Finance Receivables and Allowance for Credit Losses | NOTE 6 – FINANCE RECEIVABLES 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. The composition of loans at December 31 by lending classification was as follows: (dollars in thousands) 2016 2015 Commercial (1) $ 1,917,099 $ 1,804,615 Commercial real estate: Construction 199,509 185,449 Other 2,931,344 1,662,372 Residential real estate 2,087,530 1,644,614 Consumer credit: Home equity 476,439 359,954 Auto 1,167,737 1,050,336 Other 230,854 133,478 Covered loans — 107,587 Total loans 9,010,512 6,948,405 Allowance for loan losses (49,808 ) (51,296 ) Allowance for loan losses - covered loans — (937 ) Net loans $ 8,960,704 $ 6,896,172 (1) Includes direct finance leases of $10.8 million at December 31, 2016 and $14.4 million at December 31, 2015. The risk characteristics of each loan portfolio segment are as follows: Commercial Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Commercial Real Estate These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts, and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be adversely affected by conditions in the real estate markets or in the general economy. The properties securing Old National’s commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner 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 on-site The acquisition of Anchor on May 1, 2016 added $926.2 million of commercial real estate loans to our portfolio. At 189%, 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 December 31, 2016. Residential With respect to residential loans that are secured by 1-4 loan-to-value Consumer Home equity loans are typically secured by a subordinate interest in 1-4 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 Notes 1 and 7 to the consolidated financial statements for further details on our covered loans. Related Party Loans In the ordinary course of business, Old National grants loans to certain executive officers, directors, and significant subsidiaries (collectively referred to as “related parties”). Activity in related party loans during 2016 is presented in the following table: (dollars in thousands) 2016 Balance at January 1, $ 8,145 New loans 5,813 Repayments (5,464 ) Balance at December 31, $ 8,494 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 We utilize a probability of default (“PD”) and loss given default (“LGD”) model as a tool to determine the adequacy of the allowance for loan losses for performing commercial and commercial real estate loans. The PD is forecast using a transition matrix to determine the likelihood of a customer’s asset quality rating (“AQR”) migrating from its current AQR to any other status within the time horizon. Transition rates are measured using Old National’s own historical experience. The model assumes that recent historical transition rates will continue into the future. The LGD is defined as credit loss incurred when an obligor of the bank defaults. The sum of all net charge-offs for a particular portfolio segment are divided by all loans that have defaulted over a given period of time. The expected loss derived from the model considers the PD, LGD, and exposure at default. Additionally, qualitative factors, such as changes in lending policies or procedures, and economic business conditions are also considered. We use historic loss ratios adjusted for economic conditions to determine the appropriate level of allowance for residential real estate and consumer loans. No allowance was brought forward on any of the acquired loans as any credit deterioration evident in the loans was included in the determination of the fair value of the loans at the acquisition date. 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 years ended December 31, 2016, 2015, and 2014 was as follows: (dollars in thousands) Commercial Commercial Residential Consumer Unallocated Total 2016 Allowance for loan losses: Beginning balance $ 26,347 $ 15,993 $ 2,051 $ 7,842 $ — $ 52,233 Charge-offs (5,047 ) (2,632 ) (800 ) (6,131 ) — (14,610 ) Recoveries 3,102 4,763 174 3,186 — 11,225 Provision (2,921 ) 49 218 3,614 — 960 Ending balance $ 21,481 $ 18,173 $ 1,643 $ 8,511 $ — $ 49,808 2015 Allowance for loan losses: Beginning balance $ 20,670 $ 17,348 $ 2,962 $ 6,869 $ — $ 47,849 Charge-offs (3,513 ) (1,921 ) (1,039 ) (6,404 ) — (12,877 ) Recoveries 5,218 4,685 354 4,081 — 14,338 Provision 3,972 (4,119 ) (226 ) 3,296 — 2,923 Ending balance $ 26,347 $ 15,993 $ 2,051 $ 7,842 $ — $ 52,233 2014 Allowance for loan losses: Beginning balance $ 16,565 $ 22,401 $ 3,239 $ 4,940 $ — $ 47,145 Charge-offs (3,535 ) (3,647 ) (793 ) (4,675 ) — (12,650 ) Recoveries 3,125 3,871 205 3,056 — 10,257 Provision 4,515 (5,277 ) 311 3,548 — 3,097 Ending balance $ 20,670 $ 17,348 $ 2,962 $ 6,869 $ — $ 47,849 The following table provides Old National’s recorded investment in financing receivables by portfolio segment at December 31, 2016 and 2015 and other information regarding the allowance: (dollars in thousands) Commercial Commercial Residential Consumer Unallocated Total December 31, 2016 Allowance for loan losses: Individually evaluated for impairment $ 4,561 $ 3,437 $ — $ — $ — $ 7,998 Collectively evaluated for impairment 16,838 14,717 1,643 8,334 — 41,532 Loans acquired with deteriorated credit quality 82 19 — 177 — 278 Total allowance for loan losses $ 21,481 $ 18,173 $ 1,643 $ 8,511 $ — $ 49,808 Loans and leases outstanding: Individually evaluated for impairment $ 45,960 $ 57,230 $ — $ — $ — $ 103,190 Collectively evaluated for impairment 1,870,289 3,040,849 2,073,950 1,866,815 — 8,851,903 Loans acquired with deteriorated credit quality 850 32,774 13,580 8,215 — 55,419 Total loans and leases outstanding $ 1,917,099 $ 3,130,853 $ 2,087,530 $ 1,875,030 $ — $ 9,010,512 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 Credit Quality Old National’s management monitors the credit quality of its financing receivables in an on-going non-homogeneous Criticized Classified – Substandard Classified – Nonaccrual Classified – Doubtful Pass rated loans are those loans that are other than criticized, classified – substandard, classified – nonaccrual, or classified – doubtful. As of December 31, 2016 and 2015, the risk category of commercial and commercial real estate loans by class of loans was as follows: (dollars in thousands) Corporate Credit Exposure Credit Risk Profile by Internally Assigned Grade Commercial Commercial Real Estate - Commercial Real Estate - Other 2016 2015 (1) 2016 2015 (1) 2016 2015 (1) Grade: Pass $ 1,750,923 $ 1,672,672 $ 194,875 $ 182,701 $ 2,822,340 $ 1,508,309 Criticized 45,614 55,570 229 3,300 49,619 75,477 Classified - substandard 63,978 24,723 1,636 1,857 18,128 49,091 Classified - nonaccrual 53,062 58,469 2,769 830 32,234 39,521 Classified - doubtful 3,522 3,506 — — 9,023 7,886 Total $ 1,917,099 $ 1,814,940 $ 199,509 $ 188,688 $ 2,931,344 $ 1,680,284 (1) Includes loans previously covered by loss share agreements with the FDIC. Commercial loans as of December 31, 2016 in the table above include loans attributable to the acquisition of Anchor totaling $0.3 million in the criticized 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 December 31, 2016. Other commercial real estate as of December 31, 2016 in the table above includes loans attributable to the acquisition of Anchor totaling $8.0 million in the criticized category, $3.6 million in the classified – substandard category, $19.9 million in the classified – nonaccrual category, and $0.7 million in the classified – doubtful category. 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 December 31, 2016 and 2015: (dollars in thousands) Consumer Residential Home Auto Other 2016 Performing $ 2,069,856 $ 472,008 $ 1,166,114 $ 223,786 Nonperforming 17,674 4,431 1,623 7,068 Total $ 2,087,530 $ 476,439 $ 1,167,737 $ 230,854 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 December 31, 2016 in the table above includes loans attributable to the acquisition of Anchor totaling $5.8 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. The following table shows Old National’s impaired loans as of December 31, 2016 and 2015, respectively. Only purchased loans that have experienced subsequent impairment since the date acquired are included in the table below. (dollars in thousands) Recorded Unpaid Related December 31, 2016 With no related allowance recorded: Commercial $ 29,001 $ 29,634 $ — Commercial Real Estate - Other 30,585 32,413 — Residential 1,610 1,631 — Consumer 827 946 — With an allowance recorded: Commercial 16,959 17,283 4,561 Commercial Real Estate - Construction 467 467 107 Commercial Real Estate - Other 26,178 26,710 3,330 Residential 1,081 1,081 54 Consumer 1,924 1,924 96 Total $ 108,632 $ 112,089 $ 8,148 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. The average balance of impaired loans for the years ended December 31, 2016 and 2015 are included in the table below. (dollars in thousands) 2016 2015 (1) Average Recorded Investment With no related allowance recorded: Commercial $ 34,708 $ 33,678 Commercial Real Estate - Construction — 1,085 Commercial Real Estate - Other 28,793 28,637 Residential 1,355 985 Consumer 855 943 With an allowance recorded: Commercial 16,669 11,924 Commercial Real Estate - Construction 352 168 Commercial Real Estate - Other 20,465 14,593 Residential 1,074 1,230 Consumer 2,367 2,034 Total $ 106,638 $ 95,277 (1) Does not include $4.2 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 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 re-estimation Old National’s past due financing receivables as of December 31 were as follows: (dollars in thousands) 30-59 Days 60-89 Days Recorded Nonaccrual Total Current December 31, 2016 Commercial $ 847 $ 279 $ 23 $ 56,585 $ 57,734 $ 1,859,365 Commercial Real Estate: Construction — — — 2,769 2,769 196,740 Other 1,652 150 — 41,257 43,059 2,888,285 Residential 17,786 3,770 2 17,674 39,232 2,048,298 Consumer: Home equity 1,511 423 — 4,431 6,365 470,074 Auto 5,903 1,037 242 1,623 8,805 1,158,932 Other 3,561 1,919 61 7,068 12,609 218,245 Total $ 31,260 $ 7,578 $ 328 $ 131,407 $ 170,573 $ 8,839,939 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 $ 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 December 31, 2016, these loans totaled $424.7 million, of which $227.5 million had been sold to other financial institutions and $197.2 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. 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 years ended December 31, 2016, 2015, and 2014: (dollars in thousands) Commercial Commercial Residential Consumer Total 2016 Balance at January 1, 2016 $ 23,354 $ 14,602 $ 2,693 $ 3,602 $ 44,251 (Charge-offs)/recoveries (1,982 ) 953 42 (6 ) (993 ) Payments (21,956 ) (10,157 ) (513 ) (1,381 ) (34,007 ) Additions 14,996 11,130 761 385 27,272 Interest collected on nonaccrual loans 2,390 1,799 2 2 4,193 Balance at December 31, 2016 $ 16,802 $ 18,327 $ 2,985 $ 2,602 $ 40,716 2015 Balance at January 1, 2015 $ 15,205 $ 15,226 $ 2,063 $ 2,459 $ 34,953 (Charge-offs)/recoveries 872 1,064 (64 ) 3 1,875 Payments (29,913 ) (6,273 ) (658 ) (1,168 ) (38,012 ) Additions 37,190 4,585 1,352 2,308 45,435 Balance at December 31, 2015 $ 23,354 $ 14,602 $ 2,693 $ 3,602 $ 44,251 2014 Balance at January 1, 2014 $ 22,443 $ 22,639 $ 2,344 $ 1,441 $ 48,867 (Charge-offs)/recoveries 126 795 10 (102 ) 829 Payments (18,281 ) (9,722 ) (466 ) (466 ) (28,935 ) Additions 13,696 3,554 175 1,586 19,011 Removals - subsequent restructuring (2,779 ) (2,040 ) — — (4,819 ) Balance at December 31, 2014 $ 15,205 $ 15,226 $ 2,063 $ 2,459 $ 34,953 Approximately $26.3 million of the TDRs at December 31, 2016 were included with nonaccrual loans, compared to $30.0 million at December 31, 2015. Old National has allocated specific reserves to customers whose loan terms have been modified in TDRs totaling $4.0 million at December 31, 2016 and $2.3 million at December 31, 2015. As of December 31, 2016, Old National had committed to lend an additional $6.0 million to customers with outstanding loans that are classified as TDRs. The pre-modification (dollars in thousands) Number of Loans Pre-modification Outstanding Recorded Investment Post-modification Outstanding Recorded Investment 2016 Troubled Debt Restructuring: Commercial 20 $ 14,996 $ 14,996 Commercial Real Estate - Other 10 11,130 11,130 Residential 6 761 761 Consumer 8 385 385 Total 44 $ 27,272 $ 27,272 2015 Troubled Debt Restructuring: Commercial 42 $ 37,190 $ 37,190 Commercial Real Estate - Construction 5 1,162 1,162 Commercial Real Estate - Other 27 3,423 3,423 Residential 13 1,352 1,352 Consumer 32 2,308 2,308 Total 119 $ 45,435 $ 45,435 2014 Troubled Debt Restructuring: Commercial 32 $ 13,696 $ 13,696 Commercial Real Estate - Construction 1 484 484 Commercial Real Estate - Other 34 3,070 3,070 Residential 2 175 175 Consumer 28 1,586 1,586 Total 97 $ 19,011 $ 19,011 The TDRs that occurred during 2016 decreased the allowance for loan losses by $2.3 million due to a change in collateral position on a large commercial loan and resulted in $0.8 million of charge-offs during 2016. The TDRs that occurred during 2015 decreased the allowance for loan losses by $0.8 million and resulted in charge-offs of $0.2 million during 2015. The TDRs that occurred during 2014 increased the allowance for loan losses by $0.5 million and resulted in charge-offs of $0.1 million during 2014. A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms. There were 7 commercial loans and 1 commercial real estate loan totaling $0.3 million that were modified as TDRs within the preceding twelve months, and for which there was a payment default during 2016. There were 5 commercial loans and 5 commercial real estate loans totaling $1.4 million that were modified as TDRs within the preceding twelve months, and for which there was a payment default during 2015. There were no loans that were modified as TDRs during 2014 for which there was a payment default within the preceding twelve months. The terms of certain other loans were modified during 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 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 December 31, 2016, it has not been necessary to remove any loans from PCI accounting. In general, once a modified loan is considered a TDR, the loan will always be considered a TDR, and therefore impaired, until it is paid in full, otherwise settled, sold or charged off. However, 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, 310-40-50-2, 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), non-accretable 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 December 31, (dollars in thousands) 2016 2015 (1) Commercial $ 850 $ 3,584 Commercial real estate 32,774 47,923 Residential 13,580 16,704 Consumer 8,215 12,870 Carrying amount 55,419 81,081 Allowance for loan losses (278 ) (1,359 ) Carrying amount, net of allowance $ 55,141 $ 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, 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 $23.4 million during 2016 and $35.5 million during 2015. Improvement in cash flow expectations has resulted in a reclassification from nonaccretable difference to accretable yield as shown in the table below. Accretable yield of purchased credit impaired loans, or income expected to be collected, was as follows: (dollars in thousands) 2016 2015 2014 Balance at January 1, $ 45,310 $ 62,533 $ 101,502 New loans purchased 3,217 1,812 8,274 Accretion of income (23,447 ) (35,526 ) (77,929 ) Reclassifications from (to) nonaccretable difference 10,589 14,189 27,536 Disposals/other adjustments (2,066 ) 2,302 3,150 Balance at December 31, $ 33,603 $ 45,310 $ 62,533 Included in Old National’s allowance for loan losses is $0.3 million related to the purchased loans disclosed above at December 31, 2016, compared to $1.4 million at December 31, 2015. PCI loans purchased during 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) Anchor (1) Founders (2) Contractually required payments $ 29,544 $ 11,103 Nonaccretable difference (6,153 ) (2,684 ) Cash flows expected to be collected at acquisition 23,391 8,419 Accretable yield (3,217 ) (1,812 ) Fair value of acquired loans at acquisition $ 20,174 $ 6,607 (1) Old National acquired Anchor effective May 1, 2016. (2) Old National acquired Founders effective January 1, 2015. 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. |