to extend the terms of certain leases for four additional successive terms of five years. Old National does not have any material sub-lease agreements. Rent expense was $6.4 million for the three months ended September 30, 2016 and $20.1 million for the nine months ended September 30, 2016, compared to $7.2 million for the three months ended September 30, 2015 and $22.4 million for the nine months ended September 30, 2015.

Old National had deferred gains remaining associated with prior sale leaseback transactions totaling $31.1 million as of September 30, 2016 and $40.7 million as of December 31, 2015. The gains are being recognized over the remaining term of the leases. The leases had original terms ranging from five to twenty-four years.

Capital Leases

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.

On May 1, 2016, Old National acquired Anchor, assuming a five year capital lease obligation for equipment.

 

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At September 30, 2016, the future minimum lease payments under the capital lease arrangements were as follows:

 

(dollars in thousands)

      

2016 remaining

   $ 165   

2017

     472   

2018

     410   

2019

     430   

2020

     430   

Thereafter

     8,406   
  

 

 

 

Total minimum lease payments

     10,313   

Less amounts representing interest

     6,204   
  

 

 

 

Present value of net minimum lease payments

   $ 4,109   
  

 

 

 

NOTE 12 - GOODWILL AND OTHER INTANGIBLE ASSETS

The following table shows the changes in the carrying amount of goodwill for the nine months ended September 30, 2016 and 2015:

 

(dollars in thousands)

   2016      2015  

Balance at January 1,

   $ 584,634       $ 530,845   

Acquisitions

     111,539         57,619   

Divestitures

     (40,963      (3,830
  

 

 

    

 

 

 

Balance at September 30,

   $ 655,210       $ 584,634   
  

 

 

    

 

 

 

Goodwill is reviewed annually for impairment. Old National completed its most recent annual goodwill impairment test as of August 31, 2016 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.

During the nine months ended September 30, 2016, Old National recorded $111.5 million of goodwill associated with the acquisition of Anchor. Also during the nine months ended September 30, 2016, Old National eliminated $41.0 million of goodwill associated with the sale of its insurance operations.

The gross carrying amount and accumulated amortization of other intangible assets at September 30, 2016 and December 31, 2015 were as follows:

 

(dollars in thousands)

   Gross
Carrying
Amount
     Accumulated
Amortization
and Impairment
     Net
Carrying
Amount
 

September 30, 2016

        

Amortized intangible assets:

        

Core deposit

   $ 81,663       $ (50,553    $ 31,110   

Customer trust relationships

     16,547         (7,274      9,273   

Customer loan relationships

     4,413         (3,878      535   
  

 

 

    

 

 

    

 

 

 

Total intangible assets

   $ 102,623       $ (61,705    $ 40,918   
  

 

 

    

 

 

    

 

 

 

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 nine months ended September 30, 2016, Old National increased core deposit intangibles by $21.6 million related to the Anchor acquisition. In addition, Old National eliminated $6.7 million of customer business relationship intangibles associated with its insurance operation, which was sold May 31, 2016.

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 nine months ended September 30, 2016 or 2015. Total amortization expense associated with intangible assets was $9.2 million for the nine months ended September 30, 2016 and $8.9 million for the nine months ended September 30, 2015.

Estimated amortization expense for future years is as follows:

 

(dollars in thousands)

      

2016 remaining

   $ 3,241   

2017

     11,015   

2018

     8,687   

2019

     6,737   

2020

     4,883   

Thereafter

     6,355   
  

 

 

 

Total

   $ 40,918   
  

 

 

 

NOTE 13 – LOAN SERVICING RIGHTS

Loan servicing rights were assumed in Old National’s acquisitions of United and LSB in 2014, Founders in 2015, and Anchor in May, 2016.

At September 30, 2016, loan servicing rights derived from loans sold with servicing retained totaled $25.9 million, 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 $3.427 billion at September 30, 2016, compared to $1.263 billion at December 31, 2015. Approximately 99% of the loans serviced for others at September 30, 2016 were residential mortgage loans. Custodial escrow balances maintained in connection with serviced loans were $41.0 million at September 30, 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 nine months ended September 30, 2016 and 2015:

 

(dollars in thousands)

   2016      2015  

Balance at January 1,

   $ 10,502       $ 9,584   

Additions (1)

     18,965         2,553   

Amortization

     (3,537      (1,804
  

 

 

    

 

 

 

Balance before valuation allowance at September 30,

     25,930         10,333   
  

 

 

    

 

 

 

Valuation allowance:

     

Balance at January 1,

     (34      (50

(Additions)/recoveries

     24         —     
  

 

 

    

 

 

 

Balance at September 30,

     (10      (50
  

 

 

    

 

 

 

Loan servicing rights, net

   $ 25,920       $ 10,283   
  

 

 

    

 

 

 

 

(1) In May 2016, the Company assumed $15.3 million of loan servicing rights related to the Anchor acquisition.

At September 30, 2016, the fair value of servicing rights was $27.3 million, which was determined using a discount rate of 10% and a weighted average prepayment speed of 189% 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 14 – QUALIFIED AFFORDABLE HOUSING PROJECTS AND OTHER TAX CREDIT INVESTMENTS

The Company is a limited partner in several tax-advantaged limited partnerships whose purpose is to invest in approved qualified affordable housing or other renovation or community revitalization projects. These investments are included in other assets on the balance sheet. Certain of these assets qualify for the proportional amortization method and are amortized over the period that the Company expects to receive the tax credits, with the expense included within income tax expense on the consolidated statements of income. The other investments are accounted for under the equity method, with the expense included within pre-tax income on the consolidated statements of income. All of the Company’s tax credit investments are evaluated for impairment at the end of each reporting period. As of September 30, 2016, the Company expects to recover its remaining investments through the use of the tax credits that were generated by the investments.

The following table summarizes Old National’s investments in Low Income Housing Tax Credits (“LIHTC”), Federal Historic Tax Credits (“FHTC”), Federal New Market Tax Credits (“NMTC”), and Indiana Community Revitalization Enhancement District Tax Credits (“CReED”) at September 30, 2016: