UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2018

Commission File Number 1-15817

OLD NATIONAL BANCORP

(Exact name of the Registrant as specified in its charter)

INDIANA	35-1539838
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
One Main Street Evansville, Indiana	47708
(Address of principal executive offices)	(Zip Code)

(800) 731-2265

(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class	Name of each exchange on which registered
Common Stock, No Par Value	The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☑ No ☐

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☑

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (s232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (s229.405 of this chapter) is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐

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

Large accelerated filer	☑	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

The aggregate market value of the registrant’s voting common stock held by non-affiliates on June 30, 2018, was $2,791,017,355 (based on the closing price on that date of $18.60).  In calculating the market value of securities held by non-affiliates of the registrant, the registrant has treated as securities held by affiliates as of June 30, 2018, voting stock owned of record by its directors and principal executive officers, and voting stock held by the registrant's trust department in a fiduciary capacity for benefit of its directors and principal executive officers.  This calculation does not reflect a determination that persons are affiliates for any other purposes.

The number of shares outstanding of the registrant's common stock, as of January 31, 2019, was 175,163,000.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held May 2, 2019 are incorporated by reference into Part III of this Form 10-K.

OLD NATIONAL BANCORP

2018 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

		Page
PART I
Item 1.	Business	5
Item 1A.	Risk Factors	16
Item 1B.	Unresolved Staff Comments	25
Item 2.	Properties	25
Item 3.	Legal Proceedings	25
Item 4.	Mine Safety Disclosures	25
PART II
Item 5.	Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	26
Item 6.	Selected Financial Data	28
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	29
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	60
Item 8.	Financial Statements and Supplementary Data	61
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	133
Item 9A.	Controls and Procedures	133
Item 9B.	Other Information	133
PART III
Item 10.	Directors, Executive Officers and Corporate Governance of the Registrant	134
Item 11.	Executive Compensation	134
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	134
Item 13.	Certain Relationships and Related Transactions, and Director Independence	134
Item 14.	Principal Accounting Fees and Services	134
PART IV
Item 15.	Exhibits and Financial Statement Schedules	135
SIGNATURES		138

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GLOSSARY OF ABBREVIATIONS AND ACRONYMS

As used in this report, references to “Old National,” “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of Old National Bancorp and its wholly-owned affiliates. Old National Bancorp refers solely to the parent holding company, and Old National Bank refers to Old National’s bank subsidiary.

The acronyms and abbreviations identified below are used throughout this report, including the Notes to Consolidated Financial Statements. You may find it helpful to refer to this page as you read this report.

ACH:  Automated Clearing House

Anchor (MN):  Anchor Bancorp, Inc.

Anchor Bank (MN):  Anchor Bank, N.A.

Anchor (WI):  Anchor BanCorp Wisconsin Inc.

AnchorBank (WI):  AnchorBank, fsb

AOCI:  accumulated other comprehensive income (loss)

AQR:  asset quality rating

ASC:  Accounting Standards Codification

ASU:  Accounting Standards Update

ATM:  automated teller machine

CDO:  collateralized debt obligation

Common Stock:  Old National Bancorp common stock, without par value

CReED:  Indiana Community Revitalization Enhancement District Tax Credit

DTI:  debt-to-income

EITF:  Emerging Issues Task Force

FASB:  Financial Accounting Standards Board

FDIC:  Federal Deposit Insurance Corporation

FHLB:  Federal Home Loan Bank

FHLBI:  Federal Home Loan Bank of Indianapolis

FHTC:  Federal Historic Tax Credit

FICO:  Fair Isaac Corporation

GAAP:  U.S. generally accepted accounting principles

Klein:  Klein Financial, Inc.

LGD:  loss given default

LIBOR:  London Interbank Offered Rate

LIHTC:  Low Income Housing Tax Credit

LTV:  loan-to-value

N/A:  not applicable

N/M:  not meaningful

NASDAQ:  The NASDAQ Stock Market LLC

NOW:  negotiable order of withdrawal

OCC:  Office of the Comptroller of the Currency

ONI:  ONB Insurance Group, Inc.

OTTI:  other-than-temporary impairment

PCI:  purchased credit impaired

PD:  probability of default

PSA:  prepayment speed assumptions

Renewable Energy:  investment tax credits for solar projects

SAB:  Staff Accounting Bulletin

SEC:  Securities and Exchange Commission

TBA:  to be announced

TDR:  troubled debt restructuring

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OLD NATIONAL BANCORP

2018 ANNUAL REPORT ON FORM 10-K

FORWARD-LOOKING STATEMENTS

In this report, we have made various statements regarding current expectations or forecasts of future events, which speak only as of the date the statements are made.  These statements are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements are also made from time-to-time in press releases and in oral statements made by the officers of Old National Bancorp (“Old National” or the “Company”).  Forward-looking statements can be identified by the use of the words “expect,” “may,” “could,” “intend,” “project,” “estimate,” “believe,” “anticipate,” and other words of similar meaning.  Forward-looking statements also include, but are not limited to, statements regarding estimated cost savings, plans and objectives for future operations, the Company’s business and growth strategies, including future acquisitions of banks, regulatory developments, and expectations about performance as well as economic and market conditions and trends.  

Such forward-looking statements are based on assumptions and estimates, which although believed to be reasonable, may turn out to be incorrect.  Therefore, undue reliance should not be placed upon these estimates and statements.  We cannot assure that any of these statements, estimates, or beliefs will be realized and actual results may differ from those contemplated in these “forward-looking statements.”  We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events, or otherwise.  You are advised to consult further disclosures we may make on related subjects in our filings with the SEC.  In addition to other factors discussed in this report, some of the important factors that could cause actual results to differ materially from those discussed in the forward-looking statements include the following:

• economic, market, operational, liquidity, credit, and interest rate risks associated with our business;

• economic conditions generally and in the financial services industry;

• expected cost savings in connection with the consolidation of recent acquisitions may not be fully realized or realized within the expected time frames, and deposit attrition, customer loss, and revenue loss following completed acquisitions may be greater than expected;

• failure to properly understand risk characteristics of newly entered markets;

• increased competition in the financial services industry either nationally or regionally, resulting in, among other things, credit quality deterioration;

• our ability to achieve loan and deposit growth;

• volatility and direction of market interest rates;

• governmental legislation and regulation, including changes in accounting regulation or standards;

• our ability to execute our business plan;

• a weakening of the economy which could materially impact credit quality trends and the ability to generate loans;

• changes in the securities markets; and

• changes in fiscal, monetary, and tax policies.

Investors should consider these risks, uncertainties, and other factors in addition to risk factors included in this filing and our other filings with the SEC.

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PART I

ITEM 1. BUSINESS

GENERAL

Old National is a financial holding company incorporated in the state of Indiana and maintains its principal executive office in Evansville, Indiana.  We, through our wholly-owned banking subsidiary, provide a wide range of services, including commercial and consumer loan and depository services, private banking, brokerage, trust, investment advisory, and other traditional banking services.  At December 31, 2018, we employed 2,892 full-time equivalent associates.

COMPANY PROFILE

Old National Bank, our wholly-owned banking subsidiary (“Old National Bank”), was founded in 1834 and is the oldest company in Evansville, Indiana.  In 1982, Old National Bancorp was formed; in 2001 we became a financial holding company and we are currently the largest financial holding company headquartered in the state of Indiana with consolidated assets of $19.7 billion at December 31, 2018.

At December 31, 2018, Old National Bank operated 191 banking centers located primarily in Indiana, Kentucky, Michigan, Wisconsin, and Minnesota. Each of the branches of Old National Bank provide a group of similar community banking services, including such products and services as commercial, real estate and consumer loans, time deposits, checking and savings accounts, cash management, brokerage, trust, and investment advisory services.  The individual bank branches located throughout our Midwest footprint have similar operating and economic characteristics.

We earn interest income on loans as well as fee income from the origination of loans.  Lending activities include loans to individuals, which primarily consist of home equity lines of credit, residential real estate loans and consumer loans, and loans to commercial clients, which include commercial loans, commercial real estate loans, letters of credit, and lease financing.  Residential real estate loans are either kept in our loan portfolio or sold to secondary investors, with gains or losses from the sales being recognized.

We strive to serve individuals and commercial clients by providing depository services that fit their needs at competitive rates.  We pay interest on the interest-bearing deposits and receive service fee revenue on various accounts.  Deposit accounts include products such as noninterest-bearing demand, interest-bearing checking and NOW, savings and money market, and time deposits.  Debit and ATM cards provide clients with access to their accounts 24 hours a day at any ATM location.  We also provide 24-hour telephone access and online banking as well as other electronic and mobile banking services.

In addition to the community banking services of lending and providing deposit services, we offer comprehensive wealth management, investment, and foreign currency services.  For businesses, we provide treasury management, merchant, health savings, and capital markets services as well as community development lending and equity investment solutions that produce jobs and revitalize our communities.

MARKET AREA

We own the largest Indiana-based bank headquartered in Indiana.  Operating from a home base in Evansville, Indiana, we have continued to grow our footprint in Indiana, Kentucky, Michigan, Wisconsin, and Minnesota.  Since the beginning of 2011, Old National has transformed its franchise by reducing low-return businesses and low-growth markets and investing in higher-growth markets.

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The following table reflects information on the top markets we currently serve, demonstrating that our largest metropolitan statistical areas compare favorably to the national average.

	Percent of											2019-2024
	Old							2019-2024		2019		Projected
	National		Deposits		2010-2019			Projected		Median		Household
	Bank		Per		Population			Population		Household		Income
	Franchise		Branch		Change			Change		Income		Change
Metropolitan Statistical Area	(%)		($M)		(%)			(%)		($)		(%)
Minneapolis-St. Paul-Bloomington, MN-WI (1)		22.9		89.7		9.2			4.6		80,054		10.7
Evansville, IN-KY		14.2		117.6		1.5			1.3		53,807		10.4
Indianapolis-Carmel-Anderson, IN		8.0		53.6		9.1			3.9		62,642		10.9
Madison, WI (1)		5.8		48.3		9.8			4.0		74,588		13.0
Bloomington, IN (1)		4.9		138.6		6.3			3.2		48,854		12.5
Fort Wayne, IN (1)		3.5		99.6		5.4			3.0		56,723		10.1
Jasper, IN		2.8		78.7		0.4			1.1		61,313		7.1
Terre Haute, IN		2.7		76.5		(1.7	)		0.1		48,262		10.3
Adrian, MI (1)		2.2		78.6		(1.3	)		0.0		57,884		14.5
Ann Arbor, MI (1)		2.1		58.1		8.0			3.2		72,826		12.3
National average						6.6			3.6		63,174		8.8
Weighted average or sum total    Old National Bank top 5		55.7		82.0		8.8			4.2		63,989		11.5
Weighted average or sum total    Old National Bank top 10		69.0		81.2		8.2			3.9		61,695		11.2
(1)  Expansion markets weighted average		41.4		81.2		8.6			4.2		65,155		12.1
Weighted average total Old National Bank						4.6			2.5		62,633		10.4

Source: S&P Global Market Intelligence

ACQUISITION AND DIVESTITURE STRATEGY

Since the formation of Old National in 1982, we have acquired over 50 financial institutions and other financial services businesses.  Future acquisitions and divestitures will be driven by a disciplined financial evaluation process and will be consistent with the existing basic banking strategy which focuses on community banking, client relationships, and consistent quality earnings.  Targeted geographic markets for acquisitions include mid-size markets with average to above average growth rates.

We anticipate that, as with previous acquisitions, the consideration paid by us in future acquisitions may be in the form of cash, debt, or Old National stock, or a combination thereof.  The amount and structure of such consideration is based on reasonable growth and cost savings assumptions and a thorough analysis of the impact on both long- and short-term financial results.

Effective November 1, 2018, Old National acquired Minnesota-based Klein through a 100% stock merger.  Klein was a bank holding company with KleinBank as its wholly-owned subsidiary.  Founded in 1907 and headquartered in Chaska, Minnesota with 18 full-service branches, KleinBank was the largest family-owned community bank serving the Twin Cities and its western communities.  Pursuant to the merger agreement, each holder of Klein common stock received 7.92 shares of Old National Common Stock per share of Klein common stock such holder owned.  The total fair value of consideration for Klein was $406.5 million, consisting of 22.8 million shares of Old National Common Stock valued at $406.5 million.  See Note 2 to the consolidated financial statements for further details on the Klein acquisition.

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Prior to 2018, our most recent acquisitions included the following:

• Indiana bank holding company Tower Financial Corporation through a stock and cash merger on April 25, 2014 that added seven full-service branches in the Fort Wayne, Indiana market and strengthened Old National’s position as one of the largest deposit holders in Indiana;

• Michigan bank holding company United Bancorp, Inc. through a stock and cash merger on July 31, 2014 that added 18 branches in Ann Arbor, Michigan and the surrounding area, doubling our presence in Michigan;

• LSB Financial Corp. through a stock and cash merger on November 1, 2014 that added five branches in Lafayette, Indiana;

• Michigan-based Founders Financial Corporation through a stock and cash merger on January 1, 2015 that added four branches in the Grand Rapids, Michigan market;

• Anchor BanCorp Wisconsin Inc. through a stock and cash merger on May 1, 2016 that added 46 branches in the Madison, Milwaukee, and Fox Valley triangle markets; and

• Anchor Bank, N.A through a stock and cash merger on November 1, 2017 that added 17 branches in Minnesota.

In regard to future partnerships, we are an active looker and a selective, disciplined buyer in demographically accretive markets.  We believe our ability to bring an enhanced product set and a larger balance sheet with better capital allows a potential partner to better serve their clients. As previously disclosed, we do not feel compelled to enter into a partnership.

Divestitures

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

On May 31, 2016, the Company sold its insurance operations, ONI.  The Company received approximately $91.8 million in cash resulting in a pre-tax gain of $41.9 million and an after-tax gain of $17.6 million.  See Note 16 to the consolidated financial statements for further details on the income tax impact of this sale.  Goodwill and intangible assets of approximately $47.5 million were eliminated as part of this transaction.  ONI was an ancillary business and did not meet the criteria to be treated as a discontinued operation as defined in Accounting Standards Update 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.”

On October 26, 2018, the Company divested ten branches in Wisconsin to Marine Credit Union of La Crosse, Wisconsin.  At closing, the purchasers assumed $230.6 million in deposits and no loans.  Old National recorded a net pre-tax gain of $14.0 million in connection with the sale, which included a deposit premium of $15.0 million, goodwill allocation of $0.6 million, and $0.4 million of other transaction expenses.

We continue to focus our efforts to optimize our branch network.  Since the beginning of 2011, we have consolidated 158 banking centers (including 10 banking centers in 2018).  Over the same period, we have more than doubled our assets and have increased our average total deposits per branch from $34 million to approximately $75 million, while only increasing our number of branches by 30. We will continue to review our branch system as we adapt to client behavior changes, continue to make technology improvements, and delivery model changes. Accordingly, as a result of our ongoing branch analysis, we expect a continued reduction in our branch network in 2019.

COMPETITION

The banking industry and related financial service providers operate in a highly competitive market.  Old National competes with financial service providers such as other commercial banks, savings and loan associations, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds, and other financial intermediaries.  In addition, Financial Technology, or FinTech, start-ups are emerging in key areas of banking.

Many of our nonfinancial institution competitors have fewer regulatory constraints, broader geographic service areas, greater capital, and, in some cases, lower cost structures.  In addition, competition for quality customers has

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intensified as a result of changes in regulation, mergers and acquisitions, advances in technology and product delivery systems, consolidation among financial service providers, bank failures, and the conversion of certain former investment banks to bank holding companies.

SUPERVISION AND REGULATION

Old National is subject to extensive regulation under federal and state laws.  The regulatory framework is intended primarily for the protection of depositors, federal deposit insurance funds, and the banking system as a whole and not for the protection of shareholders and creditors.

Significant elements of the laws and regulations applicable to Old National and its subsidiaries are described below.  The descriptions are not intended to be complete and are qualified in its entirety by reference to the full text of the statutes, regulations and policies that are described.  Also, such statutes, regulations and policies are continually under review by Congress and state legislatures and federal and state regulatory agencies.  A change in statutes, regulations, or regulatory policies applicable to Old National and its subsidiaries, for which Old National cannot predict, could have a material effect on the business of the Company.

The Dodd-Frank Act.  On July 21, 2010, financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) was signed into law.  The Dodd-Frank Act significantly restructured the financial regulatory environment in the United States. The Dodd-Frank Act contains numerous provisions that affect all bank holding companies and banks, including Old National and Old National Bank, some of which are described in more detail below.  The scope and impact of many of the Dodd-Frank Act provisions were determined and issued over time. The impact of the Dodd-Frank Act on Old National has been substantial.  Provisions in the legislation that affect the payment of interest on demand deposits and collection of interchange fees increased the costs associated with certain deposits and placed limitations on certain revenues those deposits generate.

The Volcker Rule.  Section 619 of the Dodd-Frank Act contains provisions prohibiting proprietary trading and restricting the activities involving private equity and hedge funds (the “Volcker Rule”).  Rules implementing the Volcker Rule were adopted in December 2013.  Proprietary trading is defined as the trading of securities, derivatives, or futures (or options on any of the foregoing) as principal, where such trading is principally for the purpose of short-term resale, benefiting from actual or expected short-term price movements and realizing short-term arbitrage profits. The rule’s definition of proprietary trading specifically excludes market-making-related activity, certain government issued securities trading and certain risk management activities.  Old National and Old National Bank do not engage in any prohibited proprietary trading activities.

The final text of the Volcker Rule contained provisions to the effect that CDOs, including pooled trust preferred securities, would have to be sold prior to July 15, 2015. The practical implication of this rule provision, which was not expected by the industry, was that those instruments could no longer be accorded “held-to-maturity” accounting treatment but would have to be switched to “available-for-sale” accounting, and that all covered CDOs, regardless of the accounting classification, would need to be adjusted to fair value through an other-than-temporary impairment non-cash charge to earnings. On January 14, 2014, federal banking agencies released an interim final rule regarding the Volcker Rule’s impact on trust preferred CDOs, which included a nonexclusive list of CDOs backed by trust preferred securities that depository institutions will be permitted to continue to hold.  All of the trust preferred securities owned by Old National are on this list and held as “available-for-sale”.  Any unrealized losses associated with these instruments have already impacted our capital.  As of December 31, 2018, Old National does not have any securities that will have to be divested as a result of the Volcker Rule.

Bank Holding Company Regulation.  Old National is registered as a bank holding company and has elected to be a financial holding company.  It is subject to the supervision of, and regulation by, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHC Act”).  The Federal Reserve has issued regulations under the BHC Act requiring a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks.  It is the policy of the Federal Reserve that, pursuant to this requirement, a bank holding company should stand ready to use its resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity.  Under this requirement, Old National is expected to commit resources to support Old National Bank, including at times when Old National may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding

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company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.

The BHC Act requires the prior approval of the Federal Reserve to acquire more than a 5% voting interest of any bank or bank holding company.  Additionally, the BHC Act restricts Old National’s non-banking activities to those which are determined by the Federal Reserve to be closely related to banking and a proper incident thereto.

Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” (as defined in FDICIA) with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal bank regulatory agency.

Capital and Liquidity Requirements. Bank holding companies are required to comply with the Federal Reserve’s risk-based capital guidelines.  The FDIC and the OCC have adopted risk-based capital ratio guidelines to which depository institutions under their respective supervision, including Old National Bank, are subject.  The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations.  Risk-based capital ratios are determined by allocating assets and specified off-balance sheet commitments to four risk-weighted categories, with higher levels of capital being required for the categories perceived as representing greater risk.  Old National Bank exceeded all risk-based minimum capital requirements of the FDIC and OCC as of December 31, 2018 and 2017.  For Old National’s regulatory capital ratios and regulatory requirements as of December 31, 2018 and 2017, see Note 25 to the consolidated financial statements.

The federal regulatory authorities’ current risk-based capital guidelines are based upon the Basel Committee on Banking Supervision (the “Basel Committee”).  The Basel Committee is a committee of international central banks and bank regulators responsible for establishing international supervisory guidelines for use in member jurisdictions to enhance and align bank regulation on a global scale and promote financial stability.  In December 2010 and January 2011, the Basel Committee published the final revisions to the international regulatory capital framework generally referred to as “Basel III,” as a response to deficiencies in the international regulatory standards identified during the global financial crisis.

Effective July 2, 2013, the Federal Reserve and the OCC approved final rules known as the “Basel III Capital Rules” substantially revising the risk-based capital and leverage capital requirements applicable to bank holding companies and depository institutions, including Old National and Old National Bank. The Basel III Capital Rules address the components of capital and other issues affecting the numerator in banking institutions’ regulatory capital ratios.  The Basel III Capital Rules also implement the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal banking agencies’ rules. Certain of the Basel III Capital Rules came into effect for Old National and Old National Bank on January 1, 2015; subject to a phase-in period ending on December 31, 2018.

The Basel III Capital Rules introduced a new capital measure “Common Equity Tier 1” (“CET1”).  The rules specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements.  CET1 capital consists of common stock instruments that meet the eligibility criteria in the final rules, retained earnings, accumulated other comprehensive income, and common equity Tier 1 minority interest.  The rules also define CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1, and not to the other components of capital.  They also expand the scope of the adjustments as compared to existing regulations.  

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As of January 1, 2019, the Basel III Capital Rules require banking organizations to maintain:

• a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased-in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7.0% upon full implementation);

• a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased-in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation);

• a minimum ratio of total capital (that is, Tier 1 plus Tier 2 capital) to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased-in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation); and

• a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to adjusted average consolidated assets.

The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer will face limitations on the payment of dividends, common stock repurchases and discretionary cash payments to executive officers based on the amount of the shortfall.

The Basel III Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1. Under current capital standards, the effects of accumulated other comprehensive income items included in capital are excluded for the purposes of determining regulatory capital ratios. Under the Basel III Capital Rules, Old National and Old National Bank are given a one-time election (the “Opt-out Election”) to filter certain AOCI components, comparable to the treatment under the current general risk-based capital rule. The Company chose the Opt-out Election on the March 31, 2015 Call Report and FR Y-9C for Old National Bank and Old National, respectively.

Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and have been phased-in over a five-year period (20% per year). The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and was phased-in over a four-year period (increasing by that amount on each subsequent January 1, until it reached 2.5% on January 1, 2019).

The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and is not expected to have any current applicability to Old National or Old National Bank.

In addition, the Basel III Capital Rules revise the rules for calculating risk-weighted assets to enhance their risk sensitivity.  They establish a new framework under which mortgage-backed securities and other securitization exposures will be subject to risk-weights ranging from 20% to 1,250%.  The rules also establish adjusted risk-weights for credit exposures, including multi-family and commercial real estate exposures that are 90 days or more past due or on non-accrual, which will be subject to a 150% risk-weight, except in situations where qualifying collateral and/or guarantees are in place. The existing treatment of residential mortgage exposures will remain subject to either a 50% risk-weight (for prudently underwritten owner-occupied first liens that are current or less than 90 days past due) or a 100% risk-weight (for all other residential mortgage exposures including 90 days or more past due exposures).

Management believes that, as of December 31, 2018, Old National and Old National Bank would meet all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis if such requirements were currently effective. Requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely impact the Company’s net income.

The Basel III Capital Rules permit banks with less than $15 billion in assets to continue to treat trust preferred securities as Tier 1 capital.  This treatment is permanently grandfathered as Tier 1 capital for organic growth but not as a result of a merger or acquisition.  On November 1, 2017, Old National acquired Anchor (MN) and exceeded $15 billion in assets. As the result of this acquisition, Tier 1 treatment of trust preferred securities is prohibited and those securities can only be treated as Tier 2 capital.  The Basel III Capital Rules also permit banks with less than $250 billion in assets to choose to continue excluding unrealized gains and losses on certain securities holdings for purposes of calculating regulatory capital.  As previously reported, the Old National chose the Opt-out Election in its

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March 31, 2015 Call Report.  Additionally, the Basel III Capital Rules limit a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of a specified amount of CET1 capital in addition to the amount necessary to meet its minimum risk-based capital requirements.

The liquidity framework under the Basel III Capital Rules (the “Basel III liquidity framework”) applies a balance sheet perspective to establish quantitative standards designed to ensure that a banking organization is appropriately positioned to satisfy its short- and long-term funding needs. One test to address short-term liquidity risk is referred to as the liquidity coverage ratio (“LCR”), designed to calculate the ratio of a banking entities’ ratio of high-quality liquid assets to its total net cashflows over a 30-day time horizon. The other test, referred to as the net stable funding ratio (“NSFR”), is designed to promote more medium- and long-term asset funding by incenting banking entities to increase their holdings of U.S. Treasury securities and other sovereign debt, as well as increase the use of long-term debt as a funding source. The Basel III liquidity framework was implemented as a minimum standard on January 1, 2015, with a phase-in period ending January 1, 2019.  However, the federal banking agencies have not proposed rules implementing the Basel III liquidity framework and have not determined to what extent they will apply to U.S. banks that are not large, internationally active banks.

Management believes that, as of December 31, 2018, Old National Bank would meet the LCR requirement under the Basel III liquidity framework on a fully phased-in basis if such requirements were currently effective. Management’s evaluation of the impact of the NSFR requirement is ongoing as of December 31, 2018.  Requirements to maintain higher levels of liquid assets could adversely impact the Company’s net income.

Prompt Corrective Action Regulations.  The Federal Deposit Insurance Act (the “FDIA”) requires, among other things, federal bank regulatory authorities to take “prompt corrective action” with respect to banks which do not meet minimum capital requirements.  Under current prompt corrective action regulations, a bank will be (i) “well capitalized” if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, and a leverage ratio of 5.0% or greater, and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if the institution has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater, and a leverage ratio of 4.0% or greater and is not “well capitalized”; (iii) “undercapitalized” if the institution has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0% or a leverage ratio of less than 4.0%; (iv) “significantly undercapitalized” if the institution has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0% or a leverage ratio of less than 3.0%; and (v) “critically undercapitalized” if the institution’s tangible equity is equal to or less than 2.0% of average quarterly tangible assets.  An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters.  A bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects for other purposes.

The Basel III Capital Rules revised the “prompt corrective action” regulations pursuant to Section 38 of the FDIA, by:

• introducing a CET1 ratio requirement at each level (other than critically undercapitalized), with the required CET1 ratio being 6.5% for well-capitalized status;

• increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum Tier 1 risk-based capital ratio for well-capitalized status being 8.0% (as compared to the previous 6.0%); and

• eliminating the provision that provides that a bank with a composite supervisory rating of 1 may have a 3.0% leverage ratio and still be well-capitalized.

The FDIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be “undercapitalized.”  “Undercapitalized” institutions are subject to growth limitations and are required to submit a capital restoration plan. The agencies may not accept such a plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. In addition, for a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with such capital restoration plan.  The bank holding company must also provide appropriate assurances of performance.  The aggregate liability of the parent holding company is limited to

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the lesser of (i) an amount equal to 5.0% of the depository institution’s total assets at the time it became undercapitalized and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan.  If a depository institution fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.”

“Significantly undercapitalized” depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks.  “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator.

Management believes that, as of December 31, 2018, Old National Bank was “well capitalized” based on the existing ratios and the ratios as modified by the Basel III Capital Rules.

Deposit Insurance.  Substantially all of the deposits of Old National Bank are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and Old National Bank is subject to deposit insurance assessments to maintain the DIF. Deposit insurance assessments are based on average consolidated total assets minus average tangible equity. Under the FDIC’s risk-based assessment system, insured institutions with at least $10 billion in assets, such as Old National Bank, are assessed on the basis of a scoring system that combines the institution’s regulatory ratings and certain financial measures.  The scoring system assesses risk measures to produce two scores, a performance score and a loss severity score, that will be combined and converted to an initial assessment rate.

The performance score measures an institution’s financial performance and its ability to withstand stress.  The loss severity score quantifies the relative magnitude of potential losses to the FDIC in the event of an institution’s failure.  Once the performance and loss severity scores are calculated, these scores will be converted to a total score.  An institution with a total score of 30 or less will pay the minimum base assessment rate, and an institution with a total score of 90 or more will pay the maximum initial base assessment rate.  For total scores between 30 and 90, initial base assessment rates will rise at an increasing rate as the total score increases.  The FDIC has the authority to raise or lower assessment rates, subject to limits, and to impose special additional assessments.

Under the FDIA, the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

Safety and Soundness Regulations.  In accordance with the FDIA, the federal banking agencies adopted guidelines establishing general standards relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal shareholder. In addition, regulations adopted by the federal banking agencies authorize the agencies to require that an institution that has been given notice that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, the institution fails to submit an acceptable compliance plan or fails in any material respect to implement an accepted compliance plan, the agency must issue an order directing corrective actions and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the “prompt corrective action” provisions of FDIA. If the institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.

Incentive Compensation.  The Dodd-Frank Act requires the federal bank regulatory agencies and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities having at least $1 billion in total assets, such as Old National and Old National Bank, that encourage inappropriate risks by providing an executive officer, employee, director or principal shareholder with excessive compensation, fees, or benefits or that could lead to material financial loss to the entity. In addition, these regulators must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation arrangements. The agencies proposed such regulations in April 2011, but the regulations have not been finalized. If the regulations are adopted in the form initially proposed, they will impose limitations on the manner in which Old National may structure compensation for its executives.

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In June 2010, the Federal Reserve, OCC, and FDIC issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees who have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. These three principles are incorporated into the proposed joint compensation regulations under the Dodd-Frank Act, discussed above.

The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as Old National, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions.

Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

Loans to One Borrower.  Old National Bank generally may not make loans or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus. An additional amount may be loaned, up to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of December 31, 2018, Old National Bank was in compliance with the loans-to-one-borrower limitations.

Depositor Preference.  The FDIA provides that, in the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institution, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors, including depositors whose deposits are payable only outside of the United States and the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institution.

Community Reinvestment Act.  The Community Reinvestment Act of 1977 (“CRA”) requires depository institutions to assist in meeting the credit needs of their market areas consistent with safe and sound banking practice. Under the CRA, each depository institution is required to help meet the credit needs of its market areas by, among other things, providing credit to low- and moderate-income individuals and communities. Depository institutions are periodically examined for compliance with the CRA and are assigned ratings that must be publicly disclosed. In order for a financial holding company to commence any new activity permitted by the BHC Act, or to acquire any company engaged in any new activity permitted by the BHC Act, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the CRA. Furthermore, banking regulators take into account CRA ratings when considering approval of certain applications.  Old National Bank received a rating of “satisfactory” in its latest CRA examination.

Fair Lending Laws.  Fair Lending laws prohibit discrimination in banking services and include the Equal Credit Opportunity Act (“ECOA”) and the Fair Housing Act (“FHA”), which prohibit discrimination on the basis of race, gender, religion, or other prohibited factors in the extension of credit and residential real estate transactions. In May 2018, the U.S. Department of Justice (“DOJ”) and KleinBank entered into a public Settlement Agreement (“Agreement”) regarding alleged violations of the FHA and the ECOA within the Minneapolis, Minnesota market. Old National Bank, as the legal successor in interest to KleinBank, has assumed the ongoing terms and obligations of the Agreement.

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Financial Privacy.  The federal banking regulators adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. These regulations affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors.

Old National Bank is also subject to regulatory guidelines establishing standards for safeguarding customer information. These guidelines describe the federal banking agencies’ expectations for the creation, implementation and maintenance of an information security program, which would include administrative, technical and physical safeguards appropriate to the size and complexity of the institution and the nature and scope of its activities. The standards set forth in the guidelines are intended to ensure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of such records and protect against unauthorized access to or use of such records or information that could result in substantial harm or inconvenience to any customer.

Anti-Money Laundering and the USA Patriot Act. A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA Patriot Act of 2001 (the “USA Patriot Act”) substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations on financial institutions, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States.

On May 11, 2016, the Financial Crimes Enforcement Network (the “FinCEN”) issued new anti-money laundering (“AML”) rules governing corporate entities doing business with banks and other financial institutions that are subject to the requirements of the USA Patriot Act.  The new rules were effective May 11, 2018 which impose significant due diligence obligations on financial institutions with respect to opening of new accounts and the monitoring of existing accounts.  Under the AML rules, a financial institution must identify persons owning or controlling 25% or more of a “legal entity,” whenever the legal entity opens a new account at the bank.  The financial institution must also identify an individual who has substantial management authority at the legal entity, such as a CEO, CFO, or managing partner.

The AML rules codify within the FinCEN regulations the “pillars” that must be included in a financial institutions AML compliance program. Regulators previously communicated their expectations with respect to four of these pillars: (1) the development of internal policies, procedures, and control; (2) the designation of a compliance officer; (3) the establishment of an ongoing employee training program; and (4) the implementation of an independent audit function to test programs.  The new beneficial ownership requirement establishes a fifth pillar.  Among other things, this new pillar includes the necessity to monitor and update the beneficial ownership of a legal entity, including the need to subject corporate borrowers to due diligence requests from financial institutions for certifications with respect to their beneficial owners.  Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.

Office of Foreign Assets Control Regulation. The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others which are administered by the U.S. Treasury Department Office of Foreign Assets Control. Failure to comply with these sanctions could have serious legal and reputational consequences, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.

Transactions with Affiliates.  Transactions between Old National Bank and its affiliates are regulated by the Federal Reserve under sections 23A and 23B of the Federal Reserve Act and related regulations. These regulations limit the types and amounts of covered transactions engaged in by Old National Bank and generally require those transactions to be on an arm’s-length basis. The term “affiliate” is defined to mean any company that controls or is under common control with Old National Bank and includes Old National and its non-bank subsidiaries. “Covered transactions” include a loan or extension of credit, as well as a purchase of securities issued by an affiliate, a purchase of assets (unless otherwise exempted by the Federal Reserve) from the affiliate, certain derivative transactions that create a credit exposure to an affiliate, the acceptance of securities issued by the affiliate as

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collateral for a loan, and the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. In general, these regulations require that any such transaction by Old National Bank (or its subsidiaries) with an affiliate must be secured by designated amounts of specified collateral and must be limited to certain thresholds on an individual and aggregate basis.

Federal law also limits Old National Bank’s authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons. Among other things, extensions of credit to insiders are required to be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons. Also, the terms of such extensions of credit may not involve more than the normal risk of repayment or present other unfavorable features and may not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Old National Bank’s capital.

Federal Home Loan Bank System.  Old National Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions. As a member of the FHLBI, Old National Bank is required to acquire and hold shares of capital stock of the FHLBI in an amount at least equal to the sum of the membership stock purchase requirement, determined on an annual basis at the end of each calendar year, and the activity-based stock purchase requirement, determined on a daily basis. For Old National Bank, the membership stock purchase requirement is 1.0% of the Mortgage-Related Assets, as defined by the FHLBI, which consists principally of residential mortgage loans and mortgage-backed securities, held by Old National Bank.  The activity-based stock purchase requirement is equal to the sum of: (1) a specified percentage ranging from 2.0% to 5.0%, which for Old National Bank is 5.0%, of outstanding borrowings from the FHLBI; (2) a specified percentage ranging from 0.0% to 5.0%, which for Old National Bank is 3.0%, of the outstanding principal balance of Acquired Member Assets, as defined by the FHLBI, and delivery commitments for Acquired Member Assets; (3) a specified dollar amount related to certain off-balance sheet items, which for Old National Bank is inapplicable; and (4) a specified percentage ranging from 0.0% to 5.0% of the carrying value on the FHLBI’s balance sheet of derivative contracts between the FHLBI and Old National Bank, which for Old National Bank is inapplicable. The FHLBI can adjust the specified percentages and dollar amount from time to time within the ranges established by the FHLBI capital plan. As of December 31, 2018, Old National Bank was in compliance with the minimum stock ownership requirement.

Federal Reserve System.  Federal Reserve regulations require depository institutions to maintain cash reserves against their transaction accounts (primarily NOW and demand deposit accounts). A reserve of 3% is to be maintained against aggregate transaction accounts between $12.4 million and $79.5 million (subject to adjustment by the Federal Reserve) plus a reserve of 10% (subject to adjustment by the Federal Reserve between 8% and 14%) against that portion of total transaction accounts in excess of $79.5 million. The first $12.4 million of otherwise reservable balances (subject to adjustment by the Federal Reserve) is exempt from the reserve requirements. Old National Bank is in compliance with the foregoing requirements.

Other Regulations.  Old National Bank is subject to federal consumer protection statutes and regulations promulgated under those laws, including, but not limited to, the:

• Truth-In-Lending Act and Regulation Z, governing disclosures of credit terms to consumer borrowers;

• Home Mortgage Disclosure Act and Regulation C, requiring financial institutions to provide certain information about home mortgage and refinanced loans;

• Fair Credit Reporting Act and Regulation V, governing the provision of consumer information to credit reporting agencies and the use of consumer information;

• Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;

• Truth in Savings Act and Regulation DD, which requires disclosure of deposit terms to consumers;

• Regulation CC, which relates to the availability of deposit funds to consumers;

• Right to Financial Privacy Act, which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and

• Electronic Funds Transfer Act, governing automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.

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The Dodd-Frank Act also significantly impacts the various consumer protection laws, rules and regulations applicable to financial institutions.  The statute rolls back the federal preemption of state consumer protection laws that was enjoyed by national banks by (1) requiring that a state consumer financial law prevent or significantly interfere with the exercise of a national bank’s powers before it can be preempted, (2) mandating that any preemption decision be made on a case by case basis rather than a blanket rule, and (3) ending the applicability of preemption to subsidiaries and affiliates of national banks.  As a result, we may now be subject to state consumer protection laws in each state where we do business, and those laws may be interpreted and enforced differently in each state.

The Dodd-Frank Act also created the Consumer Financial Protection Bureau (the “CFPB”), a consumer financial services regulator with supervisory authority over banks and their affiliates with assets of more than $10 billion, like Old National, to carry out federal consumer protection laws. The CFPB also regulates financial products and services sold to consumers and has rulemaking authority with respect to federal consumer financial laws. Any new regulatory requirements promulgated by the CFPB or modifications in the interpretations of existing regulations could require changes to Old National’s consumer-facing businesses. The Dodd-Frank Act also gives the CFPB broad data collecting powers for fair lending for both small business and mortgage loans, as well as extensive authority to prevent unfair, deceptive, and abusive practices.

The rules issued by the CFPB have impacted our mortgage loan origination and servicing activities. Compliance with these rules will likely continue to increase our overall regulatory compliance costs.

Dividend Limitation.  Old National Bank is subject to the provisions of the National Bank Act, is supervised, regulated and examined by the OCC, and is subject to the rules and regulations of the OCC, Federal Reserve and the FDIC.  A substantial portion of Old National’s cash revenue is derived from dividends paid to it by Old National Bank.  These dividends are subject to various legal and regulatory restrictions as summarized in Note 25 to the consolidated financial statements.

Legislative and Regulatory Initiatives. From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of Old National in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. Old National cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of Old National. A change in statutes, regulations or regulatory policies applicable to Old National or any of its subsidiaries could have a material effect on Old National’s business, financial condition and results of operations.

AVAILABLE INFORMATION

All reports filed electronically by Old National with the SEC, including the annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy and information statements, other information and amendments to those reports filed or furnished (if applicable), are accessible at no cost on Old National’s web site at www.oldnational.com as soon as reasonably practicable after electronically submitting such materials to the SEC.  The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, and Old National’s filings are accessible on the SEC’s web site at www.sec.gov.

ITEM 1A. RISK FACTORS

There are a number of risks and uncertainties that could adversely affect Old National’s business, financial condition, results of operations or cash flows, and access to liquidity.  Old National’s Enterprise Risk Management program is an enterprise-wide framework for identifying, managing, mitigating, monitoring, aggregating, and reporting risks.  The following major risks identified by Old National’s Enterprise Risk Management Program are described below: strategic, financial, and reputational; credit; market, interest rate, and liquidity; operational; and legal, regulatory, and compliance.

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Strategic, Financial, and Reputational Risks

Economic conditions have affected and could continue to adversely affect our revenues and profits.

Old National’s financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services that Old National offers, is highly dependent upon the business environment in the markets where Old National operates and in the United States as a whole.  A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, low unemployment, high business and investor confidence, and strong business earnings.  Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment, natural disasters, terrorist acts, or a combination of these or other factors.

An economic downturn or sustained, high unemployment levels, and stock market volatility may negatively impact our operating results and have a negative effect on the ability of our borrowers to make timely repayments of their loans increasing the risk of loan defaults and losses.

Changes in economic or political conditions could adversely affect Old National’s earnings, as the ability of Old National’s borrowers to repay loans, and the value of the collateral securing such loans, decline.

Old National’s success depends, to a certain extent, upon economic or political conditions, local and national, as well as governmental monetary policies.  Conditions such as recession, unemployment, changes in interest rates, inflation, money supply, and other factors beyond Old National’s control may adversely affect its asset quality, deposit levels, and loan demand and, therefore, Old National’s earnings.  Because Old National has a significant amount of commercial real estate loans, decreases in real estate values could adversely affect the value of property used as collateral.  Adverse changes in the economy may also have a negative effect on the ability of Old National’s borrowers to make timely repayments of their loans, which would have an adverse impact on Old National’s earnings.  In addition, substantially all of Old National’s loans are to individuals and businesses in Old National’s market area.  Consequently, any economic decline in Old National’s primary market areas, which include Indiana, Kentucky, Michigan, Wisconsin, and Minnesota could have an adverse impact on Old National’s earnings.

Acquisitions may not produce revenue enhancements or cost savings at levels or within timeframes originally anticipated and may result in unforeseen integration difficulties and dilution to existing shareholder value.

We have acquired, and expect to continue to acquire, other financial institutions or parts of those institutions in the future, and we may engage in de novo branch expansion.  We may also consider and enter into new lines of business or offer new products or services.

We may incur substantial costs to expand, and we can give no assurance such expansion will result in the levels of profits we seek.  There can be no assurance that integration efforts for any mergers or acquisitions will be successful.  Also, we may issue equity securities in connection with acquisitions, which could cause ownership and economic dilution to our current shareholders.  There is no assurance that, following any mergers or acquisitions, our integration efforts will be successful or that, after giving effect to the acquisition, we will achieve profits comparable to, or better than, our historical experience.

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Acquisitions and mergers involve a number of expenses and risks, including:

• the time and costs associated with identifying potential new markets, as well as acquisition and merger targets;

• the accuracy of the estimates and judgments used to evaluate credit, operations, management and market risks with respect to the target institution;

• the time and costs of evaluating new markets, hiring experienced local management and opening new offices, and the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion;

• our ability to finance an acquisition and possible dilution to our existing shareholders;

• the diversion of our management’s attention to the negotiation of a transaction, and the integration of the operations and personnel of the combined businesses;

• entry into new markets where we lack experience;

• the introduction of new products and services into our business;

• the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on our results of operations;  

• closing delays and increased expenses related to the resolution of lawsuits filed by shareholders of targets; and

• the risk of loss of key employees and customers.

Old National must generally receive federal regulatory approval before it can acquire a bank or bank holding company.  Old National cannot be certain when or if, or on what terms and conditions, any required regulatory approvals will be granted.  Old National may be required to sell banks or branches as a condition to receiving regulatory approval.

Future acquisitions could be material to Old National and it may issue additional shares of stock to pay for those acquisitions, which would dilute current shareholders’ ownership interests.

Our accounting estimates and risk management processes rely on analytical and forecasting models.

The processes that we use to estimate probable loan losses and to measure the fair value of financial instruments, as well as the processes used to estimate the effects of changing interest rates and other market measures on our financial condition and results of operations, depend upon the use of analytical and forecasting models. These models reflect assumptions that may not be accurate, particularly in times of market stress or other unforeseen circumstances. Even if these assumptions are adequate, the models may prove to be inadequate or inaccurate because of other flaws in their design or their implementation. If our models for determining interest rate risk and asset-liability management are inadequate, we may incur increased or unexpected losses upon changes in market interest rates or other market measures. If our models for determining probable loan losses are inadequate, the allowance for loan losses may not be sufficient to support future charge-offs. If our models to measure the fair value of financial instruments are inadequate, the fair value of such financial instruments may fluctuate unexpectedly or may not accurately reflect what we could realize upon sale or settlement of such financial instruments. Any such failure in our analytical or forecasting models could have a material adverse effect on our business, financial condition, and results of operations.

Old National operates in an extremely competitive market, and Old National’s business will suffer if Old National is unable to compete effectively.

In our market area, Old National encounters significant competition from other commercial banks, savings and loan associations, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds, and other financial intermediaries.  In addition, FinTech start-ups are emerging in key areas of banking.  Our competitors may have substantially greater resources and lending limits than Old National does and may offer services that Old National does not or cannot provide.  Many of our nonfinancial institution competitors have fewer regulatory constraints, broader geographic service areas, and, in some cases, lower cost structures.  Old National’s profitability depends upon Old National’s continued ability to compete successfully in Old National’s market area.

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Our business could suffer if we fail to attract and retain skilled people.

Our success depends, in large part, on our ability to attract and retain key people.  Competition for the best people in most activities we engage in can be intense.  We may not be able to hire the best people or to keep them.  The loss of any of our key personnel or an inability to continue to attract, retain, and motivate key personnel could adversely affect our business.

We may not be able to pay dividends in the future in accordance with past practice.

Old National has traditionally paid a quarterly dividend to common stockholders.  The payment of dividends is subject to legal and regulatory restrictions.  Any payment of dividends in the future will depend, in large part, on Old National’s earnings, capital requirements, financial condition, and other factors considered relevant by Old National’s Board of Directors.

Old National is an entity separate and distinct from Old National Bank.  Old National Bank conducts most of our operations and Old National depends upon dividends from Old National Bank to service its debt and to pay dividends to Old National’s shareholders.  The availability of dividends from Old National Bank is limited by various statutes and regulations.  It is possible, depending upon the financial condition including liquidity and capital adequacy of Old National Bank and other factors, that the OCC could assert that the payment of dividends or other payments is an unsafe or unsound practice. In addition, the payment of dividends by our other subsidiaries is also subject to the laws of the subsidiary’s state of incorporation, and regulatory capital and liquidity requirements applicable to such subsidiaries.  At December 31, 2018, Old National Bank could pay dividends of $92.9 million without prior regulatory approval.  In the event that Old National Bank was unable to pay dividends to us, we in turn would likely have to reduce or stop paying dividends on our Common Stock.  Our failure to pay dividends on our Common Stock could have a material adverse effect on the market price of our Common Stock.  See “Business – Supervision and Regulation – Dividend Limitations” and Note 25 to the consolidated financial statements.

Old National may not realize the expected benefits of its strategic imperatives.

Old National’s ability to compete depends on a number of factors, including among others its ability to develop and successfully execute strategic plans and imperatives.  Our strategic priorities include consistent quality earnings, enhanced management discipline, and strong risk management; greater confidence in decision making and appropriate levels of risk taking; fewer operational surprises, disruptions and losses; improved operational effectiveness and efficiency; more effective deployment of resources; and increased awareness and involvement in the achievement of strategic goals.  Our inability to execute on or achieve the anticipated outcomes of our strategic priorities may affect how the market perceives us and could impede our growth and profitability.

Credit Risk

If Old National’s actual loan losses exceed Old National’s allowance for loan losses, Old National’s net income will decrease.

Old National makes various assumptions and judgments about the collectibility of Old National’s loan portfolio, including the creditworthiness of Old National’s borrowers and the value of the real estate and other assets serving as collateral for the repayment of Old National’s loans.  Despite Old National’s underwriting and monitoring practices, the effect of a declining economy could negatively impact the ability of Old National’s borrowers to repay loans in a timely manner and could also negatively impact collateral values.  As a result, Old National may experience significant loan losses that could have a material adverse effect on Old National’s operating results.  Since Old National must use assumptions regarding individual loans and the economy, Old National’s current allowance for loan losses may not be sufficient to cover actual loan losses.  Old National’s assumptions may not anticipate the severity or duration of the current credit cycle; and Old National may need to significantly increase Old National’s provision for losses on loans if one or more of Old National’s larger loans or credit relationships becomes delinquent or if Old National expands its commercial real estate and commercial lending.  In addition, federal and state regulators periodically review Old National’s allowance for loan losses and may require Old National to increase the provision for loan losses or recognize loan charge-offs.  Material additions to Old National’s allowance would materially decrease Old National’s net income.  There can be no assurance that Old National’s

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monitoring procedures and policies will reduce certain lending risks or that Old National’s allowance for loan losses will be adequate to cover actual losses.

Old National’s loan portfolio includes loans with a higher risk of loss.

Old National Bank originates commercial real estate loans, commercial loans, agricultural real estate loans, agricultural loans, consumer loans, and residential real estate loans primarily within Old National’s market areas.  Commercial real estate, commercial, consumer, and agricultural real estate and operating loans may expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans may not be sold as easily as residential real estate.  These loans also have greater credit risk than residential real estate for the following reasons:

• Commercial Real Estate Loans.  Repayment is dependent upon income being generated in amounts sufficient to cover operating expenses and debt service.

• Commercial Loans.  Repayment is dependent upon the successful operation of the borrower’s business.

• Consumer Loans.  Consumer loans (such as personal lines of credit) are collateralized, if at all, with assets that may not provide an adequate source of payment of the loan due to depreciation, damage, or loss.

• Agricultural Loans.  Repayment is dependent upon the successful operation of the business, which is greatly dependent on many things outside the control of either Old National Bank or the borrowers.  These factors include weather, input costs, commodity and land prices, and interest rates.

If Old National forecloses on collateral property, Old National may be subject to the increased costs associated with the ownership of real property, resulting in reduced revenues.

Old National may have to foreclose on collateral property to protect Old National’s investment and may thereafter own and operate such property, in which case Old National will be exposed to the risks inherent in the ownership of real estate.  The amount that Old National, as a mortgagee, may realize after a default is dependent upon factors outside of Old National’s control, including, but not limited to: (i) general or local economic conditions; (ii) neighborhood values; (iii) interest rates; (iv) real estate tax rates; (v) operating expenses of the mortgaged properties; (vi) environmental remediation liabilities; (vii) ability to obtain and maintain adequate occupancy of the properties; (viii) zoning laws; (ix) governmental rules, regulations and fiscal policies; and (x) acts of God.  Certain expenditures associated with the ownership of real estate, principally real estate taxes, insurance, and maintenance costs, may adversely affect the income from the real estate.  Therefore, the cost of operating real property may exceed the income earned from such property, and Old National may have to advance funds in order to protect Old National’s investment, or Old National may be required to dispose of the real property at a loss.  The foregoing expenditures and costs could adversely affect Old National’s ability to generate revenues, resulting in reduced levels of profitability.

The soundness of other financial institutions could adversely affect Old National.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships.  Old National has exposure to many different industries and counterparties, and Old National and certain of its subsidiaries routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutions.  Many of these transactions expose Old National to credit risk in the event of default of its counterparty. In addition, Old National’s credit risk may be affected when collateral is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure. These types of losses could materially adversely affect Old National’s results of operations or financial condition.

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Market, Interest Rate, and Liquidity Risks

The price of Old National’s Common Stock may be volatile, which may result in losses for investors.

General market price declines or market volatility in the future could adversely affect the price of Old National’s Common Stock.  In addition, the following factors may cause the market price for shares of Old National’s Common Stock to fluctuate:

• announcements of developments related to Old National’s business;

• fluctuations in Old National’s results of operations;

• sales or purchases of substantial amounts of Old National’s securities in the marketplace;

• general conditions in Old National’s banking niche or the worldwide economy;

• a shortfall or excess in revenues or earnings compared to securities analysts’ expectations;

• changes in analysts’ recommendations or projections; and

• Old National’s announcement of new acquisitions or other projects.

Changes in interest rates could adversely affect Old National’s results of operations and financial condition.

Old National’s earnings depend substantially on Old National’s interest rate spread, which is the difference between (i) the rates Old National earns on loans, securities and other earning assets and (ii) the interest rates Old National pays on deposits and other borrowings.  These rates are highly sensitive to many factors beyond Old National’s control, including general economic conditions and the policies of various governmental and regulatory authorities.  If market interest rates rise, Old National will have competitive pressures to increase the rates that Old National pays on deposits, which could result in a decrease of Old National’s net interest income.  If market interest rates decline, Old National could experience fixed-rate loan prepayments and higher investment portfolio cash flows, resulting in a lower yield on earning assets.  Old National’s earnings can also be impacted by the spread between short-term and long-term market interest rates.  If short-term and long-term market interest rates converge, Old National’s interest rate spread could decline and result in a decrease of Old National’s net interest income.

Our wholesale funding sources may prove insufficient to replace deposits or support our future growth.

As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. These sources include brokered certificates of deposit, repurchase agreements, and federal funds purchased. Negative operating results or changes in industry conditions could lead to an inability to replace these additional funding sources at maturity. Our financial flexibility could be constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our results of operations and financial condition would be negatively affected.

A reduction in our credit rating could adversely affect our business and/or the holders of our securities.

The credit rating agencies rating our indebtedness regularly evaluate Old National and Old National Bank, and credit ratings are based on a number of factors, including our financial strength and ability to generate earnings, as well as factors not entirely within our control, including conditions affecting the financial services industry and the economy and changes in rating methodologies.  There can be no assurance that we will maintain our current credit ratings.  A downgrade of the credit ratings of Old National or Old National Bank could adversely affect our access to liquidity and capital, and could significantly increase our cost of funds, and decrease the number of investors and counterparties willing to lend to us or purchase our securities.  This could affect our growth, profitability, and financial condition, including liquidity.

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Operational Risks

A failure or breach, including cyber-attacks, of our operational or security systems, could disrupt our business, result in the disclosure of confidential information, damage our reputation, and create significant financial and legal exposure.

Although we devote significant resources to maintain and regularly upgrade our systems and processes that are designed to protect the security of our computer systems, software, networks, and other technology assets and the confidentiality, integrity, and availability of information belonging to us and our customers, there is no assurance that our security measures will provide absolute security.  Further, to access our products and services our customers may use computers and mobile devices that are beyond our security control systems.  In fact, many other financial services institutions and companies engaged in data processing have reported breaches in the security of their websites or other systems, some of which have involved sophisticated and targeted attacks intended to obtain unauthorized access to confidential information, destroy data, disable or degrade service, or sabotage systems, often through the introduction of computer viruses or malware, cyberattacks, and other means.  Certain financial institutions in the United States have also experienced attacks from technically sophisticated and well-resourced third parties that were intended to disrupt normal business activities by making internet banking systems inaccessible to customers for extended periods.  These “denial-of-service” attacks have not breached our data security systems, but require substantial resources to defend, and may affect customer satisfaction and behavior.

Despite our efforts to ensure the integrity of our systems, it is possible that we may not be able to anticipate or to implement effective preventive measures against all security breaches of these types, especially because the techniques used change frequently or are not recognized until launched, and because security attacks can originate from a wide variety of sources, including persons who are involved with organized crime or associated with external service providers or who may be linked to terrorist organizations or hostile foreign governments.  Those parties may also attempt to fraudulently induce employees, customers or other users of our systems to disclose sensitive information in order to gain access to our data or that of our customers or clients.  We have implemented employee and customer awareness training around phishing, malware, and other cyber risks.  These risks may increase in the future as we continue to increase our mobile payments and other internet-based product offerings and expand our internal usage of web-based products and applications.

If our security systems were penetrated or circumvented, it could cause serious negative consequences for us, including significant disruption of our operations, misappropriation of our confidential information or that of our customers, or damage our computers or systems and those of our customers and counterparties, and could result in violations of applicable privacy and other laws, financial loss to us or to our customers, loss of confidence in our security measures, customer dissatisfaction, significant litigation exposure, and harm to our reputation, all of which could have a material adverse effect on us.

We rely on third party vendors, which could expose Old National to additional cybersecurity risks.

Third party vendors provide key components of our business infrastructure, including certain data processing and information services.  On our behalf, third parties may transmit confidential, propriety information.  Although we require third party providers to maintain certain levels of information security, such providers may remain vulnerable to breaches, unauthorized access, misuse, computer viruses, or other malicious attacks that could ultimately compromise sensitive information.  While we may contractually limit our liability in connection with attacks against third party providers, Old National remains exposed to the risk of loss associated with such vendors.  In addition, a number of our vendors are large national entities with dominant market presence in their respective fields. Their services could prove difficult to replace in a timely manner if a failure or other service interruption were to occur. Failures of certain vendors to provide contracted services could adversely affect our ability to deliver products and services to our customers and cause us to incur significant expense.

Failure to keep pace with technological change could adversely affect Old National’s results of operations and financial condition.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services.  The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs.  Old National’s future success depends, in part,

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upon its ability to address customer needs by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in Old National’s operations.  Old National may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers.  Failure to successfully keep pace with technological change affecting the financial services industry could negatively affect Old National’s growth, revenue, and profit.

Changes in consumer use of banks and changes in consumer spending and savings habits could adversely affect Old National’s financial results.

Technology and other changes now allow many customers to complete financial transactions without using banks.  For example, consumers can pay bills and transfer funds directly without going through a bank.  This process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits.  In addition, changes in consumer spending and savings habits could adversely affect Old National’s operations, and Old National may be unable to timely develop competitive new products and services in response to these changes.

Old National’s controls and procedures may fail or be circumvented, and Old National’s methods of reducing risk exposure may not be effective.

Old National regularly reviews and updates its internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Old National also maintains an Enterprise Risk Management program designed to identify, manage, mitigate, monitor, aggregate, and report risks.  Any system of controls and any system to reduce risk exposure, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met.  Additionally, instruments, systems, and strategies used to hedge or otherwise manage exposure to various types of market compliance, credit, liquidity, operational, and business risks and enterprise-wide risk could be less effective than anticipated.  As a result, Old National may not be able to effectively mitigate its risk exposures in particular market environments or against particular types of risk.

Legal, Regulatory, and Compliance Risks

We have risk related to legal proceedings.

We are involved in judicial, regulatory, and arbitration proceedings concerning matters arising from our business activities and fiduciary responsibilities.  We establish reserves for legal claims when payments associated with the claims become probable and the costs can be reasonably estimated.  We may still incur legal costs for a matter even if we have not established a reserve.  In addition, the actual cost of resolving a legal claim may be substantially higher than any amounts reserved for that matter.  The ultimate resolution of a pending or future legal proceeding, depending on the remedy sought and granted, could materially adversely affect our results of operations and financial condition.

Old National operates in a highly regulated environment, and changes in laws and regulations to which Old National is subject may adversely affect Old National’s results of operations.

Old National operates in a highly regulated environment and is subject to extensive regulation, supervision, and examination by, among others, the OCC, the FDIC, the CFPB, the Federal Reserve, and the State of Indiana.  Such regulation and supervision of the activities in which an institution may engage is primarily intended for the protection of the depositors and federal deposit insurance funds.  In addition, the Treasury has certain supervisory and oversight duties and responsibilities under EESA and the CPP.  See “Business – Supervision and Regulation” herein.  Applicable laws and regulations may change, and such changes may adversely affect Old National’s business.  The Dodd-Frank Act, enacted in July 2010, mandated the most wide-ranging overhaul of financial industry regulation in decades.  This legislation, among other things, weakened federal preemption of state consumer protection laws and established the CFPB with broad authority to administer and enforce a new federal regulatory framework of consumer financial regulation, including consumer mortgage banking.  The scope and impact of many of the Dodd-Frank Act provisions were determined and issued over time.  The impact of the Dodd-Frank Act on Old National has been substantial.  Provisions in the legislation that affect the payment of interest on demand deposits and collection of interchange fees increased the costs associated with certain deposits and placed

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limitations on certain revenues those deposits generate.  In addition, the Dodd-Frank Act required Old National to change certain of its business practices, intensified the regulatory supervision of Old National and the financial services industry, increased Old National’s capital requirements, and imposed additional assessments and costs on Old National.  Requirements to maintain higher levels of capital or liquidity to address potential adverse stress scenarios could adversely impact the Company’s net income.

Regulatory authorities also have extensive discretion in connection with their supervisory and enforcement activities, including but not limited to the imposition of restrictions on the operation of an institution, the classification of assets by the institution, the adequacy of an institution’s Bank Secrecy Act/Anti Money Laundering program management, and the adequacy of an institution’s allowance for loan losses.  Any change in such regulation and oversight, whether in the form of restrictions on activities, regulatory policy, regulations, or legislation, including but not limited to changes in the regulations governing institutions, could have a material impact on Old National and its operations.

Changes in accounting policies, standards, and interpretations could materially affect how Old National reports its financial condition and results of operations.

The FASB periodically changes the financial accounting and reporting standards governing the preparation of Old National’s financial statements.  Additionally, those bodies that establish and/or interpret the financial accounting and reporting standards (such as the FASB, SEC, and banking regulators) may change prior interpretations on how these standards should be applied.  These changes can be difficult to predict and can materially affect how Old National records and reports its financial condition and results of operations.  In some cases, Old National could be required to retroactively apply a new or revised standard, resulting in changes to previously reported financial results.

If Old National fails to meet regulatory capital requirements which may require heightened capital, we may be forced to raise capital or sell assets.

Old National is subject to regulations that require us to satisfy certain capital ratios, such as the ratio of our Tier 1 capital to our risk-based assets.  Both the Dodd-Frank Act, which reformed the regulation of financial institutions in a comprehensive manner, and the Basel III regulatory capital reforms, which increase both the amount and quality of capital that financial institutions must hold, will impact our capital requirements.  Specifically, in July 2013, the U.S. federal banking authorities approved the implementation of the Basel III Capital Rules. The Basel III Capital Rules are applicable to all U.S. banks that are subject to minimum capital requirements as well as to bank and saving and loan holding companies, other than “small bank holding companies” (generally bank holding companies with consolidated assets of less than $500 million).  The Basel III Capital Rules not only increase most of the required minimum regulatory capital ratios, they introduce a new Common Equity Tier 1 Capital ratio and the concept of a capital conservation buffer.  The Basel III Capital Rules also expand the current definition of capital by establishing additional criteria that capital instruments must meet to be considered Additional Tier 1 Capital (i.e., Tier 1 Capital in addition to Common Equity) and Tier 2 Capital. A number of instruments that now generally qualify as Tier 1 Capital will not qualify or their qualifications will change when the Basel III Capital Rules are fully implemented.  The Basel III Capital Rules have maintained the general structure of the current prompt corrective action thresholds while incorporating the increased requirements, including the Common Equity Tier 1 Capital ratio.  In order to be a “well-capitalized” depository institution under the new regime, an institution must maintain a Common Equity Tier 1 Capital ratio of 6.5% or more, a Tier 1 Capital ratio of 8% or more, a Total Capital ratio of 10% or more, and a leverage ratio of 5% or more.  Institutions must also maintain a capital conservation buffer consisting of Common Equity Tier 1 Capital. Financial institutions became subject to the Basel III Capital Rules on January 1, 2015 with a phase-in period through 2019 for many of the changes.  If we are unable to satisfy these heightened regulatory capital requirements, due to a decline in the value of our loan portfolio or otherwise, we will be required to improve such capital ratios by either raising additional capital or by disposing of assets.  If we choose to dispose of assets, we cannot be certain that we will be able to do so at prices that we believe to be appropriate, and our future operating results could be negatively affected.  If we choose to raise additional capital, we may accomplish this by selling additional shares of Common Stock, or securities convertible into or exchangeable for Common Stock, which could significantly dilute the ownership percentage of holders of our Common Stock and cause the market price of our Common Stock to decline. Additionally, events or circumstances in the capital markets generally may increase our capital costs and impair our ability to raise capital at any given time.

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Our earnings could be adversely impacted by incidences of fraud and compliance failure.

Financial institutions are inherently exposed to fraud risk.  A fraud can be perpetrated by a customer of Old National, an employee, a vendor, or members of the general public.  We are most subject to fraud and compliance risk in connection with the origination of loans, ACH transactions, wire transactions, ATM transactions, and checking transactions.  Our largest fraud risk, associated with the origination of loans, includes the intentional misstatement of information in property appraisals or other underwriting documentation provided to us by third parties.  Compliance risk is the risk that loans are not originated in compliance with applicable laws and regulations and our standards.  There can be no assurance that we can prevent or detect acts of fraud or violation of law or our compliance standards by the third parties that we deal with.  Repeated incidences of fraud or compliance failures would adversely impact the performance of our loan portfolio.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

As of December 31, 2018, Old National and its affiliates operated a total of 191 banking centers, primarily in the states of Indiana, Kentucky, Michigan, Wisconsin, and Minnesota.  Of these facilities, 118 were owned.  We lease 73 banking centers from unaffiliated third parties.  The terms of these leases range from one years and five months to twenty-five years. See Note 7 to the consolidated financial statements.

Impacting the number of Old National’s banking centers in 2018 was the acquisition of Klein (18 banking centers), the sale of 10 banking centers in Wisconsin to Marine Credit Union of La Crosse, Wisconsin, and the consolidation of 10 banking centers throughout the franchise.

Old National also has several administrative offices located throughout its footprint, including the executive offices of Old National which are located at 1 Main Street, Evansville, Indiana.  This building, which was previously leased, was purchased in 2016.

ITEM 3. LEGAL PROCEEDINGS

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

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

Old National is not currently involved in any material litigation.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Old National’s Common Stock is traded on the NASDAQ under the ticker symbol ONB.  There were 34,536 shareholders of record as of December 31, 2018.

The following table summarizes the purchases of equity securities made by Old National during the fourth quarter of 2018:

					Total Number
					of Shares
	Total		Average		Purchased as		Maximum Number of
	Number		Price		Part of Publicly		Shares that May Yet
	of Shares		Paid Per		Announced Plans		Be Purchased Under
Period	Purchased		Share		or Programs		the Plans or Programs
10/01/18 - 10/31/18		—	$	—		—		—
11/01/18 - 11/30/18		1,294		18.16		—		—
12/01/18 - 12/31/18		295		15.94		—		—
Total		1,589	$	17.75		—		—

The Board of Directors did not authorize a stock repurchase plan for 2018.  During the year ended December 31, 2018, Old National repurchased a limited number of shares associated with employee share-based incentive programs.

On January 24, 2019, the Board of Directors declared a quarterly cash dividend of $0.13 per common share.

EQUITY COMPENSATION PLAN INFORMATION

The following table contains information concerning the Amended and Restated 2008 Incentive Compensation Plan approved by security holders, as of December 31, 2018.

					Number of securities
					remaining available for
	Number of securities to		Weighted-average		future issuance under
	be issued upon exercise		exercise price of		equity compensation plans
	of outstanding options,		outstanding options,		(excluding securities
	warrants, and rights		warrants, and rights		reflected in column (a))
Plan Category	(a)		(b)		(c)
Equity compensation plans    approved by security holders		1,404,238	$	13.88		4,398,631
Equity compensation plans not    approved by security holders		—		—		—
Total		1,404,238	$	13.88		4,398,631

At December 31, 2018, 4.4 million shares remain available for issuance under the Amended and Restated 2008 Incentive Compensation Plan.

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The following table compares cumulative five-year total shareholder returns, assuming reinvestment of dividends, for our common stock to cumulative total returns of a broad-based equity market index and two published industry indices.  The comparison of shareholder returns (change in December year end stock price plus reinvested dividends) for each of the periods assumes that $100 was invested on December 31, 2013, in common stock of each of the Company, the S&P Small Cap 600 Index, the NYSE Financial Index and the SNL Bank and Thrift Index with investment weighted on the basis of market capitalization.

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ITEM 6. SELECTED FINANCIAL DATA

(dollars in thousands, except per share data)	2018				2017			2016			2015				2014
Operating Results
Net interest income	$	537,602		$	437,168		$	402,703		$	366,116			$	366,370
Conversion to fully taxable equivalent (1)		11,394			23,091			21,293			19,543				16,999
Net interest income - tax equivalent basis		548,996			460,259			423,996			385,659				383,369
Provision for loan losses		6,966			3,050			960			2,923				3,097
Noninterest income		195,305			183,382			252,830			230,632				165,129
Noninterest expense		517,261			448,836			454,147			430,932				386,438
Net income		190,830			95,725			134,264			116,716				103,667
Common Share Data (2)
Weighted average diluted shares		156,539			138,513			128,301			116,255				108,365
Net income (diluted)	$	1.22		$	0.69		$	1.05		$	1.00			$	0.95
Cash dividends		0.52			0.52			0.52			0.48				0.44
Common dividend payout ratio (3)		42	%		75	%		50	%		48		%		46	%
Book value at year-end		15.36		$	14.17		$	13.42		$	13.05			$	12.54
Stock price at year-end		15.40			17.45			18.15			13.56				14.88
Balance Sheet Data (at December 31)
Loans (4)	$	12,258,803		$	11,136,051		$	9,101,194		$	6,962,215			$	6,531,691
Total assets		19,728,435			17,518,292			14,860,237			11,991,527				11,646,051
Deposits		14,349,949			12,605,764			10,743,253			8,400,860				8,490,664
Borrowings		2,493,793			2,578,204			2,152,086			1,920,246				1,469,911
Shareholders' equity		2,689,570			2,154,397			1,814,417			1,491,170				1,465,764
Performance Ratios
Return on average assets		1.07	%		0.63	%		0.98	%		0.98		%		0.99	%
Return on average common shareholders'    equity		8.42			4.98			7.84			7.88				7.91
Net interest margin (5)		3.54			3.48			3.58			3.72				4.22
Efficiency ratio (5)		67.74			68.87			65.82			68.65				70.03
Asset Quality (6)
Net charge-offs (recoveries) to average loans		0.02	%		0.03	%		0.04	%		(0.02	)	%		0.04	%
Allowance for loan losses to ending loans		0.45			0.45			0.55			0.75				0.76
Allowance for loan losses	$	55,461		$	50,381		$	49,808		$	52,233			$	47,849
Underperforming assets (7)		179,425			154,220			164,657			160,072				170,535
Allowance for loan losses to nonaccrual    loans (8)		35.22	%		40.33	%		37.90	%		39.46		%		33.97	%
Other Data
Full-time equivalent employees		2,892			2,801			2,733			2,652				2,938
Banking centers		191			191			203			160				195

(1) Calculated using the federal statutory tax rate in effect of 21% for 2018 and 35% for 2014 - 2017.

(2) Diluted data assumes the exercise of stock options and the vesting of restricted stock.

(3) Cash dividends per share divided by net income per share (basic).

(4) Includes loans held for sale.

(5) Represents a non-GAAP financial measure.  Refer to the “Non-GAAP Financial Measures” section of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for reconciliations to GAAP financial measures.

(6) Excludes loans held for sale.

(7) Includes nonaccrual loans, renegotiated loans, loans 90 days past due still accruing, and other real estate owned.  Includes $12.4 million and $24.4 million of covered assets in 2015 and 2014, respectively, acquired in an FDIC assisted transaction, which were covered by loss sharing agreements with the FDIC providing for specified loss protection. On June 22, 2016, Old National entered into an early termination agreement with the FDIC that terminated all loss share agreements.

(8) Includes approximately $20.5 million, $12.6 million, $16.7 million, $15.9 million, and $41.2 million for 2018, 2017, 2016, 2015, and 2014, respectively, of purchased credit impaired loans that are categorized as nonaccrual because the collection of principal or interest is doubtful.  These loans are accounted for under FASB ASC 310-30 and accordingly treated as performing assets.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

	Page
General Overview	30
Corporate Developments in Fiscal 2018	30
Business Outlook	30
Financial Highlights	32
Non-GAAP Financial Measures	32
Results of Operations	34
Financial Condition	41
Risk Management	46
Off-Balance Sheet Arrangements	57
Contractual Obligations, Commitments, and Contingent Liabilities	57
Critical Accounting Policies and Estimates	58

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The following discussion is an analysis of our results of operations for the fiscal years ended December 31, 2018, 2017, and 2016, and financial condition as of December 31, 2018 and 2017.  This discussion and analysis should be read in conjunction with our consolidated financial statements and related notes.  This discussion contains forward-looking statements concerning our business.  Readers are cautioned that, by their nature, forward-looking statements are based on estimates and assumptions and are subject to risks, uncertainties, and other factors.  Actual results may differ materially from our expectations that are expressed or implied by any forward-looking statement.  The discussion in Item 1A, “Risk Factors,” lists some of the factors that could cause our actual results to vary materially from those expressed or implied by any forward-looking statements, and such discussion is incorporated into this discussion by reference.

GENERAL OVERVIEW

Old National is the largest financial holding company incorporated in the state of Indiana and maintains its principal executive offices in Evansville, Indiana.  Old National, through Old National Bank, provides a wide range of services, including commercial and consumer loan and depository services, and other traditional banking services.  Old National also provides services to supplement the traditional banking business including fiduciary and wealth management services, investment and brokerage services, investment consulting, and other financial services.

Our basic mission is to be THE community bank in the cities and towns we serve.  We focus on establishing and maintaining long-term relationships with customers, and are committed to serving the financial needs of the communities in our market area.  Old National provides financial services primarily in Indiana, Kentucky, Michigan, Wisconsin, and Minnesota.

CORPORATE DEVELOPMENTS IN FISCAL 2018

In 2018, we increased our presence in Minnesota through our acquisition of Klein. The acquisition provides us not only additional opportunities in the large and rapidly growing Minneapolis-St. Paul market, but also enables greater scale economics across our entire five-state footprint.  Other highlights experienced in 2018 include:

• highest loan production year in our history with a strong pipeline that continues to build;

• organic commercial and commercial real estate loan growth of 4% (including loans held for sale) in addition to $1.049 billion of loans from the Klein partnership;

• cost of total deposits remained well controlled, with an increase of only 13 basis points to 0.32% and a deposit beta of 14.7%;

• strong credit quality metrics including charge-offs to average loans of 0.02%; and

• continued rationalization of our banking center network, resulting in the sale of 10 branches at a gain of $14.0 million.

During 2018, our net interest income increased substantially to $537.6 million compared to $437.2 million in 2017, an increase of 23%.  Noninterest income grew from $183.4 million in 2017 to $195.3 million in 2018 primarily due to the gain on branch sales.  We benefited from higher noninterest income attributable to a full year of Anchor (MN) results in 2018 and the two months of Klein contribution as compared to 2017, which only reflected two months of the Anchor (MN) operations.  Offsetting some of the benefit of the Anchor (MN) and Klein results was a decline in gains from sales of investment securities.  Our noninterest expenses increased from $448.8 million in 2017 to $517.3 million in 2018 reflecting acquisition related expenses and divestiture costs.  Net income for 2018 was $190.8 million compared to $95.7 million in 2017.  Diluted earnings per share were $1.22 per share in 2018, compared to $0.69 per share in 2017.  As did other banks and U.S. corporations, our 2018 results benefited from the reduction in the federal corporate tax rate to 21%, which became effective on January 1, 2018. Net income in 2017 reflected a 35% federal tax rate and also included a one-time $39.3 million tax expense recorded in December 2017 for the revaluation of our deferred income tax asset.

BUSINESS OUTLOOK

The U.S. economy grew by approximately 3% in 2018 as measured by the change in GDP.   The strong economic growth was aided by the federal tax cuts and other fiscal measures.  Other measures of economic health include the near record low unemployment level of 3.7% despite an increase in the labor force participation rate, increases in personal income of 2.7% year-over-year, increases in home prices, lower household debt burdens, well-controlled inflation, and interest rates that remain low relative to historical levels.  It is anticipated that the economy will

30

continue to achieve healthy growth in 2019 as a result of the stimulus effect of the tax reductions but probably not as robust as experienced in 2018.    There are ongoing threats to economic expansion in 2019 and beyond, including the potential impact of the trade dispute with China, a slowdown in new home construction, and the increasing federal and household debt burdens.

We will continue to focus on our core strategic principles of basic banking in 2019, which are loan growth, fee-based income, and expense management.

Organic loan growth is a priority and we expect our strong loan production to continue. We will continue to adhere to our risk profile and disciplined underwriting standards.  We have not experienced any specific sector credit related weaknesses, yet we remain particularly diligent in various commercial real estate subsectors such as senior housing, retail, and multifamily.

Our fee-based businesses continue to build up their product sets in all of our markets. We have made investments in these businesses and believe they are well positioned for growth in 2019.

At the same time, we will continue to enhance our technology and operational efficiency to improve the client experience. Since 2010, we have consolidated or closed 201 branches and increased our average branch size from approximately $34 million to $75 million in deposits.  We will continue to evaluate our franchise for additional consolidation opportunities in 2019.

As we continue our measured growth strategy, our view toward additional partnerships has not changed in this more challenging environment.  We remain an active looker in our target markets and a highly selective, disciplined buyer.  We continue to believe in our ability to bring a larger balance sheet with better capital and an enhanced product set to a partner that will allow them to better serve their clients.

On May 2, 2019, Bob Jones will retire as CEO and will continue to serve as the Company’s Chairman of the Board through January 2020.  Our corporate board of directors has appointed Jim Ryan, currently Old National’s CFO, to succeed Mr. Jones as CEO and has elected Brendon Falconer to succeed Mr. Ryan as the Company’s CFO.  Mr. Jones’ tenure has further strengthened the bank’s culture of transparency, ethics, and character.  We believe this succession will continue these attributes that define our bank’s culture.

As we look ahead to 2019, we believe our increased scale will allow us to continue our focus on increasing positive operating leverage.

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FINANCIAL HIGHLIGHTS

The following table sets forth certain financial highlights of Old National:

	Three Months Ended										Years Ended
(dollars and shares in thousands,	December 31,			September 30,			December 31,				December 31,
except per share data)	2018			2018			2017				2018			2017
Income Statement:
Net interest income	$	146,225		$	130,842		$	118,556			$	537,602		$	437,168
Taxable equivalent adjustment (1)		3,049			2,753			6,139				11,394			23,091
Provision for loan losses		3,390			750			1,037				6,966			3,050
Noninterest income		58,154			45,957			44,825				195,305			183,382
Noninterest expense		150,268			119,376			140,432				517,261			448,836
Net income (loss)		47,498			51,348			(18,493	)			190,830			95,725
Common Share Data:
Weighted average diluted shares		167,992			152,784			146,875				156,539			138,513
Net income (loss) (diluted)	$	0.28		$	0.34		$	(0.13	)		$	1.22		$	0.69
Cash dividends		0.13			0.13			0.13			$	0.52		$	0.52
Common dividend payout ratio (2)		46	%		38	%	N/M			%		42	%		75	%
Book value	$	15.36		$	14.58		$	14.17			$	15.36		$	14.17
Stock price		15.40			19.30			17.45				15.40			17.45
Tangible common book value (3)		9.00			8.86			8.37				9.00			8.37
Performance Ratios:
Return on average assets		1.01	%		1.18	%		(0.45	)	%		1.07	%		0.63	%
Return on average common equity		7.59			9.28			(3.51	)			8.42			4.98
Return on tangible common equity (3)		12.88			15.99			(5.12	)			12.83			8.12
Return on average tangible common    equity (3)		13.84			16.10			(5.05	)			14.97			8.59
Net interest margin (3)		3.64			3.51			3.47				3.54			3.48
Efficiency ratio (3)		70.33			64.71			81.60				67.74			68.87
Net charge-offs (recoveries) to average    loans		0.02			0.06			0.03				0.02			0.03
Allowance for loan losses to ending loans		0.45			0.47			0.45				0.45			0.45
Non-performing loans to ending loans		1.43			1.47			1.30				1.43			1.30
Balance Sheet:
Total loans	$	12,243,892		$	11,292,659		$	11,118,121			$	12,243,892		$	11,118,121
Total assets		19,728,435			17,567,759		$	17,518,292				19,728,435			17,518,292
Total deposits		14,349,949			12,598,200			12,605,764				14,349,949			12,605,764
Total borrowed funds		2,493,793			2,576,039			2,578,204				2,493,793			2,578,204
Total shareholders' equity		2,689,570			2,220,680			2,154,397				2,689,570			2,154,397
Nonfinancial Data:
Full-time equivalent employees		2,892			2,554			2,801				2,892			2,801
Banking centers		191			182			191				191			191

(1) Calculated using the federal statutory tax rate in effect of 21% for the 2018 periods and 35% for the 2017 periods.

(2) Cash dividends per share divided by net income per share (basic).

(3) Represents a non-GAAP financial measure.  Refer to the "Non-GAAP Financial Measures" section for reconciliations to GAAP financial measures.

NON-GAAP FINANCIAL MEASURES

Non-GAAP financial measures exclude certain items that are included in the financial results presented in accordance with GAAP.  Management believes these non-GAAP financial measures enhance an investor’s understanding of the financial results of Old National by providing a meaningful basis for period-to-period comparisons, assisting in operating results analysis, and predicting future performance.

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The following table presents GAAP to non-GAAP reconciliations.

		Three Months Ended								Years Ended
(dollars and shares in thousands,		December 31,								December 31,
except per share data)		2018				2017				2018			2017
Tangible common book value:
Shareholders' equity (GAAP)		$	2,689,570			$	2,154,397			$	2,689,570		$	2,154,397
Deduct:	Goodwill		1,036,258				828,051				1,036,258			828,051
	Intangible assets		77,016				53,096				77,016			53,096
Tangible shareholders' equity (non-GAAP)		$	1,576,296			$	1,273,250			$	1,576,296		$	1,273,250
Period end common shares			175,141				152,040				175,141			152,040
Tangible common book value			9.00				8.37				9.00			8.37
Return on tangible common equity:
Net income (loss) (GAAP)		$	47,498			$	(18,493	)		$	190,830		$	95,725
Add: Intangible amortization (net of tax)			3,266				2,210				11,410			7,697
Tangible net income (loss) (non-GAAP)		$	50,764			$	(16,283	)		$	202,240		$	103,422
Tangible shareholders' equity (non-GAAP)    (see above)		$	1,576,296			$	1,273,250			$	1,576,296		$	1,273,250
Return on tangible common equity			12.88		%		(5.12	)	%		12.83	%		8.12	%
Return on average tangible common equity:
Tangible net income (loss) (non-GAAP) (see above)		$	50,764			$	(16,283	)		$	202,240		$	103,422
Average shareholders' equity (GAAP)		$	2,503,835			$	2,104,646			$	2,267,327		$	1,923,645
Deduct:	Average goodwill		969,403				776,862				864,079			685,729
	Average intangible assets		66,927				37,802				52,209			34,392
Average tangible shareholders' equity    (non-GAAP)		$	1,467,505			$	1,289,982			$	1,351,039		$	1,203,524
Return on average tangible common equity			13.84		%		(5.05	)	%		14.97	%		8.59	%
Net interest margin:
Net interest income (GAAP)		$	146,225			$	118,556			$	537,602		$	437,168
Taxable equivalent adjustment			3,049				6,139				11,394			23,091
Net interest income - taxable equivalent basis    (non-GAAP)		$	149,274			$	124,695			$	548,996		$	460,259
Average earning assets		$	16,398,288			$	14,389,502			$	15,501,053		$	13,237,906
Net interest margin			3.64		%		3.47		%		3.54	%		3.48	%
Efficiency ratio:
Noninterest expense (GAAP)		$	150,268			$	140,432			$	517,261		$	448,836
Deduct:  Intangible amortization expense			4,134				3,399				14,442			11,841
Adjusted noninterest expense (non-GAAP)		$	146,134			$	137,033			$	502,819		$	436,995
Net interest income - taxable equivalent basis    (non-GAAP) (see above)		$	149,274			$	124,695			$	548,996		$	460,259
Noninterest income			58,154				44,825				195,305			183,382
Deduct:  Net securities gains (losses)			(357	)			1,588				2,060			9,135
Adjusted total revenue (non-GAAP)		$	207,785			$	167,932			$	742,241		$	634,506
Efficiency ratio			70.33		%		81.60		%		67.74	%		68.87	%

Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited.  Although these non-GAAP financial measures are frequently used by investors to evaluate a company, they have limitations as analytical tools, and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP.  These non-GAAP measures are not necessarily comparable to similar measures that may be represented by other companies.

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RESULTS OF OPERATIONS

The following table sets forth certain income statement information of Old National for the years ended December 31, 2018, 2017, and 2016:

	Years Ended December 31,
(dollars in thousands)	2018			2017			2016
Income Statement Summary:
Net interest income	$	537,602		$	437,168		$	402,703
Provision for loan losses		6,966			3,050			960
Noninterest income		195,305			183,382			252,830
Noninterest expense		517,261			448,836			454,147
Other Data:
Return on average common equity		8.42	%		4.98	%		7.84	%
Return on tangible common equity (1)		12.83	%		8.12	%		12.69	%
Return on average tangible common equity (1)		14.97	%		8.59	%		13.73	%
Efficiency ratio (1)		67.74	%		68.87	%		65.82	%
Tier 1 leverage ratio		9.17	%		8.28	%		8.43	%
Net charge-offs (recoveries) to average loans		0.02	%		0.03	%		0.04	%

(1) Represents a non-GAAP financial measure.  Refer to "Non-GAAP Financial Measures" section for reconciliations to GAAP financial measures.

Comparison of Fiscal Years 2018 and 2017

Net Interest Income

Net interest income is the most significant component of our earnings, comprising 73% of 2018 revenues.  Net interest income and margin are influenced by many factors, primarily the volume and mix of earning assets, funding sources, and interest rate fluctuations.  Other factors include the level of accretion income on purchased loans, prepayment risk on mortgage and investment-related assets, and the composition and maturity of earning assets and interest-bearing liabilities.

Short-term interest rates increased 100 basis points in 2018 as the Federal Reserve increased the discount rate 25 basis points at their March, June, September, and December meetings.  The rate increases were driven by the Federal Reserve’s inflation and wage pressure expectations in conjunction with an expanding economy.  The Treasury yield curve flattened as short-term rates rose while long-term interest rates remained flat.  Collectively, these factors marginally improved the outlook for our net interest income and margin.

Loans typically generate more interest income than investment securities with similar maturities.  Funding from client deposits generally costs less than wholesale funding sources.  Factors such as general economic activity, Federal Reserve monetary policy, and price volatility of competing alternative investments, can also exert significant influence on our ability to optimize the mix of assets and funding and the net interest income and margin.

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Net interest income is the excess of interest received from earning assets over interest paid on interest-bearing liabilities.  For analytical purposes, net interest income is also presented in the table that follows, adjusted to a taxable equivalent basis to reflect what our tax-exempt assets would need to yield in order to achieve the same after-tax yield as a taxable asset.  We used the federal statutory tax rate in effect of 21% for 2018 and 35% for 2017 and 2016.  This analysis portrays the income tax benefits associated in tax-exempt assets and helps to facilitate a comparison between taxable and tax-exempt assets.  Management believes that it is a standard practice in the banking industry to present net interest margin and net interest income on a fully taxable equivalent basis.  Therefore, management believes these measures provide useful information for both management and investors by allowing them to make peer comparisons.

	Years Ended December 31,
(dollars in thousands)	2018			2017			2016
Net interest income	$	537,602		$	437,168		$	402,703
Conversion to fully taxable equivalent		11,394			23,091			21,293
Net interest income - taxable equivalent basis	$	548,996		$	460,259		$	423,996
Average earning assets	$	15,501,053		$	13,237,906		$	11,840,967
Net interest margin		3.47	%		3.30	%		3.40	%
Net interest margin - taxable equivalent basis		3.54	%		3.48	%		3.58	%

Net interest income was $537.6 million in 2018, a $100.4 million increase from $437.2 million in 2017.  Taxable equivalent net interest income was $549.0 million in 2018, a 19% increase from $460.3 million in 2017.  The net interest margin on a fully taxable equivalent basis was 3.54% in 2018, a 6 basis point increase compared to 3.48% in 2017.  The increase in net interest income in 2018 when compared to 2017 was primarily due to higher average earning assets of $2.263 billion in 2018.  Partially offsetting higher average earning assets were higher average interest-bearing liabilities of $1.585 billion.  In addition, interest income in 2018 included lower fully taxable equivalent interest income resulting from the income tax rate decrease to 21% in 2018.  Net interest income in both 2018 and 2017 included accretion income (interest income in excess of contractual interest income) associated with acquired loans.  Accretion income totaled $41.1 million in 2018, compared to $40.8 million in 2017.  We expect accretion income to decrease over time, but this may be offset by future acquisitions.

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The following table presents a three-year average balance sheet and for each major asset and liability category, its related interest income and yield, or its expense and rate for the years ended December 31.

	2018								2017								2016
(tax equivalent basis,	Average			Income/		Yield/			Average			Income/		Yield/			Average			Income/		Yield/
dollars in thousands)	Balance			Expense		Rate			Balance			Expense		Rate			Balance			Expense		Rate
Earning Assets
Money market and other interest-    earning investments (1)	$	48,240		$	630		1.31	%	$	35,584		$	258		0.72	%	$	32,697		$	130		0.40	%
Investment securities: (2)
Treasury and government-    sponsored agencies (3)		2,380,817			55,926		2.35			2,085,317			42,235		2.03			1,968,408			37,381		1.90
States and political    subdivisions (4)		1,153,315			42,326		3.67			1,134,532			53,359		4.70			1,125,713			53,003		4.71
Other securities		490,464			15,633		3.19			450,127			11,863		2.64			438,832			10,391		2.37
Total investment securities		4,024,596			113,885		2.83			3,669,976			107,457		2.93			3,532,953			100,775		2.85
Loans (including loans held for sale): (5)
Commercial (4)		2,924,878			131,471		4.49			2,083,779			85,747		4.11			1,835,317			70,591		3.85
Commercial real estate		4,536,897			235,876		5.20			3,426,757			171,483		5.00			2,648,911			150,592		5.69
Residential real estate		2,195,078			89,888		4.09			2,146,279			85,340		3.98			1,995,060			80,963		4.06
Consumer		1,771,364			71,689		4.05			1,875,531			68,142		3.63			1,796,029			65,376		3.64
Total loans		11,428,217			528,924		4.63			9,532,346			410,712		4.31			8,275,317			367,522		4.44
Total earning assets		15,501,053		$	643,439		4.15	%		13,237,906		$	518,427		3.92	%		11,840,967		$	468,427		3.96	%
Less: Allowance for loan losses		(52,316	)							(50,845	)							(52,215	)
Non-Earning Assets
Cash and due from banks		210,716								207,677								192,401
Other assets		2,130,588								1,907,963								1,661,200
Total assets	$	17,790,041							$	15,302,701							$	13,642,353
Interest-Bearing Liabilities
Checking and NOW accounts	$	3,146,309		$	4,973		0.16	%	$	2,676,760		$	2,224		0.08	%	$	2,389,143		$	1,529		0.06	%
Savings accounts		2,995,484			7,464		0.25			2,964,875			4,980		0.17			2,595,622			3,723		0.14
Money market accounts		1,225,220			4,424		0.36			762,540			831		0.11			763,909			840		0.11
Time deposits		1,839,974			24,416		1.33			1,487,077			12,321		0.83			1,361,647			11,191		0.82
Total interest-bearing    deposits		9,206,987			41,277		0.45			7,891,252			20,356		0.26			7,110,321			17,283		0.24
Federal funds purchased and    interbank borrowings		238,408			4,793		2.01			187,426			1,966		1.05			137,997			673		0.49
Securities sold under    agreements to repurchase		344,964			1,962		0.57			336,539			1,270		0.38			368,757			1,509		0.41
Federal Home Loan    Bank advances		1,665,689			34,925		2.10			1,481,314			24,818		1.68			1,121,413			15,547		1.39
Other borrowings		249,832			11,486		4.60			224,793			9,758		4.34			222,708			9,419		4.23
Total interest-bearing liabilities	$	11,705,880		$	94,443		0.81	%	$	10,121,324		$	58,168		0.57	%	$	8,961,196		$	44,431		0.50	%
Noninterest-Bearing Liabilities
Demand deposits		3,657,234								3,111,672								2,776,140
Other liabilities		159,600								146,060								192,443
Shareholders' equity		2,267,327								1,923,645								1,712,574
Total liabilities and shareholders'    equity	$	17,790,041							$	15,302,701							$	13,642,353
Interest Margin Recap
Interest income/average earning    assets				$	643,439		4.15	%				$	518,427		3.92	%				$	468,427		3.96	%
Interest expense/average earning    assets					94,443		0.61						58,168		0.44						44,431		0.38
Net interest income and margin				$	548,996		3.54	%				$	460,259		3.48	%				$	423,996		3.58	%

(1) The 2018, 2017, and 2016 average balances include $31.0 million, $21.2 million, and $24.8 million, respectively, of required and excess balances held at the Federal Reserve.

(2) Changes in fair value are reflected in the average balance; however, yield information does not give effect to changes in fair value that are reflected as a component of shareholders' equity.

(3) Includes U.S. government-sponsored entities and agency mortgage-backed securities at December 31, 2018.

(4) Interest on state and political subdivision investment securities and commercial loans includes the effect of taxable equivalent adjustments of $7.1 million and $4.3 million, respectively, in 2018; $15.6 million and $7.5 million, respectively, in 2017; and $15.2 million and $6.1 million, respectively, in 2016; using the federal statutory tax rate in effect of 21% in 2018 and 35% in 2017 and 2016.

(5) Includes principal balances of nonaccrual loans.  Interest income relating to nonaccrual loans is included only if received.

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The yield on average earning assets increased 23 basis points from 3.92% in 2017 to 4.15% in 2018 and the cost of interest-bearing liabilities increased 24 basis points from 0.57% in 2017 to 0.81% in 2018.  Average earning assets increased by $2.263 billion, or 17%.  The increase in average earning assets consisted of a $1.896 billion increase in loans, a $354.6 million increase in lower yielding investment securities, and a $12.7 million increase in money market and other interest-earning investments.  Average interest-bearing liabilities increased $1.585 billion, or 16%.  The increase in average interest-bearing liabilities consisted of a $1.316 billion increase in interest-bearing deposits, a $51.0 million increase in federal funds purchased and interbank borrowings, an $8.4 million increase in securities sold under agreements to repurchase, a $184.4 million increase in FHLB advances, and a $25.0 million increase in other borrowings.  Average noninterest-bearing deposits increased by $545.6 million.

The increase in average earning assets in 2018 compared to 2017 was primarily due to our acquisitions of Anchor (MN) in November 2017 and Klein in November 2018.  Including loans held for sale, the loan portfolio, which generally has an average yield higher than the investment portfolio, was approximately 74% of average interest earning assets in 2018 compared to 72% in 2017.

Average loans including loans held for sale increased $1.896 billion in 2018 compared to 2017 reflecting loans acquired from Anchor (MN) in November 2017 and Klein in November 2018, along with organic loan growth.  Loans including loans held for sale attributable to the Anchor (MN) acquisition totaled $1.595 billion as of the closing date of the acquisition, which was November 1, 2017. Loans including loans held for sale attributable to the Klein acquisition totaled $1.052 billion as of the closing date of the acquisition, which was November 1, 2018.

The increases in average investments and average deposits also reflected the Anchor (MN) and Klein acquisitions.

Average non-interest-bearing deposits increased $545.6 million in 2018 compared to 2017 reflecting the Anchor (MN) and Klein acquisitions.  Average interest-bearing deposits increased $1.316 million in 2018 compared to 2017 reflecting the Anchor (MN) and Klein acquisitions.

Average borrowed funds increased $268.8 million in 2018 compared to 2017 primarily due to increased funding needed as a result of growth in our loan portfolio that outpaced deposit growth.

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The following table shows fluctuations in taxable equivalent net interest income attributable to changes in the average balances of assets and liabilities and the yields earned or rates paid for the years ended December 31.

	From 2017 to 2018							From 2016 to 2017
	Total		Attributed to					Total			Attributed to
(dollars in thousands)	Change		Volume		Rate			Change			Volume			Rate
Interest Income
Money market and other interest-earning    investments	$	372	$	129	$	243		$	128		$	16		$	112
Investment securities (1)		6,428		10,208		(3,780	)		6,682			3,960			2,722
Loans (1)		118,212		84,716		33,496			43,190			54,994			(11,804	)
Total interest income		125,012		95,053		29,959			50,000			58,970			(8,970	)
Interest Expense
Checking and NOW deposits		2,749		566		2,183			695			212			483
Savings deposits		2,484		64		2,420			1,257			575			682
Money market deposits		3,593		1,087		2,506			(9	)		(1	)		(8	)
Time deposits		12,095		3,804		8,291			1,130			1,035			95
Federal funds purchased and interbank    borrowings		2,827		780		2,047			1,293			380			913
Securities sold under agreements to    repurchase		692		40		652			(239	)		(127	)		(112	)
Federal Home Loan Bank advances		10,107		3,478		6,629			9,271			5,510			3,761
Other borrowings		1,728		1,120		608			339			89			250
Total interest expense		36,275		10,939		25,336			13,737			7,673			6,064
Net interest income	$	88,737	$	84,114	$	4,623		$	36,263		$	51,297		$	(15,034	)

The variance not solely due to rate or volume is allocated equally between the rate and volume variances.

(1) Interest on investment securities and loans includes the effect of taxable equivalent adjustments of $7.1 million and $4.3 million, respectively, in 2018; $15.6 million and $7.5 million, respectively, in 2017; and $15.2 million and $6.1 million, respectively, in 2016; using the federal statutory tax rate in effect of 21% in 2018 and 35% in 2017 and 2016.

Provision for Loan Losses

The provision for loan losses was an expense of $7.0 million in 2018, compared to an expense of $3.1 million in 2017.  Net charge-offs totaled $1.9 million in 2018, compared to net charge-offs of $2.5 million in 2017.  The higher provision for loan losses is the result of an increase in specific reserves on loans individually evaluated for impairment and loan growth, partially offset by lower incurred loss rate expectations.  Continued loan growth in future periods, a decline in our current level of recoveries, or an increase in charge-offs could result in an increase in provision expense. For additional information about non-performing loans, charge-offs, and additional items impacting the provision, refer to the “Risk Management – Credit Risk” section of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Noninterest Income

We generate revenues in the form of noninterest income through client fees, sales commissions, and other gains and losses from our core banking franchise and other related businesses, such as wealth management, investment consulting, and investment products.  This source of revenue as a percentage of total revenue was 27% in 2018 compared to 30% in 2017.

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The following table details the components of noninterest income for the years ended December 31.

										% Change From
	Years Ended December 31,									Prior Year
(dollars in thousands)	2018			2017			2016			2018				2017
Wealth management fees	$	36,863		$	37,316		$	34,641			(1.2	)	%		7.7		%
Service charges on deposit accounts		44,026			41,331			41,578			6.5				(0.6	)
Debit card and ATM fees		20,216			17,676			16,769			14.4				5.4
Mortgage banking revenue		17,657			18,449			20,240			(4.3	)			(8.8	)
Insurance premiums and commissions		399			617			20,527			(35.3	)			(97.0	)
Investment product fees		20,539			20,977			18,822			(2.1	)			11.4
Capital markets income		4,934			6,544			3,227			(24.6	)			102.8
Company-owned life insurance		10,584			8,654			8,479			22.3				2.1
Net securities gains (losses)		2,060			9,135			5,848			(77.4	)			56.2
Recognition of deferred gain on sale    leaseback transactions		1,577			2,080			16,057			(24.2	)			(87.0	)
Net gain on branch divestitures		13,989			—			—		N/M				N/M
Gain on sale of ONB Insurance Group, Inc.		—			—			41,864		N/M					(100.0	)
Other income		22,461			20,603			24,778			9.0				(16.8	)
Total noninterest income	$	195,305		$	183,382		$	252,830			6.5		%		(27.5	)	%
Noninterest income to total revenue (1)		26.2	%		28.5	%		37.4	%

(1) Total revenue includes the effect of a taxable equivalent adjustment of $11.4 million in 2018, $23.1 million in 2017, and $21.3 million in 2016.

The increase in noninterest income in 2018 when compared to 2017 was primarily due to a $14.0 million gain on the sale of 10 Wisconsin branches and higher noninterest income attributable to the Anchor (MN) and Klein partnerships.  This increase was partially offset by lower net securities gains and 2017 recoveries on loans originated by AnchorBank (WI) that had been fully charged-off prior to the acquisition totaling $4.0 million.

Service charges and overdraft fees increased $2.7 million in 2018 compared to 2017 primarily due to higher service charges and overdraft fees attributable to the Anchor (MN) and Klein partnerships, partially offset by lower overdraft charges.

Debit card and ATM fees increased $2.5 million in 2018 compared to 2017 primarily due to higher interchange income attributable to the Anchor (MN) and Klein partnerships.

Capital markets income is comprised of customer interest rate swap fees, debt placement fees, foreign currency exchange fees, and net gains (losses) on foreign currency adjustments.  Capital markets income decreased $1.6 million in 2018 compared to 2017 primarily due to lower customer interest rate swap fees.

Company-owned life insurance income increased $1.9 million in 2018 compared to 2017 primarily due to higher settlements in 2018.

Net securities gains decreased $7.1 million in 2018 compared to 2017 primarily due to lower realized gains on sales of available-for-sale securities in 2018.

In 2018, we recorded a net gain of $14.0 million in connection with the October 2018 divestiture of 10 Wisconsin branches, which included a deposit premium of $15.0 million, goodwill allocation of $0.6 million, and $0.4 million of other transaction expenses.

Other income increased $1.9 million in 2018 when compared to 2017 reflecting a $2.2 million gain on the sale of our student loan portfolio in the second quarter of 2018 and higher other income attributable to the Anchor (MN) and Klein partnerships, partially offset by 2017 recoveries on loans originated by AnchorBank (WI) that had been fully charged-off prior to the acquisition totaling $4.0 million.

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Noninterest Expense

The following table details the components of noninterest expense for the years ended December 31.

							% Change From
	Years Ended December 31,						Prior Year
(dollars in thousands)	2018		2017		2016		2018				2017
Salaries and employee benefits	$	281,275	$	246,738	$	252,892		14.0		%		(2.4	)	%
Occupancy		51,941		46,511		50,947		11.7				(8.7	)
Equipment		14,861		13,560		13,448		9.6				0.8
Marketing		15,847		13,172		14,620		20.3				(9.9	)
Data processing		36,170		32,306		32,002		12.0				0.9
Communication		10,846		9,284		9,959		16.8				(6.8	)
Professional fees		14,503		16,840		15,705		(13.9	)			7.2
Loan expense		7,028		6,596		7,632		6.5				(13.6	)
Supplies		3,037		2,406		2,865		26.2				(16.0	)
FDIC assessment		10,638		9,480		8,681		12.2				9.2
Other real estate owned expense		878		3,376		4,195		(74.0	)			(19.5	)
Amortization of intangibles		14,442		11,841		12,486		22.0				(5.2	)
Amortization of tax credit investments		22,949		11,733		—		95.6			N/M
Other expense		32,846		24,993		28,715		31.4				(13.0	)
Total noninterest expense	$	517,261	$	448,836	$	454,147		15.2		%		(1.2	)	%

Noninterest expense increased $68.4 million in 2018 when compared to 2017 primarily due to higher operating expenses and acquisition and integration costs associated with Anchor (MN) and Klein.  Also contributing to the increase in noninterest expense was higher amortization of tax credit investments in 2018 reflecting the completion of investment tax credit projects, higher salaries and benefits, and higher charitable contributions.

Salaries and benefits is the largest component of noninterest expense.  Salaries and benefits increased $34.5 million in 2018 compared to 2017.  Impacting salaries and benefits expense were the acquisitions of Anchor (MN) and Klein.  Also contributing to the increase in salaries and benefits were higher incentive compensation expenses, hospitalization expenses, and profit sharing expenses. The increase in profit sharing expenses reflected Old National’s increase in its 401(k) match to 75% of employee compensation deferral contributions of the first 4% of compensation, and 50% of the next 4% of compensation during the second quarter of 2018.  The change was retroactive for all of 2018.  For 2017, we matched 50% of employee compensation deferral contributions, up to 6% of compensation.

Occupancy expenses increased $5.4 million in 2018 compared to 2017 primarily due to higher occupancy expenses attributable to the Anchor (MN) and Klein partnerships and higher real estate taxes.

Marketing expense increased $2.7 million in 2018 compared to 2017 primarily due to additional expenses associated with the Anchor (MN) and Klein partnerships and higher public relations expense.

Data processing increased $3.9 million in 2018 compared to 2017 primarily due to integration expenses associated with the Anchor (MN) and Klein partnerships and higher software expenses.

Professional fees decreased $2.3 million in 2018 compared to 2017 primarily due to $3.5 million in pre-tax expenses recorded in 2017 related to an initiative to improve how we serve our clients and increase efficiency, partially offset by professional fees associated with the Klein partnership.

Amortization of tax credit investments was $22.9 million in 2018 compared to $11.7 million in 2017.   The recognition of tax credit amortization expense is contingent upon the successful rehabilitation of a historic building or completion of a solar project within the reporting period. Many factors including weather, labor availability, building regulations, inspections, and other unexpected construction delays related to a rehabilitation project can cause a project to exceed its estimated completion date.  Amortization of tax credit investments is expected to be de minimis in 2019.  See Note 10 to the consolidated financial statements for additional information on our tax credit investments.

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Other expense increased $7.9 million in 2018 compared to 2017 primarily due to higher charitable contributions of $6.3 million and higher other expense associated with the Anchor (MN) and Klein partnerships.

Provision for Income Taxes

We record a provision for income taxes currently payable and for income taxes payable or benefits to be received in the future, which arise due to timing differences in the recognition of certain items for financial statement and income tax purposes.  The major difference between the effective tax rate applied to our financial statement income and the federal statutory tax rate is caused by a tax benefit from our tax credit investments and interest on tax-exempt securities and loans.  The effective tax rate was 8.6% in 2018 compared to 43.3% in 2017.  The lower effective tax rate in 2018 when compared to 2017 is the result of $39.3 million of additional tax expense recorded in 2017 for the revaluation of deferred tax assets due to the lowering of the federal corporate tax rate to 21% and an increase in federal tax credits available.  See Note 16 to the consolidated financial statements for additional details on Old National’s income tax provision.

Comparison of Fiscal Years 2017 and 2016

In 2017, we generated net income of $95.7 million and diluted net income per share of $0.69 compared to $134.3 million and diluted net income per share of $1.05, respectively, in 2016. The 2017 earnings included a $69.4 million decrease in noninterest income, a $6.7 million increase in income tax expense, and a $2.1 million increase in provision for loan losses.  These decreases to net income were partially offset by a $34.5 million increase in net interest income and a $5.3 million decrease in noninterest expense.  The successful conversion and integration of our acquisition of Anchor (MN) in 2017, strong commercial and commercial real estate loan growth, consistently low credit metrics, and well-controlled noninterest expenses all contributed to positive 2017 performance when compared to 2016.

Net interest income was $437.2 million in 2017, a $34.5 million increase from $402.7 million in 2016.  Taxable equivalent net interest income was $460.3 million in 2017, a 9% increase from $424.0 million in 2016.  The net interest margin on a fully taxable equivalent basis was 3.48% in 2017, a 10 basis point decrease compared to 3.58% in 2016.  Average earning assets increased by $1.397 billion during 2017 and the yield on average earning assets decreased 4 basis points from 3.96% in 2016 to 3.92% in 2017.  Average interest-bearing liabilities increased $1.160 billion and the cost of interest-bearing liabilities increased 7 basis points from 0.50% in 2016 to 0.57% in 2017.

The provision for loan losses was an expense of $3.1 million in 2017, compared to an expense of $1.0 million in 2016. Charge-offs remained low during 2017 and we continued to see positive trends in credit quality.

Noninterest income decreased to $183.4 million in 2017 from $252.8 million in 2016 primarily due to a $41.9 million gain and lower insurance premiums and commissions in 2016 resulting from the sale of ONI in May 2016, partially offset by higher wealth management fees, investment product fees, and capital markets income in 2017.

Noninterest expense decreased $5.3 million to $448.8 million in 2017 from $454.1 million in 2016 primarily due to the reduction of costs associated with the divestiture of ONI in May 2016.  Offsetting these decreases was $11.7 million of amortization of tax credit investments in 2017.  In addition, noninterest expense in 2017 included $12.3 million of acquisition and integration costs associated with Anchor (MN), compared to $15.9 million in 2016 of acquisition and integration costs associated with Anchor (WI).

The provision for income taxes was $72.9 million in 2017 compared to $66.2 million in 2016.  Old National’s effective tax rate was 43.3% in 2017 compared to 33.0% in 2016.  The higher effective tax rate in 2017 when compared to 2016 is the result of $39.3 million of additional tax expense to estimate the revaluation of deferred tax assets due to the lowering of the federal corporate tax rate to 21%, partially offset by an increase in federal tax credits available.

FINANCIAL CONDITION

Overview

At December 31, 2018, our assets were $19.728 billion, a 13% increase compared to $17.518 billion at December 31, 2017.  The increase was primarily due to the acquisition of Klein in November 2018, which had $2.157 billion in

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assets as of the closing date of the acquisition, including goodwill of $208.0 million. Organic growth in our commercial loan portfolios also contributed to the increase in assets.

Earning Assets

Our earning assets are comprised of investment securities, portfolio loans, loans held for sale, money market investments, interest earning accounts with the Federal Reserve, and equity securities.  Earning assets were $17.070 billion at December 31, 2018, an increase of 12% compared to $15.209 billion at December 31, 2017.

Investment Securities

We classify the majority of our investment securities as available-for-sale to give management the flexibility to sell the securities prior to maturity if needed, based on fluctuating interest rates or changes in our funding requirements.  However, we also have $74.0 million of U.S. government-sponsored entities and agencies securities, $127.1 million of fixed-rate mortgage-backed securities, and $305.2 million of state and political subdivision securities in our held-to-maturity investment portfolio at December 31, 2018.

Equity securities, which consist of mutual funds held in trusts associated with deferred compensation plans for former directors and executives, are recorded at fair value and totaled $5.6 million at December 31, 2018 and December 31, 2017.

At December 31, 2018, the investment securities portfolio, including equity securities, was $4.778 billion compared to $4.006 billion at December 31, 2017, an increase of $772.8 million, or 19%.  Investment securities attributable to the Klein acquisition totaled $700.6 million as of the closing date of the acquisition.  Investment securities represented 28% of earning assets at December 31, 2018, compared to 26% at December 31, 2017.  Stronger commercial loan demand in the future and management’s decision to deleverage the balance sheet could result in a reduction in the securities portfolio.  As of December 31, 2018, management does not intend to sell any securities in an unrealized loss position and does not believe we will be required to sell such securities.

The investment securities available-for-sale portfolio had net unrealized losses of $49.2 million at December 31, 2018, compared to net unrealized losses of $56.4 million at December 31, 2017.  Net unrealized losses decreased from December 31, 2017 to December 31, 2018 reflecting higher net unrealized gains on state and political subdivision securities.

The investment portfolio had an effective duration of 4.00 at December 31, 2018, compared 4.15 at December 31, 2017.  Effective duration measures the percentage change in value of the portfolio in response to a change in interest rates.  Generally, there is more uncertainty in interest rates over a longer average maturity, resulting in a higher duration percentage.  The weighted average yields on available-for-sale investment securities were 2.89% in 2018 and 2.43% in 2017.  The average yields on the held-to-maturity portfolio were 3.75% in 2018 and 5.44% in 2017.

At December 31, 2018, Old National had a concentration of investment securities issued by certain states and their political subdivisions with the following aggregate market values: $344.4 million by Indiana, which represented 12.8% of shareholders’ equity, and $176.0 million by Texas, which represented 6.5% of shareholders’ equity. Of the Indiana municipal bonds, 99% are rated “A” or better, and the remaining 1% generally represent non-rated local interest bonds where Old National has a market presence.  All of the Texas municipal bonds are rated “A” or better, and the majority of issues are backed by the “AAA” rated State of Texas Permanent School Fund Guarantee Program.

Loan Portfolio

We lend primarily to consumers and small to medium-sized commercial and commercial real estate clients in various industries including manufacturing, agribusiness, transportation, mining, wholesaling, and retailing.  Our policy is to concentrate our lending activity in the geographic market areas we serve, primarily Indiana, Kentucky, Michigan, Wisconsin, and Minnesota.

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The following table presents the composition of the loan portfolio at December 31.

											Four- Year
(dollars in thousands)	2018		2017		2016		2015		2014		Growth Rate
Commercial	$	3,232,970	$	2,717,269	$	1,917,099	$	1,814,940	$	1,646,767		18.4	%
Commercial real estate		4,958,851		4,354,552		3,130,853		1,868,972		1,751,907		29.7
Consumer		1,803,667		1,879,247		1,875,030		1,603,158		1,379,117		6.9
Total loans excluding residential    real estate		9,995,488		8,951,068		6,922,982		5,287,070		4,777,791		20.3
Residential real estate		2,248,404		2,167,053		2,087,530		1,661,335		1,540,410		9.9
Total loans		12,243,892		11,118,121		9,010,512		6,948,405		6,318,201		18.0	%
Less: Allowance for loan losses		55,461		50,381		49,808		52,233		47,849
Net loans	$	12,188,431	$	11,067,740	$	8,960,704	$	6,896,172	$	6,270,352

Commercial and Commercial Real Estate Loans

At December 31, 2018, commercial and commercial real estate loans were $8.192 billion, an increase of $1.120 billion, or 16%, compared to December 31, 2017.  Commercial and commercial real estate loans attributable to the Klein acquisition totaled $836.8 million as of the closing date of the acquisition.  Excluding these acquired loans, commercial and commercial real estate loans grew 4% in 2018.

The following table presents the maturity distribution and rate sensitivity of commercial loans at December 31, 2018 and an analysis of these loans that have predetermined and floating interest rates.

	Within		1 - 5		Beyond				% of
(dollars in thousands)	1 Year		Years		5 Years		Total		Total
Interest rates:
Predetermined	$	183,669	$	866,138	$	619,329	$	1,669,136		52	%
Floating		771,332		506,598		285,904		1,563,834		48
Total	$	955,001	$	1,372,736	$	905,233	$	3,232,970		100	%

Residential Real Estate Loans

Residential real estate loans, primarily 1-4 family properties, increased $81.4 million, or 4%, at December 31, 2018 compared to December 31, 2017.  Residential real estate loans attributable to the Klein acquisition totaled $77.7 million as of the closing date of the acquisition.  Future increases in interest rates could result in a decline in the level of refinancings and new originations of residential real estate loans.

Consumer Loans

Consumer loans, including automobile loans, personal and home equity loans and lines of credit, and student loans, decreased $75.6 million at December 31, 2018 compared to December 31, 2017.  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.  Consumer loans attributable to the Klein acquisition totaled $134.6 million as of the closing date of the acquisition.  We continue to see runoff in our less profitable indirect consumer loan portfolio.

Allowance for Loan Losses

To provide for the risk of loss inherent in extending credit, we maintain an 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.  Additional information about our Allowance for Loan Losses is included in the “Risk Management – Credit Risk” section of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Notes 1 and 5 to the consolidated financial statements.

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At December 31, 2018, the allowance for loan losses was $55.5 million, an increase of $5.1 million compared to $50.4 million at December 31, 2017.  Continued loan growth in future periods, a decline in our current level of recoveries, or an increase in charge-offs could result in an increase in provision expense.  As a percentage of total loans excluding loans held for sale, the allowance was 0.45% at December 31, 2018 and December 31, 2017.  The Klein acquisition added $1.049 billion of loans.  In accordance with ASC 805, no allowance for loan losses is recorded at the date of acquisition and a reserve is only established to absorb any subsequent credit deterioration or adverse changes in expected cash flows.  The provision for loan losses was an expense of $7.0 million in 2018 compared to an expense of $3.1 million in 2017.

For commercial loans, the allowance for loan losses increased by $2.5 million at December 31, 2018 compared to December 31, 2017.  The allowance for loan losses as a percentage of the commercial loan portfolio decreased to 0.67% at December 31, 2018, from 0.71% at December 31, 2017.

For commercial real estate loans, the allowance for loan losses increased by $2.0 million at December 31, 2018 compared to December 31, 2017.  The allowance for loan losses as a percentage of the commercial real estate loan portfolio decreased to 0.47% at December 31, 2018, from 0.49% at December 31, 2017.

The allowance for loan losses for residential real estate loans as a percentage of that portfolio increased to 0.10% at December 31, 2018, from 0.08% at December 31, 2017.  The allowance for loan losses for consumer loans as a percentage of that portfolio increased to 0.44% at December 31, 2018, from 0.42% at December 31, 2017.

Allowance for Losses on Unfunded Commitments

We maintain an allowance for losses on unfunded commercial lending commitments and letters of credit to provide for the risk of loss inherent in these arrangements.  The allowance is computed using a methodology similar to that used to determine the allowance for loan losses, modified to take into account the probability of a drawdown on the commitment.  This allowance is classified as a liability on the balance sheet within accrued expenses and other liabilities, while the corresponding provision for these loan losses is recorded as a component of other expense.  The allowance for losses on unfunded commitments was $2.5 million at December 31, 2018, compared to $3.1 million at December 31, 2017.

Loans Held for Sale

Mortgage loans held for immediate sale in the secondary market were $14.9 million at December 31, 2018, compared to $17.9 million at December 31, 2017.  Certain mortgage loans are committed for sale at or prior to origination at a contracted price to an outside investor.  Other mortgage loans held for immediate sale are hedged with TBA forward agreements and committed for sale when they are ready for delivery and remain on the Company’s balance sheet for a short period of time (typically 30 to 60 days).  These loans are sold without recourse, beyond customary representations and warranties, and Old National has not experienced material losses arising from these sales.  Mortgage originations are subject to volatility due to interest rates and home sales, among other factors.

We have elected the fair value option under FASB ASC 825-10 prospectively for residential loans held for sale.  The aggregate fair value exceeded the unpaid principal balance by $0.5 million as of December 31, 2018 and December 31, 2017.

Goodwill and Other Intangible Assets

Goodwill and other intangible assets at December 31, 2018 totaled $1.113 billion, an increase of $232.1 million compared to $881.1 million at December 31, 2017.  During 2018, we recorded $247.1 million of goodwill and other intangible assets associated with the acquisition of Klein.

Net Deferred Tax Assets

Net deferred tax assets decreased $23.8 million since December 31, 2017 primarily due to a decrease in alternative minimum tax credit deferred tax assets.  Old National reclassified $21.5 million from deferred tax assets related to alternative minimum tax credits to accrued income taxes in 2018 as a result of the enactment of the Tax Cuts and Jobs Act.  Future changes in the corporate tax rate could result in a change in value of Old National’s deferred tax assets and future income tax expense.  See Note 16 to the consolidated financial statements for additional information.

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Other Assets

Other assets increased $23.6 million, or 15%, since December 31, 2017 primarily due to higher accrued income taxes.  Old National reclassified $21.5 million from deferred tax assets related to alternative minimum tax credits to accrued income taxes in 2018 as a result of the enactment of the Tax Cuts and Jobs Act.  See Note 16 to the consolidated financial statements for additional information.

Funding

Total funding, comprised of deposits and wholesale borrowings, was $16.844 billion at December 31, 2018, an increase of $1.660 billion from $15.184 billion at December 31, 2017.  Total deposits were $14.350 billion, including $12.326 billion in transaction accounts and $2.024 billion in time deposits at December 31, 2018.  Total deposits increased $1.744 billion, or 14%, compared to December 31, 2017.  Deposits attributable to the Klein acquisition totaled $1.713 billion as of the closing date of the acquisition. Noninterest-bearing demand deposits increased $284.6 million from December 31, 2017 to December 31, 2018.  Interest-bearing checking and NOW deposits increased $672.5 million from December 31, 2017 to December 31, 2018, while savings deposits decreased $91.5 million. Money market deposits increased $488.8 million from December 31, 2017 to December 31, 2018, while time deposits increased $389.8 million.

We use wholesale funding to augment deposit funding and to help maintain our desired interest rate risk position.  At December 31, 2018, wholesale borrowings, including federal funds purchased and interbank borrowings, securities sold under agreements to repurchase, FHLB advances, and other borrowings, totaled $2.494 billion, a decrease of $84.4 million, or 3%, from December 31, 2017.  The decrease in wholesale funding from December 31, 2017 to December 31, 2018 was primarily due to a decrease in federal funds purchased and interbank borrowings and securities sold under agreements to repurchase.  Wholesale funding as a percentage of total funding was 15% at December 31, 2018, compared to 17% at December 31, 2017.  See Notes 12, 13, and 14 to the consolidated financial statements for additional details on our financing activities.

The following table details the average balances of all funding sources for the years ended December 31.

							% Change From
							Prior Year
(dollars in thousands)	2018		2017		2016		2018			2017
Demand deposits	$	3,657,234	$	3,111,672	$	2,776,140		17.5	%		12.1		%
Interest-bearing checking and NOW deposits		3,146,309		2,676,760		2,389,143		17.5			12.0
Savings deposits		2,995,484		2,964,875		2,595,622		1.0			14.2
Money market deposits		1,225,220		762,540		763,909		60.7			(0.2	)
Time deposits		1,839,974		1,487,077		1,361,647		23.7			9.2
Total deposits		12,864,221		11,002,924		9,886,461		16.9			11.3
Federal funds purchased and interbank borrowings		238,408		187,426		137,997		27.2			35.8
Securities sold under agreements to repurchase		344,964		336,539		368,757		2.5			(8.7	)
Federal Home Loan Bank advances		1,665,689		1,481,314		1,121,413		12.4			32.1
Other borrowings		249,832		224,793		222,708		11.1			0.9
Total funding sources	$	15,363,114	$	13,232,996	$	11,737,336		16.1	%		12.7		%

The following table presents a maturity distribution for certificates of deposit with denominations of $100,000 or more at December 31.

			Maturity Distribution
	Year-End		1-90		91-180		181-365		Beyond
(dollars in thousands)	Balance		Days		Days		Days		1 Year
2018	$	1,133,130	$	397,990	$	265,232	$	280,402	$	189,506
2017		727,496		265,872		109,584		171,877		180,163
2016		544,803		142,806		91,704		115,151		195,142

Accrued Expenses and Other Liabilities

Accrued expenses and other liabilities increased $15.2 million, or 8%, from December 31, 2017 primarily due an increase in accrued expenses attributable to the Klein acquisition.

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Capital

Shareholders’ equity totaled $2.690 billion, or 14% of total assets, at December 31, 2018 and $2.154 billion, or 12% of total assets, at December 31, 2017. Shareholders’ equity at December 31, 2018 included $406.5 million from the 22.8 million shares of Common Stock that were issued in conjunction with the acquisition of Klein.  We paid cash dividends of $0.52 per share in 2018, which reduced equity by $82.2 million. Old National’s Common Stock is traded on the NASDAQ under the symbol “ONB” with 34,536 shareholders of record at December 31, 2018.

Capital Adequacy

Old National and the banking industry are subject to various regulatory capital requirements administered by the federal banking agencies.  Management routinely analyzes Old National’s capital to ensure an optimized capital structure.  Accordingly, such evaluations may result in Old National taking a capital action.  For additional information on capital adequacy see Note 25 to the consolidated financial statements.

RISK MANAGEMENT

Overview

Old National has adopted a Risk Appetite Statement to enable the Board of Directors, Executive Leadership Group, and Senior Management to better assess, understand, and mitigate the risks of Old National.  The Risk Appetite Statement addresses the following major risks:  strategic, market, liquidity, credit, operational/technology/cyber, regulatory/compliance/legal, reputational, and human resources.  Our Chief Risk Officer is independent of management and reports directly to the Chair of the Board’s Enterprise Risk Management Committee.  The following discussion addresses these major risks: credit, market, liquidity, operational/technology/cyber, and regulatory/compliance/legal.

Credit Risk

Credit risk represents the risk of loss arising from an obligor’s inability or failure to meet contractual payment or performance terms.  Our primary credit risks result from our investment and lending activities.

Investment Activities

We carry a higher exposure to loss in our pooled trust preferred securities, which are collateralized debt obligations, due to illiquidity in that market and the performance of the underlying collateral.  At December 31, 2018, we had pooled trust preferred securities with a fair value of $8.5 million, or less than 1% of the available-for-sale securities portfolio.  These securities remained classified as available-for-sale and at December 31, 2018, the unrealized loss on our pooled trust preferred securities was approximately $5.4 million.  The fair value of these securities should improve as we get closer to maturity, but not in all cases.  During the first quarter of 2018, Old National sold a pooled trust security for proceeds of $1.8 million, which resulted in a loss of $0.9 million.  There was no OTTI recorded in 2018 or 2017.

All of our mortgage-backed securities are backed by U.S. government-sponsored or federal agencies.  Municipal bonds, corporate bonds, and other debt securities are evaluated by reviewing the credit-worthiness of the issuer and general market conditions.  See Note 3 to the consolidated financial statements for additional details about our investment security portfolio.

Counterparty Exposure

Counterparty exposure is the risk that the other party in a financial transaction will not fulfill its obligation.  We define counterparty exposure as nonperformance risk in transactions involving federal funds sold and purchased, repurchase agreements, correspondent bank relationships, and derivative contracts with companies in the financial services industry.  Old National manages exposure to counterparty risk in connection with its derivatives transactions by generally engaging in transactions with counterparties having ratings of at least A by Standard & Poor’s Rating Service or A2 by Moody’s Investors Service.  Total credit exposure is monitored by counterparty and managed within limits that management believes to be prudent.  Old National’s net counterparty exposure was an asset of $396.4 million at December 31, 2018.

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Lending Activities

Commercial

Commercial and industrial loans are made primarily for the purpose of financing equipment acquisition, expansion, working capital, and other general business purposes.  Lease financing consists of direct financing leases and are used by commercial customers to finance capital purchases ranging from computer equipment to transportation equipment.  The credit decisions for these transactions are based upon an assessment of the overall financial capacity of the applicant.  A determination is made as to the applicant’s ability to repay in accordance with the proposed terms as well as an overall assessment of the risks involved.  In addition to an evaluation of the applicant’s financial condition, a determination is made of the probable adequacy of the primary and secondary sources of repayment, such as additional collateral or personal guarantees, to be relied upon in the transaction.  Credit agency reports of the applicant’s credit history supplement the analysis of the applicant’s creditworthiness.

Commercial mortgages and construction loans are offered to real estate investors, developers, and builders primarily domiciled in the geographic market areas we serve: Indiana, Kentucky, Michigan, Wisconsin, and Minnesota.  These loans are secured by first mortgages on real estate at LTV margins deemed appropriate for the property type, quality, location, and sponsorship.  Generally, these LTV ratios do not exceed 80%.  The commercial properties are predominantly non-residential properties such as retail centers, apartments, industrial properties and, to a lesser extent, more specialized properties.  Substantially all of our commercial real estate loans are secured by properties located in our primary market area.

In the underwriting of our commercial real estate loans, we obtain appraisals for the underlying properties.  Decisions to lend are based on the economic viability of the property and the creditworthiness of the borrower.  In evaluating a proposed commercial real estate loan, we primarily emphasize the ratio of the property’s projected net cash flows to the loan’s debt service requirement.  The debt service coverage ratio normally is not less than 120% and it is computed after deduction for a vacancy factor and property expenses as appropriate.  In addition, a personal guarantee of the loan or a portion thereof is often required from the principal(s) of the borrower.  In most cases, we require title insurance insuring the priority of our lien, fire, and extended coverage casualty insurance, and flood insurance, if appropriate, in order to protect our security interest in the underlying property.  In addition, business interruption insurance or other insurance may be required.

Construction loans are underwritten against projected cash flows derived from rental income, business income from an owner-occupant, or the sale of the property to an end-user.  We may mitigate the risks associated with these types of loans by requiring fixed-price construction contracts, performance and payment bonding, controlled disbursements, and pre-sale contracts or pre-lease agreements.

Consumer

We offer a variety of first mortgage and junior lien loans to consumers within our markets, with residential home mortgages comprising our largest consumer loan category.  These loans are secured by a primary residence and are underwritten using traditional underwriting systems to assess the credit risks of the consumer.  Decisions are primarily based on LTV ratios, DTI ratios, liquidity, and credit scores.  A maximum LTV ratio of 80% is generally required, although higher levels are permitted with mortgage insurance or other mitigating factors.  We offer fixed rate mortgages and variable rate mortgages with interest rates that are subject to change every year after the first, third, fifth, or seventh year, depending on the product and are based on fully-indexed rates such as LIBOR.  We do not offer payment-option facilities, sub-prime loans, or any product with negative amortization.

Home equity loans are secured primarily by second mortgages on residential property of the borrower.  The underwriting terms for the home equity product generally permits borrowing availability, in the aggregate, up to 90% of the appraised value of the collateral property at the time of origination.  We offer fixed and variable rate home equity loans, with variable rate loans underwritten at fully-indexed rates.  Decisions are primarily based on LTV ratios, DTI ratios, and credit scores.  We do not offer home equity loan products with reduced documentation.

Automobile loans include loans and leases secured by new or used automobiles.  We originate automobile loans and leases primarily on an indirect basis through selected dealerships.  We require borrowers to maintain collision insurance on automobiles securing consumer loans, with us listed as loss payee.  Our procedures for underwriting automobile loans include an assessment of an applicant’s overall financial capacity, including credit history and the ability to meet existing obligations and payments on the proposed loan.  Although an applicant’s creditworthiness is

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the primary consideration, the underwriting process also includes a comparison of the value of the collateral security to the proposed loan amount.

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.

Asset Quality

Community-based lending personnel, along with region-based independent underwriting and analytic support staff, extend credit under guidelines established and administered by our Enterprise Risk Committee.  This committee, which meets quarterly, is made up of outside directors.  The committee monitors credit quality through its review of information such as delinquencies, credit exposures, peer comparisons, problem loans, and charge-offs. In addition, the committee reviews and approves recommended loan policy changes to assure it remains appropriate for the current lending environment.

We lend to commercial and commercial real estate clients in various industries including manufacturing, agribusiness, transportation, mining, wholesaling, and retailing.  Old National manages concentrations of credit exposure by industry, product, geography, customer relationship, and loan size.  At December 31, 2018, our average commercial loan size was under $400,000 and our average commercial real estate loan size was under $600,000.  In addition, while loans to lessors of both residential and non-residential real estate exceed 10% of total loans, no individual sub-segment category within those broader categories reaches the 10% threshold.  At December 31, 2018, we had minimal exposure to foreign borrowers and no sovereign debt.  Our policy is to concentrate our lending activity in the geographic market areas we serve, primarily Indiana, Kentucky, Michigan, Wisconsin, and Minnesota.  We are experiencing a slow and gradual improvement in the economy of our principal markets.  Management expects that trends in under-performing, criticized, and classified loans will be influenced by the degree to which the economy strengthens or weakens.

On November 1, 2018, Old National closed on its acquisition of Klein.  As of the closing date of the acquisition, loans totaled $1.049 billion and other real estate owned totaled $1.0 million.  In accordance with accounting for business combinations, there was no allowance brought forward on any of the acquired loans, as the credit losses evident in the loans were included in the determination of the fair value of the loans at the acquisition date.  Old National reviewed the acquired loans and determined that as of December 31, 2018, $46.3 million met the definition of criticized and $56.6 million were considered classified (of which $14.6 million are reported with nonaccrual loans).  Our current preference would be to work these loans and avoid foreclosure actions unless additional credit deterioration becomes apparent.  These acquired impaired loans are included in our summary of under-performing, criticized, and classified assets found below.

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Summary of under-performing, criticized, and classified assets at December 31:

(dollars in thousands)	2018			2017			2016			2015			2014
Nonaccrual loans:
Commercial	$	38,648		$	27,202		$	56,585		$	57,536		$	38,460
Commercial real estate		86,601			62,425			44,026			47,350			67,402
Residential real estate		24,954			22,171			17,674			14,953			13,968
Consumer		7,281			13,129			13,122			5,198			5,903
Covered loans (1)		—			—			—			7,336			15,124
Total nonaccrual loans (2)		157,484			124,927			131,407			132,373			140,857
Renegotiated loans not on nonaccrual:
Noncovered loans		17,356			19,589			14,376			14,147			12,710
Covered loans (1)		—			—			—			138			148
Past due loans (90 days or more and still accruing):
Commercial		52			144			23			565			33
Commercial real estate		40			—			—			—			138
Residential real estate		258			—			2			114			1
Consumer		1,003			750			303			227			286
Covered loans (1)		—			—			—			10			—
Total past due loans		1,353			894			328			916			458
Other real estate owned		3,232			8,810			18,546			7,594			7,241
Other real estate owned, covered (1)		—			—			—			4,904			9,121
Total under-performing assets	$	179,425		$	154,220		$	164,657		$	160,072		$	170,535
Classified loans (includes nonaccrual,    renegotiated, past due 90 days, and    other problem loans)	$	334,785		$	226,583		$	220,429		$	204,710		$	233,486
Classified loans, covered (1)		—			—			—			8,584			17,413
Other classified assets (3)		2,820			4,556			7,063			6,857			14,752
Criticized loans		238,752			188,085			95,462			132,898			194,809
Criticized loans, covered (1)		—			—			—			1,449			4,525
Total criticized and classified assets	$	576,357		$	419,224		$	322,954		$	354,498		$	464,985
Asset Quality Ratios including covered assets:
Non-performing loans/total loans (4) (5)		1.43	%		1.30	%		1.62	%		2.11	%		2.43	%
Under-performing assets/total loans and    other real estate owned (4)		1.47			1.39			1.82			2.30			2.69
Under-performing assets/total assets		0.91			0.88			1.11			1.33			1.46
Allowance for loan losses/under-    performing assets (6)		30.91			32.67			30.25			32.63			28.06
Allowance for loan losses/nonaccrual loans (2)		35.22			40.33			37.90			39.46			33.97

(1) Old National entered into separate loss sharing agreements with the FDIC providing for specified credit loss protection for substantially all acquired single family residential loans, commercial loans, and other real estate owned.  On June 22, 2016, Old National entered into an early termination agreement with the FDIC that terminated all loss share agreements.  Old National reclassified all covered assets to noncovered assets effective June 22, 2016.

(2) Includes approximately $20.5 million, $12.6 million, $16.7 million, $15.9 million, and $41.2 million for 2018, 2017, 2016, 2015, and 2014, respectively, of purchased credit impaired loans 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.

(3) Includes 1 pooled trust preferred securities and 1 insurance policy at December 31, 2018.

(4) Loans exclude loans held for sale.

(5) Non-performing loans include nonaccrual and renegotiated loans.

(6) Because the acquired loans were recorded at fair value in accordance with ASC 805 at the date of acquisition, the credit risk is incorporated in the fair value recorded.  No allowance for loan losses is recorded on the acquisition date.

Under-performing assets totaled $179.4 million at December 31, 2018, compared to $154.2 million at December 31, 2017.  Under-performing assets as a percentage of total loans and other real estate owned at December 31, 2018 were 1.47%, an 8 basis point increase from 1.39% at December 31, 2017.

Nonaccrual loans increased $32.6 million from December 31, 2017 to December 31, 2018 primarily due to an increase in nonaccrual commercial and commercial real estate loans. Nonaccrual loans at December 31, 2018 include $14.6 million of loans related to the Klein acquisition.  As a percentage of nonaccrual loans, the allowance for loan losses was 35.22% at December 31, 2018, compared to 40.33% at December 31, 2017.  PCI loans that were included in the nonaccrual category because the collection of principal or interest is doubtful totaled $20.5 million at December 31, 2018, compared to $12.6 million at December 31, 2017.  However, they are accounted for under FASB ASC 310-30 and accordingly treated as performing assets.

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Interest income of approximately $5.6 million and $6.7 million would have been recorded on nonaccrual and renegotiated loans outstanding at December 31, 2018 and 2017, respectively, if such loans had been accruing interest throughout the year in accordance with their original terms.  Excluding PCI loans accounted for under ASC 310-30, the amount of interest income actually recorded on nonaccrual and renegotiated loans was $2.8 million in 2018 and $1.6 million in 2017.  We had $26.3 million of renegotiated loans which are included in nonaccrual loans at December 31, 2018, compared to $34.0 million at December 31, 2017.

Total criticized and classified assets were $576.4 million at December 31, 2018, an increase of $157.1 million from December 31, 2017.  Other classified assets include investment securities that fell below investment grade rating totaling $2.8 million at December 31, 2018, compared to $4.6 million at December 31, 2017.

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.

At December 31, 2018, our TDRs consisted of $10.3 million of commercial loans, $27.6 million of commercial real estate loans, $3.4 million of residential loans, and $2.4 million of consumer loans totaling $43.7 million.  Approximately $26.3 million of the TDRs at December 31, 2018 were included with nonaccrual loans.  At December 31, 2017, our TDRs consisted of $12.1 million of commercial loans, $34.7 million of commercial real estate loans, $3.3 million of residential loans, and $3.9 million of consumer loans totaling $54.0 million.  Approximately $34.0 million of the TDRs at December 31, 2017 were included with nonaccrual loans.

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 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

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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.  At 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. 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.

To provide for the risk of loss inherent in extending credit, we maintain an 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 activity in our allowance for loan losses was as follows:

(dollars in thousands)	2018			2017			2016			2015				2014
Balance at beginning of period	$	50,381		$	49,808		$	52,233		$	47,849			$	47,145
Loans charged-off:
Commercial		3,087			1,108			5,047			3,513				3,535
Commercial real estate		879			3,700			2,632			1,921				3,647
Residential real estate		1,100			985			800			1,039				793
Consumer credit		7,903			6,924			6,131			6,404				4,675
Total charge-offs		12,969			12,717			14,610			12,877				12,650
Recoveries on charged-off loans:
Commercial		1,519			2,281			3,102			5,218				3,125
Commercial real estate		2,740			3,777			4,763			4,685				3,871
Residential real estate		2,118			255			174			354				205
Consumer credit		4,706			3,927			3,186			4,081				3,056
Total recoveries		11,083			10,240			11,225			14,338				10,257
Net charge-offs (recoveries)		1,886			2,477			3,385			(1,461	)			2,393
Provision for loan losses		6,966			3,050			960			2,923				3,097
Balance at end of period	$	55,461		$	50,381		$	49,808		$	52,233			$	47,849
Average loans for the year (1)	$	11,422,967		$	9,525,888		$	8,265,169		$	6,756,135			$	5,703,294
Asset Quality Ratios:
Allowance/year-end loans (1)		0.45	%		0.45	%		0.55	%		0.75		%		0.76	%
Allowance/average loans (1)		0.49			0.53			0.60			0.77				0.84
Net charge-offs (recoveries)/average loans (2)		0.02			0.03			0.04			(0.02	)			0.04

(1) Loans exclude loans held for sale.

(2) Net charge-offs include write-downs on loans transferred to held for sale.

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The allowance for loan losses increased $5.1 million from December 31, 2017 to December 31, 2018.  Net charge-offs totaled $1.9 million in 2018 compared to net charge-offs of $2.5 million in 2017.  There were no industry segments representing a significant share of total net charge-offs.  Net charge-offs (recoveries) to average loans was 0.02% in 2018 compared to 0.03% in 2017.  Over the last twelve months, net charge-offs have remained low.  Continued loan growth in future periods, a decline in our current level of recoveries, or an increase in charge-offs could result in an increase in provision expense.

As a percentage of total loans, the allowance ranged from 0.45% to 0.76% for the last five years, and was 0.45% at December 31, 2018. Our ratio of allowance for loan losses to total loans remained the same as of December 31, 2018 compared to December 31, 2017.  The addition of Klein added $1.049 billion to the loan portfolio.  In accordance with ASC 805, no allowance for loan losses is recorded at the date of acquisition and a reserve is only established to absorb any subsequent credit deterioration or adverse changes in expected cash flows.

The following table provides additional details of the components of the allowance for loan losses, including ASC 450, Contingencies, for loans collectively evaluated for impairment, ASC 310-10, Receivables, for loans individually evaluated for impairment, and ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, for loans acquired with deteriorated credit quality:

	Collectively			Individually			Acquired with
	Evaluated for			Evaluated for			Deteriorated
(dollars in thousands)	Impairment			Impairment			Credit Quality			Total
Originated loans	$	8,805,227		$	87,219		$	—		$	8,892,446
Acquired loans		3,369,245			35,013			68,452			3,472,710
Total loans	$	12,174,472		$	122,232		$	68,452		$	12,365,156
Remaining purchase discount		(93,487	)		(3,718	)		(24,059	)		(121,264	)
Loans, net of discount	$	12,080,985		$	118,514		$	44,393		$	12,243,892
Allowance, January 1, 2018	$	40,137		$	10,078		$	166		$	50,381
Charge-offs		(8,979	)		(3,927	)		(63	)		(12,969	)
Recoveries		6,736			4,045			302			11,083
Provision expense		2,748			4,145			73			6,966
Allowance, December 31, 2018	$	40,642		$	14,341		$	478		$	55,461

We maintain an allowance for losses on unfunded commercial lending commitments and letters of credit to provide for the risk of loss inherent in these arrangements.  The allowance is computed using a methodology similar to that used to determine the allowance for loan losses, modified to take into account the probability of a drawdown on the commitment.  The reserve for unfunded loan commitments is classified as a liability account on the balance sheet and totaled $2.5 million at December 31, 2018, compared to $3.1 million at December 31, 2017.

The following table details the allowance for loan losses by loan category and the percent of loans in each category compared to total loans at December 31.

	2018					2017					2016					2015					2014
			% of					% of					% of					% of					% of
			Loans					Loans					Loans					Loans					Loans
	Allowance		to Total			Allowance		to Total			Allowance		to Total			Allowance		to Total			Allowance		to Total
(dollars in thousands)	Amount		Loans			Amount		Loans			Amount		Loans			Amount		Loans			Amount		Loans
Commercial	$	21,742		26.4	%	$	19,246		24.4	%	$	21,481		21.3	%	$	25,568		26.0	%	$	17,401		25.8	%
Commercial real estate		23,470		40.5			21,436		39.2			18,173		34.7			15,993		26.6			17,348		27.1
Residential real estate		2,277		18.4			1,763		19.5			1,643		23.2			2,051		23.7			2,962		24.1
Consumer credit		7,972		14.7			7,936		16.9			8,511		20.8			7,684		22.2			6,586		20.7
Covered loans		—		—			—		—			—		—			937		1.5			3,552		2.3
Total	$	55,461		100.0	%	$	50,381		100.0	%	$	49,808		100.0	%	$	52,233		100.0	%	$	47,849		100.0	%

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Market Risk

Market risk is the risk that the estimated fair value of our assets, liabilities, and derivative financial instruments will decline as a result of changes in interest rates or financial market volatility, or that our net income will be significantly reduced by interest rate changes.

The objective of our interest rate management process is to maximize net interest income while operating within acceptable limits established for interest rate risk and maintaining adequate levels of funding and liquidity.

Potential cash flows, sales, or replacement value of many of our assets and liabilities, especially those that earn or pay interest, are sensitive to changes in the general level of interest rates.  This interest rate risk arises primarily from our normal business activities of gathering deposits and extending loans.  Many factors affect our exposure to changes in interest rates, such as general economic and financial conditions, customer preferences, historical pricing relationships, and re-pricing characteristics of financial instruments.  Our earnings can also be affected by the monetary and fiscal policies of the U.S. Government and its agencies, particularly the Federal Reserve.

In managing interest rate risk, we, through the Funds Management Committee, a committee of the Board of Directors, establish guidelines, for asset and liability management, including measurement of short and long-term sensitivities to changes in interest rates.  Based on the results of our analysis, we may use different techniques to manage changing trends in interest rates including:

• adjusting balance sheet mix or altering interest rate characteristics of assets and liabilities;

• changing product pricing strategies;

• modifying characteristics of the investment securities portfolio; or

• using derivative financial instruments, to a limited degree.

A key element in our ongoing process is to measure and monitor interest rate risk using a model to quantify the impact of changing interest rates on Old National.  The model quantifies the effects of various possible interest rate scenarios on projected net interest income.  The model measures the impact on net interest income relative to a base case scenario.  The base case scenario assumes that the balance sheet and interest rates are held at current levels.  The model shows our projected net interest income sensitivity based on interest rate changes only and does not consider other forecast assumptions.

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The following table illustrates our projected net interest income sensitivity over a two-year cumulative horizon based on the asset/liability model as of December 31, 2018 and 2017:

	Immediate
	Rate Decrease					Immediate Rate Increase
	-50					+100			+200			+300
(dollars in thousands)	Basis Points			Base		Basis Points			Basis Points			Basis Points
December 31, 2018
Projected interest income:
Money market, other interest earning    investments, and investment securities	$	300,290		$	308,302	$	322,252		$	335,523		$	347,517
Loans		1,074,017			1,133,140		1,253,101			1,368,890			1,484,341
Total interest income		1,374,307			1,441,442		1,575,353			1,704,413			1,831,858
Projected interest expense:
Deposits		87,031			127,300		217,029			306,754			396,473
Borrowings		113,737			130,971		165,406			199,865			234,336
Total interest expense		200,768			258,271		382,435			506,619			630,809
Net interest income	$	1,173,539		$	1,183,171	$	1,192,918		$	1,197,794		$	1,201,049
Change from base	$	(9,632	)			$	9,747		$	14,623		$	17,878
% change from base		-0.81	%				0.82	%		1.24	%		1.51	%
December 31, 2017
Projected interest income:
Money market, other interest earning    investments, and investment securities	$	225,619		$	234,618	$	247,478		$	259,531		$	272,707
Loans		856,693			914,205		1,026,924			1,138,107			1,248,623
Total interest income		1,082,312			1,148,823		1,274,402			1,397,638			1,521,330
Projected interest expense:
Deposits		33,625			60,527		135,504			210,475			285,441
Borrowings		84,359			101,521		135,861			170,210			204,542
Total interest expense		117,984			162,048		271,365			380,685			489,983
Net interest income	$	964,328		$	986,775	$	1,003,037		$	1,016,953		$	1,031,347
Change from base	$	(22,447	)			$	16,262		$	30,178		$	44,572
% change from base		-2.27	%				1.65	%		3.06	%		4.52	%

Our asset sensitivity decreased year over year primarily due to changes in our balance sheet mix, investment duration, and prepayment speed behavior.

A key element in the measurement and modeling of interest rate risk is the re-pricing assumptions of our transaction deposit accounts, which have no contractual maturity dates.  We assume this deposit base is comprised of both core and more volatile balances and consists of both noninterest-bearing and interest-bearing accounts.  Core deposit balances are assumed to be less interest rate sensitive and provide longer term funding.  Volatile balances are assumed to be more interest rate sensitive and shorter in term.  As part of our semi-static balance sheet modeling, we assume interest rates paid on the volatile deposits move in conjunction with changes in interest rates, in order to retain these deposits.  This may include current noninterest-bearing accounts.

Because the models are driven by expected behavior in various interest rate scenarios and many factors besides market interest rates affect our net interest income, we recognize that model outputs are not guarantees of actual results.  For this reason, we model many different combinations of interest rates and balance sheet assumptions to understand our overall sensitivity to market interest rate changes, including shocks, yield curve flattening, yield curve steepening, as well as forecasts of likely interest rate scenarios.  At December 31, 2018, our projected net interest income sensitivity based on the asset/liability models we utilize was within the limits of our interest rate risk policy for the scenarios tested.

We use derivative instruments, primarily interest rate swaps, to mitigate interest rate risk, including certain cash flow hedges on variable-rate debt with a notional amount of $725 million at December 31, 2018.  Our derivatives had an estimated fair value gain of $16.5 million at December 31, 2018, compared to an estimated fair value loss of

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$2.2 million at December 31, 2017.  See Note 21 to the consolidated financial statements for further discussion of derivative financial instruments.

Liquidity Risk

Liquidity risk arises from the possibility that we may not be able to satisfy current or future financial commitments, or may become unduly reliant on alternative funding sources.  The Funds Management Committee of the Board of Directors establishes liquidity risk guidelines and, along with the Balance Sheet Management Committee, monitors liquidity risk.  The objective of liquidity management is to ensure we have the ability to fund balance sheet growth and meet deposit and debt obligations in a timely and cost-effective manner.  Management monitors liquidity through a regular review of asset and liability maturities, funding sources, and loan and deposit forecasts.  We maintain strategic and contingency liquidity plans to ensure sufficient available funding to satisfy requirements for balance sheet growth, properly manage capital markets’ funding sources and to address unexpected liquidity requirements.

Loan repayments and maturing investment securities are a relatively predictable source of funds.  However, deposit flows, calls of investment securities and prepayments of loans and mortgage-related securities are strongly influenced by interest rates, the housing market, general and local economic conditions, and competition in the marketplace.  We continually monitor marketplace trends to identify patterns that might improve the predictability of the timing of deposit flows or asset prepayments.

A time deposit maturity schedule for Old National Bank is shown in the following table at December 31, 2018.

(dollars in thousands)
Maturity Bucket	Amount		Rate
2019	$	1,505,694		1.68	%
2020		277,142		1.45
2021		109,890		1.43
2022		52,697		1.47
2023		54,637		1.73
2024 and beyond		24,196		1.79
Total	$	2,024,256		1.64	%

Our ability to acquire funding at competitive prices is influenced by rating agencies’ views of our credit quality, liquidity, capital, and earnings.  Moody’s Investor Service places us in an investment grade that indicates a low risk of default.  For both Old National and Old National Bank:

• Moody’s Investor Service affirmed the Long-Term Rating of A3 of Old National’s senior unsecured/issuer rating on February 2, 2018.

• Moody’s Investor Service affirmed Old National Bank’s long-term deposit rating of Aa3 on February 2, 2018.  The bank’s short-term deposit rating was affirmed at P-1 and the bank’s issuer rating was affirmed at A3.

The rating outlook from Moody’s Investor Service is negative.  Moody’s Investor Service concluded a rating review of Old National Bank on February 2, 2018.

The credit ratings of Old National and Old National Bank at December 31, 2018 are shown in the following table.

	Moody's Investor Service
	Long-term	Short-term
Old National	A3	N/A
Old National Bank	Aa3	P-1

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Old National Bank maintains relationships in capital markets with brokers and dealers to issue certificates of deposit and short-term and medium-term bank notes as well.  At December 31, 2018, Old National and its subsidiaries had the following availability of liquid funds and borrowings:

	Parent
(dollars in thousands)	Company		Subsidiaries
Available liquid funds:
Cash and due from banks	$	94,122	$	223,043
Unencumbered government-issued debt securities		—		1,551,735
Unencumbered investment grade municipal securities		—		532,240
Unencumbered corporate securities		—		137,539
Availability of borrowings:
Amount available from Federal Reserve discount window*		—		477,108
Amount available from Federal Home Loan Bank Indianapolis*		—		660,052
Total available funds	$	94,122	$	3,581,717

*  Based on collateral pledged

Old National Bancorp has routine funding requirements consisting primarily of operating expenses, dividends to shareholders, debt service, net derivative cash flows, and funds used for acquisitions.  Old National Bancorp can obtain funding to meet its obligations from dividends and management fees collected from its subsidiaries, operating line of credit, and through the issuance of debt securities.  Additionally, Old National Bancorp has a shelf registration in place with the SEC permitting ready access to the public debt and equity markets.  At December 31, 2018, Old National Bancorp’s other borrowings outstanding were $231.4 million.

Federal banking laws regulate the amount of dividends that may be paid by banking subsidiaries without prior approval.  Prior regulatory approval is required if dividends to be declared in any year would exceed net earnings of the current year plus retained net profits for the preceding two years.  Prior regulatory approval to pay dividends was not required in 2017 or 2018 and is not currently required.

Operational/Technology/Cyber Risk

Operational/technology/cyber risk is the potential that inadequate information systems, operational problems, breaches in internal controls, information security breaches, fraud, or unforeseen catastrophes will result in unexpected losses.  We maintain frameworks, programs, and internal controls to prevent or minimize financial loss from failure of systems, people, or processes.  This includes specific programs and frameworks intended to prevent or limit the effects of cyber risks including cyber-attacks or other information security breaches that might allow unauthorized transactions or unauthorized access to customer, associate, or company sensitive information.  Metrics and measurements are used by Executive Leaders in the management of day-to-day operations to ensure effective customer service, minimization of service disruptions, and oversight of operational and cyber risk.  We continually monitor and report on operational, technology, and cyber risks related to clients, products, and business practices; external and internal fraud; business disruptions and systems failures; cyber-attacks, information security or data breaches; damage to physical assets; and execution, delivery, and process management.

The Enterprise Risk Management Committee of the Board of Directors is responsible for the oversight, guidance, and monitoring of risks, including operational/technology/cyber risks, being taken by the Company.  The monitoring is accomplished through on-going review of management reports, data on risks, policy limits and discussion on enterprise risk management strategies, policies, and risk assessments.

Regulatory/Compliance/Legal Risk

Regulatory/compliance/legal risk is the risk that the Company violated or was not in compliance with applicable laws, regulations or practices, industry standards, or ethical standards.  The legal portion assesses the risk that unenforceable contracts, lawsuits, or adverse judgments can disrupt or otherwise negatively impact the Company.  The Board of Directors expects we will perform business in a manner compliant with applicable laws and/or regulations and expects issues to be identified, analyzed, and remediated in a timely and complete manner.

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OFF-BALANCE SHEET ARRANGEMENTS

Off-balance sheet arrangements include commitments to extend credit and financial guarantees.  Commitments to extend credit and financial guarantees are used to meet the financial needs of our customers.  Our banking affiliates have entered into various agreements to extend credit, including loan commitments of $3.566 billion and standby letters of credit of $319.0 million at December 31, 2018.  At December 31, 2018, approximately $3.348 billion of the loan commitments had fixed rates and $218.1 million had floating rates, with the floating interest rates ranging from 1% to 16%.  At December 31, 2017, loan commitments were $3.144 billion and standby letters of credit of $68.7 million.  The term of these off-balance sheet arrangements is typically one year or less.

Old National is a party in risk participation transactions of interest rate swaps, which had total notional amount of $38.7 million at December 31, 2018.

CONTRACTUAL OBLIGATIONS, COMMITMENTS, AND CONTINGENT LIABILITIES

The following table presents our significant fixed and determinable contractual obligations and significant commitments at December 31, 2018.  Further discussion of each obligation or commitment is included in the referenced note to the consolidated financial statements.

		Payments Due In
	Note	One Year		One to		Three to		Over
(dollars in thousands)	Reference	or Less		Three Years		Five Years		Five Years		Total
Deposits without stated maturity		$	12,325,693	$	—	$	—	$	—	$	12,325,693
IRAs, consumer, and brokered   certificates of deposit	11		1,505,694		387,032		107,334		24,196		2,024,256
Federal funds purchased and   interbank borrowings			270,135		—		—		—		270,135
Securities sold under agreements   to repurchase	12		362,294		—		—		—		362,294
Federal Home Loan Bank advances	13		326,474		120,000		57,169		1,109,838		1,613,481
Other borrowings	14		137		307		368		247,071		247,883
Fixed interest payments (1)			44,894		82,780		78,248		122,218		328,140
Operating leases	7		19,480		35,816		24,866		65,612		145,774
Other long-term liabilities (2)			32,593		5,879		28		48		38,548

(1) Our senior notes, subordinated notes, certain trust preferred securities, and certain FHLB advances have fixed rates ranging from 1.50% to 6.08%. All of our other long-term debt is at LIBOR based variable rates at December 31, 2018. The projected variable interest assumes no increase in LIBOR rates from December 31, 2018.

(2) Includes unfunded commitments on qualified affordable housing projects and other tax credit investments.

We rent certain premises and equipment under operating leases.  See Note 7 to the consolidated financial statements for additional information on long-term lease arrangements.

We are party to various derivative contracts as a means to manage the balance sheet and our related exposure to changes in interest rates, to manage our residential real estate loan origination and sale activity, and to provide derivative contracts to our clients.  Since the derivative liabilities recorded on the balance sheet change frequently and do not represent the amounts that may ultimately be paid under these contracts, these liabilities are not included in the table of contractual obligations presented above.  Further discussion of derivative instruments is included in Note 21 to the consolidated financial statements.

In the normal course of business, various legal actions and proceedings are pending against us and our affiliates which are incidental to the business in which they are engaged.  Further discussion of contingent liabilities is included in Note 22 to the consolidated financial statements.  

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In addition, liabilities recorded under FASB ASC 740-10 (FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109) are not included in the table because the amount and timing of any cash payments cannot be reasonably estimated.  Further discussion of income taxes and liabilities recorded under FASB ASC 740-10 is included in Note 16 to the consolidated financial statements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our accounting policies are described in Note 1 to the consolidated financial statements.  Certain accounting policies require management to use significant judgment and estimates, which can have a material impact on the carrying value of certain assets and liabilities.  We consider these policies to be critical accounting policies.  The judgment and assumptions made are based upon historical experience or other factors that management believes to be reasonable under the circumstances.  Because of the nature of the judgment and assumptions, actual results could differ from estimates, which could have a material effect on our financial condition and results of operations.

The following accounting policies materially affect our reported earnings and financial condition and require significant judgments and estimates.  Management has reviewed these critical accounting estimates and related disclosures with our Audit Committee.

Goodwill

• Description.  For acquisitions, we are required to record the assets acquired, including identified intangible assets, and the liabilities assumed at their fair value.  These often involve estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques that may include estimates of attrition, inflation, asset growth rates, or other relevant factors.  Under FASB ASC 350, Intangibles – Goodwill and Other, goodwill recorded must be reviewed for impairment on an annual basis, as well as on an interim basis if events or changes indicate that the asset might be impaired.  An impairment loss must be recognized for any excess of carrying value over fair value of the goodwill.

• Judgments and Uncertainties.  The determination of fair values is based on valuations using management’s assumptions of future growth rates, future attrition, discount rates, multiples of earnings or other relevant factors.

• Effect if Actual Results Differ From Assumptions.  Changes in these factors, as well as downturns in economic or business conditions, could have a significant adverse impact on the carrying value of goodwill and could result in impairment losses affecting our financials as a whole and our banking subsidiary in which the goodwill resides.

Allowance for Loan Losses

• Description.  The allowance for loan losses is maintained at a level believed adequate by management to absorb probable incurred losses 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 represents management’s best estimate, but significant downturns in circumstances relating to loan quality and economic conditions could result in a requirement for additional allowance.  Likewise, an upturn in loan quality and improved economic conditions may allow a reduction in the required allowance.  In either instance, unanticipated changes could have a significant impact on results of operations.

The allowance is increased through a provision charged to operating expense.  Uncollectible loans are charged-off through the allowance.  Recoveries of loans previously charged-off are added to the allowance.  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.  Our policy for recognizing income on impaired loans is to accrue interest unless a loan is placed on nonaccrual status.  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.  We monitor the quality of our loan portfolio on an on-going basis and use a combination of detailed credit assessments by relationship managers and credit officers, historic loss trends, and economic and business environment factors in determining the allowance for loan losses.  We

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record provisions for loan losses based on current loans outstanding, grade changes, mix of loans, and expected losses.  A detailed loan loss evaluation on an individual loan basis for our highest risk loans is performed quarterly.  Management follows the progress of the economy and how it might affect our borrowers in both the near and the intermediate term.  We have a formalized and disciplined independent loan review program to evaluate loan administration, credit quality, and compliance with corporate loan standards.  This program includes periodic, regular reviews of problem loan reports, delinquencies and charge-offs.

• Judgments and Uncertainties.  We utilize a PD/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 historic loss ratios adjusted for economic conditions to determine the appropriate level of allowance for residential real estate and consumer loans.

• Effect if Actual Results Differ From Assumptions.  The allowance represents management’s best estimate, but significant downturns in circumstances relating to loan quality and economic conditions could result in a requirement for additional allowance.  Likewise, an upturn in loan quality and improved economic conditions may allow a reduction in the required allowance.  In either instance, unanticipated changes could have a significant impact on results of operations.

Management’s analysis of probable losses in the portfolio at December 31, 2018 resulted in a range for allowance for loan losses of $16.2 million.  The range pertains to general (FASB ASC 450, Contingencies) reserves for both retail and performing commercial loans.  Specific (FASB ASC 310, Receivables) reserves do not have a range of probable loss.  Due to the risks and uncertainty associated with the economy and our projection of loss rates inherent in the portfolio, we establish a range of probable outcomes (a high-end estimate and a low-end estimate) and evaluate our position within this range.  The potential effect to net income based on our position in the range relative to the high and low endpoints is a decrease of $1.8 million and an increase of $10.5 million, respectively, after taking into account the tax effects.  These sensitivities are hypothetical and may not represent actual results.

Derivative Financial Instruments

• Description.  As part of our overall interest rate risk management, we use derivative instruments to reduce exposure to changes in interest rates and market prices for financial instruments.  The application of the hedge accounting policy requires judgment in the assessment of hedge effectiveness, identification of similar hedged item groupings and measurement of changes in the fair value of derivative financial instruments and hedged items.  To the extent hedging relationships are found to be effective, as determined by FASB ASC 815, Derivatives and Hedging (“ASC Topic 815”), changes in fair value of the derivatives are offset by changes in the fair value of the related hedged item or recorded to other comprehensive income.  Management believes hedge effectiveness is evaluated properly in preparation of the financial statements.  All of the derivative financial instruments we use have an active market and indications of fair value can be readily obtained.  We are not using the “short-cut” method of accounting for any fair value derivatives.

• Judgments and Uncertainties.  The application of the hedge accounting policy requires judgment in the assessment of hedge effectiveness, identification of similar hedged item groupings and measurement of changes in the fair value of derivative financial instruments and hedged items.

• Effect if Actual Results Differ From Assumptions.  To the extent hedging relationships are found to be effective, as determined by ASC Topic 815, changes in fair value of the derivatives are offset by changes in the fair value of the related hedged item or recorded to other comprehensive income.  However, if in the future the derivative financial instruments used by us no longer qualify for hedge accounting treatment, all

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changes in fair value of the derivative would flow through the consolidated statements of income in other noninterest income, resulting in greater volatility in our earnings.

Income Taxes

• Description.  We are subject to the income tax laws of the U.S., its states, and the municipalities in which we operate.  These tax laws are complex and subject to different interpretations by the taxpayer and the relevant government taxing authorities.  We review income tax expense and the carrying value of deferred tax assets quarterly; and as new information becomes available, the balances are adjusted as appropriate.  FASB ASC 740-10 (FIN 48) prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements.  See Note 16 to the consolidated financial statements for a further description of our provision and related income tax assets and liabilities.

• Judgments and Uncertainties. In establishing a provision for income tax expense, we must make judgments and interpretations about the application of these inherently complex tax laws.  We must also make estimates about when in the future certain items will affect taxable income in the various tax jurisdictions.  Disputes over interpretations of the tax laws may be subject to review/adjudication by the court systems of the various tax jurisdictions or may be settled with the taxing authority upon examination or audit.

• Effect if Actual Results Differ From Assumptions.  Although management believes that the judgments and estimates used are reasonable, actual results could differ and we may be exposed to losses or gains that could be material.  To the extent we prevail in matters for which reserves have been established, or are required to pay amounts in excess of our reserves, our effective income tax rate in a given financial statement period could be materially affected.  An unfavorable tax settlement would result in an increase in our effective income tax rate in the period of resolution.  A favorable tax settlement would result in a reduction in our effective income tax rate in the period of resolution.

Management has discussed the development and selection of these critical accounting estimates with the Audit Committee and the Audit Committee has reviewed our disclosure relating to it in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information contained under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Risk” of this Form 10-K is incorporated herein by reference in response to this item.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

	Page
Report of Management	62
Report of Independent Registered Public Accounting Firm	63
Consolidated Balance Sheets	65
Consolidated Statements of Income	66
Consolidated Statements of Comprehensive Income	67
Consolidated Statements of Changes in Shareholders’ Equity	68
Consolidated Statements of Cash Flows	69
Notes to Consolidated Financial Statements	70
Note 1.  Basis of Presentation and Significant Accounting Policies	70
Note 2.  Acquisition and Divestiture Activity	83
Note 3.  Investment Securities	86
Note 4.  Loans Held for Sale	90
Note 5.  Loans and Allowance for Loan Losses	90
Note 6.  Other Real Estate Owned	102
Note 7.  Premises and Equipment	103
Note 8.  Goodwill and Other Intangible Assets	104
Note 9.  Loan Servicing Rights	105
Note 10.  Qualified Affordable Housing Projects and Other Tax Credit Investments	105
Note 11.  Deposits	107
Note 12.  Securities Sold Under Agreements to Repurchase	107
Note 13.  Federal Home Loan Bank Advances	107
Note 14.  Other Borrowings	108
Note 15.  Accumulated Other Comprehensive Income (Loss)	110
Note 16.  Income Taxes	111
Note 17.  Employee Benefit Plans	114
Note 18.  Share-Based Compensation	114
Note 19.  Shareholders’ Equity	116
Note 20.  Fair Value	117
Note 21.  Derivative Financial Instruments	123
Note 22.  Commitments and Contingencies	126
Note 23.  Financial Guarantees	127
Note 24.  Revenue From Contracts With Customers	127
Note 25.  Regulatory Restrictions	128
Note 26.  Parent Company Financial Statements	130
Note 27.  Segment Information	131
Note 28.  Interim Financial Data (Unaudited)	132

61

REPORT OF MANAGEMENT

MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL REPORTING

Management is responsible for the preparation of the financial statements and related financial information appearing in this annual report on Form 10-K.  The financial statements and notes have been prepared in conformity with accounting principles generally accepted in the United States and include some amounts which are estimates based upon currently available information and management’s judgment of current conditions and circumstances.  Financial information throughout this annual report on Form 10-K is consistent with that in the financial statements.

Management maintains a system of internal accounting controls which is believed to provide, in all material respects, reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition, transactions are properly authorized and recorded, and the financial records are reliable for preparing financial statements and maintaining accountability for assets.  In addition, Old National has a Code of Business Conduct and Ethics, a Senior Financial and Executive Officer Code of Ethics and Corporate Governance Guidelines that outline high levels of ethical business standards.  Old National has also appointed a Chief Ethics Officer and had a third party perform an independent validation of our ethics program.  All systems of internal accounting controls are based on management’s judgment that the cost of controls should not exceed the benefits to be achieved and that no system can provide absolute assurance that control objectives are achieved.  Management believes Old National’s system provides the appropriate balance between cost of controls and the related benefits.

In order to monitor compliance with this system of controls, Old National maintains an extensive internal audit program.  Internal audit reports are issued to appropriate officers and significant audit exceptions, if any, are reviewed with management and the Audit Committee.

The Board of Directors, through an Audit Committee comprised solely of independent outside directors, oversees management’s discharge of its financial reporting responsibilities.  The Audit Committee meets regularly with Old National’s independent registered public accounting firm, Crowe LLP, and the managers of financial reporting, internal audit, and risk.  During these meetings, the committee meets privately with the independent registered public accounting firm as well as with financial reporting and internal audit personnel to review accounting, auditing, and financial reporting matters.  The appointment of the independent registered public accounting firm is made by the Audit Committee.

The consolidated financial statements in this annual report on Form 10-K have been audited by Crowe LLP, for the purpose of determining that the consolidated financial statements are presented fairly, in all material respects in conformity with accounting principles generally accepted in the United States.  Crowe LLP’s report on the financial statements follows.

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of Old National is responsible for establishing and maintaining adequate internal control over financial reporting.  A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Old National’s management assessed the effectiveness of Old National’s internal control over financial reporting as of December 31, 2018.  In making this assessment, management used the criteria established in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control - Integrated Framework.  As permitted, Old National has excluded the operations of Klein Financial, Inc. acquired November 1, 2018, which is described in Note 2 to the consolidated financial statements.  The assets acquired in this acquisition and excluded from management’s assessment on internal control over financial reporting comprised approximately 5.8% of total consolidated assets at December 31, 2018.  Based on that assessment Old National has concluded that, as of December 31, 2018, Old National’s internal control over financial reporting is effective.  Old National’s independent registered public accounting firm has audited the effectiveness of Old National’s internal control over financial reporting as of December 31, 2018 as stated in their report which follows.

62

	Crowe LLP Independent Member Crowe Global

Report of Independent Registered Public Accounting Firm

Shareholders and the Board of Directors of Old National Bancorp

Evansville, Indiana

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Old National Bancorp (the "Company") as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America.  Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO.

Basis for Opinions

The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting.  Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.  We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements.

63

Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.  As permitted, the Company has excluded the operations of Klein Financial, Inc. acquired during 2018, which is described in Note 2 of the consolidated financial statements, from the scope of management’s report on internal control over financial reporting. As such, it has also been excluded from the scope of our audit of internal control over financial reporting. Our audits also included performing such other procedures as we considered necessary in the circumstances.  We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.  

Crowe LLP

We have served as the Company's auditor since 2005, which is the year the engagement letter was signed for the audit of the 2006 financial statements.

Louisville, Kentucky

February 12, 2019

64

OLD NATIONAL BANCORP

CONSOLIDATED BALANCE SHEETS

	December 31,
(dollars and shares in thousands, except per share data)	2018			2017
Assets
Cash and due from banks	$	284,003		$	222,753
Money market and other interest-earning investments		33,162			67,679
Total cash and cash equivalents		317,165			290,432
Equity securities		5,582			5,584
Investment securities - available-for-sale, at fair value		4,123,416			3,196,207
Investment securities - held-to-maturity, at amortized cost (fair value $506,103 and    $727,703, respectively)		506,334			684,063
Federal Home Loan Bank/Federal Reserve Bank stock, at cost		142,980			119,686
Loans held for sale, at fair value		14,911			17,930
Loans, net of unearned income		12,243,892			11,118,121
Allowance for loan losses		(55,461	)		(50,381	)
Net loans		12,188,431			11,067,740
Premises and equipment, net		485,912			458,074
Accrued interest receivable		89,464			87,102
Goodwill		1,036,258			828,051
Other intangible assets		77,016			53,096
Company-owned life insurance		444,224			403,753
Net deferred tax assets		87,048			110,857
Loan servicing rights		24,497			24,661
Assets held for sale		3,253			7,180
Other real estate owned and repossessed personal property		3,232			8,810
Other assets		178,712			155,066
Total assets	$	19,728,435		$	17,518,292
Liabilities
Deposits:
Noninterest-bearing demand	$	3,965,380		$	3,680,807
Interest-bearing:
Checking and NOW		3,788,339			3,115,822
Savings		2,944,092			3,035,622
Money market		1,627,882			1,139,077
Time		2,024,256			1,634,436
Total deposits		14,349,949			12,605,764
Federal funds purchased and interbank borrowings		270,135			335,033
Securities sold under agreements to repurchase		362,294			384,810
Federal Home Loan Bank advances		1,613,481			1,609,579
Other borrowings		247,883			248,782
Accrued expenses and other liabilities		195,123			179,927
Total liabilities		17,038,865			15,363,895
Commitments and contingencies (Note 22)
Shareholders' Equity
Preferred stock, series A, 2,000 shares authorized, no shares issued or outstanding		—			—
Common stock, $1.00 per share stated value, 300,000 shares authorized, 175,141    and 152,040 shares issued and outstanding, respectively		175,141			152,040
Capital surplus		2,031,695			1,639,499
Retained earnings		527,684			413,130
Accumulated other comprehensive income (loss), net of tax		(44,950	)		(50,272	)
Total shareholders' equity		2,689,570			2,154,397
Total liabilities and shareholders' equity	$	19,728,435		$	17,518,292

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

65

OLD NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF INCOME

	Years Ended December 31,
(dollars and shares in thousands, except per share data)	2018		2017		2016
Interest Income
Loans including fees:
Taxable	$	508,293	$	389,219	$	349,095
Nontaxable		16,299		13,970		12,287
Investment securities:
Taxable		80,168		63,031		57,005
Nontaxable		26,655		28,858		28,617
Money market and other interest-earning investments		630		258		130
Total interest income		632,045		495,336		447,134
Interest Expense
Deposits		41,277		20,356		17,283
Federal funds purchased and interbank borrowings		4,793		1,966		673
Securities sold under agreements to repurchase		1,962		1,270		1,509
Federal Home Loan Bank advances		34,925		24,818		15,547
Other borrowings		11,486		9,758		9,419
Total interest expense		94,443		58,168		44,431
Net interest income		537,602		437,168		402,703
Provision for loan losses		6,966		3,050		960
Net interest income after provision for loan losses		530,636		434,118		401,743
Noninterest Income
Wealth management fees		36,863		37,316		34,641
Service charges on deposit accounts		44,026		41,331		41,578
Debit card and ATM fees		20,216		17,676		16,769
Mortgage banking revenue		17,657		18,449		20,240
Insurance premiums and commissions		399		617		20,527
Investment product fees		20,539		20,977		18,822
Capital markets income		4,934		6,544		3,227
Company-owned life insurance		10,584		8,654		8,479
Net securities gains (losses)		2,060		9,135		5,848
Recognition of deferred gain on sale leaseback transactions		1,577		2,080		16,057
Net gain on branch divestitures		13,989		—		—
Gain on sale of ONB Insurance Group, Inc.		—		—		41,864
Other income		22,461		20,603		24,778
Total noninterest income		195,305		183,382		252,830
Noninterest Expense
Salaries and employee benefits		281,275		246,738		252,892
Occupancy		51,941		46,511		50,947
Equipment		14,861		13,560		13,448
Marketing		15,847		13,172		14,620
Data processing		36,170		32,306		32,002
Communication		10,846		9,284		9,959
Professional fees		14,503		16,840		15,705
Loan expense		7,028		6,596		7,632
Supplies		3,037		2,406		2,865
FDIC assessment		10,638		9,480		8,681
Other real estate owned expense		878		3,376		4,195
Amortization of intangibles		14,442		11,841		12,486
Amortization of tax credit investments		22,949		11,733		—
Other expense		32,846		24,993		28,715
Total noninterest expense		517,261		448,836		454,147
Income before income taxes		208,680		168,664		200,426
Income tax expense		17,850		72,939		66,162
Net income	$	190,830	$	95,725	$	134,264
Net income per common share - basic	$	1.23	$	0.69	$	1.05
Net income per common share - diluted		1.22		0.69		1.05
Weighted average number of common shares outstanding - basic		155,675		137,821		127,705
Weighted average number of common shares outstanding - diluted		156,539		138,513		128,301
Dividends per common share	$	0.52	$	0.52	$	0.52

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

66

OLD NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

	Years Ended December 31,
(dollars in thousands)	2018			2017			2016
Net income	$	190,830		$	95,725		$	134,264
Other comprehensive income (loss):
Change in debt securities available-for-sale:
Unrealized holding gains (losses) for the period		(4,769	)		14,259			(49,813	)
Reclassification for securities transferred to held-to-maturity		14,007			—			—
Reclassification adjustment for securities gains realized in income		(2,060	)		(9,135	)		(5,848	)
Income tax effect		(1,386	)		(1,669	)		20,455
Unrealized gains (losses) on available-for-sale debt securities		5,792			3,455			(35,206	)
Change in securities held-to-maturity:
Adjustment for securities transferred to available-for-sale		19,412			—			—
Adjustment for securities transferred from available-for-sale		(14,007	)		—			—
Amortization of unrealized losses on securities transferred     from available-for-sale		2,181			1,830			1,776
Income tax effect		(1,394	)		(627	)		(606	)
Changes from securities held-to-maturity		6,192			1,203			1,170
Cash flow hedges:
Net unrealized derivative gains (losses) on cash flow hedges		5,145			927			(2,323	)
Reclassification adjustment for (gains) losses realized in net income		150			6,135			6,453
Income tax effect		(1,298	)		(2,684	)		(1,569	)
Changes from cash flow hedges		3,997			4,378			2,561
Defined benefit pension plans:
Amortization of net loss and settlement cost recognized in income		191			159			11,203
Income tax effect		(47	)		(95	)		(4,303	)
Changes from defined benefit pension plans		144			64			6,900
Other comprehensive income (loss), net of tax		16,125			9,100			(24,575	)
Comprehensive income	$	206,955		$	104,825		$	109,689

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

67

OLD NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

										Accumulated
										Other			Total
	Common			Capital			Retained			Comprehensive			Shareholders'
(dollars in thousands)	Stock			Surplus			Earnings			Income (Loss)			Equity
Balance,  January 1, 2016	$	114,297		$	1,087,911		$	323,759		$	(34,797	)	$	1,491,170
Net income		—			—			134,264			—			134,264
Other comprehensive income (loss)		—			—			—			(24,575	)		(24,575	)
Acquisition of Anchor BanCorp Wisconsin Inc.		20,415			253,150			—			—			273,565
Dividends - common stock ($0.52 per share)		—			—			(67,536	)		—			(67,536	)
Common stock issued		32			356			—			—			388
Common stock repurchased		(154	)		(1,890	)		—			—			(2,044	)
Share-based compensation expense		—			7,318			—			—			7,318
Stock activity under incentive compensation plans		569			1,493			(195	)		—			1,867
Balance,  December 31, 2016		135,159			1,348,338			390,292			(59,372	)		1,814,417
Net income		—			—			95,725			—			95,725
Other comprehensive income (loss)		—			—			—			9,100			9,100
Acquisition of Anchor Bancorp, Inc.		16,527			284,301			—			—			300,828
Dividends - common stock ($0.52 per share)		—			—			(72,604	)		—			(72,604	)
Common stock issued		24			380			—			—			404
Common stock repurchased		(153	)		(2,608	)		—			—			(2,761	)
Share-based compensation expense		—			6,275			—			—			6,275
Stock activity under incentive compensation plans		483			2,813			(283	)		—			3,013
Balance,  December 31, 2017		152,040			1,639,499			413,130			(50,272	)		2,154,397
Cumulative effect of change in accounting    principles (Note 1)		—			—			(4,127	)		(52	)		(4,179	)
Balance, January 1, 2018		152,040			1,639,499			409,003			(50,324	)		2,150,218
Reclassification of certain tax effects related    to the Tax Cuts and Jobs Act of 2017 (Note 1)		—			—			10,751			(10,751	)		—
Net income		—			—			190,830			—			190,830
Other comprehensive income (loss)		—			—			—			16,125			16,125
Acquisition of Klein Financial, Inc.		22,772			383,702			—			—			406,474
Dividends - common stock ($0.52 per share)		—			—			(82,161	)		—			(82,161	)
Common stock issued		29			468			—			—			497
Common stock repurchased		(104	)		(1,701	)		—			—			(1,805	)
Share-based compensation expense		—			8,118			—			—			8,118
Stock activity under incentive compensation plans		404			1,609			(739	)		—			1,274
Balance,  December 31, 2018	$	175,141		$	2,031,695		$	527,684		$	(44,950	)	$	2,689,570

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

68

OLD NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Years Ended December 31,
(dollars in thousands)	2018			2017			2016
Cash Flows From Operating Activities
Net income	$	190,830		$	95,725		$	134,264
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation		23,773			22,183			16,558
Amortization of other intangible assets		14,442			11,841			12,486
Amortization of tax credit investments		22,949			11,733			—
Net premium amortization on investment securities		14,384			15,302			18,633
Accretion income related to acquired loans		(40,598	)		(40,576	)		(57,244	)
Share-based compensation expense		8,118			6,275			7,318
Excess tax (benefit) expense on share-based compensation		401			79			—
Provision for loan losses		6,966			3,050			960
Net securities (gains) losses		(2,060	)		(9,135	)		(5,848	)
Recognition of deferred gain on sale leaseback transactions		(1,577	)		(2,080	)		(16,057	)
Gain on sale of ONB Insurance Group, Inc.		—			—			(41,864	)
Net gain on branch divestitures		(13,989	)		—			—
Net (gains) losses on sales of loans and other assets		(2,290	)		(6,421	)		(4,741	)
Increase in cash surrender value of company-owned life insurance		(10,584	)		(8,654	)		(8,479	)
Residential real estate loans originated for sale		(501,999	)		(452,604	)		(637,639	)
Proceeds from sale of residential real estate loans		514,891			535,271			578,653
(Increase) decrease in interest receivable		2,038			151			(4,974	)
(Increase) decrease in other real estate owned		6,532			10,794			11,301
(Increase) decrease in other assets		2,046			45,008			46,004
Increase (decrease) in accrued expenses and other liabilities		134			12,141			(24,524	)
Total adjustments		43,577			154,358			(109,457	)
Net cash flows provided by (used in) operating activities		234,407			250,083			24,807
Cash Flows From Investing Activities
Cash portion of bank purchase price, net of cash acquired		60,759			2,564			(62,532	)
Payments related to branch divestitures		(210,659	)		—			—
Proceeds from sale of ONB Insurance Group, Inc.		—			—			91,771
Purchases of investment securities available-for-sale		(663,338	)		(874,555	)		(1,625,746	)
Purchases of Federal Home Loan Bank/Federal Reserve Bank stock		(23,066	)		(17,979	)		(10,974	)
Proceeds from maturities, prepayments, and calls of investment securities    available-for-sale		419,270			438,818			1,177,130
Proceeds from sales of investment securities available-for-sale		139,364			342,233			243,312
Proceeds from maturities, prepayments, and calls of investment securities held-to-maturity		55,520			57,682			120,954
Proceeds from sales of Federal Home Loan Bank/Federal Reserve Bank stock		2,409			6,594			—
Proceeds from sales of equity securities		128			127			—
Proceeds from sale of student loan portfolio		70,674			—			—
Reimbursements under FDIC loss share agreements		—			—			10,000
Net principal collected from (loans made to) loan customers		(102,928	)		(475,519	)		(370,442	)
Proceeds from settlements on company-owned life insurance		6,501			2,347			4,095
Proceeds from sale of premises and equipment and other assets		7,341			18,592			6,332
Purchases of premises and equipment and other assets		(33,391	)		(37,303	)		(224,659	)
Net cash flows provided by (used in) investing activities		(271,416	)		(536,399	)		(640,759	)
Cash Flows From Financing Activities
Net increase (decrease) in:
Deposits		261,551			85,062			489,680
Federal funds purchased and interbank borrowings		(64,898	)		76,430			(78,087	)
Securities sold under agreements to repurchase		(41,997	)		(5,207	)		(23,489	)
Other borrowings		(1,505	)		(20,056	)		(67	)
Payments for maturities of Federal Home Loan Bank advances		(1,001,888	)		(947,694	)		(594,541	)
Proceeds from Federal Home Loan Bank advances		995,000			1,205,000			925,000
Cash dividends paid on common stock		(82,161	)		(72,604	)		(67,536	)
Common stock repurchased		(1,805	)		(2,761	)		(2,044	)
Proceeds from exercise of stock options		948			2,655			2,349
Common stock issued		497			404			388
Net cash flows provided by (used in) financing activities		63,742			321,229			651,653
Net increase (decrease) in cash and cash equivalents		26,733			34,913			35,701
Cash and cash equivalents at beginning of period		290,432			255,519			219,818
Cash and cash equivalents at end of period	$	317,165		$	290,432		$	255,519

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

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OLD NATIONAL BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NATURE OF OPERATIONS

Old National Bancorp, a financial holding company headquartered in Evansville, Indiana, operates primarily in Indiana, Kentucky, Michigan, Wisconsin, and Minnesota.  Its principal subsidiary is Old National Bank.  Through its bank and non-bank affiliates, Old National Bancorp provides to its clients an array of financial services including loan, deposit, wealth management, investment consulting, and investment products.

NOTE 1 – BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements include the accounts of Old National Bancorp and its wholly-owned affiliates (hereinafter collectively referred to as “Old National”) and have been prepared in conformity with accounting principles generally accepted in the United States of America and prevailing practices within the banking industry.  Such principles require management to make estimates and assumptions that affect the reported amounts of assets, liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements and amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

All significant intercompany transactions and balances have been eliminated. Certain prior year amounts have been reclassified to conform to the 2018 presentation.  Such reclassifications had no effect on net income or shareholders’ equity and were insignificant amounts.

Equity Securities

Equity securities consist of mutual funds held in trusts associated with deferred compensation plans for former directors and executives.  These mutual funds are recorded as equity securities at fair value.  Gains and losses are included in net securities gains.

Investment Securities

Old National classifies debt investment securities as available-for-sale or held-to-maturity on the date of purchase.  Debt securities classified as available-for-sale are recorded at fair value with the unrealized gains and losses, net of tax effect, recorded in other comprehensive income.  Realized gains and losses affect income and the prior fair value adjustments are reclassified within shareholders’ equity.  Debt securities classified as held-to-maturity, which management has the intent and ability to hold to maturity, are reported at amortized cost.  Premiums and discounts are amortized on the level-yield method.  Anticipated prepayments are considered when amortizing premiums and discounts on mortgage backed securities.  Gains and losses on the sale of available-for-sale debt securities are determined using the specific-identification method.  Equity investments are measured at fair value with changes in fair value recognized in net income.

Other-Than-Temporary Impairment – Management evaluates debt securities for OTTI at least on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation.  Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer including an evaluation of credit ratings, (3) whether the market decline was affected by macroeconomic conditions, (4) the intent of Old National to sell a debt security, and (5) whether it is more likely than not Old National will have to sell the debt security before recovery of its cost basis.  If Old National intends to sell an impaired debt security, Old National records an other-than-temporary loss in an amount equal to the entire difference between fair value and amortized cost.  If a debt security is determined to be other-than-temporarily impaired, but Old National does not intend to sell the debt security and it is not more likely than not that it will be required to sell the debt security, only the credit portion of the estimated loss is recognized in earnings, with the other portion of the loss recognized in other comprehensive income. See Note 3 to the consolidated financial statements for a detailed description of the quarterly evaluation process.

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Federal Home Loan Bank Stock

Old National is a member of the FHLB system.  Members are required to own a certain amount of stock based on the level of borrowings and other factors and may invest in additional amounts.  FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value.  Both cash and stock dividends are reported as income.

Loans Held for Sale

Loans that Old National has originated with an intent to sell are classified as loans held for sale and are recorded in accordance with FASB ASC 825-10 at fair value, determined individually, as of the balance sheet date.  The loan’s fair value includes the servicing value of the loans as well as any accrued interest.

Loans

Loans that Old National intends to hold for investment purposes are classified as portfolio loans.  Portfolio loans are carried at the principal balance outstanding, net of earned interest, purchase premiums or discounts, deferred loan fees and costs, and an allowance for loan losses.  Interest income is accrued on the principal balances of loans outstanding.  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.

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.

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.

For all loan classes, 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.

Acquired loans accounted for under ASC Topic 310-30 accrue interest, even though they may be contractually past due, as any nonpayment of contractual principal or interest is considered in the periodic re-estimation of expected cash flows and is included in the resulting recognition of current period loan loss provision or prospective yield adjustments.

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Old National 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 all portfolio segments, the general component covers non-impaired loans and is based on historical loss experience adjusted for current factors.  This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment.  These economic factors include consideration of the following:  levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.

Further information regarding Old National’s policies and methodology used to estimate the allowance for loan losses is presented in Note 5.

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation.  Land is stated at cost.  Depreciation is charged to operating expense over the useful lives of the assets, principally on the straight-line method.  Useful lives for premises and equipment are as follows: buildings and building improvements – 15 to 39 years; and furniture and equipment – 3 to 7 years.  Leasehold improvements are depreciated over the lesser of their useful lives or the term of the lease.  Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized.  Interest costs on construction of qualifying assets are capitalized.

Premises and equipment are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows.  If impaired, the assets are adjusted to fair value.  Such impairments are included in other expense.

Goodwill and Other Intangible Assets

The excess of the cost of acquired entities over the fair value of identifiable assets acquired less liabilities assumed is recorded as goodwill.  In accordance with FASB ASC 350, Intangibles – Goodwill and Other, amortization of goodwill and indefinite-lived assets is not recorded.  However, the recoverability of goodwill and other intangible assets are annually tested for impairment.  Other intangible assets, including core deposits and customer business relationships, are amortized primarily on an accelerated basis over their estimated useful lives, generally over a period of 5 to 15 years.

Company-Owned Life Insurance

Old National has purchased, as well as obtained through acquisitions, life insurance policies on certain key executives.  Old National records company-owned life insurance at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

Loan Servicing Rights

When loans are sold with servicing retained, servicing rights are initially recorded at fair value with the income statement effect recorded in gain on sales of loans.  Fair value is based on market prices for comparable servicing contracts, when available or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income.  All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans.

Loan servicing rights are evaluated for impairment based upon the fair value of the rights as compared to carrying amount.  Impairment is determined by stratifying rights into groupings based on predominant risk characteristics, such as interest rate, loan type, term, and investor type.  Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair value is less than the carrying amount.  If Old National later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance may be recorded as an increase to income.  Changes in valuation allowances are reported with mortgage banking revenue on the income statement.  The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.

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Servicing fee income, which is reported on the income statement as mortgage banking revenue, is recorded for fees earned for servicing loans.  The fees are based on a contractual percentage of the outstanding principal, or a fixed amount per loan and are recorded as income when earned.

Derivative Financial Instruments

As part of Old National’s overall interest rate risk management, Old National uses derivative instruments, including TBA forward agreements and interest rate swaps, collars, caps, and floors.  All derivative instruments are recognized on the balance sheet at their fair value in accordance with ASC 815, as amended. At the inception of the derivative contract, Old National will designate the derivative as (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), or (3) an instrument with no hedging designation (“stand-alone derivative”).  For derivatives that are designated and qualify as a fair value hedge, the change in value of the derivative, as well as the offsetting change in value of the hedged item attributable to the hedged risk, are recognized in current earnings during the period of the change in fair values.  For derivatives that are designated and qualify as a cash flow hedge, the effective portion of the change in value on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings.  For all hedging relationships, changes in fair value of derivatives that are not effective in hedging the changes in fair value or expected cash flows of the hedged item are recognized immediately in current earnings during the period of the change.  Similarly, the changes in the fair value of derivatives that do not qualify for hedge accounting under ASC Topic 815 are also reported currently in earnings, in noninterest income.

The accrued net settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, consistent with the item being hedged.

Old National formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions.  This process includes linking all derivative instruments that are designated as fair-value or cash-flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions.  Old National also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items.  Old National discontinues hedge accounting prospectively when it is determined that (1) the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item; (2) the derivative expires, is sold, or terminated; (3) the derivative instrument is de-designated as a hedge because  the forecasted transaction is no longer probable of occurring; (4) a hedged firm commitment no longer meets the definition of a firm commitment; (5) or management otherwise determines that designation of the derivative as a hedging instrument is no longer appropriate.

When hedge accounting is discontinued, the future changes in fair value of the derivative are recorded as noninterest income.  When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability.  When a cash flow hedge is discontinued but the hedged cash flows or forecasted transaction is still expected to occur, changes in value that were accumulated in other comprehensive income are amortized or accreted into earnings over the same periods which the hedged transactions will affect earnings.

Old National enters into various stand-alone mortgage-banking derivatives in order to hedge the risk associated with the fluctuation of interest rates.  Changes in fair value are recorded as mortgage banking revenue.  Old National also enters into various stand-alone derivative contracts to provide derivative products to customers which are carried at fair value with changes in fair value recorded as other noninterest income.

Old National is exposed to losses if a counterparty fails to make its payments under a contract in which Old National is in the net receiving position.  Old National anticipates that the counterparties will be able to fully satisfy their obligations under the agreements.  In addition, Old National obtains collateral above certain thresholds of the fair value of its hedges for each counterparty based upon their credit standing.  All of the contracts to which Old National is a party settle monthly, quarterly, or semiannually.  Further, Old National has netting agreements with the dealers with which it does business.

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Credit-Related Financial Instruments

In the ordinary course of business, Old National’s affiliate bank has entered into credit-related financial instruments consisting of commitments to extend credit, commercial letters of credit, and standby letters of credit.  The notional amount of these commitments is not reflected in the consolidated financial statements until they are funded.

Repossessed Collateral

Other real estate owned and repossessed personal property are initially recorded at the fair value of the property less estimated cost to sell.  Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of foreclosure or when the borrower conveys all interest in the property to satisfy the loan through the completion of a deed in lieu of foreclosure or through a similar legal agreement  Any excess recorded investment over the fair value of the property received is charged to the allowance for loan losses.  Any subsequent write-downs are recorded in noninterest expense, as are the costs of operating the properties.  Gains or losses resulting from the sale of collateral are recognized in noninterest expense at the date of sale.

Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to Repurchase

We purchase certain securities, generally U.S. government-sponsored entity and agency securities, under agreements to resell.  The amounts advanced under these agreements represent short-term secured loans and are reflected as assets in the accompanying consolidated balance sheets.  We also sell certain securities under agreements to repurchase.  These agreements are treated as collateralized financing transactions.  These secured borrowings are reflected as liabilities in the accompanying consolidated balance sheets and are recorded at the amount of cash received in connection with the transaction.  Short-term securities sold under agreements to repurchase generally mature within one to four days from the transaction date.  Securities, generally U.S. government and federal agency securities, pledged as collateral under these financing arrangements can be repledged by the secured party.  Additional collateral may be required based on the fair value of the underlying securities.

Net Income per Share

Basic and diluted net income per share are calculated using the two-class method.  Net income is divided by the weighted-average number of common shares outstanding during the period.  Adjustments to the weighted average number of common shares outstanding are made only when such adjustments will dilute net income per common share.  Net income is then divided by the weighted-average number of common shares and common share equivalents during the period.

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The following table reconciles basic and diluted net income per share for the years ended December 31.

(dollars and shares in thousands,	Years Ended December 31,
except per share data)	2018		2017		2016
Basic Net Income Per Share
Net income	$	190,830	$	95,725	$	134,264
Weighted average common shares outstanding		155,675		137,821		127,705
Basic Net Income Per Share	$	1.23	$	0.69	$	1.05
Diluted Net Income Per Share
Net income	$	190,830	$	95,725	$	134,264
Weighted average common shares outstanding		155,675		137,821		127,705
Effect of dilutive securities:
Restricted stock		796		599		543
Stock options (1)		68		93		53
Weighted average shares outstanding		156,539		138,513		128,301
Diluted Earnings Per Share	$	1.22	$	0.69	$	1.05

(1) Options to purchase 14 thousand shares, 0.1 million shares, and 0.5 million shares outstanding at December 31, 2018, 2017, and 2016, respectively, were not included in the computation of net income per diluted share because the exercise price of these options was greater than the average market price of the common shares and, therefore, the effect would be antidilutive.

Share-Based Compensation

Compensation cost is recognized for stock options and restricted stock awards and units issued to employees based on the fair value of these awards at the date of grant.  A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of our Common Stock at the date of grant is used for restricted stock awards. A third party provider is used to value certain restricted stock units where the performance measure is based on total shareholder return.  Compensation expense is recognized over the requisite service period.  Forfeitures are recognized as they occur.

Income Taxes

Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities.  Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates.  A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

We recognize a tax position as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur.  The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination.  For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

We recognize interest and/or penalties related to income tax matters in income tax expense.

Old National is a limited partner in several tax-advantaged limited partnerships whose purpose is to invest in approved qualified affordable housing, renewable energy, or other renovation or community revitalization projects. These investments are included in other assets on the balance sheet, with any unfunded commitments included with other liabilities.  Certain of these assets qualify for the proportional amortization method and are amortized over the period that Old National expects to receive the tax credits, with the expense included within income tax expense on the consolidated statements of income.  The other investments are accounted for under the equity method, with the expense included within pre-tax income on the consolidated statements of income.  All of our tax credit investments are evaluated for impairment at the end of each reporting period.

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Loss Contingencies

Loss contingencies, including claims and legal actions arising in the normal course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.  See Note 22 to the consolidated financial statements for further disclosure.

Cash Equivalents and Cash Flows

For the purpose of presentation in the accompanying consolidated statement of cash flows, cash and cash equivalents are defined as cash, due from banks, federal funds sold and resell agreements, and money market investments, which have maturities less than 90 days.  Cash flows from loans, either originated or acquired, are classified at that time according to management’s intent to either sell or hold the loan for the foreseeable future. When management’s intent is to sell the loan, the cash flows of that loan are presented as operating cash flows. When management’s intent is to hold the loan for the foreseeable future, the cash flows of that loan are presented as investing cash flows.

The following table summarizes the supplemental cash flow information for the years ended December 31:

	Years Ended December 31,
(dollars in thousands)	2018			2017		2016
Cash payments:
Interest	$	91,813		$	56,682	$	43,698
Income taxes (net of refunds)		(2,505	)		4,326		23,636
Noncash Investing and Financing Activities:
Securities transferred from held-to-maturity to available-for-sale		447,026			—		—
Securities transferred from available-for-sale to held-to-maturity		323,990			—		—
Transfer of premises and equipment to assets held for sale		9,634			16,617		4,620

The following table summarizes the common shares issued and resultant value of total shareholders’ equity associated with acquisitions for the years ended December 31:

			Total
	Shares of		Shareholders'
(dollars and shares in thousands)	Common Stock		Equity
2018
Acquisition of Klein		22,772	$	406,474
2017
Acquisition of Anchor (MN)		16,527	$	300,828
2016
Acquisition of Anchor (WI)		20,415	$	273,565

Business Combinations

Old National accounts for business combinations using the acquisition method of accounting.  The accounts of an acquired entity are included as of the date of acquisition, and any excess of purchase price over the fair value of the net assets acquired is capitalized as goodwill.  Old National typically issues common stock and/or pays cash for an acquisition, depending on the terms of the acquisition agreement.  The value of common shares issued is determined based on the market price of the stock as of the closing of the acquisition.

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Impact of Accounting Changes

Accounting Guidance Adopted in 2018

FASB ASC 606 – On January 1, 2018, Old National adopted ASU 2014-09, Revenue from Contracts with Customers and all subsequent amendments to the ASU (collectively, “Topic 606”), which creates a single framework for recognizing revenue from contracts with customers that fall within its scope.  A significant majority of Old National’s revenues come from interest income and other sources, including loans, leases, securities and derivatives, that are not subject to Topic 606.  Services within the scope of Topic 606 include wealth management fees, service charges on deposit accounts, debit card and ATM fees, and investment product fees, all of which are presented within noninterest income.  Old National enters into various contracts with customers to provide these traditional banking services on a routine basis.  Old National’s performance obligations are generally service-related and provided on a daily, monthly, or quarterly basis.  The performance obligations are generally satisfied as services are rendered and the fees are collected at such time, or shortly thereafter.  It is not typical for contracts to require significant judgment to determine the transaction price.  See Note 24 for additional information.

Old National adopted Topic 606 using the modified retrospective method applied to all contracts not completed as of January 1, 2018.  Results for reporting periods beginning after adoption are presented under Topic 606.  As allowed under the update, results for prior periods continue to be reported under the accounting standards in effect for those periods.  The adoption of this update did not have a material impact on the measurement, timing, or recognition of revenue.  Accordingly, no cumulative effect adjustment to opening retained earnings was deemed necessary.

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

In February 2018, the FASB issued an update (ASU No. 2018-03, Technical Corrections and Improvements to Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities).  The amendments in this update clarified the guidance in ASU No. 2016-01 specifically for equity securities without a readily determinable fair value and financial liabilities for which the fair value option is elected.  The amendments in this update became effective for annual periods beginning after December 15, 2017 and interim periods within those fiscal years beginning after June 15, 2018 and did not have a material impact on the consolidated financial statements.

FASB ASC 740 – In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory.  Current guidance prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party.  This prohibition on recognition is an exception to the principle of comprehensive recognition of current and deferred income taxes in generally accepted accounting principles.  The exception has led to diversity in practice and is a source of complexity in financial reporting.  FASB decided that an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs.  Consequently, the amendments in this

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update eliminate the exception for an intra-entity transfer of an asset other than inventory.  The amendments in this update do not include new disclosure requirements; however, existing disclosure requirements might be applicable when accounting for the current and deferred income taxes for an intra-entity transfer of an asset other than inventory.  The amendments in this update became effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within those annual reporting periods.  The amendments in this update were applied on a modified retrospective basis through a cumulative-effect reduction of $1.0 million directly to retained earnings as of the beginning of 2018.

FASB ASC 805 – In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business.  The amendments in this update provide a more robust framework to use in determining when a set of assets and activities is a business.  Because the current definition of a business is interpreted broadly and can be difficult to apply, stakeholders indicated that analyzing transactions is inefficient and costly and that the definition does not permit the use of reasonable judgment.  The amendments provide more consistency in applying the guidance, reduce the costs of application, and make the definition of a business more operable.  The amendments in this update became effective for annual periods and interim periods within those annual periods beginning after December 15, 2017.  Old National has completed its evaluation of adopting the new guidance on the consolidated financial statements and there is no impact.

FASB ASC 610 – In February 2017, the FASB issued ASU No. 2017-05, Other Income – Gains and Losses from the Derecognition of Nonfinancial Assets (Topic 610): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets.  Subtopic 610-20 was originally issued as part of ASU No. 2014-09 to provide guidance for recognizing gains and losses from the transfer of nonfinancial assets in contracts with noncustomers.  This update was issued to help clarify uncertainties and complexities of ASU 2014-09.  The amendments in this update define the term in substance nonfinancial asset, in part, as a financial asset promised to a counterparty in a contract if substantially all of its fair value of the assets (recognized and unrecognized) that are promised to the counterparty in the contract is concentrated in nonfinancial assets.  If substantially all of the fair value of the assets that are promised to the counterparty in a contract is concentrated in nonfinancial assets, then all of the financial assets promised to the counterparty are in substance nonfinancial assets.  The amendments in this update also clarify that nonfinancial assets within the scope of Subtopic 610-20 may include nonfinancial assets transferred within a legal entity to a counterparty.  The amendments in this update require an entity to derecognize a distinct nonfinancial asset or distinct in substance nonfinancial asset in a partial sale transaction when it (1) does not have (or ceases to have) a controlling financial interest in the legal entity that holds the asset in accordance with Topic 810 and (2) transfers control of the asset in accordance with Topic 606.  Once an entity transfers control of a distinct nonfinancial asset or distinct in substance nonfinancial asset, it is required to measure any noncontrolling interest it receives (or retains) at fair value.  The amendments were effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period and did not have a material impact on the consolidated financial statements.

FASB ASC 715 – In March 2017, the FASB issued ASU No. 2017-07, Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.  The amendments in this update require that an employer disaggregate the service cost component from the other components of net benefit cost.  The amendments also provide explicit guidance on how to present the service cost component and the other components of net benefit cost in the income statement and allow only the service cost component of net benefit cost to be eligible for capitalization.  The amendments in this update improve the consistency, transparency, and usefulness of financial information to users that have communicated that the service cost component generally is analyzed differently from the other components of net benefit cost.  The amendments in this update became effective for annual periods and interim periods within those annual periods beginning after December 15, 2017 and did not have a material impact on the consolidated financial statements.

FASB ASC 718 – In May 2017, the FASB issued ASU No. 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting.  The amendments in this update provide guidance about which changes to the terms and conditions of a share-based payment award require an entity to apply modification accounting.  An entity should account for the effect of a modification unless all the following are met: (1) the fair value of the modified award is the same as the fair value of the original award immediately before the original award is modified – if the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate the value immediately before and after the modification; (2) the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the

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original award is modified; (3) the classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified.  The amendments in this update became effective for annual periods and interim periods within those annual periods beginning after December 15, 2017 and did not have a material impact on the consolidated financial statements.

FASB ASC 815 – In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.  The amendments in the update make certain targeted improvements to simplify the application of the hedge accounting guidance in GAAP.  The amendments in this update better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results.  To meet that objective, the amendments expand and refine hedge accounting for both nonfinancial and financial risk components and align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements.  This update addresses several limitations that GAAP placed on the risk components, how an entity can designate the hedged item in a fair value hedge of interest rate risk, and how an entity can measure changes in fair value of the hedged item attributable to interest rate risk.  In addition to the amendments to the designation and measurement guidance for qualifying hedging relationships, the amendments in this update also align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements to increase the understandability of the results of an entity’s intended hedging strategies.  The amendments in this update require an entity to present the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported.  Prior to the issuance of this update, GAAP provided special hedge accounting only for the portion of the hedge deemed to be “highly effective” and required an entity to separately reflect the amount by which the hedging instrument did not offset the hedged item, which is referred to as the “ineffective” amount.  However, the concept and reporting of hedge ineffectiveness were difficult for financial statement users to understand and, at times, for preparers to explain.  The FASB decided on an approach that no longer separately measures and reports hedge ineffectiveness.  This update also includes certain targeted improvements to ease the application of current guidance related to the assessment of hedge effectiveness.  Prior to the issuance of this update, GAAP contained specific requirements for initial and ongoing quantitative hedge effectiveness testing and strict requirements for specialized effectiveness testing methods that allowed an entity to forgo quantitative hedge effectiveness assessments for qualifying relationships.  The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2018.  Early adoption is permitted in any interim period.  Management elected to early adopt this update effective January 1, 2018 using the modified retrospective method.  The impact of the adoption resulted in a reduction to Old National’s opening retained earnings of $3.2 million.  In addition, as permitted by the amendments in the update, Old National reclassified $447.0 million in state and political subdivision securities with unrealized holding gains of $26.1 million from the held-to-maturity portfolio to the available-for-sale portfolio.

FASB ASC 220 – In February 2018, the FASB issued ASU No. 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.  The amendments in this ASU help organizations address certain stranded income tax effects in AOCI resulting from the Tax Cuts and Jobs Act.  The ASU provides financial statement preparers with an option to reclassify stranded tax effects within AOCI to retained earnings in each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act (or portion thereof) is recorded.  The amendments are effective for all organizations for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years.  Early adoption is permitted.  Management has elected to early adopt this update effective January 1, 2018, which resulted in a reclassification that decreased beginning accumulated other comprehensive income and increased beginning retained earnings by $10.8 million.

Accounting Guidance Issued But Not Yet Adopted in 2018

FASB ASC 842 – In February 2016, the FASB issued its new lease accounting guidance in ASU No. 2016-02, Leases (Topic 842).  Under the new guidance, lessees will be required to recognize the following for all leases, with the exception of short-term leases, at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.  Under the new guidance, lessor accounting is largely unchanged.

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In July 2018, the FASB issued ASU No. 2018-10, Codification Improvements to Topic 842, Leases and ASU No. 2018-11, Leases (Topic 842): Targeted Improvements.  ASU No. 2018-10 provides improvements related to ASU No. 2016-02 to increase stakeholders’ awareness of the amendments and to expedite the improvements.  The amendments affect narrow aspects of the guidance issued in ASU No. 2016-02.  ASU No. 2018-11 allows entities adopting ASU No. 2016-02 to choose an additional (and optional) transition method, under which an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption.  ASU No. 2018-11 also allows lessors to not separate non-lease components from the associated lease component if certain conditions are met.  The amendments in these updates become effective for annual periods and interim periods within those annual periods beginning after December 15, 2018.

Old National elected the optional transition method permitted by ASU No. 2018-11.  Under this method, an entity shall recognize and measure leases that exist at the application date and prior comparative periods are not adjusted.  In addition, Old National elected the package of practical expedients to leases that commenced before the effective date:

1. An entity need not reassess whether any expired or existing contracts contain leases.

2. An entity need not reassess the lease classification for any expired or existing leases.

3. An entity need not reassess initial direct costs for any existing leases.

Old National also elected the practical expedient, which must be applied consistently to all leases, to use hindsight in determining the lease term and in assessing impairment of our right-of-use assets.  We also elected a practical expedient to not assess whether existing or expired land easements that were not previously accounted for as leases under Topic 840 contain a lease under this Topic.  Both of these practical expedients may be elected separately or in conjunction with each other or the package noted above.

Based on leases outstanding at December 31, 2018, the impact of adoption on January 1, 2019 was recording a lease liability of approximately $123 million, a right-of-use asset of approximately $119 million, and a cumulative-effect adjustment to retained earnings of approximately $6 million.

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

As previously disclosed, Old National formed a cross functional committee to oversee the adoption of the ASU at the effective date.  A working group was also formed and has developed a project plan focused on understanding the ASU, researching issues, identifying data needs for modeling inputs, technology requirements, modeling considerations, and ensuring overarching governance has been achieved for each objective and milestone.  The project plan is targeting data and model validation completion during the first half of 2019, with parallel processing of our existing allowance for loan losses model with the CECL for 2 – 3 quarters prior to implementation, depending on how model completion and validation occurs.  Currently, the working group has identified seven distinct loan portfolios for which a model has been or is in the process of being developed. For five of the seven loan portfolios, the data sets have been identified, populated, and internally validated.  During 2019, Old National is focused on the completion of its remaining models, refining assumptions, and continued review and challenge of its models.  Concurrent with this, Old National is also focused on researching and resolving interpretive accounting issues in the ASU, contemplating various related accounting policies, developing processes and related controls, and considering various reporting disclosures.

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As of the beginning of the first reporting period in which the new standard is effective, Old National expects to recognize a one-time cumulative effect adjustment increasing the allowance for loan losses, since the ASU covers credit losses over the expected life of a loan as well as considering future changes in macroeconomic conditions.  The magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements cannot yet be reasonably estimated , however, we expect to identify a range in our Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2019.

In December 2018, the OCC, the Board of Governors of the Federal Reserve System, and the FDIC approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL.  The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard.

FASB ASC 350 – In January 2017, the FASB issued ASU No. 2017-04, Intangibles: Goodwill and Other: Simplifying the Test for Goodwill Impairment.  To simplify the subsequent measurement of goodwill, the amendments eliminate Step 2 from the goodwill impairment test.  The annual, or interim, goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount.  An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.  In addition, the income tax effects of tax deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss, if applicable.  The amendments also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform Step 2 of the goodwill impairment test.  An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the qualitative impairment test is necessary.  The amendments should be applied on a prospective basis.  The nature of and reason for the change in accounting principle should be disclosed upon transition.  The amendments in this update should be adopted for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019.  Early adoption is permitted on testing dates after January 1, 2017.  Old National is currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

FASB ASC 310 – In March 2017, the FASB issued ASU No. 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities.  This update amends the amortization period for certain purchased callable debt securities held at a premium.  FASB is shortening the amortization period for the premium to the earliest call date.  Under current GAAP, entities generally amortize the premium as an adjustment of yield over the contractual life of the instrument.  Concerns were raised that current GAAP excludes certain callable debt securities from consideration of early repayment of principal even if the holder is certain that the call will be exercised.  As a result, upon the exercise of a call on a callable debt security held at a premium, the unamortized premium is recorded as a loss in earnings.  There is diversity in practice (1) in the amortization period for premiums of callable debt securities and (2) in how the potential for exercise of a call is factored into current impairment assessments.  The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2018.  Old National completed the evaluation of adopting the new guidance on the consolidated financial statements and the impact was immaterial.

FASB ASC 718 – In June 2018, the FASB issued ASU No. 2018-07, Compensation – Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.  The amendments in this update expand the scope of Topic 718, Compensation—Stock Compensation (which currently only includes share-based payments to employees) to include share-based payments issued to nonemployees for goods or services.  Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned.  The ASU supersedes Subtopic 505-50, Equity—Equity-Based Payments to Non-Employees.  The amendments in this update become effective for annual periods beginning after December 15, 2018, including interim periods within that fiscal year and will not have a material impact on the consolidated financial statements.

FASB ASC 958 – In June 2018, the FASB issued ASU No. 2018-08, Not-for-Profit Entities (Topic 958): Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made.  The amendments in this update clarify and improve the scope and accounting guidance around contributions of cash and other assets received and made by not-for-profit organizations and business enterprises.  The ASU clarifies and improves current guidance about whether a transfer of assets, or the reduction, settlement, or cancellation of liabilities, is a contribution or an exchange transaction.  It provides criteria for determining whether the resource provider is receiving commensurate value in return for the resources transferred which, depending on the outcome, determines

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whether the organization follows contribution guidance or exchange transaction guidance in the revenue recognition and other applicable standards.  It also provides a more robust framework for determining whether a contribution is conditional or unconditional, and for distinguishing a donor-imposed condition from a donor-imposed restriction.  This is important because such classification affects the timing of contribution revenue and expense recognition.  The new ASU does not apply to transfers of assets from governments to businesses.  The amendments in this update become effective for a public business entity for transactions in which the entity serves as a resource recipient to annual periods beginning after June 15, 2018, including interim periods within those annual periods. The amendments in this update become effective for a public business entity for transactions in which the entity serves as a resource provider to annual periods beginning after December 15, 2018, including interim periods within those annual periods.  Early adoption is permitted.  Old National completed the evaluation of adopting the new guidance on the consolidated financial statements and there is no impact.

In July 2018, the FASB issued an update (ASU No. 2018-09, Codification Improvements).  The amendments in this update affect a wide variety of topics in the Codification and are intended to clarify the Codification or correct the unintended application of guidance that is not expected to have a significant effect on current accounting practice.  The transition and effective date guidance is based on the facts and circumstances of each amendment.  Old National completed the evaluation of adopting the new guidance on the consolidated financial statements and there is no impact.

FASB ASC 820 – In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement.  The updated guidance improves the disclosure requirements on fair value measurements.  The ASU removes certain disclosures required by Topic 820 related to transfers between Level 1 and Level 2 of the fair value hierarchy; the policy for timing of transfers between levels; the valuation processes for Level 3 fair value measurements; and for nonpublic entities, the changes in unrealized gains and losses for the period included in earnings for recurring Level 3 fair value measurements held at the end of the reporting period.  The ASU modifies certain disclosures required by Topic 820 related to disclosure of transfers into and out of Level 3 of the fair value hierarchy and purchases and issues of Level 3 assets and liabilities for nonpublic entities; the requirement to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly for investments in certain entities that calculate net asset value; and clarification that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date.  The ASU adds certain disclosure requirements related to changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements.  For certain unobservable inputs, an entity may disclose other quantitative information in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements.  The amendments in this update become effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2019.  Early adoption is permitted.  Old National is currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

FASB ASC 715 – In August 2018, the FASB issued ASU No. 2018-14, Compensation – Retirement Benefits – Defined Benefit Plans – General (Subtopic 715-20): Disclosure Framework – Changes to the Disclosure Requirements for Defined Benefit Plans.  The amendments in this update modify the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans.  The amendments in this update become effective for fiscal years ending after December 15, 2020 and will not have a material impact on the consolidated financial statements.

FASB ASC 350 – In August 2018, the FASB issued ASU No. 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract.  The amendments in this update align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software.  The amendments in this update become effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years.  Early adoption is permitted.  Old National is currently evaluating the impact of adopting the new guidance on the consolidated financial statements.

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FASB ASC 815 – In October 2018, the FASB issued ASU No. 2018-16, Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting.  In the United States, eligible benchmark interest rates under Topic 815 are interest rates on direct Treasury obligations of the U.S. government (“UST”), the London Interbank Offered Rate (“LIBOR”) swap rate, and the Overnight Index Swap (“OIS”) Rate based on the Fed Funds Effective Rate. When the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, in August 2017, it introduced the Securities Industry and Financial Markets Association (“SIFMA”) Municipal Swap Rate as the fourth permissible U.S. benchmark rate.

The new ASU adds the OIS rate based on SOFR as a U.S. benchmark interest rate to facilitate the LIBOR to SOFR transition and provide sufficient lead time for entities to prepare for changes to interest rate risk hedging strategies for both risk management and hedge accounting purposes.  The amendments in this update become effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years.  Old National is currently evaluating the impact of adopting the new guidance on the consolidated financial statements and the financial statement impact immediately upon adoption is immaterial.  The future financial statement impact will depend on any new contracts entered into using new benchmark rates, as well as any existing contracts that get migrated from LIBOR to new benchmark interest rates.  The Company has formed a working group who is developing a transition plan for all exposed contracts migrating from LIBOR to SOFR.  Additionally, the working group is monitoring industry specific transition guidance around a LIBOR contract’s “fallback” language with the industry goal to minimize or eliminate value transfers resulting from the transition.

NOTE 2 – ACQUISITION AND DIVESTITURE ACTIVITY

Acquisitions

Anchor Bancorp, Inc.

Effective November 1, 2017, Old National completed the acquisition of St. Paul, Minnesota-based Anchor (MN) through a stock and cash merger. Anchor (MN) was a bank holding company with Anchor Bank (MN) as its wholly-owned subsidiary.  Founded in 1967 and with 17 total branches, Anchor Bank (MN) was one of the largest community banks headquartered in the Twin Cities, and also served Mankato, Minnesota.  Anchor Bank (MN) has no affiliation with the former AnchorBank (WI) in Madison, Wisconsin, which Old National acquired in 2016.  Old National achieved cost savings by integrating the two companies and combining accounting, data processing, retail and lending support, and other administrative functions, which enabled Old National to achieve economies of scale in these areas.

Pursuant to the merger agreement, each holder of Anchor (MN) common stock received $2.625 in cash and 1.350 shares of Old National Common Stock per share of Anchor (MN) common stock such holder owned.  The total fair value of consideration for Anchor (MN) was $332.8 million, consisting of $31.9 million of cash and the issuance of 16.5 million shares of Old National Common Stock valued at $300.8 million.  Through December 31, 2018, transaction and integration costs of $19.2 million associated with this acquisition have been expensed and remaining integration costs will be expensed in future periods as incurred.  We do not anticipate additional expenses related to this acquisition.

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As of June 30, 2018, Old National finalized its valuation of all assets acquired and liabilities assumed, resulting in immaterial changes to acquisition accounting adjustments.  A summary of the fair values of the acquired assets, liabilities assumed, and resulting goodwill follows (in thousands):

Cash and cash equivalents	$	34,501
Investment securities		302,195
FHLB/Federal Reserve Bank stock		6,585
Loans held for sale		1,407
Loans		1,593,991
Premises and equipment		33,433
Accrued interest receivable		5,872
Other real estate owned		1,058
Company-owned life insurance		44,490
Other assets		30,036
Deposits		(1,777,588	)
Federal funds purchased and interbank borrowings		(45,600	)
Securities sold under agreements to repurchase		(22,965	)
Other borrowings		(49,257	)
Accrued expenses and other liabilities		(25,784	)
Net tangible assets acquired		132,374
Definite-lived intangible assets acquired		26,606
Goodwill		173,785
Total consideration	$	332,765

Goodwill related to this acquisition will not be deductible for tax purposes.

The estimated fair value of the core deposit intangible was $26.6 million and is being amortized over an estimated useful life of 10 years.

Acquired loan data for Anchor (MN) can be found in the table below:

(in thousands)	Fair Value of Acquired Loans at Acquisition Date		Gross Contractual Amounts Receivable at Acquisition Date		Best Estimate at Acquisition Date of Contractual Cash Flows Not Expected to be Collected
Acquired receivables subject    to ASC 310-30	$	10,555	$	16,898	$	4,787
Acquired receivables not subject    to ASC 310-30	$	1,583,436	$	1,879,449	$	87,767

Klein Financial, Inc.

Effective November 1, 2018, Old National completed the acquisition of Minnesota-based Klein through a 100% stock merger.  Klein was a bank holding company with KleinBank as its wholly-owned subsidiary.  Founded in 1907 and headquartered in Chaska, Minnesota with 18 full-service branches, KleinBank was the largest family-owned community bank serving the Twin Cities and its western communities.  Old National believes that it will be able to achieve cost savings by integrating the two companies and combining accounting, data processing, retail and lending support, and other administrative functions, which will enable Old National to achieve economies of scale in these areas.

Pursuant to the merger agreement, each holder of Klein common stock received 7.92 shares of Old National Common Stock per share of Klein common stock such holder owned.  The total fair value of consideration for Klein was $406.5 million, consisting of 22.8 million shares of Old National Common Stock valued at $406.5 million.  Through December 31, 2018, transaction and integration costs of $14.3 million associated with this acquisition have been expensed and remaining integration costs will be expensed in future periods as incurred.

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The following table reflects management’s preliminary valuation of the assets acquired and liabilities assumed (in thousands):

Cash and cash equivalents	$	60,759
Investment securities		697,951
FHLB/Federal Reserve Bank stock		2,637
Loans held for sale		3,371
Loans		1,049,073
Premises and equipment		33,391
Accrued interest receivable		7,896
Company-owned life insurance		36,380
Net deferred tax assets		6,500
Other real estate owned		954
Other assets		10,299
Deposits		(1,713,086	)
Securities sold under agreements to repurchase		(19,481	)
Accrued expenses and other liabilities		(17,506	)
Net tangible assets acquired		159,138
Definite-lived intangible assets acquired		39,017
Loan servicing rights		285
Goodwill		208,034
Total consideration	$	406,474

Old National is in the process of finalizing Klein’s 2018 short-period tax return; thus, provisional measurements of goodwill, deferred income tax assets, and contingent consideration are subject to change during the measurement period.  In addition, certain loan, intangible assets, and premises and equipment measurements have not been finalized and are subject to change.  As Old National receives the information related to facts and circumstances that existed as of the acquisition date, we will finalize the provisional measurements recorded as of December 31, 2018.  Such adjustments will be included in the allocation in the reporting period in which the final amounts are determined, not to exceed one year from the acquisition date.

Goodwill related to this acquisition will not be deductible for tax purposes.

The estimated fair value of the core deposit intangible was $39.0 million and is being amortized over an estimated useful life of 12 years.

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

(in thousands)	Fair Value of Acquired Loans at Acquisition Date		Gross Contractual Amounts Receivable at Acquisition Date		Best Estimate at Acquisition Date of Contractual Cash Flows Not Expected to be Collected
Acquired receivables subject    to ASC 310-30	$	11,663	$	18,568	$	4,521
Acquired receivables not subject    to ASC 310-30	$	1,037,410	$	1,252,954	$	76,534

Summary of Unaudited Pro-Forma Information

The unaudited pro-forma information below for 2018 and 2017 gives effect to the Klein acquisition as if it had occurred on January 1, 2017.  The pro-forma financial information is not necessarily indicative of the results of operations if the acquisition had been effective as of this date.

(dollars in thousands)	2018		2017
Revenue (1)	$	819,777	$	708,422
Income before income taxes	$	273,125	$	183,494

(1) Net interest income plus noninterest income.

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Supplemental pro-forma earnings for 2018 were adjusted to exclude $14.3 million of acquisition-related costs incurred during 2018.  Supplemental pro-forma earnings for 2017 were adjusted to include these charges.

Divestitures

On October 26, 2018, Old National divested ten branches in Wisconsin to Marine Credit Union of La Crosse, Wisconsin.  At closing, the purchasers assumed $230.6 million in deposits and no loans. Old National recorded a net pre-tax gain of $14.0 million in the fourth quarter of 2018, which included a deposit premium of $15.0 million, goodwill allocation of $0.6 million, and $0.4 million of other transaction expenses.

Based on an ongoing assessment of our service and delivery network, Old National consolidated 5 branches during 2016, 29 in 2017, and an additional 10 branches in 2018.

NOTE 3 – INVESTMENT SECURITIES

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

	Amortized		Unrealized		Unrealized			Fair
(dollars in thousands)	Cost		Gains		Losses			Value
December 31, 2018
Available-for-Sale
U.S. Treasury	$	5,332	$	—	$	(31	)	$	5,301
U.S. government-sponsored entities and agencies		639,458		35		(11,342	)		628,151
Mortgage-backed securities - Agency		2,243,774		9,738		(44,217	)		2,209,295
States and political subdivisions		932,757		11,113		(3,441	)		940,429
Pooled trust preferred securities		13,861		—		(5,366	)		8,495
Other securities		337,435		486		(6,176	)		331,745
Total available-for-sale securities	$	4,172,617	$	21,372	$	(70,573	)	$	4,123,416
Held-to-Maturity
U.S. government-sponsored entities and agencies	$	73,986	$	—	$	(1,627	)	$	72,359
Mortgage-backed securities - Agency		127,120		39		(2,750	)		124,409
States and political subdivisions		305,228		6,208		(2,101	)		309,335
Total held-to-maturity securities	$	506,334	$	6,247	$	(6,478	)	$	506,103
December 31, 2017
Available-for-Sale
U.S. Treasury	$	5,473	$	83	$	(5	)	$	5,551
U.S. government-sponsored entities and agencies		675,643		3		(11,360	)		664,286
Mortgage-backed securities - Agency		1,704,014		1,600		(37,932	)		1,667,682
States and political subdivisions		529,835		5,085		(4,727	)		530,193
Pooled trust preferred securities		16,605		—		(8,157	)		8,448
Other securities		321,016		1,172		(2,141	)		320,047
Total available-for-sale securities	$	3,252,586	$	7,943	$	(64,322	)	$	3,196,207
Held-to-Maturity
Mortgage-backed securities - Agency	$	6,903	$	153	$	—		$	7,056
States and political subdivisions		677,160		43,495		(8	)		720,647
Total held-to-maturity securities	$	684,063	$	43,648	$	(8	)	$	727,703

As previously disclosed in Note 1, upon the early adoption of ASU No. 2017-12 on January 1, 2018, Old National reclassified $447.0 million in state and political subdivision securities from the held-to-maturity portfolio to the available-for-sale portfolio.  Separately, on January 1, 2018, U.S. government-sponsored entities and agencies, agency mortgage-backed securities, and state and political subdivision securities with a fair value of $324.0 million were transferred from the available-for-sale portfolio to the held-to-maturity portfolio.  The $10.8 million unrealized holding loss, net of tax, at the date of transfer shall continue to be reported as a separate component of shareholders’

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equity and is being amortized over the remaining term of the securities as an adjustment to yield.  The corresponding discount on these securities will offset this adjustment to yield as it is amortized.

Proceeds from sales or calls of available-for-sale investment securities, the resulting realized gains and realized losses, and other securities gains or losses were as follows for the years ended December 31:

	Years Ended December 31,
(dollars in thousands)	2018			2017			2016
Proceeds from sales of available-for-sale securities	$	139,364		$	342,233		$	243,312
Proceeds from calls of available-for-sale securities		32,437			88,233			635,624
Total	$	171,801		$	430,466		$	878,936
Realized gains on sales of available-for-sale securities	$	3,259		$	8,710		$	5,423
Realized gains on calls of available-for-sale securities		283			29			922
Realized losses on sales of available-for-sale securities		(1,469	)		(263	)		(450	)
Realized losses on calls of available-for-sale securities		(63	)		(8	)		(147	)
Other securities gains (losses) (1)		50			667			100
Net securities gains	$	2,060		$	9,135		$	5,848

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

Investment securities pledged to secure public and other funds had a carrying value of $2.4 billion at December 31, 2018 and $1.8 billion at December 31, 2017.

Equity securities, which consist of mutual funds held in trusts associated with deferred compensation plans for former directors and executives, are recorded at fair value and totaled $5.6 million at December 31, 2018 and December 31, 2017.

At December 31, 2018, Old National had a concentration of investment securities issued by certain states and their political subdivisions with the following aggregate market values: $344.4 million by Indiana, which represented 12.8% of shareholders’ equity, and $176.0 million by Texas, which represented 6.5% of shareholders’ equity. Of the Indiana municipal bonds, 99% are rated “A” or better, and the remaining 1% generally represent non-rated local interest bonds where Old National has a market presence.  All of the Texas municipal bonds are rated “A” or better, and the majority of issues are backed by the “AAA” rated State of Texas Permanent School Fund Guarantee Program.

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

	At December 31, 2018
(dollars in thousands)					Weighted
	Amortized		Fair		Average
Maturity	Cost		Value		Yield
Available-for-Sale
Within one year	$	101,077	$	101,138		2.58	%
One to five years		532,706		527,283		2.39
Five to ten years		483,510		482,231		3.22
Beyond ten years		3,055,324		3,012,764		2.94
Total	$	4,172,617	$	4,123,416		2.89	%
Held-to-Maturity
Within one year	$	30,188	$	30,352		3.96	%
One to five years		34,511		35,246		3.93
Five to ten years		72,442		74,199		4.44
Beyond ten years		369,193		366,306		3.58
Total	$	506,334	$	506,103		3.75	%

The following table summarizes the available-for-sale investment securities with unrealized losses at December 31 by aggregated major security type and length of time in a continuous unrealized loss position:

	Less than 12 months					12 months or longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
(dollars in thousands)	Value		Losses			Value		Losses			Value		Losses
December 31, 2018
Available-for-Sale
U.S. Treasury	$	3,829	$	(12	)	$	1,472	$	(19	)	$	5,301	$	(31	)
U.S. government-sponsored entities    and agencies		54,701		(594	)		519,911		(10,748	)		574,612		(11,342	)
Mortgage-backed securities - Agency		82,289		(742	)		1,172,984		(43,475	)		1,255,273		(44,217	)
States and political subdivisions		99,162		(1,340	)		151,097		(2,101	)		250,259		(3,441	)
Pooled trust preferred securities		—		—			8,495		(5,366	)		8,495		(5,366	)
Other securities		94,607		(1,965	)		143,842		(4,211	)		238,449		(6,176	)
Total available-for-sale	$	334,588	$	(4,653	)	$	1,997,801	$	(65,920	)	$	2,332,389	$	(70,573	)
December 31, 2017
Available-for-Sale
U.S. Treasury	$	1,480	$	(5	)	$	—	$	—		$	1,480	$	(5	)
U.S. government-sponsored entities    and agencies		201,773		(1,333	)		408,493		(10,027	)		610,266		(11,360	)
Mortgage-backed securities - Agency		789,804		(8,692	)		774,825		(29,240	)		1,564,629		(37,932	)
States and political subdivisions		196,024		(1,899	)		90,637		(2,828	)		286,661		(4,727	)
Pooled trust preferred securities		—		—			8,448		(8,157	)		8,448		(8,157	)
Other securities		61,260		(429	)		125,517		(1,712	)		186,777		(2,141	)
Total available-for-sale	$	1,250,341	$	(12,358	)	$	1,407,920	$	(51,964	)	$	2,658,261	$	(64,322	)

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The following table summarizes the held-to-maturity investment securities with unrecognized losses at December 31 by aggregated major security type and length of time in a continuous unrecognized loss position:

	Less than 12 months					12 months or longer					Total
	Fair		Unrecognized			Fair		Unrecognized			Fair		Unrecognized
(dollars in thousands)	Value		Losses			Value		Losses			Value		Losses
December 31, 2018
Held-to-Maturity
U.S. government-sponsored entities    and agencies	$	—	$	—		$	72,359	$	(4,642	)	$	72,359	$	(4,642	)
Mortgage-backed securities - Agency		4,335		(24	)		119,207		(8,006	)		123,542		(8,030	)
States and political subdivisions		24,533		(983	)		70,022		(3,556	)		94,555		(4,539	)
Total held-to-maturity	$	28,868	$	(1,007	)	$	261,588	$	(16,204	)	$	290,456	$	(17,211	)
December 31, 2017
Held-to-Maturity
States and political subdivisions	$	2,309	$	(8	)	$	—	$	—		$	2,309	$	(8	)
Total held-to-maturity	$	2,309	$	(8	)	$	—	$	—		$	2,309	$	(8	)

The unrecognized losses on held-to-maturity investment securities presented in the table above include unrecognized losses on securities that were transferred from available-for-sale to held-to-maturity totaling $10.7 million at December 31, 2018.  There were no unrecognized losses on securities that were transferred from available-for-sale to held-to-maturity at December 31, 2017.

Management evaluates debt securities for OTTI at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.  Management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery.  The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

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

We did not record OTTI in 2018, 2017, or 2016.

As of December 31, 2018, Old National’s securities portfolio consisted of 2,100 securities, 791 of which were in an unrealized loss position.  The unrealized losses attributable to our U.S. Treasury, U.S. government-sponsored entities and agencies, agency mortgage-backed securities, states and political subdivisions, and other securities are the result of fluctuations in interest rates.  Our pooled trust preferred securities are discussed below.  At December 31, 2018, we had no intent to sell any securities that were in an unrealized loss position nor is it expected that we would be required to sell any securities.

Pooled Trust Preferred Securities

At December 31, 2018, our securities portfolio contained two pooled trust preferred securities with a fair value of $8.5 million and unrealized losses of $5.4 million.  These securities are not subject to FASB ASC 325-10 and are evaluated using collateral-specific assumptions to estimate the expected future interest and principal cash flows.  For the years ended December 31, 2018 and 2017, our analysis indicated no OTTI on these securities.

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During the first quarter of 2018, Old National sold a pooled trust security that fell within the scope of FASB ASC 325-10 (EITF 99-20).  Proceeds from the sale were $1.8 million, which resulted in a loss of $0.9 million.  Although Old National typically does not sell securities in an unrealized loss position, this security was sold because the final liquidation value was significantly higher than our assessment of value for this position.

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

Trust preferred securities													Actual	Expected	Excess
December 31, 2018													Deferrals	Defaults as	Subordination
(dollars in thousands)												# of Issuers	and Defaults	a % of	as a % of
		Lowest					Unrealized			Realized		Currently	as a % of	Remaining	Current
		Credit	Amortized		Fair		Gain/			Losses		Performing/	Original	Performing	Performing
	Class	Rating  (1)	Cost		Value		(Loss)			2018		Remaining	Collateral	Collateral	Collateral
Pooled trust preferred securities:
Pretsl XXVII LTD	B	B		4,349		2,404		(1,945	)	$	—	33/43	17.3%	10.7%	38.8%
Trapeza Ser 13A	A2A	BBB		9,512		6,091		(3,421	)		—	44/49	4.5%	7.2%	56.1%
				13,861		8,495		(5,366	)		—
Single Issuer trust preferred securities:
JP Morgan Chase Cap    XIII		BBB-		4,788		4,500		(288	)		—
				4,788		4,500		(288	)		—
Total			$	18,649	$	12,995	$	(5,654	)	$	—

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

NOTE 4 – LOANS HELD FOR SALE

Mortgage loans held for immediate sale in the secondary market were $14.9 million at December 31, 2018, compared to $17.9 million at December 31, 2017.  Residential loans that Old National has originated with the intent to sell are recorded at fair value in accordance with FASB ASC 825-10, Financial Instruments.  Conventional mortgage production is sold on a servicing retained basis.  Certain loans, such as government guaranteed mortgage loans are sold on servicing released basis.

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% of total loans, no individual sub-segment category within those broader categories reaches the 10% threshold.

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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.

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

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No allowance was brought forward on any of the acquired loans as any credit deterioration evident in the loans was included in the determination of the fair value of the loans at the acquisition date.  An allowance for loan losses will be established for any subsequent credit deterioration or adverse changes in expected cash flows.

Old National’s activity in the allowance for loan losses for the 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

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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.

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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.

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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.

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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.

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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.

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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.

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The pre-modification and post-modification outstanding recorded investments of loans modified as TDRs during the years ended December 31, 2018, 2017, and 2016 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 years ended December 31, 2018, 2017, and 2016:

		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

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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. 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.  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 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 $12.3 million during 2018 and $15.2 million during 2017.  Improvement in cash flow expectations has resulted in a reclassification from nonaccretable difference to accretable yield as shown in the table below.

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Accretable yield of PCI loans, or income expected to be collected, was as follows:

	Years Ended December 31,
(dollars in thousands)	2018			2017			2016
Balance at beginning of period	$	27,835		$	33,603		$	45,310
New loans purchased		2,384			1,556			3,217
Accretion of income		(12,252	)		(15,217	)		(23,447	)
Reclassifications from (to) nonaccretable difference		6,133			7,614			10,589
Disposals/other adjustments		951			279			(2,066	)
Balance at end of period	$	25,051		$	27,835		$	33,603

Included in Old National’s allowance for loan losses is $0.5 million related to the purchased loans disclosed above at December 31, 2018, compared to $0.2 million at December 31, 2017.

PCI loans purchased during 2018 and 2017 for which it was probable at acquisition that all contractually required payments would not be collected were as follows:

(dollars in thousands)	Anchor (MN) (1)			Klein (2)
Contractually required payments	$	16,898		$	18,568
Nonaccretable difference		(4,787	)		(4,521	)
Cash flows expected to be collected at acquisition		12,111			14,047
Accretable yield		(1,556	)		(2,384	)
Fair value of acquired loans at acquisition	$	10,555		$	11,663

(1) Old National acquired Anchor (MN) effective November 1, 2017.

(2) Old National acquired Klein effective November 1, 2018.

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

NOTE 6 – OTHER REAL ESTATE OWNED

The following table presents activity in other real estate owned for the years ended December 31, 2018 and 2017:

	Years Ended December 31,
(dollars in thousands)	2018			2017
Balance at beginning of period	$	8,810		$	18,546
Additions (1)		2,025			4,016
Sales		(6,689	)		(11,160	)
Impairment		(914	)		(2,592	)
Balance at end of period (2)	$	3,232		$	8,810

(1) Additions in 2018 include other real estate owned of $1.0 million acquired from Klein in November 2018.  Additions in 2017 include other real estate owned of $1.1 million acquired from Anchor (MN) in November 2017.

(2) Includes repossessed personal property of $0.3 million at December 31, 2018 and 2017.

Foreclosed residential real estate property included in the table above totaled $1.3 million at December 31, 2018 and $1.6 million at December 31, 2017.  Consumer mortgage loans collateralized by residential real property that were in the process of foreclosure totaled $4.9 million at December 31, 2018 and $5.2 million at December 31, 2017.

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NOTE 7 – PREMISES AND EQUIPMENT

The composition of premises and equipment was as follows at December 31:

	December 31,
(dollars in thousands)	2018			2017
Land	$	79,231		$	73,046
Buildings		365,102			343,833
Furniture, fixtures, and equipment		107,862			94,254
Leasehold improvements		42,288			38,918
Total		594,483			550,051
Accumulated depreciation		(108,571	)		(91,977	)
Premises and equipment, net	$	485,912		$	458,074

The increase in premises and equipment at December 31, 2018 was primarily due to $33.4 million of assets attributable to the Klein acquisition.

Depreciation expense was $23.8 million in 2018, $22.2 million in 2017, and $16.6 million in 2016.

Operating Leases

Old National rents certain premises and equipment under operating leases, which expire at various dates.  Many of these leases require the payment of property taxes, insurance premiums, maintenance, and other costs.  In some cases, rentals are subject to increase in relation to a cost-of-living index.  The leases have original terms ranging from one year and five months to twenty-five years, and Old National has the right, at its option, to extend the terms of certain leases for five additional successive terms of five years.  Old National does not have any material sub-lease agreements.  See Note 1 to the consolidated financial statements for details regarding new guidance in Topic 842 that will affect the accounting for these leases effective January 1, 2019.

Rent expense was $17.9 million in 2018, $15.8 million in 2017, and $25.4 million in 2016. The following is a summary of future minimum lease commitments as of December 31, 2018:

(dollars in thousands)
2019	$	19,480
2020		18,416
2021		17,400
2022		15,169
2023		9,697
Thereafter		65,612
Total	$	145,774

Old National purchased 23 properties during 2016 that it had previously leased, 20 of which had deferred gains that were accelerated when the associated leases were terminated.  These gains were partially offset by the recognition of deferred rent expense, cease-use liabilities, and other expense, resulting in a net gain of $12.0 million.

Old National had deferred gains remaining associated with prior sale leaseback transactions totaling $6.5 million at December 31, 2018 and $8.2 million at December 31, 2017. The deferred gains were eliminated as a cumulative-effect adjustment upon adoption of the new accounting guidance in Topic 842 effective January 1, 2019.  See Note 1 to the consolidated financial statements for details regarding new accounting guidance in Topic 842.

Capital Leases

Old National leases two branch buildings and certain equipment under capital leases.  See Note 14 to the consolidated financial statements for detail regarding these leases.

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NOTE 8 – GOODWILL AND OTHER INTANGIBLE ASSETS

The following table shows the changes in the carrying amount of goodwill for the years ended December 31, 2018 and 2017:

	Years Ended December 31,
(dollars in thousands)	2018			2017
Balance at beginning of period	$	828,051		$	655,018
Acquisitions		208,787			173,033
Divestitures		(580	)		—
Balance at end of period	$	1,036,258		$	828,051

Goodwill is reviewed annually for impairment.  No events or circumstances since the August 31, 2018 annual impairment test were noted that would indicate it was more likely than not a goodwill impairment exists.

During 2018, Old National recorded $208.0 million of goodwill associated with the acquisition of Klein and increased goodwill associated with the acquisition of Anchor (MN) by $0.8 million.  Also during 2018, Old National eliminated $0.6 million of goodwill associated with the sale of branches to Marine Credit Union.  See Note 2 to the consolidated financial statements for detail regarding changes in goodwill recorded in 2017 associated with acquisitions and divestitures.

The gross carrying amounts and accumulated amortization of other intangible assets at December 31, 2018 and 2017 were as follows:

	Gross		Accumulated			Net
	Carrying		Amortization			Carrying
(dollars in thousands)	Amount		and Impairment			Amount
December 31, 2018
Core deposit	$	129,100	$	(57,524	)	$	71,576
Customer trust relationships		16,547		(11,107	)		5,440
Total intangible assets	$	145,647	$	(68,631	)	$	77,016
December 31, 2017
Core deposit	$	108,923	$	(62,874	)	$	46,049
Customer trust relationships		16,547		(9,533	)		7,014
Customer loan relationships		4,413		(4,380	)		33
Total intangible assets	$	129,883	$	(76,787	)	$	53,096

Other intangible assets consist of core deposit intangibles and customer relationship intangibles and are being amortized primarily on an accelerated basis over their estimated useful lives, generally over a period of 5 to 15 years.  During 2018, Old National increased core deposit intangibles by $39.0 million related to the Klein acquisition.

Old National reviews other intangible assets for possible impairment whenever events or changes in circumstances indicate that carrying amounts may not be recoverable.  No impairment charges were recorded in 2018, 2017, or 2016.  Total amortization expense associated with intangible assets was $14.4 million in 2018, $11.8 million in 2017, and $12.5 million in 2016.

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Estimated amortization expense for future years is as follows:

(dollars in thousands)
2019	$	16,929
2020		14,091
2021		11,336
2022		9,014
2023		7,053
Thereafter		18,593
Total	$	77,016

NOTE 9 – LOAN SERVICING RIGHTS

At December 31, 2018, loan servicing rights derived from loans sold with servicing retained totaled $24.5 million, compared to $24.7 million at December 31, 2017.  Loans serviced for others are not reported as assets.  The principal balance of loans serviced for others was $3.306 billion at December 31, 2018, compared to $3.321 billion at December 31, 2017.  Approximately 99.7% of the loans serviced for others at December 31, 2018 were residential mortgage loans.  Custodial escrow balances maintained in connection with serviced loans were $10.7 million at December 31, 2018 and $8.9 million at December 31, 2017.

The following table summarizes the activity related to loan servicing rights and the related valuation allowance in 2018 and 2017:

	Years Ended December 31,
(dollars in thousands)	2018			2017
Balance at beginning of period	$	24,690		$	25,629
Additions (1)		4,264			4,206
Amortization		(4,442	)		(5,145	)
Balance before valuation allowance at end of period		24,512			24,690
Valuation allowance:
Balance at beginning of period		(29	)		(68	)
(Additions)/recoveries		14			39
Balance at end of period		(15	)		(29	)
Loan servicing rights, net	$	24,497		$	24,661

(1) Additions in 2018 include loan servicing rights of $0.3 million acquired from Klein in November 2018.

At December 31, 2018, the fair value of servicing rights was $27.4 million, which was determined using a discount rate of 12% and a weighted average prepayment speed of 119% PSA.  At December 31, 2017, the fair value of servicing rights was $25.8 million, which was determined using a discount rate of 13% and a weighted average prepayment speed of 140% PSA.

NOTE 10 – QUALIFIED AFFORDABLE HOUSING PROJECTS AND OTHER TAX CREDIT INVESTMENTS

Old National is a limited partner in several tax-advantaged limited partnerships whose purpose is to invest in approved qualified affordable housing, renewable energy, or other renovation or community revitalization projects. As of December 31, 2018, Old National expects to recover its remaining investments through the use of the tax credits that are generated by the investments.

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The following table summarizes Old National’s investments in qualified affordable housing projects and other tax credit investments at December 31, 2018 and 2017:

(dollars in thousands)		December 31, 2018				December 31, 2017
				Unfunded				Unfunded
Investment	Accounting Method	Investment		Commitment (1)		Investment		Commitment
LIHTC	Proportional amortization	$	28,396	$	2,238	$	31,183	$	15,553
FHTC	Equity		16,815		17,945		10,645		12,040
CReED	Equity		17		538		704		1,502
Renewable Energy	Equity		9,176		17,827		22,364		19,771
Total		$	54,404	$	38,548	$	64,896	$	48,866

(1) All commitments will be paid by Old National by 2027.

The following table summarizes the amortization expense and tax benefit recognized for Old National’s qualified affordable housing projects and other tax credit investments during 2018, 2017, and 2016:

			Tax Expense
	Amortization		(Benefit)
(dollars in thousands)	Expense (1)		Recognized (2)
Year Ended December 31, 2018
LIHTC	$	2,585	$	(3,349	)
FHTC		9,206		(10,775	)
CReED (3)		687		(687	)
Renewable Energy		13,055		(14,566	)
Total	$	25,533	$	(29,377	)
Year Ended December 31, 2017
LIHTC	$	1,922	$	(2,666	)
FHTC		10,441		(11,348	)
CReED (3)		800		(1,074	)
Renewable Energy		492		(613	)
Total	$	13,655	$	(15,701	)
Year Ended December 31, 2016
LIHTC	$	804	$	(1,125	)
FHTC		—		—
CReED (3)		—		—
Total	$	804	$	(1,125	)

(1) The amortization expense for the LIHTC investments are included in our income tax expense. The amortization expense for the FHTC, CReED, and Renewable Energy tax credits are included in noninterest expense.

(2) All of the tax benefits recognized are included in our income tax expense.  The tax benefit recognized for the FHTC, CReED, and Renewable Energy investments primarily reflects the tax credits generated from the investments and excludes the net tax expense/benefit of the investments’ income (loss).

(3) The CReED tax credit investment qualifies for an Indiana state tax credit.

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NOTE 11 – DEPOSITS

The aggregate amount of time deposits in denominations of $250,000 or more was $612.7 million at December 31, 2018 and $422.3 million at December 31, 2017.  At December 31, 2018, the scheduled maturities of total time deposits were as follows:

(dollars in thousands)
Due in 2019	$	1,505,694
Due in 2020		277,142
Due in 2021		109,890
Due in 2022		52,697
Due in 2023		54,637
Thereafter		24,196
Total	$	2,024,256

NOTE 12 – SECURITES SOLD UNDER AGREEMENTS TO REPURCHASE

Securities sold under agreements to repurchase are secured borrowings.  Old National pledges investment securities to secure these borrowings.  The following table presents securities sold under agreements to repurchase and related weighted-average interest rates for each of the years ended December 31:

(dollars in thousands)	2018			2017
Outstanding at year-end	$	362,294		$	384,810
Average amount outstanding		344,964			336,539
Maximum amount outstanding at any month-end		364,001			402,543
Weighted-average interest rate:
During year		0.57	%		0.38	%
End of year		0.75			0.49

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

	At December 31, 2018
	Remaining Contractual Maturity of the Agreements
	Overnight and		Up to				Greater Than
(dollars in thousands)	Continuous		30 Days		30-90 Days		90 days		Total
Repurchase Agreements:
U.S. Treasury and agency securities	$	362,294	$	—	$	—	$	—	$	362,294
Total	$	362,294	$	—	$	—	$	—	$	362,294

The fair value of securities pledged to secure repurchase agreements may decline.  Old National has pledged securities valued at 122% of the gross outstanding balance of repurchase agreements at December 31, 2018 to manage this risk.

NOTE 13 – FEDERAL HOME LOAN BANK ADVANCES

The following table summarizes Old National Bank’s FHLB advances at December 31:

	December 31,
(dollars in thousands)	2018		2017
FHLB advances (fixed rates 1.50% to 6.08% and    variable rates 2.51% to 2.75%) maturing    January 2019 to October 2028	$	1,603,643	$	1,610,531
ASC 815 fair value hedge and other basis adjustments		9,838		(952	)
Total other borrowings	$	1,613,481	$	1,609,579

FHLB advances had weighted-average rates of 2.56% at December 31, 2018 and 1.55% at December 31, 2017.  These borrowings are collateralized by investment securities and residential real estate loans up to 140% of outstanding debt.

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Contractual maturities of FHLB advances at December 31, 2018 were as follows:

(dollars in thousands)
Due in 2019	$	326,474
Due in 2020		100,000
Due in 2021		20,000
Due in 2022		57,000
Due in 2023		169
Thereafter		1,100,000
ASC 815 fair value hedge and other basis adjustments		9,838
Total	$	1,613,481

NOTE 14 – OTHER BORROWINGS

The following table summarizes Old National’s other borrowings at December 31:

	December 31,
(dollars in thousands)	2018			2017
Old National Bancorp:
Senior unsecured notes (fixed rate 4.125%)    maturing August 2024	$	175,000		$	175,000
Unamortized debt issuance costs related    to senior unsecured bank notes		(870	)		(1,026	)
Junior subordinated debentures (variable rates    of 4.01% to 6.39%) maturing April 2032    to June 2037		60,310			60,310
Other basis adjustments		(3,046	)		(3,585	)
Old National Bank:
Capital lease obligations		5,262			5,389
Subordinated debentures (fixed rate 5.75%)		12,000			12,000
Other		(773	)		694
Total other borrowings	$	247,883		$	248,782

Contractual maturities of other borrowings at December 31, 2018 were as follows:

(dollars in thousands)
Due in 2019	$	137
Due in 2020		147
Due in 2021		160
Due in 2022		172
Due in 2023		196
Thereafter		250,382
Unamortized debt issuance costs and other    basis adjustments		(3,311	)
Total	$	247,883

Senior Notes

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

Junior Subordinated Debentures

Junior subordinated debentures related to trust preferred securities are classified in “other borrowings.”  With the addition of Anchor (MN) assets, these securities now qualify as Tier 2 capital for regulatory purposes, subject to certain limitations.  Prior to the fourth quarter of 2017, these securities qualified as Tier 1 capital for regulatory purposes.

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Through various acquisitions, Old National assumed junior subordinated debenture obligations related to various trusts that issued trust preferred securities.  Old National guarantees the payment of distributions on the trust preferred securities issued by the trusts.  Proceeds from the issuance of each of these securities were used to purchase junior subordinated debentures with the same financial terms as the securities issued by the trusts.

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

The following table summarizes the terms of our outstanding junior subordinated debentures as of December 31, 2018:

(dollars in thousands)					Rate at
		Issuance			December 31,
Name of Trust	Issuance Date	Amount		Rate	2018	Maturity Date
VFSC Capital Trust I	April 2002	$	3,093	6-month LIBOR plus 3.70%	6.39%	April 22, 2032
VFSC Capital Trust II	October 2002		4,124	3-month LIBOR plus 3.45%	6.09%	November 7, 2032
VFSC Capital Trust III	April 2004		3,093	3-month LIBOR plus 2.80%	5.57%	September 8, 2034
St. Joseph Capital Trust II	March 2005		5,000	3-month LIBOR plus 1.75%	4.54%	March 17, 2035
Anchor Capital Trust III	August 2005		5,000	3-month LIBOR plus 1.55%	4.35%	September 30, 2035
Tower Capital Trust 2	December 2005		8,000	3-month LIBOR plus 1.34%	4.14%	December 30, 2035
Home Federal Statutory    Trust I	September 2006		15,000	3-month LIBOR plus 1.65%	4.44%	September 15, 2036
Monroe Bancorp Capital    Trust I	July 2006		3,000	3-month LIBOR plus 1.60%	4.01%	October 7, 2036
Tower Capital Trust 3	December 2006		9,000	3-month LIBOR plus 1.69%	4.43%	March 1, 2037
Monroe Bancorp Statutory    Trust II	March 2007		5,000	3-month LIBOR plus 1.60%	4.39%	June 15, 2037
Total		$	60,310

Subordinated Debentures

On November 1, 2017, Old National assumed $12.0 million of subordinated fixed-to-floating notes related to the acquisition of Anchor (MN).  The subordinated debentures have a 5.75% fixed rate of interest through October 29, 2020.  From October 30, 2020 to the October 30, 2025 maturity date, the debentures have a floating rate of interest equal to the three-month LIBOR rate plus 4.356%.

Capital Lease Obligations

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

On November 1, 2017, Old National assumed a capital lease obligation for a banking center in Arden Hills, Minnesota related to the acquisition of Anchor (MN).  The remaining base term of the lease is five years with one renewal option of ten years.  For purposes of measuring the lease obligation, we determined that we would be “reasonably assured” to exercise the renewal option.  The fair value of the capital lease obligation was estimated using a discounted cash flow analysis based on a market rate for similar types of borrowing arrangements.  Based on the above assumptions, Old National measured the capital lease obligation at $1.5 million as of the date of acquisition.

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At December 31, 2018, the future minimum lease payments under the capital lease arrangements were as follows:

(dollars in thousands)
2019	$	589
2020		589
2021		589
2022		589
2023		599
Thereafter		8,676
Total minimum lease payments		11,631
Less amounts representing interest		(6,369	)
Present value of net minimum lease payments	$	5,262

See Note 1 to the consolidated financial statements for details regarding new guidance in Topic 842 that will affect the accounting for these leases effective January 1, 2019.

NOTE 15 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table summarizes the changes within each classification of AOCI, net of tax, for the years ended December 31, 2018, 2017, and 2016:

(dollars in thousands)	Unrealized Gains and Losses on Available- for-Sale Debt Securities			Unrealized Gains and Losses on Held-to- Maturity Securities			Gains and Losses on Cash Flow Hedges			Defined Benefit Pension Plans			Total
2018
Balance at beginning of period	$	(35,557	)	$	(12,107	)	$	(2,337	)	$	(271	)	$	(50,272	)
Other comprehensive income (loss) before       reclassifications		7,454			4,514			3,884			—			15,852
Amounts reclassified from AOCI to income (1)		(1,662	)		1,678			113			144			273
Amount reclassified from AOCI to retained       earnings for cumulative effect of       change in accounting principle (2)		—			—			(52	)		—			(52	)
Amounts reclassified from AOCI to retained       earnings related to the Tax Cuts and Jobs       Act of 2017 (3)		(7,583	)		(2,600	)		(509	)		(59	)		(10,751	)
Balance at end of period	$	(37,348	)	$	(8,515	)	$	1,099		$	(186	)	$	(44,950	)
2017
Balance at beginning of period	$	(39,012	)	$	(13,310	)	$	(6,715	)	$	(335	)	$	(59,372	)
Other comprehensive income (loss) before       reclassifications		9,615			—			575			—			10,190
Amounts reclassified from AOCI (1)		(6,160	)		1,203			3,803			64			(1,090	)
Balance at end of period	$	(35,557	)	$	(12,107	)	$	(2,337	)	$	(271	)	$	(50,272	)
2016
Balance at beginning of period	$	(3,806	)	$	(14,480	)	$	(9,276	)	$	(7,235	)	$	(34,797	)
Other comprehensive income (loss) before       reclassifications		(31,513	)		—			(1,440	)		—			(32,953	)
Amounts reclassified from AOCI (1)		(3,693	)		1,170			4,001			6,900			8,378
Balance at end of period	$	(39,012	)	$	(13,310	)	$	(6,715	)	$	(335	)	$	(59,372	)

(1) See table below for details about reclassifications.

(2) See Note 1 for details about reclassification from AOCI to beginning retained earnings resulting from the adoption of ASU 2017-12.

(3) See Note 1 for details about reclassification from AOCI to beginning retained earnings resulting from the adoption of ASU 2018-02.

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The following tables summarize the significant amounts reclassified out of each component of AOCI for the years ended December 31, 2018, 2017, and 2016:

	Amount Reclassified									Affected Line Item in the
Details about AOCI Components	from AOCI									Statement of Income
	Years Ended December 31,
(dollars in thousands)	2018			2017			2016
Unrealized gains and losses on    available-for-sale debt securities	$	2,060		$	9,135		$	5,848		Net securities gains
		(398	)		(2,975	)		(2,155	)	Income tax (expense) benefit
	$	1,662		$	6,160		$	3,693		Net income
Unrealized gains and losses on    held-to-maturity securities	$	(2,181	)	$	(1,830	)	$	(1,776	)	Interest income (expense)
		503			627			606		Income tax (expense) benefit
	$	(1,678	)	$	(1,203	)	$	(1,170	)	Net income
Gains and losses on cash flow hedges    Interest rate contracts	$	(150	)	$	(6,135	)	$	(6,453	)	Interest income (expense)
		37			2,332			2,452		Income tax (expense) benefit
	$	(113	)	$	(3,803	)	$	(4,001	)	Net income
Amortization of defined benefit    pension items
Actuarial gains (losses) and settlement cost	$	(191	)	$	(159	)	$	(11,203	)	Salaries and employee benefits
		47			95			4,303		Income tax (expense) benefit
	$	(144	)	$	(64	)	$	(6,900	)	Net income
Total reclassifications for the period	$	(273	)	$	1,090		$	(8,378	)	Net income

NOTE 16 – INCOME TAXES

Following is a summary of the major items comprising the differences in taxes from continuing operations computed at the federal statutory rate and as recorded in the consolidated statement of income:

	Years Ended December 31,
(dollars in thousands)	2018				2017				2016
Provision at statutory rate (1)	$	43,823			$	59,032			$	70,149
Tax-exempt income:
Tax-exempt interest		(9,021	)			(15,026	)			(14,356	)
Section 291/265 interest disallowance		321				289				191
Company-owned life insurance income		(2,223	)			(3,029	)			(2,968	)
Tax-exempt income		(10,923	)			(17,766	)			(17,133	)
State income taxes		5,621				998				3,461
Tax credit investments - federal		(21,576	)			(8,500	)			(321	)
Revaluation of deferred tax assets		—				39,300				—
ONB Insurance Group, Inc. nondeductible goodwill		—				—				8,328
Other, net		905				(125	)			1,678
Income tax expense	$	17,850			$	72,939			$	66,162
Effective tax rate		8.6		%		43.3		%		33.0		%

(1) The statutory rate in effect was 21% for 2018, compared to 35% for 2017 and 2016.

The lower effective tax rate in 2018 when compared 2017 is primarily the result of the lowering of the federal corporate tax rate to 21% in 2018 and an increase in federal tax credits available.

The higher effective tax rate in 2017 when compared to 2016 was the result of $39.3 million of additional tax expense in 2017 to estimate the revaluation of deferred tax assets due to the lowering of the federal corporate tax rate to 21%, partially offset by an increase in federal tax credits available.  On December 22, 2017, the Tax Cuts and Jobs Act (“H.R. 1”) was enacted into legislation.  Under ASC 740, the effects of changes in tax rates and laws are recognized in the period in which the new legislation is enacted.  Accordingly, Old National recorded an estimated $39.3 million for the revaluation of Old National’s deferred tax assets.

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Shortly after the enactment date, the SEC issued Staff Accounting Bulletin (“SAB”) 118, which addresses the situations where the accounting for changes in tax laws is complete, incomplete but can be reasonably estimated, and incomplete and cannot be reasonably estimated.  SAB 118 also permits a measurement period of up to one year from the date of enactment to refine the provisional accounting. Old National completed its analysis of H.R. 1 during the second quarter of 2018 and there were immaterial adjustments made to the revaluation of Old National’s deferred tax assets.

The provision for income taxes consisted of the following components for the years ended December 31:

	Years Ended December 31,
(dollars in thousands)	2018			2017		2016
Income taxes currently payable:
Federal	$	12,256		$	—	$	23,735
State		4,601			—		2,242
Deferred income taxes related to:
Federal		(1,513	)		31,915		35,955
Revaluation of deferred tax assets		—			39,300		—
State		2,506			1,724		4,230
Deferred income tax expense		993			72,939		40,185
Income tax expense	$	17,850		$	72,939	$	66,162

Net Deferred Tax Assets

Significant components of net deferred tax assets (liabilities) were as follows at December 31:

(dollars in thousands)	2018			2017
Deferred Tax Assets
Allowance for loan losses, net of recapture	$	14,514		$	12,958
Benefit plan accruals		21,694			11,080
Alternative minimum tax credit		2,545			25,084
Unrealized losses on benefit plans		61			108
Net operating loss carryforwards		31,765			39,631
Federal tax credits		1,779			5,516
Deferred gain on securities		1,976			—
Other-than-temporary impairment		37			1,424
Acquired loans		26,956			29,669
Lease exit obligation		1,025			1,337
Unrealized losses on available-for-sale investment securities		11,853			14,011
Unrealized losses on held-to-maturity investment securities		2,497			3,630
Unrealized losses on hedges		—			923
Tax credit investments		662			—
Other real estate owned		144			369
Other, net		5,471			829
Total deferred tax assets		122,979			146,569
Deferred Tax Liabilities
Accretion on investment securities		(595	)		(493	)
Purchase accounting		(18,100	)		(16,718	)
Loan servicing rights		(6,141	)		(6,058	)
Premises and equipment		(8,507	)		(10,052	)
Prepaid expenses		(681	)		(1,277	)
Tax credit investments		—			(168	)
Unrealized gains on hedges		(358	)		—
Other, net		(1,549	)		(946	)
Total deferred tax liabilities		(35,931	)		(35,712	)
Net deferred tax assets	$	87,048		$	110,857

Through the acquisition of Anchor (WI) in the second quarter of 2016 and Lafayette Savings Bank in the fourth quarter of 2014, both former thrifts, Old National Bank’s retained earnings at December 31, 2018 include base-year

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bad debt reserves, created for tax purposes prior to 1988, totaling $52.8 million.  Of this total, $50.9 million was acquired from Anchor (WI), and $1.9 million was acquired from Lafayette Savings Bank.  Base-year reserves are subject to recapture in the unlikely event that Old National Bank (1) makes distributions in excess of current and accumulated earnings and profits, as calculated for federal income tax purposes, (2) redeems its stock, or (3) liquidates.  Old National Bank has no intention of making such a nondividend distribution. Accordingly, under current accounting principles, a related deferred income tax liability of $13.0 million has not been recognized.

No valuation allowance was recorded at December 31, 2018 or 2017 because, based on current expectations, Old National believes it will generate sufficient income in future years to realize deferred tax assets.  Old National has federal net operating loss carryforwards totaling $104.5 million at December 31, 2018 and $130.7 million at December 31, 2017.  This federal net operating loss was acquired from the acquisition of Anchor (WI) in 2016.  If not used, the federal net operating loss carryforwards will expire from 2028 to 2033.  Old National has alternative minimum tax credit carryforwards totaling $10.1 million at December 31, 2018 and $25.1 million at December 31, 2017.  The enactment of H.R.1 eliminates the parallel tax system known as the alternative minimum tax and allows any existing alternative minimum tax credits to be used to reduce regular tax or be refunded from 2018 to 2021. ASC 740 allows for the reclassification of the alternative minimum tax credit from a deferred tax asset to a current tax asset, except for the amount limited by section 382. Old National has $2.5 million of alternative minimum tax credit carryforward subject to section 382 limitations.  The $2.5 million is maintained in deferred tax assets and the remaining $21.5 million has been reclassified to a current tax asset. Old National has federal tax credit carryforwards of $1.8 million at December 31, 2018 and $5.5 million at December 31, 2017.  The federal tax credits consist mainly of energy efficient home credits, low income housing credits, and research and development credits that, if not used, will expire from 2025 to 2038.  Old National has recorded state net operating loss carryforwards totaling $165.6 million at December 31, 2018 and $203.6 million at December 31, 2017.  If not used, the state net operating loss carryforwards will expire from 2024 to 2033.

The federal and recorded state net operating loss carryforwards are subject to an annual limitation under Internal Revenue Code section 382.  Old National believes that all of the recorded net operating loss carryforwards will be used prior to expiration.

Unrecognized Tax Benefits

Unrecognized state income tax benefits are reported net of their related deferred federal income tax benefit.

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

	Years Ended December 31,
(dollars in thousands)	2018			2017			2016
Balance at beginning of period	$	874		$	777		$	124
Additions based on tax positions related to the current year		—			162			118
Additions (reductions) based on tax positions related to prior years		(78	)		—			537
Reductions due to statute of limitations expiring		(301	)		(173	)		(2	)
Revaluation due to Tax Reform		—			108			—
Balance at end of period	$	495		$	874		$	777

If recognized, approximately $0.5 million of unrecognized tax benefits, net of interest, would favorably affect the effective income tax rate in future periods.  Old National expects the total amount of unrecognized tax benefits to be reduced to zero in the next twelve months.

It is our policy to recognize interest and penalties accrued relative to unrecognized tax benefits in their respective federal or state income tax accounts.  We did not recognize any interest and penalties in 2018.  We recorded interest and penalties in the income statement of $10 thousand in 2017 and $0.1 million in 2016.  The amount accrued for interest and penalties in the balance sheet was $0.1 million at December 31, 2018 and 2017.

Old National and its subsidiaries file a consolidated U.S. federal income tax return, as well as filing various state returns.  The 2015 through 2018 tax years are open and subject to examination.

Old National reversed $0.4 million in 2018 related to uncertain tax positions accounted for under FASB ASC 740-10 (FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes) (“ASC Topic 740-10”).  The income tax reversal related to the 2014 statute of limitations expiring in the third quarter of 2018 totaled $0.3 million.  The

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income tax reversal related to reductions for tax positions in prior years totaled $0.1 million.  As a result, Old National reversed a total of $0.4 million from its unrecognized tax benefit liability.

NOTE 17 – EMPLOYEE BENEFIT PLANS

Retirement Plan

Old National had a funded noncontributory defined benefit plan (the “Retirement Plan”) that had been frozen since December 31, 2005.  During the first quarter of 2016, we notified plan participants of our intent to terminate the Retirement Plan effective May 15, 2016.  During October 2016, the Retirement Plan settled plan liabilities through either lump sum distributions to plan participants or annuity contracts purchased from a third party insurance company that provided for the payment of vested benefits to those participants that did not elect the lump sum option.  At December 31, 2018, there were no remaining plan assets.  Old National made contributions to the Retirement Plan totaling $7.6 million during 2016.

As a result of the pension termination, unrecognized losses, which previously were recorded in accumulated other comprehensive loss on the consolidated balance sheets, were recognized as expense and the pension plan settlement loss of $9.8 million was recorded in the consolidated statements of income for the year ended December 31, 2016.  Including this settlement charge, the total expense under the Retirement Plan was $11.6 million in 2016.

Employee Stock Ownership Plan

The Employee Stock Ownership and Savings Plan (the “401(k) Plan”) permits employees to participate the first month following one month of service.  Effective as of April 1, 2010, we suspended safe harbor matching contributions to the 401(k) Plan.  However, we may make discretionary matching contributions to the 401(k) Plan.  During the second quarter of 2018, Old National increased its match to 75% of employee compensation deferral contributions of the first 4% of compensation, and 50% of the next 4% of compensation.  The change was retroactive for all of 2018.  For 2017 and 2016, we matched 50% of employee compensation deferral contributions, up to 6% of compensation.  In addition to matching contributions, Old National may contribute to the 401(k) Plan an amount designated as a profit sharing contribution in the form of Old National stock or cash.  Our Board of Directors designated no discretionary profit sharing contributions in 2018, 2017, or 2016. All contributions vest immediately and plan participants may elect to redirect funds among any of the investment options provided under the 401(k) Plan.  The number of Old National shares in the 401(k) Plan were 0.7 million at December 31, 2018 and 2017.  All shares owned through the 401(k) Plan are included in the calculation of weighted-average shares outstanding for purposes of calculating diluted and basic earnings per share.  Contribution expense under the 401(k) Plan was $8.6 million in 2018, $4.7 million in 2017, and $5.0 million in 2016.

NOTE 18 – SHARE-BASED COMPENSATION

Our Amended and Restated 2008 Incentive Compensation Plan (the “ICP”), which was shareholder-approved, permits the grant of share-based awards to its employees.  At December 31, 2018, 4.4 million shares were available for issuance.  The granting of awards to key employees is typically in the form of restricted stock awards or units.  We believe that such awards better align the interests of our employees with those of our shareholders.  Total compensation cost that has been charged against income for the ICP was $8.1 million in 2018, $6.3 million in 2017, and $7.3 million in 2016.  The total income tax benefit was $2.0 million in 2018, $2.4 million in 2017, and $2.8 million in 2016.

Restricted Stock Awards

Restricted stock awards require certain service requirements and commonly have vesting periods of 3 years.  Compensation expense is recognized on a straight-line basis over the vesting period.  Shares are subject to certain restrictions and risk of forfeiture by the participants.

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A summary of changes in our nonvested shares for the year follows:

				Weighted
				Average
				Grant-Date
(shares in thousands)	Shares			Fair Value
Year Ended December 31, 2018
Nonvested balance at beginning of period		407		$	15.41
Granted during the year		217			17.47
Vested during the year		(195	)		14.80
Forfeited during the year		(10	)		15.08
Nonvested balance at end of period		419		$	16.77

As of December 31, 2018, there was $4.5 million of total unrecognized compensation cost related to nonvested shares granted under the ICP.  The cost is expected to be recognized over a weighted-average period of 1.9 years.  The total fair value of the shares vested was $3.4 million in 2018, $3.4 million in 2017, and $3.8 million in 2016.

Restricted Stock Units

Restricted stock units require certain performance requirements and have vesting periods of 3 years.  Compensation expense is recognized on a straight-line basis over the vesting period.  Shares are subject to certain restrictions and risk of forfeiture by the participants.

A summary of changes in our nonvested shares for the year follows:

				Weighted
				Average
				Grant-Date
(shares in thousands)	Shares			Fair Value
Year Ended December 31, 2018
Nonvested balance at beginning of period		849		$	13.30
Granted during the year		288			13.62
Vested during the year		(92	)		13.65
Forfeited during the year		(185	)		13.58
Dividend equivalents adjustment		33			13.32
Nonvested balance at end of period		893		$	13.31

As of December 31, 2018, there was $4.3 million of total unrecognized compensation cost related to nonvested shares granted under the ICP.  The cost is expected to be recognized over a weighted-average period of 1.6 years.

Stock Options

Option awards are generally granted with an exercise price equal to the market price of our Common Stock at the date of grant; these option awards have vesting periods ranging from 3 to 5 years and have 10-year contractual terms.

Old National has not granted stock options since 2009.  However, Old National did acquire stock options through prior year acquisitions. Old National recorded no incremental expense associated with the conversion of these options.

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A summary of the activity in the stock option plan in 2018 follows:

						Weighted
				Weighted		Average		Aggregate
				Average		Remaining		Intrinsic
				Exercise		Contractual		Value
(shares in thousands)	Shares			Price		Term in Years		(in thousands)
Year Ended December 31, 2018
Outstanding at beginning of period		225		$	11.92
Exercised		(76	)		12.59
Forfeited/expired		(57	)		20.16
Outstanding at end of period		92		$	6.30		2.08	$	836.7
Options exercisable at end of year		92		$	6.30		2.08	$	836.7

Information related to the stock option plan during each year follows:

	Years Ended December 31,
(dollars in thousands)	2018		2017		2016
Intrinsic value of options exercised	$	385	$	806	$	660
Cash received from option exercises		948		2,655		2,349
Tax benefit realized from option exercises		154		318		264

As of December 31, 2018, all options were fully vested and all compensation costs had been expensed.

Stock Appreciation Rights

Old National has never granted stock appreciation rights.  However, Old National did acquire stock appreciation rights through a prior year acquisition.  Old National recorded no incremental expense associated with the conversion of these stock appreciation rights.  At December 31, 2018, 61 thousand stock appreciation rights remained outstanding.

Outside Director Stock Compensation Program

Old National maintains a director stock compensation program covering all outside directors.  Compensation shares are earned semi-annually.  Beginning in 2017, any shares awarded to directors are anticipated to be issued from the ICP.  In 2018, 16 thousand shares were issued to directors, compared to 20 thousand shares in 2017.

NOTE 19 – SHAREHOLDERS’ EQUITY

Dividend Reinvestment and Stock Purchase Plan

Old National has a dividend reinvestment and stock purchase plan under which common shares issued may be either repurchased shares or authorized and previously unissued shares.  A new plan became effective on August 13, 2018, with total authorized and unissued common shares reserved for issuance of 3.3 million.  At December 31, 2018, 3.3 million authorized and unissued common shares were available for issuance under the plan.

Employee Stock Purchase Plan

Old National has an employee stock purchase plan under which eligible employees can purchase common shares at a price not less than 95% of the fair market value of the common shares on the purchase date.  The amount of common shares purchased cannot exceed 10% of the employee’s compensation.  The maximum number of shares that may be purchased under this plan is 500,000 shares.  In 2018, 29,000 shares were issued related to this plan with proceeds of approximately $497,000.  In 2017, 24,000 shares were issued related to this plan with proceeds of approximately $404,000.

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NOTE 20 – FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  There are three levels of inputs that may be used to measure fair values:

• Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

• Level 2 – Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

• Level 3 – Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Old National used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Investment securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1).  For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2).  For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).  Discounted cash flows are calculated using swap and LIBOR curves plus spreads that adjust for loss severities, volatility, credit risk, and optionality.  During times when trading is more liquid, broker quotes are used (if available) to validate the model.  Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Residential loans held for sale: The fair value of loans held for sale is determined using quoted prices for a similar asset, adjusted for specific attributes of that loan (Level 2).

Derivative financial instruments: The fair values of derivative financial instruments are based on derivative valuation models using market data inputs as of the valuation date (Level 2).

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Assets and liabilities measured at fair value on a recurring basis, including financial assets and liabilities for which we have elected the fair value option, are summarized below:

			Fair Value Measurements at December 31, 2018 Using
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
(dollars in thousands)	Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets
Equity securities	$	5,582	$	5,582	$	—	$	—
Investment securities available-for-sale:
U.S. Treasury		5,301		5,301		—		—
U.S. government-sponsored entities and agencies		628,151		—		628,151		—
Mortgage-backed securities - Agency		2,209,295		—		2,209,295		—
States and political subdivisions		940,429		—		936,321		4,108
Pooled trust preferred securities		8,495		—		—		8,495
Other securities		331,745		30,259		301,486		—
Residential loans held for sale		14,911		—		14,911		—
Derivative assets		29,005		—		29,005		—
Financial Liabilities
Derivative liabilities		12,550		—		12,550		—
			Fair Value Measurements at December 31, 2017 Using
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
(dollars in thousands)	Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets
Equity securities	$	5,584	$	5,584	$	—	$	—
Investment securities available-for-sale:
U.S. Treasury		5,551		5,551		—		—
U.S. government-sponsored entities and agencies		664,286		—		664,286		—
Mortgage-backed securities - Agency		1,667,682		—		1,667,682		—
States and political subdivisions		530,193		—		530,193		—
Pooled trust preferred securities		8,448		—		—		8,448
Other securities		320,047		30,965		289,082		—
Residential loans held for sale		17,930		—		17,930		—
Derivative assets		14,118		—		14,118		—
Financial Liabilities
Derivative liabilities		16,292		—		16,292		—

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3):

	Pooled Trust			State and
	Preferred			Political
(dollars in thousands)	Securities			Subdivisions
2018
Balance at beginning of period	$	8,448		$	—
Accretion (amortization) of discount		17			(56	)
Sales/payments received		(338	)		—
Increase in fair value of securities		368			28
Transfers into Level 3		—			4,136
Balance at end of period	$	8,495		$	4,108
2017
Balance at beginning of period	$	8,119		$	—
Accretion of discount		17			—
Sales/payments received		(424	)		—
Increase in fair value of securities		736			—
Balance at end of period	$	8,448		$	—

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The accretion or amortization of discounts on securities in the table above is included in interest income.  An increase in fair value is reflected in the balance sheet as an increase in the fair value of investment securities available-for-sale, an increase in accumulated other comprehensive income, which is included in shareholders’ equity, and a decrease in other assets related to the tax impact.  Old National transferred $4.1 million of state and political subdivisions securities to Level 3 during 2018 because Old National could no longer obtain evidence of observable inputs.

The table below provides quantitative information about significant unobservable inputs used in fair value measurements within Level 3 of the fair value hierarchy:

			Valuation	Unobservable	Range (Weighted
(dollars in thousands)	Fair Value		Techniques	Input	Average)
December 31, 2018
Pooled trust preferred securities	$	8,495	Discounted cash flow	Constant prepayment rate (a)	0.00%
				Additional asset defaults (b)	6.8% - 8.5% (7.3%)
				Expected asset recoveries (c)	0.0% - 0.0% (0.0%)
State and political subdivisions		4,108	Discounted cash flow	No observable inputs	N/A
				Local municipality issuances
				Old National owns 100%
				Carried at par
December 31, 2017
Pooled trust preferred securities	$	8,448	Discounted cash flow	Constant prepayment rate (a)	0.00%
				Additional asset defaults (b)	4.2% - 9.6% (7.5%)
				Expected asset recoveries (c)	0.0% - 4.1% (0.6%)

(a) Assuming no prepayments.

(b) Each currently performing pool asset is assigned a default probability based on the banking environment, which is adjusted for specific issuer evaluation, of 0%, 50%, or 100%.

(c) Each currently defaulted pool asset is assigned a recovery probability based on specific issuer evaluation of 0%, 25%, or 100%.

Significant changes in any of the unobservable inputs used in the fair value measurement in isolation would result in a significant change to the fair value measurement.  The pooled trust preferred securities Old National owns are subordinate note classes that rely on an ongoing cash flow stream to support their values.  The senior note classes receive the benefit of prepayments to the detriment of subordinate note classes since the ongoing interest cash flow stream is reduced by the early redemption.  Generally, a change in prepayment rates or additional pool asset defaults has an impact that is directionally opposite from a change in the expected recovery of a defaulted pool asset.

Assets measured at fair value on a non-recurring basis at December 31, 2018 are summarized below:

			Fair Value Measurements at December 31, 2018 Using
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
(dollars in thousands)	Value		(Level 1)		(Level 2)		(Level 3)
Collateral Dependent Impaired Loans:
Commercial loans	$	7,242	$	—	$	—	$	7,242
Commercial real estate loans		29,125		—		—		29,125
Foreclosed Assets:
Residential		68		—		—		68
Loan servicing rights		104		—		104		—

Impaired commercial and commercial real estate loans that are deemed collateral dependent are valued based on the fair value of the underlying collateral.  These estimates are based on the most recently available appraisals with certain adjustments made based on the type of property, age of appraisal, current status of the property, and other related factors to estimate the current value of the collateral.  These impaired commercial and commercial real estate loans had a principal amount of $49.3 million, with a valuation allowance of $12.9 million at December 31, 2018.  Old National recorded provision expense associated with these loans totaling $9.9 million in 2018.

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Other real estate owned and other repossessed property is measured at fair value less costs to sell and had a net carrying amount of $68 thousand at December 31, 2018.  The estimates of fair value are based on the most recently available appraisals with certain adjustments made based on the type of property, age of appraisal, current status of the property, and other related factors to estimate the current value of the collateral.  There were write-downs of other real estate owned of $0.6 million in 2018.

Loan servicing rights are evaluated for impairment based upon the fair value of the rights as compared to the carrying amount.  If the carrying amount of an individual tranche exceeds fair value, impairment is recorded on that tranche so that the servicing asset is carried at fair value.  Fair value is determined at a tranche level, based on market prices for comparable mortgage servicing contracts when available, or alternatively based on a valuation model that calculates the present value of estimated future net servicing income.  The valuation model utilizes a discount rate, weighted average prepayment speed, and other economic factors that market participants would use in estimating future net servicing income and that can be validated against available market data (Level 2).  The valuation allowance for loan servicing rights with impairments at December 31, 2018 totaled $15 thousand.  Old National recorded recoveries associated with these loan servicing rights totaling $14 thousand in 2018.

Assets measured at fair value on a non-recurring basis at December 31, 2017 are summarized below:

			Fair Value Measurements at December 31, 2017 Using
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
(dollars in thousands)	Value		(Level 1)		(Level 2)		(Level 3)
Collateral Dependent Impaired Loans:
Commercial loans	$	2,217	$	—	$	—	$	2,217
Commercial real estate loans		26,319		—		—		26,319
Foreclosed Assets:
Commercial real estate		1,726		—		—		1,726
Residential		55		—		—		55
Loan servicing rights		2,964		—		2,964		—

At December 31, 2017, impaired commercial and commercial real estate loans had a principal amount of $38.6 million, with a valuation allowance of $10.1 million.  Old National recorded provision expense associated with these loans totaling $5.2 million in 2017.

Other real estate owned and other repossessed property had a net carrying amount of $1.8 million at December 31, 2017.  There were write-downs of other real estate owned of $2.5 million in 2017.

The valuation allowance for loan servicing rights with impairments at December 31, 2017 totaled $29 thousand.  There were recoveries associated with these loan servicing rights totaling $39 thousand in 2017.

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The table below provides quantitative information about significant unobservable inputs used in fair value measurements within Level 3 of the fair value hierarchy:

			Valuation	Unobservable	Range (Weighted
(dollars in thousands)	Fair Value		Techniques	Input	Average)
December 31, 2018
Collateral Dependent Impaired     Loans
Commercial loans	$	7,242	Fair value of collateral	Discount for type of property, age of appraisal, and current status	0% - 90% (35%)
Commercial real estate loans		29,125	Fair value of collateral	Discount for type of property, age of appraisal and current status	0% - 50% (35%)
Foreclosed Assets
Residential		68	Fair value of collateral	Discount for type of property, age of appraisal, and current status	15%-16% (15%)
December 31, 2017
Collateral Dependent Impaired     Loans
Commercial loans	$	2,217	Fair value of collateral	Discount for type of property, age of appraisal, and current status	0% - 98% (49%)
Commercial real estate loans		26,319	Fair value of collateral	Discount for type of property, age of appraisal, and current status	10% - 78% (32%)
Foreclosed Assets
Commercial real estate		1,726	Fair value of collateral	Discount for type of property, age of appraisal, and current status	7% - 25% (18%)
Residential (1)		55	Fair value of collateral	Discount for type of property, age of appraisal, and current status	39%
(1)  There was only one foreclosed residential asset at December 31, 2017, so no range or weighted average rate is reported.

Financial instruments recorded using fair value option

Old National may elect to report most financial instruments and certain other items at fair value on an instrument-by instrument basis with changes in fair value reported in net income.  After the initial adoption, the election is made at the acquisition of an eligible financial asset, financial liability or firm commitment or when certain specified reconsideration events occur.  The fair value election may not be revoked once an election is made.

Old National has elected the fair value option for residential loans held for sale.  For these loans, interest income is recorded in the consolidated statements of income based on the contractual amount of interest income earned on the financial assets (except any that are on nonaccrual status).  None of these loans are 90 days or more past due, nor are any on nonaccrual status.  Included in the income statement is interest income for loans held for sale totaling $0.5 million in 2018 and $0.2 million in 2017.

Residential loans held for sale

Old National has elected the fair value option for newly originated conforming fixed-rate and adjustable-rate first mortgage loans held for sale.  These loans are intended for sale and are hedged with derivative instruments.  Old National has elected the fair value option to mitigate accounting mismatches in cases where hedge accounting is complex and to achieve operational simplification.  The fair value option was not elected for loans held for investment.

The difference between the aggregate fair value and the aggregate remaining principal balance for loans for which the fair value option has been elected as of December 31, 2018 and 2017 was as follows:

	Aggregate				Contractual
(dollars in thousands)	Fair Value		Difference		Principal
2018
Residential loans held for sale	$	14,911	$	475	$	14,436
2017
Residential loans held for sale	$	17,930	$	546	$	17,384

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Accrued interest at period end is included in the fair value of the instruments.

The following table presents the amount of gains and losses from fair value changes included in income before income taxes for financial assets carried at fair value for the years ended December 31:

									Total Changes
									in Fair Values
	Other								Included in
	Gains and			Interest		Interest			Current Period
(dollars in thousands)	(Losses)			Income		(Expense)			Earnings
2018
Residential loans held for sale	$	(67	)	$	6	$	(10	)	$	(71	)
2017
Residential loans held for sale	$	409		$	4	$	—		$	413

The carrying amounts and estimated fair values of financial instruments not carried at fair value at December 31, 2018 and 2017 were as follows:

			Fair Value Measurements at December 31, 2018 Using
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
(dollars in thousands)	Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets
Cash, due from banks, money market,    and other interest-earning investments	$	317,165	$	317,165	$	—	$	—
Investment securities held-to-maturity:
U.S. government-sponsored entities and agencies		73,986		—		72,359		—
Mortgage-backed securities - Agency		127,120		—		124,409		—
State and political subdivisions		305,228		—		309,335		—
Loans, net:
Commercial		3,211,228		—		—		3,161,132
Commercial real estate		4,935,381		—		—		4,781,294
Residential real estate		2,246,127		—		—		2,225,853
Consumer credit		1,795,695		—		—		1,773,352
Accrued interest receivable		89,464		13		27,580		61,871
Financial Liabilities
Deposits:
Noninterest-bearing demand deposits	$	3,965,380	$	3,965,380	$	—	$	—
Checking, NOW, savings, and money market    interest-bearing deposits		8,360,313		8,360,313		—		—
Time deposits		2,024,256	—			2,002,187		—
Federal funds purchased and interbank borrowings		270,135		270,135		—		—
Securities sold under agreements to repurchase		362,294		362,294		—		—
FHLB advances		1,613,481		—		—		1,611,103
Other borrowings		247,883		—		248,065		—
Accrued interest payable		9,871		—		9,871		—
Standby letters of credit		525		—		—		525
Off-Balance Sheet Financial Instruments
Commitments to extend credit	$	—	$	—	$	—	$	3,115

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			Fair Value Measurements at December 31, 2017 Using
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
(dollars in thousands)	Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets
Cash, due from banks, money market,    and other interest-earning investments	$	290,432	$	290,432	$	—	$	—
Investment securities held-to-maturity:
Mortgage-backed securities - Agency		6,903		—		7,056		—
State and political subdivisions		677,160		—		720,647		—
Loans, net:
Commercial		2,698,023		—		—		2,707,385
Commercial real estate		4,333,116		—		—		4,347,949
Residential real estate		2,165,290		—		—		2,210,951
Consumer credit		1,871,311		—		—		1,998,194
Accrued interest receivable		87,102		16		24,001		63,085
Financial Liabilities
Deposits:
Noninterest-bearing demand deposits	$	3,680,807	$	3,680,807	$	—	$	—
Checking, NOW, savings, and money market    interest-bearing deposits		7,290,521		7,290,521		—		—
Time deposits		1,634,436		—		1,620,685		—
Federal funds purchased and interbank borrowings		335,033		335,033		—		—
Securities sold under agreements to repurchase		384,810		359,810		25,133		—
FHLB advances		1,609,579		—		—		1,607,189
Other borrowings		248,782		—		250,443		—
Accrued interest payable		7,029		—		7,029		—
Standby letters of credit		351		—		—		351
Off-Balance Sheet Financial Instruments
Commitments to extend credit	$	—	$	—	$	—	$	2,449

The methods utilized to estimate the fair value of financial instruments at December 31, 2017 did not necessarily represent an exit price.  In accordance with our adoption of ASU 2016-01 in 2018, the methods utilized to measure the fair value of financial instruments at December 31, 2018 represent an approximation of exit price, however, an actual exit price may differ.

NOTE 21 – DERIVATIVE FINANCIAL INSTRUMENTS

As discussed in Note 1, Old National adopted ASU 2017-12 in the first quarter of 2018.  This adoption primarily impacted our existing cash flow and fair value hedges related to certain FHLB advances.  For cash flow hedges as of the date of adoption, the transition guidance in paragraph 815-20-65-3(d) eliminated the separate measurement of ineffectiveness by means of a cumulative-effect adjustment to accumulated other comprehensive income with a corresponding adjustment to the opening balance of retained earnings.  For fair value hedges of interest rate risk, the provisions of paragraph 815-25-35-13 permit Old National to elect to modify the measurement methodology to be based on the benchmark rate component of the contractual coupon cash flows without dedesignation of the hedging relationship.  The measurement methodology modification shall be applied as of the hedging relationship’s original inception date.  The cumulative effect of applying this election shall be recognized as an adjustment to the basis adjustment of the hedged item recognized on the balance sheet with a corresponding adjustment to the opening balance of retained earnings as of the initial application date.

As part of our overall interest rate risk management, Old National uses derivative instruments, including interest rate swaps, collars, caps, and floors.  The notional amount of these derivative instruments was $1.482 billion at December 31, 2018 and $708.5 million at December 31, 2017.  These derivative financial instruments at December 31, 2018 consisted of $757.0 million notional amount of receive-fixed, pay-variable interest rate swaps on certain of its FHLB advances, $525.0 million notional amount of pay-fixed, receive-variable interest rate swaps on certain of its FHLB advances, and $200.0 million notional amount interest rate collars related to a variable-rate commercial loan pool.  Derivative financial instruments at December 31, 2017 consisted of $33.5 million notional amount of

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receive-fixed, pay-variable interest rate swaps on certain of its FHLB advances and $675.0 million notional amount of pay-fixed, receive-variable interest rate swaps on certain of its FHLB advances.  These hedges were entered into to manage interest rate risk.  Derivative instruments are recognized on the balance sheet at their fair value and are not reported on a net basis.

In accordance with ASC 815-20-35-1, subsequent changes in fair value for a hedging instrument that has been designated and qualifies as part of a hedging relationship should be accounted for in the following manner:

Cash flow hedges: changes in fair value will be recognized as a component in other comprehensive income.

Fair value hedges: changes in fair value will be recognized concurrently in earnings.

Consistent with this guidance, as long as a hedging instrument is designated and the results of the effectiveness testing support that the instrument qualifies for hedge accounting treatment, 100% of the periodic changes in fair value of the hedging instrument will be accounted for as outlined above. This is the case whether or not economic mismatches exist in the hedging relationship. As a result, there will be no periodic measurement or recognition of ineffectiveness. Rather, the full impact of hedge gains and losses will be recognized in the period in which the hedged transactions impact earnings.

While separate measurement and presentation of ineffectiveness is being eliminated, paragraph 815-20-45-1A requires the change in fair value of the hedging instrument that is included in the assessment of hedge effectiveness be presented in the same income statement line item that is used to present the earnings effect of the hedged item.

Commitments to fund certain mortgage loans (interest rate lock commitments) and forward commitments for the future delivery of mortgage loans to third party investors are considered derivatives.  These derivative contracts do not qualify for hedge accounting.  At December 31, 2018, the notional amount of the interest rate lock commitments was $27.6 million and forward commitments were $34.5 million.  At December 31, 2017, the notional amount of the interest rate lock commitments was $29.9 million and forward commitments were $41.2 million.  It is our practice to enter into forward commitments for the future delivery of residential mortgage loans to third party investors when interest rate lock commitments are entered into in order to economically hedge the effect of changes in interest rates resulting from our commitment to fund the loans.

Old National also enters into derivative instruments for the benefit of its customers.  The notional amounts of these customer derivative instruments and the offsetting counterparty derivative instruments were $793.4 million at December 31, 2018.  The notional amounts of these customer derivative instruments and the offsetting counterparty derivative instruments were $826.6 million at December 31, 2017.  These derivative contracts do not qualify for hedge accounting.  These instruments include interest rate swaps, caps, and collars.  Commonly, Old National will economically hedge significant exposures related to these derivative contracts entered into for the benefit of customers by entering into offsetting contracts with approved, reputable, independent counterparties with substantially matching terms.

Old National enters into derivative financial instruments as part of its foreign currency risk management strategies.  These derivative instruments consist of foreign currency forward contracts to accommodate the business needs of its customers.  Old National does not designate these foreign currency forward contracts for hedge accounting treatment.  The notional amounts of these foreign currency forward contracts and the offsetting counterparty derivative instruments were $3.6 million at December 31, 2018 and $0.8 million at December 31, 2017.

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

Amounts reported in AOCI related to cash flow hedges will be reclassified to interest income or interest expense as interest payments are received or paid on Old National’s derivative instruments.  During the next 12 months, we estimate that $1.2 million will be reclassified to interest income and $0.4 million will be reclassified to interest expense.

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The following table summarizes the fair value of derivative financial instruments utilized by Old National:

	Balance			Balance
	Sheet	Fair		Sheet	Fair
(dollars in thousands)	Location	Value		Location	Value
December 31, 2018
Derivatives designated as hedging instruments
Interest rate contracts	Other Assets	$	12,741	Other Liabilities	$	1,603
Total derivatives designated as hedging instruments		$	12,741		$	1,603
Derivatives not designated as hedging instruments
Interest rate contracts	Other Assets	$	15,278	Other Liabilities	$	10,562
Mortgage contracts	Other Assets		874	Other Liabilities		316
Foreign currency contracts	Other Assets		112	Other Liabilities		69
Total derivatives not designated as hedging instruments		$	16,264		$	10,947
Total		$	29,005		$	12,550
December 31, 2017
Derivatives designated as hedging instruments
Interest rate contracts	Other Assets	$	3,351	Other Liabilities	$	5,351
Total derivatives designated as hedging instruments		$	3,351		$	5,351
Derivatives not designated as hedging instruments
Interest rate contracts	Other Assets	$	10,012	Other Liabilities	$	10,933
Mortgage contracts	Other Assets		747	Other Liabilities		—
Foreign currency contracts	Other Assets		8	Other Liabilities		8
Total derivatives not designated as hedging instruments		$	10,767		$	10,941
Total		$	14,118		$	16,292

The effect of derivative instruments in fair value hedging relationships on the consolidated statements of income for the years ended December 31 were as follows:

(dollars in thousands)							Gain (Loss)
							Recognized
	Location of Gain or	Gain (Loss)			Hedged Items	Location of Gain or	in Income on
Derivatives in	(Loss) Recognized in	Recognized			in Fair Value	(Loss) Recognized in	Related
Fair Value Hedging	in Income on	in Income on			Hedging	in Income on Related	Hedged
Relationships	Derivative	Derivative			Relationships	Hedged Item	Items
2018
Interest rate contracts	Interest income / (expense)	$	7,662		Fixed-rate debt	Interest income / (expense)	$	(7,634	)
2017
Interest rate contracts	Interest income / (expense)	$	(836	)	Fixed-rate debt	Interest income / (expense)	$	1,006
2016
Interest rate contracts	Interest income / (expense)	$	(863	)	Fixed-rate debt	Interest income / (expense)	$	991

The difference between the gain (loss) recognized in income on derivatives and the gain (loss) recognized in income on the related hedged items represents hedge ineffectiveness.  In addition, the net swap settlements that accrue each period are also reported in interest expense.

The effect of derivative instruments in cash flow hedging relationships on the consolidated statements of income for the years ended December 31 were as follows:

		Years Ended December 31,							Years Ended December 31,
(dollars in thousands)		2018		2017		2016			2018			2017			2016
		Gain (Loss)							Gain (Loss)
	Location of Gain or	Recognized in Other							Reclassified from
Derivatives in	(Loss) Reclassified	Comprehensive							AOCI into
Cash Flow Hedging	from AOCI into Income	Income on Derivative							Income (Effective
Relationships	(Effective Portion)	(Effective Portion)							Portion)
Interest rate contracts	Interest income/(expense)	$	5,145	$	927	$	(2,323	)	$	(150	)	$	(6,135	)	$	(6,453	)

The ineffective portion and amount excluded from effectiveness testing related to derivatives in cash flow hedging relationships was immaterial for the years ended December 31, 2018, 2017, and 2016.

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The effect of derivatives not designated as hedging instruments on the consolidated statements of income for the years ended December 31 were as follows:

		Years Ended December 31,
(dollars in thousands)		2018			2017			2016
	Location of Gain or (Loss)	Gain (Loss)
Derivatives Not Designated as	Recognized in Income on	Recognized in Income on
Hedging Instruments	Derivative	Derivative
Interest rate contracts (1)	Other income/(expense)	$	(7	)	$	56		$	28
Mortgage contracts	Mortgage banking revenue		(189	)		(1,995	)		1,390
Foreign currency contracts	Other income/(expense)		42			—			—
Total		$	(154	)	$	(1,939	)	$	1,418

(1)Includes the valuation difference between the customer and offsetting swaps.

NOTE 22 – COMMITMENTS AND CONTINGENCIES

Litigation

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

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

Old National is not currently involved in any material litigation.

Credit-Related Financial Instruments

In the normal course of business, Old National’s banking affiliates have entered into various agreements to extend credit, including loan commitments of $3.566 billion and standby letters of credit of $319.0 million at December 31, 2018.  At December 31, 2018, approximately $3.348 billion of the loan commitments had fixed rates and $218.1 million had floating rates, with the floating interest rates ranging from 1% to 16%.  At December 31, 2017, loan commitments totaled $3.144 billion and standby letters of credit totaled $68.7 million.  These commitments are not reflected in the consolidated financial statements.  The allowance for unfunded loan commitments totaled $2.5 million at December 31, 2018 and $3.1 million at December 31, 2017.

Old National had credit extensions with various unaffiliated banks related to letter of credit commitments issued on behalf of Old National’s clients totaling $15.5 million at December 31, 2018 and $12.4 million at December 31, 2017.  Old National provided collateral to the unaffiliated banks to secure credit extensions totaling $7.8 million at December 31, 2018 and $11.5 million December 31, 2017.  Old National did not provide collateral for the remaining credit extensions.

Visa Class B Restricted Shares

In 2008, Old National received Visa Class B restricted shares as part of Visa’s initial public offering.  These shares are transferable only under limited circumstances until they can be converted into the publicly traded Class A common shares.  This conversion will not occur until the final settlement of certain litigation for which Visa is indemnified by the holders of Visa’s Class B shares, including Old National.  Visa funded an escrow account from

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its initial public offering to settle these litigation claims.  Increases in litigation claims requiring Visa to fund the escrow account due to insufficient funds will result in a reduction of the conversion ratio of each Visa Class B share to unrestricted Class A shares.  As of December 31, 2018, the conversion ratio was 1.6298.  Based on the existing transfer restriction and the uncertainty of the outcome of the Visa litigation, the 56,210 Class B shares that Old National owns at December 31, 2018 are carried at a zero cost basis.

NOTE 23 – FINANCIAL GUARANTEES

Old National holds instruments, in the normal course of business with clients, that are considered financial guarantees in accordance with FASB ASC 460-10 (FIN 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others), which requires Old National to record the instruments at fair value.  Standby letters of credit guarantees are issued in connection with agreements made by clients to counterparties.  Standby letters of credit are contingent upon failure of the client to perform the terms of the underlying contract.  Credit risk associated with standby letters of credit is essentially the same as that associated with extending loans to clients and is subject to normal credit policies.  The term of these standby letters of credit is typically one year or less.  At December 31, 2018, the notional amount of standby letters of credit was $319.0 million, which represented the maximum amount of future funding requirements, and the carrying value was $0.5 million.  At December 31, 2017, the notional amount of standby letters of credit was $68.7 million, which represented the maximum amount of future funding requirements, and the carrying value was $0.4 million.

Old National is a party in risk participation transactions of interest rate swaps, which had total notional amount of $38.7 million at December 31, 2018.

NOTE 24 – REVENUE FROM CONTRACTS WITH CUSTOMERS

Old National’s revenue from contracts with customers in the scope of Topic 606 is recognized within noninterest income.  The consolidated statements of income include all categories of noninterest income.  The following table reflects only the categories of noninterest income that are within the scope of Topic 606:

	Years Ended December 31,
(dollars in thousands)	2018		2017		2016
Wealth management fees	$	36,863	$	37,316	$	34,641
Service charges on deposit accounts		44,026		41,331		41,578
Debit card and ATM fees		20,216		17,676		16,769
Insurance premiums and commissions		399		617		20,527
Investment product fees		20,539		20,977		18,822
Other income:
Merchant processing fees		2,927		2,634		2,574
Gain (loss) on other real estate owned		1,270		939		1,419
Safe deposit box fees		1,124		926		961
Total	$	127,364	$	122,416	$	137,291

The adoption of Topic 606 did not have a material impact on our consolidated financial position, results of operations, equity, or cash flows as of the adoption date or for the year ended December 31, 2018.  A description of wealth management fees, service charges on deposit accounts, debit card and ATM fees, and investment product fees are provided below.

Wealth management fees: Old National earns wealth management fees based upon asset custody and investment management services provided to individual and institutional customers.  Most of these customers receive monthly or quarterly billings for services rendered based upon the market value of assets in custody.  Fees that are transaction based are recognized at the point in time that the transaction is executed.

Service charges on deposit accounts: Old National earns fees from deposit customers for transaction-based, account maintenance, and overdraft services.  Transaction-based fees and overdraft fees are recognized at a point in time, since the customer generally has a right to cancel the depository arrangement at any time.  The arrangement is considered a day-to-day contract with ongoing renewals and optional purchases, so the duration of the contract does not extend beyond the services already performed.  Account maintenance fees, which relate primarily to monthly

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maintenance, are earned over the course of a month, representing the period over which Old National satisfies its performance obligation.

Debit card and ATM fees: Debit card and ATM fees include ATM usage fees and debit card interchange income.  As with the transaction-based fees on deposit accounts, the ATM fees are recognized at the point in time that Old National fulfills the customer’s request.  Old National earns interchange fees from cardholder transactions processed through card association networks.  Interchange rates are generally set by the card associations based upon purchase volumes and other factors.  Interchange fees represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder.

Investment product fees: Investment product fees are the commissions and fees received from a registered broker/dealer and investment adviser that provide those services to Old National customers.  Old National acts as an agent in arranging the relationship between the customer and the third-party service provider.  These fees are recognized monthly from the third-party broker based upon services already performed, net of the processing fees charged to Old National by the broker.

NOTE 25 – REGULATORY RESTRICTIONS

Restrictions on Cash and Due from Banks

Old National’s affiliate bank is required to maintain reserve balances on hand and with the Federal Reserve Bank that are interest-bearing and unavailable for investment purposes.  The reserve balances were $108.1 million at December 31, 2018 and $100.9 million at December 31, 2017.  In addition, Old National had cash and due from banks which was held as collateral for collateralized swap positions of $5.7 million at December 31, 2017.  Old National did not have any cash and due from banks held as collateral for collateralized swap positions at December 31, 2018.

Restrictions on Transfers from Affiliate Bank

Regulations limit the amount of dividends an affiliate bank can declare in any year without obtaining prior regulatory approval.  Prior regulatory approval is required if dividends to be declared in any year would exceed net earnings of the current year plus retained net profits for the preceding two years. Prior regulatory approval to pay dividends was not required in 2016, 2017, or 2018 and is not currently required.

Restrictions on the Payment of Dividends

Old National has traditionally paid a quarterly dividend to common stockholders.  The payment of dividends is subject to legal and regulatory restrictions.  Any payment of dividends in the future will depend, in large part, on Old National’s earnings, capital requirements, financial condition, and other factors considered relevant by our Board of Directors.

Capital Adequacy

Old National and Old National Bank are subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can elicit certain mandatory actions by regulators that, if undertaken, could have a direct material effect on Old National’s financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Old National and Old National Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.  The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.  Prompt corrective action provisions are not applicable to bank holding companies.  Quantitative measures established by regulation to ensure capital adequacy require Old National and Old National Bank to maintain minimum amounts and ratios as set forth in the following tables.

At December 31, 2018, Old National and Old National Bank exceeded the regulatory minimums and Old National Bank met the regulatory definition of well-capitalized based on the most recent regulatory notification.

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The following table summarizes capital ratios for Old National and Old National Bank as of December 31:

						Fully Phased-In
						Regulatory						Well Capitalized
	Actual					Guidelines Minimum (1)						Guidelines
(dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount			Ratio
2018
Total capital to risk- weighted    assets
Old National Bancorp	$	1,748,231		12.27	%	$	1,496,099		10.50	%	$	N/A		N/A		%
Old National Bank		1,769,930		12.47			1,489,938		10.50				1,418,989		10.00
Common equity Tier 1 capital    to risk-weighted assets
Old National Bancorp		1,617,936		11.36			997,399		7.00			N/A		N/A
Old National Bank		1,699,945		11.98			993,292		7.00				922,343		6.50
Tier 1 capital to risk-weighted    assets
Old National Bancorp		1,617,936		11.36			1,211,128		8.50			N/A		N/A
Old National Bank		1,699,945		11.98			1,206,141		8.50				1,135,191		8.00
Tier 1 capital to average assets
Old National Bancorp		1,617,936		9.17			705,681		4.00			N/A		N/A
Old National Bank		1,699,945		9.58			709,929		4.00				887,412		5.00
2017
Total capital to risk-weighted    assets
Old National Bancorp	$	1,424,123		11.40	%	$	1,311,600		10.50	%	$	N/A		N/A		%
Old National Bank		1,458,546		11.73			1,305,076		10.50				1,242,929		10.00
Common equity Tier 1 capital    to risk-weighted assets
Old National Bancorp		1,298,327		10.39			874,400		7.00			N/A		N/A
Old National Bank		1,393,059		11.21			870,051		7.00				807,904		6.50
Tier 1 capital to risk-weighted    assets
Old National Bancorp		1,298,327		10.39			1,061,772		8.50			N/A		N/A
Old National Bank		1,393,059		11.21			1,056,490		8.50				994,344		8.00
Tier 1 capital to average assets
Old National Bancorp		1,298,327		8.28			627,258		4.00			N/A		N/A
Old National Bank		1,393,059		8.93			623,758		4.00				779,697		5.00

(1) As of January 1, 2019, Basel III Capital Rules required banking organizations to maintain: a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer”; a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer; a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer; and a minimum ratio of Tier 1 capital to adjusted average consolidated assets of at least 4.0%.

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NOTE 26 – PARENT COMPANY FINANCIAL STATEMENTS

The following are the condensed parent company only financial statements of Old National:

OLD NATIONAL BANCORP (PARENT COMPANY ONLY)

CONDENSED BALANCE SHEETS

	December 31,
(dollars in thousands)	2018		2017
Assets
Deposits in affiliate bank	$	90,005	$	43,538
Equity securities		5,582		5,584
Investment securities - available-for-sale		1,527		1,547
Investment in affiliates:
Banking subsidiaries		2,769,166		2,248,700
Non-banks		5,151		5,142
Other assets		87,096		112,353
Total assets	$	2,958,527	$	2,416,864
Liabilities and Shareholders' Equity
Other liabilities	$	37,563	$	31,768
Other borrowings		231,394		230,699
Shareholders' equity		2,689,570		2,154,397
Total liabilities and shareholders' equity	$	2,958,527	$	2,416,864

OLD NATIONAL BANCORP (PARENT COMPANY ONLY)

CONDENSED STATEMENTS OF INCOME

	Years Ended December 31,
(dollars in thousands)	2018			2017			2016
Income
Dividends from affiliates	$	105,000		$	100,000		$	160,007
Net securities gains		49			667			100
Other income		2,126			1,966			40,841
Other income from affiliates		5			5			6
Total income		107,180			102,638			200,954
Expense
Interest on borrowings		10,425			9,298			9,077
Other expenses		21,936			16,335			18,460
Total expense		32,361			25,633			27,537
Income before income taxes and equity    in undistributed earnings of affiliates		74,819			77,005			173,417
Income tax expense (benefit)		(5,693	)		(6,240	)		11,952
Income before equity in undistributed    earnings of affiliates		80,512			83,245			161,465
Equity in undistributed earnings of affiliates		110,318			12,480			(27,201	)
Net income	$	190,830		$	95,725		$	134,264

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OLD NATIONAL BANCORP (PARENT COMPANY ONLY)

CONDENSED STATEMENT OF CASH FLOWS

	Years Ended December 31,
(dollars in thousands)	2018			2017			2016
Cash Flows From Operating Activities
Net income	$	190,830		$	95,725		$	134,264
Adjustments to reconcile net income to cash    provided by operating activities:
Depreciation		53			36			29
Net securities (gains) losses		(49	)		(667	)		(100	)
Gain on sale of ONB Insurance Group, Inc.		—			—			(41,864	)
Share-based compensation expense		8,118			6,275			7,318
(Increase) decrease in other assets		28,754			(24,005	)		(3,958	)
Increase (decrease) in other liabilities		3,147			3,968			(225	)
Equity in undistributed earnings of affiliates		(110,318	)		(12,480	)		27,201
Total adjustments		(70,295	)		(26,873	)		(11,599	)
Net cash flows provided by (used in) operating activities		120,535			68,852			122,665
Cash Flows From Investing Activities
Net cash and cash equivalents of acquisitions		8,281			(24,005	)		(100,220	)
Proceeds from sale of ONB Insurance Group, Inc.		—			—			91,771
Proceeds from sales of equity securities		128			127			—
Purchases of investment securities		(76	)		(62	)		(52	)
Net advances to affiliates		—			(250	)		(3,500	)
Proceeds from sale of premises and equipment		1,065			—			—
Purchases of premises and equipment		(945	)		(612	)		(13	)
Net cash flows provided by (used in) investing activities		8,453			(24,802	)		(12,014	)
Cash Flows From Financing Activities
Payments for maturities/redemptions of other borrowings		—			(19,856	)		—
Cash dividends paid on common stock		(82,161	)		(72,604	)		(67,536	)
Common stock repurchased		(1,805	)		(2,761	)		(2,202	)
Proceeds from exercise of stock options		948			2,655			2,349
Common stock issued		497			404			388
Net cash flows provided by (used in) financing activities		(82,521	)		(92,162	)		(67,001	)
Net increase (decrease) in cash and cash equivalents		46,467			(48,112	)		43,650
Cash and cash equivalents at beginning of period		43,538			91,650			48,000
Cash and cash equivalents at end of period	$	90,005		$	43,538		$	91,650

NOTE 27 – SEGMENT INFORMATION

Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.  Old National Bank, Old National’s bank subsidiary, is the only significant subsidiary upon which management makes decisions regarding how to allocate resources and assess performance.  Each of the branches of Old National Bank provide a group of similar community banking services, including such products and services as commercial, real estate and consumer loans, time deposits, checking and savings accounts, cash management, brokerage, trust, and investment advisory services.  The individual bank branches located throughout our Midwest footprint have similar operating and economic characteristics.  While the chief decision maker monitors the revenue streams of the various products, services, and regional locations, operations are managed and financial performance is evaluated on a Company-wide basis.  Accordingly, all of the community banking services and branch locations are considered by management to be aggregated into one reportable operating segment, community banking.

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NOTE 28 – INTERIM FINANCIAL DATA (UNAUDITED)

The following table details the quarterly results of operations for the years ended December 31, 2018 and 2017.

(unaudited, dollars
and shares in thousands,	Three Months Ended								Three Months Ended
except per share data)	12/31/2018		9/30/2018		6/30/2018		3/31/2018		12/31/2017			9/30/2017		6/30/2017		3/31/2017
Interest income	$	175,234	$	155,369	$	153,736	$	147,706	$	135,134		$	123,525	$	118,209	$	118,468
Interest expense		29,009		24,527		21,773		19,134		16,578			15,047		13,876		12,667
Net interest income		146,225		130,842		131,963		128,572		118,556			108,478		104,333		105,801
Provision for loan losses		3,390		750		2,446		380		1,037			311		1,355		347
Noninterest income		58,154		45,957		49,289		41,905		44,825			46,366		49,271		42,920
Noninterest expense		150,268		119,376		130,460		117,157		140,432			103,702		102,811		101,891
Income before income taxes		50,721		56,673		48,346		52,940		21,912			50,831		49,438		46,483
Income tax expense		3,223		5,325		4,345		4,957		40,405			11,459		10,584		10,491
Net income (loss)	$	47,498	$	51,348	$	44,001	$	47,983	$	(18,493	)	$	39,372	$	38,854	$	35,992
Net income (loss) per share:
Basic	$	0.28	$	0.34	$	0.29	$	0.32	$	(0.13	)	$	0.30	$	0.28	$	0.27
Diluted		0.28		0.34		0.29		0.31		(0.13	)		0.29		0.28		0.27
Average shares:
Basic		167,044		151,930		151,878		151,721		146,073			135,120		135,085		134,912
Diluted		167,992		152,784		152,568		152,370		146,875			135,796		135,697		135,431

Quarterly results, most notably interest income, noninterest income, and noninterest expense, were impacted by the acquisitions of Klein in November 2018 and Anchor (MN) in November 2017. Income tax expense in the three months ended December 31, 2017 included $39.3 million of additional tax expense to estimate the revaluation of Old National’s deferred tax assets due to the lowering of the federal corporate tax rate to 21%.

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

ITEM 9A. CONTROLS AND PROCEDURES

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Evaluation of disclosure controls and procedures.  Old National’s principal executive officer and principal financial officer have concluded that Old National’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended), based on their evaluation of these controls and procedures as of the end of the period covered by this annual report on Form 10-K, are effective at the reasonable assurance level as discussed below to ensure that information required to be disclosed by Old National in the reports it files under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to Old National’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Limitations on the Effectiveness of Controls.  Management, including the principal executive officer and principal financial officer, does not expect that Old National’s disclosure controls and internal controls will prevent all error and all fraud.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls.

The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be only reasonable assurance that any design will succeed in achieving its stated goals under all potential future conditions.  Over time, control may become inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Changes in Internal Control over Financial Reporting.  There were no changes in Old National’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, Old National’s internal control over financial reporting.

ITEM 9B. OTHER INFORMATION

None.

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PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE OF THE REGISTRANT

This information is omitted from this report pursuant to General Instruction G.(3) of Form 10-K as Old National will file with the SEC its definitive Proxy Statement pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, not later than 120 days after December 31, 2018.  The applicable information appearing in the Proxy Statement for the 2019 annual meeting is incorporated by reference.

Old National has adopted a code of ethics that applies to directors, officers, and all other employees including Old National’s principal executive officer, principal financial officer and principal accounting officer.  The text of the code of ethics is available on Old National’s Internet website at www.oldnational.com or in print to any shareholder who requests it.  Old National intends to post information regarding any amendments to, or waivers from, its code of ethics on its Internet website.

ITEM 11. EXECUTIVE COMPENSATION

This information is omitted from this report pursuant to General Instruction G.(3) of Form 10-K as Old National will file with the SEC its definitive Proxy Statement pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, not later than 120 days after December 31, 2018.  The applicable information appearing in our Proxy Statement for the 2019 annual meeting is incorporated by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

This information is omitted from this report, (with the exception of the “Equity Compensation Plan Information,” which is reported in Item 5 of this report and is incorporated herein by reference) pursuant to General Instruction G.(3) of Form 10-K as Old National will file with the SEC its definitive Proxy Statement pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, not later than 120 days after December 31, 2018.  The applicable information appearing in the Proxy Statement for the 2019 annual meeting is incorporated by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

This information is omitted from this report pursuant to General Instruction G.(3) of Form 10-K as Old National will file with the SEC its definitive Proxy Statement pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, not later than 120 days after December 31, 2018.  The applicable information appearing in the Proxy Statement for the 2019 annual meeting is incorporated by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

This information is omitted from this report pursuant to General Instruction G.(3) of Form 10-K as Old National will file with the SEC its definitive Proxy Statement pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, not later than 120 days after December 31, 2018.  The applicable information appearing in the Proxy Statement for the 2019 annual meeting is incorporated by reference.

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PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

1. Financial Statements:

The following consolidated financial statements of the registrant and its subsidiaries are filed as part of this document under “Item 8.  Financial Statements and Supplementary Data.”

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets – December 31, 2018 and 2017

Consolidated Statements of Income – Years Ended December 31, 2018, 2017, and 2016

Consolidated Statements of Comprehensive Income – Years Ended December 31, 2018, 2017, and 2016

Consolidated Statements of Changes in Shareholders’ Equity – Years Ended December 31, 2018, 2017, and 2016

Consolidated Statements of Cash Flows – Years Ended December 31, 2018, 2017, and 2016

Notes to Consolidated Financial Statements

2. Financial Statement Schedules

The schedules for Old National and its subsidiaries are omitted because of the absence of conditions under which they are required, or because the information is set forth in the consolidated financial statements or the notes thereto.

3. Exhibits

The exhibits filed as part of this report and exhibits incorporated herein by reference to other documents are as follows:

Exhibit
Number
2	Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession.
2(a)	Agreement and Plan of Merger dated as of August 7, 2017 by and between Old National Bancorp and Anchor Bancorp, Inc. (the schedules and exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K) (incorporated by reference to Exhibit 2.1 of Old National’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 8, 2017).
2(b)	Agreement and Plan of Merger dated as of June 20, 2018 by and between Old National Bancorp and Klein Financial, Inc. (the schedules and exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K) (incorporated by reference to Exhibit 2.1 of Old National’s Current Report on Form 8-K filed with the Securities and Exchange Commission on June 21, 2018).
3(i)	Articles of Incorporation.
3(i)(a)	Fourth Amended and Restated Articles of Incorporation of Old National, amended May 13, 2016 (incorporated by reference to Exhibit 3.1 of Old National’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 16, 2016).
3(ii)	By-Laws.
3(ii)(a)	Amended and Restated By-Laws of Old National, amended July 28, 2016 (incorporated by reference to Exhibit 3.1 of Old National’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 1, 2016).
4	Instruments Defining Rights of Security Holders, Including Indentures.

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4(a)	Senior Indenture between Old National and The Bank of New York Trust Company (as successor to J.P. Morgan Trust Company, National Association (as successor to Bank One, N.A.)), as trustee, dated as of July 23, 1997 (incorporated by reference to Exhibit 4.3 to Old National’s Registration Statement on Form S-3, Registration No. 333-118374, filed with the Securities and Exchange Commission on December 2, 2004).
4(b)	Second Indenture Supplement, dated as of August 15, 2014, between Old National and The Bank of New York Mellon Trust Company, N.A., as trustee, providing for the issuance of its 4.125% Senior Notes due 2024 (incorporated by reference to Exhibit 4.1 of Old National’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 15, 2014).
10	Material Contracts.
(a)	Form of 2009 Executive Stock Option Agreement between Old National and certain key associates (incorporated by reference to Old National’s Current Report on Form 8-K/A filed with the Securities and Exchange Commission on February 13, 2009).*
(b)	Form of Employment Agreement for Robert G. Jones (incorporated by reference to Exhibit 10.1 of Old National’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 1, 2011).*
(c)	Form of Employment Agreement for Daryl D. Moore (incorporated by reference to Exhibit 10.2 of Old National’s Current Report on Form 8-K with the Securities and Exchange Commission on February 1, 2011).*
(d)	Form of Amended Severance/Change of Control Agreement for Jeffrey L. Knight (incorporated by reference to Exhibit 10(bb) of Old National’s Annual Report on Form 10-K for the year ended December 31, 2011).*
(e)	Form of 2015 Performance Units Award Agreement between Old National and certain key associates (incorporated by reference to Exhibit 10(au) of Old National's Annual Report on Form 10-K for the year ended December 31, 2014).*
(f)	Form of 2015 Restricted Stock Award Agreement between Old National and certain key associates (incorporated by reference to Exhibit 10(av) of Old National's Annual Report on Form 10-K for the year ended December 31, 2014).*
(g)	Form of 2016 Performance Units Award Agreement between Old National and certain key associates (incorporated by reference to Exhibit 10(av) of Old National’s Annual Report on Form 10-K for the year ended December 31, 2015).*
(h)	Form of 2016 Restricted Stock Award Agreement between Old National and certain key associates (incorporated by reference to Exhibit 10(aw) of Old National’s Annual Report on Form 10-K for the year ended December 31, 2015).*
(i)	Employment Agreement dated as of March 18, 2014, as amended and effective as of May 12, 2016 between Old National Bancorp and James A. Sandgren (incorporated by reference to Exhibit 10.1 of Old National’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 12, 2016).*
(j)	Employment Agreement dated as of May 12, 2016 between Old National Bancorp and James C. Ryan, III (incorporated by reference to Exhibit 10.2 of Old National’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 12, 2016).*
(k)	Employment Agreement dated as of January 1, 2008, as amended and effective as of January 1, 2009, January 1, 2011, and May 12, 2016 between Old National Bancorp and Christopher A. Wolking (incorporated by reference to Exhibit 10.3 of Old National’s Current Report on Form 8-K with the Securities and Exchange Commission on May 12, 2016).*
(l)	Form of 2017 Performance Units Award Agreement between Old National and certain key associates (incorporated by reference to Exhibit 10(n) of Old National’s Annual Report on Form 10-K for the year ended December 31, 2016).*

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(m)	Form of 2017 Restricted Stock Award Agreement between Old National and certain key associates (incorporated by reference to Exhibit 10(o) of Old National’s Annual Report on Form 10-K for the year ended December 31, 2016).*
(n)	Old National Bancorp Amended and Restated 2008 Incentive Compensation Plan (incorporated by reference to Appendix I of Old National’s Definitive Proxy Statement filed with the Securities and Exchange Commission on March 6, 2017).*
(o)	Form of 2018 Performance Units Award Agreement between Old National and certain key associates (incorporated by reference to Exhibit 10(s) of Old National’s Annual Report on Form 10-K for the year ended December 31, 2017).*
(p)	Form of 2018 Restricted Stock Award Agreement between Old National and certain key associates (incorporated by reference to Exhibit 10(t) of Old National’s Annual Report on Form 10-K for the year ended December 31, 2017).*
(q)	Stock Purchase and Dividend Reinvestment Plan (incorporated by reference to Old National’s Registration Statement on Form S-3, Registration No. 333-226817 filed with the Securities and Exchange Commission on August 13, 2018).
(r)	Form of 2019 Internal Performance Units Award Agreement between Old National and certain key associates is filed herewith.*
(s)	Form of 2019 Relative Performance Units Award Agreement between Old National and certain key associates is filed herewith.*
(t)	Form of 2019 Restricted Stock Award Agreement between Old National and certain key associates is filed herewith.*
21	Subsidiaries of Old National Bancorp
23.1	Consent of Crowe LLP
31.1	Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	The following materials from Old National Bancorp’s Annual Report on Form 10-K Report for the year ended December 31, 2018, formatted in iXBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to Consolidated Financial Statements.

*     Management contract or compensatory plan or arrangement

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Old National has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

OLD NATIONAL BANCORP

By:	/s/ Robert G. Jones	Date:	February 12, 2019
	Robert G. Jones,
	Chairman and Chief Executive Officer
	(Principal Executive Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on February 12, 2019, by the following persons on behalf of Old National and in the capacities indicated.

By:	/s/ Alan W. Braun	By:	/s/ Randall T. Shepard
	Alan W. Braun, Director		Randall T. Shepard, Director
By:	/s/ Andrew E. Goebel	By:	/s/ Rebecca S. Skillman
	Andrew E. Goebel, Director		Rebecca S. Skillman, Lead Director
By:	/s/ Jerome F. Henry Jr.	By:	/s/ Kelly N. Stanley
	Jerome F. Henry Jr., Director		Kelly N. Stanley, Director
By:	/s/ Robert G. Jones	By:	/s/ Derrick J. Stewart
	Robert G. Jones,		Derrick J. Stewart, Director
	Chairman and Chief Executive Officer
	(Principal Executive Officer)	By:	/s/ Katherine E. White
			Katherine E. White, Director
By:	/s/ Ryan C. Kitchell
	Ryan C. Kitchell, Director	By:	/s/ Linda E. White
			Linda E. White, Director
By:	/s/ Phelps L. Lambert
	Phelps L. Lambert, Director	By:	/s/ Michael W. Woods
			Michael W. Woods,
By:	/s/ James C. Ryan, III		Senior Vice President and Corporate Controller
	James C. Ryan, III,		(Principal Accounting Officer)
	Senior Executive Vice President and Chief
	Financial Officer (Principal Financial Officer)
By:	/s/ Thomas E. Salmon
	Thomas E. Salmon, Director

138