| 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)
2019
2018
Commercial (1)
$
2,890,296
$
3,232,970
Commercial real estate:
Construction
713,092
504,625
Other
4,453,700
4,454,226
Residential real estate
2,334,289
2,248,404
Consumer credit:
Home equity
559,021
589,322
Auto
1,017,287
1,059,633
Other
149,839
154,712
Total loans
12,117,524
12,243,892
Allowance for loan losses
(54,619
)
(55,461
)
Net loans
$
12,062,905
$
12,188,431
(1)
Includes direct finance leases of $47.2 million at December 31, 2019 and $60.0 million at December 31, 2018.
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 Commercial real estate 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 . At 194%, 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, 2019. 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. 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 for the years ended December 31, 2019, 2018, and 2017 is presented in the following table:
Years Ended December 31,
(dollars in thousands)
2019
2018
2017
Balance at beginning of period
$
9,310
$
9,481
$
8,494
New loans
1,218
9,152
6,041
Repayments
(2,063
)
(8,721
)
(4,885
)
Officer and director changes
(6,120
)
(602
)
(169
)
Balance at end of period
$
2,345
$
9,310
$
9,481
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, 2019, 2018, and 2017 was as follows:
Commercial
(dollars in thousands)
Commercial
Real Estate
Residential
Consumer
Total
2019
Allowance for loan losses:
Balance at beginning of period
$
21,742
$
23,470
$
2,277
$
7,972
$
55,461
Charge-offs
(3,819
)
(2,846
)
(661
)
(7,463
)
(14,789
)
Recoveries
1,650
3,774
146
3,630
9,200
Provision
3,012
(2,810
)
537
4,008
4,747
Balance at end of period
$
22,585
$
21,588
$
2,299
$
8,147
$
54,619
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
The following table presents Old National’s recorded investment in loans by portfolio segment at December 31, 2019 and 2018 and other information regarding the allowance:
Commercial
(dollars in thousands)
Commercial
Real Estate
Residential
Consumer
Total
December 31, 2019
Allowance for loan losses:
Individually evaluated for impairment
$
7,891
$
1,006
$
—
$
—
$
8,897
Collectively evaluated for impairment
14,692
20,582
2,299
7,954
45,527
Loans acquired with deteriorated credit quality
2
—
—
193
195
Total allowance for loan losses
$
22,585
$
21,588
$
2,299
$
8,147
$
54,619
Loans and leases outstanding:
Individually evaluated for impairment
$
41,479
$
63,288
$
—
$
—
$
104,767
Collectively evaluated for impairment
2,843,536
5,084,737
2,326,907
1,723,715
11,978,895
Loans acquired with deteriorated credit quality
5,281
18,767
7,382
2,432
33,862
Total loans and leases outstanding
$
2,890,296
$
5,166,792
$
2,334,289
$
1,726,147
$
12,117,524
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
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 or liquidation 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, 2019 and 2018 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
2019
2018
2019
2018
2019
2018
Grade:
Pass
$
2,702,605
$
3,029,130
$
665,512
$
460,158
$
4,191,455
$
4,167,902
Criticized
84,676
98,798
34,651
29,368
115,514
110,586
Classified - substandard
63,979
66,394
—
1,275
101,693
102,961
Classified - nonaccrual
22,240
29,003
12,929
13,824
38,822
37,441
Classified - doubtful
16,796
9,645
—
—
6,216
35,336
Total
$
2,890,296
$
3,232,970
$
713,092
$
504,625
$
4,453,700
$
4,454,226
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, 2019 and 2018:
Consumer
Home
(dollars in thousands)
Residential
Equity
Auto
Other
December 31, 2019
Performing
$
2,311,670
$
555,025
$
1,013,760
$
147,383
Nonperforming
22,619
3,996
3,527
2,456
Total
$
2,334,289
$
559,021
$
1,017,287
$
149,839
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
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, 2019 and 2018, 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, 2019
With no related allowance recorded:
Commercial
$
23,227
$
23,665
$
—
Commercial Real Estate - Construction
12,929
12,929
—
Commercial Real Estate - Other
37,674
38,112
—
Residential
1,774
1,794
—
Consumer
403
568
—
With an allowance recorded:
Commercial
18,252
18,305
7,891
Commercial Real Estate - Construction
-
-
-
Commercial Real Estate - Other
12,685
12,685
1,006
Residential
1,201
1,201
39
Consumer
1,094
1,094
55
Total
$
109,239
$
110,353
$
8,991
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
The average balance of impaired loans for the years ended December 31, 2019, 2018, and 2017 are included in the table below.
Years Ended December 31,
(dollars in thousands)
2019
2018
2017
Average Recorded Investment
With no related allowance recorded:
Commercial
$
22,629
$
21,295
$
24,780
Commercial Real Estate - Construction
6,465
—
—
Commercial Real Estate - Other
39,401
39,902
34,632
Residential
2,052
2,305
2,415
Consumer
923
832
1,761
With an allowance recorded:
Commercial
15,816
9,546
7,002
Commercial Real Estate - Construction
6,912
7,365
453
Commercial Real Estate - Other
20,420
27,317
26,562
Residential
981
840
1,012
Consumer
1,219
1,957
2,155
Total
$
116,818
$
111,359
$
100,772
Old National does not record interest on nonaccrual loans until principal is recovered. Interest income recognized on impaired loans during 2019, 2018, and 2017 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 collectability 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, 2019
Commercial
$
1,489
$
498
$
—
$
39,036
$
41,023
$
2,849,273
Commercial Real Estate:
Construction
187
—
—
12,929
13,116
699,976
Other
2,223
665
181
45,038
48,107
4,405,593
Residential
11,054
2,426
20
21,023
34,523
2,299,766
Consumer:
Home equity
1,020
554
107
3,785
5,466
553,555
Auto
7,704
919
154
3,527
12,304
1,004,983
Other
1,372
147
108
1,074
2,701
147,138
Total
$
25,049
$
5,209
$
570
$
126,412
$
157,240
$
11,960,284
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
(1)
Includes purchased credit impaired loans of $7.9 million at December 31, 2019 and $20.5 million at December 31, 2018 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, 2019, these loans totaled $868.1 million, of which $405.2 million had been sold to other financial institutions and $462.9 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 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, 2019, 2018, and 2017:
Commercial
(dollars in thousands)
Commercial
Real Estate
Residential
Consumer
Total
2019
Balance at beginning of period
$
10,275
$
27,671
$
3,390
$
2,374
$
43,710
(Charge-offs)/recoveries
(1,911
)
(2,112
)
—
13
(4,010
)
(Payments)/disbursements
(3,733
)
(23,182
)
(971
)
(1,207
)
(29,093
)
Additions
10,231
10,027
557
316
21,131
Balance at end of period
$
14,862
$
12,404
$
2,976
$
1,496
$
31,738
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
TDRs included with nonaccrual loans totaled $13.8 million at December 31, 2019 and $26.3 million at December 31, 2018. Old National has allocated specific reserves to customers whose loan terms have been modified in TDRs totaling $0.9 million at December 31, 2019 and $3.0 million at December 31, 2018. At December 31, 2019, Old National had committed to lend an additional $2.3 million to customers with outstanding loans that are classified as TDRs, compared to $4.4 million at December 31, 2018. The pre-modification and post-modification outstanding recorded investments of loans modified as TDRs during t he years ended December 31, 201 9 , 201 8 , and 201 7 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 9 , 201 8 , and 201 7 :
Pre-modification
Post-modification
Number
Outstanding Recorded
Outstanding Recorded
(dollars in thousands)
of Loans
Investment
Investment
2019
Troubled Debt Restructuring:
Commercial
8
$
10,231
$
10,231
Commercial Real Estate - Other
4
10,027
10,027
Residential
1
557
557
Consumer
1
316
316
Total
14
$
21,131
$
21,131
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
The TDRs that occurred during 2019 increased the allowance for loan losses by $2.0 million and resulted in $3.9 million in charge-offs during 2019. 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. 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 2019, 2018, and 2017. The terms of certain other loans were modified during 2019 and 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, 2019, it has not been necessary to remove any loans from PCI accounting. In general, once a modified loan is considered a , the loan will always be considered a , 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 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. The carrying amount of those loans was as follows:
December 31,
(dollars in thousands)
2019
2018
Commercial
$
5,281
$
6,193
Commercial real estate
18,767
25,391
Residential
7,382
9,257
Consumer
2,432
3,552
Carrying amount
33,862
44,393
Allowance for loan losses
(195
)
(478
)
Carrying amount, net of allowance
$
33,667
$
43,915
The outstanding balance of loans accounted for under ASC 310-30, including contractual principal, interest, fees and penalties, was $223.3 million at December 31, 2019 and $246.9 million at December 31, 2018. The accretable |
