Loans and Allowance for Loan Losses | NOTE 5 – LOANS AND ALLOWANCE FOR LOAN LOSSES Old National’s loans 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, Wisconsin, and Minnesota. Old National manages concentrations of credit exposure by industry, product, geography, customer relationship, and loan size. While loans to lessors of both residential and non-residential real estate exceed 10% The composition of loans at December 31 by lending classification was as follows: December 31, (dollars in thousands) 2018 2017 Commercial (1) $ 3,232,970 $ 2,717,269 Commercial real estate: Construction 504,625 374,306 Other 4,454,226 3,980,246 Residential real estate 2,248,404 2,167,053 Consumer credit: Home equity 589,322 507,507 Auto 1,059,633 1,148,672 Other 154,712 223,068 Total loans 12,243,892 11,118,121 Allowance for loan losses (55,461 ) (50,381 ) Net loans $ 12,188,431 $ 11,067,740 (1) Includes direct finance leases of $60.0 million at December 31, 2018 and $29.5 million at December 31, 2017. 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 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 (including Old National), 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. The acquisition of Klein on November 1, 2018 added $559.5 million of commercial real estate loans to our portfolio. At 198%, 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, 2018. 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 generally requires private mortgage insurance if that ratio is exceeded. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in residential property values. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers. Consumer Home equity loans are typically secured by a subordinate interest in 1-4 family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in residential property or other collateral values. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers. Old National assumed student loans in the acquisition of Anchor (WI) in May 2016. Student loans are guaranteed by the government from 97% to 100% and totaled $68.2 million at December 31, 2017. Old National sold the remaining student loan portfolio totaling $64.9 million during the second quarter of 2018, resulting in a $2.2 million gain that is included in other income on the income statement. 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 2018 is presented in the following table: Year Ended (dollars in thousands) December 31, 2018 Balance at beginning of period $ 9,481 New loans 9,152 Repayments (8,721 ) Officer and director changes (602 ) Balance at end of period $ 9,310 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 PD and 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 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 h istoric 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, 2018, 2017, and 2016 was as follows: Commercial (dollars in thousands) Commercial Real Estate Residential Consumer Total 2018 Allowance for loan losses: Balance at beginning of period $ 19,246 $ 21,436 $ 1,763 $ 7,936 $ 50,381 Charge-offs (3,087 ) (879 ) (1,100 ) (7,903 ) (12,969 ) Recoveries 1,519 2,740 2,118 4,706 11,083 Provision 4,064 173 (504 ) 3,233 6,966 Balance at end of period $ 21,742 $ 23,470 $ 2,277 $ 7,972 $ 55,461 2017 Allowance for loan losses: Balance at beginning of period $ 21,481 $ 18,173 $ 1,643 $ 8,511 $ 49,808 Charge-offs (1,108 ) (3,700 ) (985 ) (6,924 ) (12,717 ) Recoveries 2,281 3,777 255 3,927 10,240 Provision (3,408 ) 3,186 850 2,422 3,050 Balance at end of period $ 19,246 $ 21,436 $ 1,763 $ 7,936 $ 50,381 2016 Allowance for loan losses: Balance at beginning of period $ 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 Balance at end of period $ 21,481 $ 18,173 $ 1,643 $ 8,511 $ 49,808 The following table provides Old National’s recorded investment in loans by portfolio segment at December 31, 2018 and 2017 and other information regarding the allowance: Commercial (dollars in thousands) Commercial Real Estate Residential Consumer Total December 31, 2018 Allowance for loan losses: Individually evaluated for impairment $ 6,035 $ 8,306 $ — $ — $ 14,341 Collectively evaluated for impairment 15,700 14,845 2,276 7,821 40,642 Loans acquired with deteriorated credit quality 7 319 1 151 478 Total allowance for loan losses $ 21,742 $ 23,470 $ 2,277 $ 7,972 $ 55,461 Loans and leases outstanding: Individually evaluated for impairment $ 35,410 $ 83,104 $ — $ — $ 118,514 Collectively evaluated for impairment 3,191,367 4,850,356 2,239,147 1,800,115 12,080,985 Loans acquired with deteriorated credit quality 6,193 25,391 9,257 3,552 44,393 Total loans and leases outstanding $ 3,232,970 $ 4,958,851 $ 2,248,404 $ 1,803,667 $ 12,243,892 December 31, 2017 Allowance for loan losses: Individually evaluated for impairment $ 3,424 $ 6,654 $ — $ — $ 10,078 Collectively evaluated for impairment 15,790 14,782 1,763 7,802 40,137 Loans acquired with deteriorated credit quality 32 — — 134 166 Total allowance for loan losses $ 19,246 $ 21,436 $ 1,763 $ 7,936 $ 50,381 Loans and leases outstanding: Individually evaluated for impairment $ 26,270 $ 66,061 $ — $ — $ 92,331 Collectively evaluated for impairment 2,685,847 4,266,665 2,155,750 1,874,002 10,982,264 Loans acquired with deteriorated credit quality 5,152 21,826 11,303 5,245 43,526 Total loans and leases outstanding $ 2,717,269 $ 4,354,552 $ 2,167,053 $ 1,879,247 $ 11,118,121 Credit Quality Old National’s management monitors the credit quality of its loans in an on-going manner. Internally, management assigns an AQR to each non-homogeneous commercial and commercial real estate loan in the portfolio, with the exception of certain FICO-scored small business loans. 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. The risk category of commercial and commercial real estate loans by class of loans at December 31, 2018 and 2017 was as follows: (dollars in thousands) Commercial Commercial Corporate Credit Exposure Real Estate - Real Estate - Credit Risk Profile by Commercial Construction Other Internally Assigned Grade 2018 2017 2018 2017 2018 2017 Grade: Pass $ 3,029,130 $ 2,577,824 $ 460,158 $ 357,438 $ 4,167,902 $ 3,762,896 Criticized 98,798 74,876 29,368 14,758 110,586 98,451 Classified - substandard 66,394 37,367 1,275 — 102,961 58,584 Classified - nonaccrual 29,003 24,798 13,824 2,110 37,441 30,108 Classified - doubtful 9,645 2,404 — — 35,336 30,207 Total $ 3,232,970 $ 2,717,269 $ 504,625 $ 374,306 $ 4,454,226 $ 3,980,246 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 at December 31, 2018 and 2017: (dollars in thousands) Consumer Home Residential Equity Auto Other December 31, 2018 Performing $ 2,223,450 $ 586,235 $ 1,057,038 $ 153,113 Nonperforming 24,954 3,087 2,595 1,599 Total $ 2,248,404 $ 589,322 $ 1,059,633 $ 154,712 December 31, 2017 Performing $ 2,144,882 $ 502,322 $ 1,145,977 $ 217,819 Nonperforming 22,171 5,185 2,695 5,249 Total $ 2,167,053 $ 507,507 $ 1,148,672 $ 223,068 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 TDR. 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 PCI 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 at December 31, 2018 and 2017, respectively. Only purchased loans that have experienced subsequent impairment since the date acquired (excluding loans acquired with deteriorated credit quality) are included in the table below. Unpaid Recorded Principal Related (dollars in thousands) Investment Balance Allowance December 31, 2018 With no related allowance recorded: Commercial $ 22,031 $ 22,292 $ — Commercial Real Estate - Other 41,126 41,914 — Residential 2,276 2,296 — Consumer 362 535 — With an allowance recorded: Commercial 13,379 13,432 6,035 Commercial Real Estate - Construction 13,824 13,824 1,830 Commercial Real Estate - Other 28,154 28,154 6,476 Residential 889 889 44 Consumer 2,013 2,013 101 Total $ 124,054 $ 125,349 $ 14,486 December 31, 2017 With no related allowance recorded: Commercial $ 20,557 $ 21,483 $ — Commercial Real Estate - Other 38,678 44,564 — Residential 2,443 2,464 — Consumer 1,685 2,105 — With an allowance recorded: Commercial 5,713 5,713 3,424 Commercial Real Estate - Construction 905 1,371 401 Commercial Real Estate - Other 26,478 26,902 6,253 Residential 870 870 44 Consumer 2,211 2,228 110 Total $ 99,540 $ 107,700 $ 10,232 The average balance of impaired loans for the years ended December 31, 2018, 2017, and 2016 are included in the table below. Years Ended December 31, (dollars in thousands) 2018 2017 2016 Average Recorded Investment With no related allowance recorded: Commercial $ 21,295 $ 24,780 $ 34,708 Commercial Real Estate - Other 39,902 34,632 28,793 Residential 2,305 2,415 1,355 Consumer 832 1,761 855 With an allowance recorded: Commercial 9,546 7,002 16,669 Commercial Real Estate - Construction 7,365 453 352 Commercial Real Estate - Other 27,317 26,562 20,465 Residential 840 1,012 1,074 Consumer 1,957 2,155 2,367 Total $ 111,359 $ 100,772 $ 106,638 Old National does not record interest on nonaccrual loans until principal is recovered. Interest income recognized on impaired loans during 2018, 2017, and 2016 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 interest income. 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. Old National’s past due loans as of December 31 were as follows: Past Due 90 Days or 30-59 Days 60-89 Days More and Total (dollars in thousands) Past Due Past Due Accruing Nonaccrual (1) Past Due Current December 31, 2018 Commercial $ 3,627 $ 279 $ 52 $ 38,648 $ 42,606 $ 3,190,364 Commercial Real Estate: Construction — — — 13,824 13,824 490,801 Other 1,633 500 40 72,777 74,950 4,379,276 Residential 25,947 3,437 258 24,954 54,596 2,193,808 Consumer: Home equity 1,434 960 456 3,087 5,937 583,385 Auto 7,091 1,903 377 2,595 11,966 1,047,667 Other 711 210 170 1,599 2,690 152,022 Total $ 40,443 $ 7,289 $ 1,353 $ 157,484 $ 206,569 $ 12,037,323 December 31, 2017 Commercial $ 986 $ 360 $ 144 $ 27,202 $ 28,692 $ 2,688,577 Commercial Real Estate: Construction — — — 2,110 2,110 372,196 Other 2,247 89 — 60,315 62,651 3,917,595 Residential 18,948 3,416 — 22,171 44,535 2,122,518 Consumer: Home equity 1,467 230 68 5,185 6,950 500,557 Auto 6,487 1,402 532 2,695 11,116 1,137,556 Other 3,967 1,514 150 5,249 10,880 212,188 Total $ 34,102 $ 7,011 $ 894 $ 124,927 $ 166,934 $ 10,951,187 (1) Includes purchased credit impaired loans of $20.5 million at December 31, 2018 and $12.6 million at December 31, 2017 that are categorized as nonaccrual for credit analysis purposes because the collection of principal or interest is doubtful. However, these loans are accounted for under FASB ASC 310-30 and accordingly treated as performing assets. Loan Participations Old National has loan participations, which qualify as participating interests, with other financial institutions. At December 31, 2018, these loans totaled $924.8 million, of which $461.7 million had been sold to other financial institutions and $463.1 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 TDR has occurred, which is when for economic or legal reasons related to a borrower’s financial difficulties, Old National 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. Generally, Old National charges off small commercial loans scored through our small business credit center with contractual balances under $250,000 that are 90 days or more delinquent and do not have adequate collateral support. 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 TDR, 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, 2018, 2017, and 2016: Commercial (dollars in thousands) Commercial Real Estate Residential Consumer Total 2018 Balance at beginning of period $ 12,088 $ 34,705 $ 3,315 $ 3,895 $ 54,003 (Charge-offs)/recoveries (169 ) 561 23 16 431 (Payments)/disbursements (5,188 ) (8,808 ) (450 ) (1,969 ) (16,415 ) Additions 3,544 1,213 502 432 5,691 Balance at end of period $ 10,275 $ 27,671 $ 3,390 $ 2,374 $ 43,710 2017 Balance at beginning of period $ 16,802 $ 18,327 $ 2,985 $ 2,602 $ 40,716 (Charge-offs)/recoveries 417 381 — (294 ) 504 (Payments)/disbursements (18,519 ) (11,752 ) (608 ) (981 ) (31,860 ) Additions 13,388 27,749 938 2,568 44,643 Balance at end of period $ 12,088 $ 34,705 $ 3,315 $ 3,895 $ 54,003 2016 Balance at beginning of period $ 23,354 $ 14,602 $ 2,693 $ 3,602 $ 44,251 (Charge-offs)/recoveries (1,982 ) 953 42 (6 ) (993 ) (Payments)/disbursements (19,566 ) (8,358 ) (511 ) (1,379 ) (29,814 ) Additions 14,996 11,130 761 385 27,272 Balance at end of period $ 16,802 $ 18,327 $ 2,985 $ 2,602 $ 40,716 Approximately $26.3 million of the TDRs at December 31, 2018 were included with nonaccrual loans, compared to $34.0 million at December 31, 2017. Old National has allocated specific reserves to customers whose loan terms have been modified in TDRs totaling $3.0 million at December 31, 2018 and $5.7 million at December 31, 2017. As of December 31, 2018, Old National had committed to lend an additional $4.4 million to customers with outstanding loans that are classified as TDRs. The pre-modification and post-modification outstanding recorded investments of loans modified as TDRs during t he years ended December 31, 201 8 , 201 7 , and 201 6 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 year s ended December 31, 201 8 , 201 7 , and 201 6 : Pre-modification Post-modification Number Outstanding Recorded Outstanding Recorded (dollars in thousands) of Loans Investment Investment 2018 Troubled Debt Restructuring: Commercial 6 $ 3,544 $ 3,544 Commercial Real Estate - Other 2 1,213 1,213 Residential 1 502 502 Consumer 1 432 432 Total 10 $ 5,691 $ 5,691 2017 Troubled Debt Restructuring: Commercial 11 $ 13,388 $ 13,388 Commercial Real Estate - Other 12 27,749 27,749 Residential 6 938 938 Consumer 7 2,568 2,568 Total 36 $ 44,643 $ 44,643 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 The TDRs that occurred during 2018 did not have a material impact on the allowance for loan losses and resulted in no charge-offs during 2018. The TDRs that occurred during 2017 increased the allowance for loan losses by $2.7 million and resulted in $0.2 million of charge-offs during 2017. 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. A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms. TDRs for which there was a payment default within twelve months following the modification during the year were insignificant in 2018, 2017, and 2016. The terms of certain other loans were modified during 2018 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 PCI loan is being accounted for as part of a pool, it will not be removed from the pool. As of December 31, 2018, 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 Troubled Debt Restructurings by Creditors, Creditor Disclosure of Troubled Debt Restructurings Purchased Credit Impaired Loans Purchased loans acquired in a business combination are recorded at estimated fair value on their purchase date with no carryover of the related allowance for loan and lease losses. In determining the estimated fair value of purchased loans, management considers a number of factors including, among others, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, and net present value of cash flows expected to be received. Purchased loans are accounted for in accordance with guidance for certain loans acquired in a transfer (ASC 310-30), when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition that the acquirer will not collect all contractually required principal and interest payments. The difference between contractually required payments and the cash flows expected to be collected at acquisition is referred to as the non-accretable difference. Subsequent decreases to the expected cash flows will generally result in a provision for loan and lease losses. Subsequent increases in expected cash flows will result in a reversal of the provision for loan losses to the extent of prior charges and then an adjustment to accretable yield, which would have a positive impact on interest income prospectively. 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 was as follows: December 31, (dollars in thousands) 2018 2017 Commercial $ 6,193 $ 5,152 Commercial real estate 25,391 21,826 Residential 9,257 11,303 Consumer 3,552 5,245 Carrying amount 44,393 43,526 Allowance for loan losses (478 ) (166 ) Carrying amount, net of allowance $ 43,915 $ 43,360 The outstanding balance of loans accounted for under ASC 310-30, including contractual principal, interest, fees and penalties, was $246.9 million at December 31, 2018 and $235.9 million at December 31, 2017. The accretable difference on PCI loans is the difference between the expected cash |