Fair Value

6 Months Ended

Jun. 30, 2013

Fair Value Disclosures [Abstract]

Fair Value

NOTE 21 – FAIR VALUE

FASB ASC 820-10 defines fair value as 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. FASB ASC 820-10 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes 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).

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

			Fair Value Measurements at June 30, 2013 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
Trading securities	$	3,331	$	3,331	$	—	$	—
Investment securities available-for-sale:
U.S. Treasury		14,366		14,366		—		—
U.S. Government-sponsored entities and agencies		374,956		—		374,956		—
Mortgage-backed securities—Agency		1,392,512		—		1,392,512		—
Mortgage-backed securities—Non-agency		20,357		—		20,357		—
States and political subdivisions		643,887		—		643,211		676
Pooled trust preferred securities		9,152		—		—		9,152
Other securities		203,854		31,470		172,384		—
Residential loans held for sale		13,572		—		13,572		—
Derivative assets		26,722		—		26,722		—
Financial Liabilities
Derivative liabilities		21,217		—		21,217		—
			Fair Value Measurements at December 31, 2012  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
Trading securities	$	3,097	$	3,097	$	—	$	—
Investment securities available-for-sale:
U.S. Treasury		11,841		11,841		—		—
U.S. Government-sponsored entities and agencies		517,325		—		517,325		—
Mortgage-backed securities—Agency		1,163,788		—		1,163,788		—
Mortgage-backed securities—Non-agency		30,196		—		30,196		—
States and political subdivisions		577,324		—		576,340		984
Pooled trust preferred securities		9,359		—		—		9,359
Other securities		190,951		32,762		158,189		—
Residential loans held for sale		12,591		—		12,591		—
Derivative assets		36,512		—		36,512		—
Financial Liabilities
Derivative liabilities		30,010		—		30,010		—

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended June 30, 2013:

	Fair Value Measurements using
	Significant Unobservable Inputs
	(Level 3)
	Pooled Trust Preferred			State and
	Securities Available-			Political
(dollars in thousands)	for-Sale			Subdivisions
Beginning balance, January 1, 2013	$	9,359		$	984
Accretion/(amortization) of discount or premium		9			2
Sales/payments received		(1,403	)		—
Matured securities		—			(310	)
Credit loss write-downs		—			—
Increase/(decrease) in fair value of securities		1,187			—
Ending balance, June 30, 2013	$	9,152		$	676

Included in the income statement is $11 thousand of income included in interest income from the accretion of discounts on securities. The 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.

$32.8 million of mutual fund securities were transferred from Level 2 to Level 1 as of December 31, 2012 because Old National could obtain quoted prices for the securities.

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended June 30, 2012:

	Fair Value Measurements using
	Significant Unobservable Inputs
	(Level 3)
	Pooled Trust Preferred			State and
	Securities Available-			Political
(dollars in thousands)	for-Sale			Subdivisions
Beginning balance, January 1, 2012	$	7,327		$	1,306
Accretion/(amortization) of discount or premium		8			3
Payments received		(43	)		—
Matured securities		—			(320	)
Credit loss write-downs		(161	)		—
Increase/(decrease) in fair value of securities		1,329			—
Ending balance, June 30, 2012	$	8,460		$	989

Included in the income statement is $11 thousand of income included in interest income from the accretion of discounts on securities and $161 thousand of credit losses included in noninterest income. The 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.

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

	Quantitative Information about Level 3 Fair Value  Measurements
	Fair Value at		Valuation		Unobservable	Range (Weighted
(dollars in thousands)	June 30, 2013		Techniques		Input	Average)
Pooled trust preferred securities	$	9,152		Discounted cash flow	Constant prepayment rate (a)	0.00%
					Additional asset defaults (b)	1% - 32% (8%)
					Expected asset recoveries (c)	3% - 21% (14%)
State and political subdivision securities		676		Discounted cash flow	No unobservable inputs	NA
					Illiquid local municipality issuance
					Old National owns 100%
					Carried at par

(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%.

The significant unobservable inputs used in the fair value measurement for pooled trust preferred securities are prepayment rates, assumed additional pool asset defaults and expected return to performing status of defaulted pool assets. Significant changes in any of the inputs in isolation would result in a significant change to the fair value measurement. Three of the five 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 are summarized below:

			Fair Value Measurements at June 30, 2013 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	$	10,482		—		—	$	10,482
Commercial real estate loans		14,794		—		—		14,794
Foreclosed Assets
Commercial real estate		20,985		—		—		20,985
Residential		593		—		—		593
Finance Leases Transferred to Held for Sale		11,553		—		11,553		—

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 $32.5 million, with a valuation allowance of $7.2 million at June 30, 2013. Old National recorded $3.9 million of provision expense associated with these loans for the six months ended June 30, 2013.

Other real estate owned and other repossessed property is measured at fair value less costs to sell and had a net carrying amount of $21.6 million. 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. These appraisals are discounted 0% to 45% depending on the type of property and the type of appraisal (market value vs. liquidation value). There were net write-downs of other real estate owned of $2.1 million in the first six months of 2013.

During the second quarter of 2013, finance leases of $11.6 million were transferred from the commercial loan category at fair value, which is the offer price, and a loss of $0.2 million was recognized.

			Fair Value Measurements at December 31, 2012 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	$	14,159		—		—	$	14,159
Commercial real estate loans		13,111		—		—		13,111
Foreclosed Assets
Commercial real estate		24,032		—		—		24,032
Residential		471		—		—		471

As of December 31, 2012, impaired commercial and commercial real estate loans had a principal amount of $34.1 million, with a valuation allowance of $6.8 million. Old National recorded $4.0 million of provision expense associated with these loans in 2012.

Other real estate owned and other repossessed property is measured at fair value less costs to sell and had a net carrying amount of $24.5 million at December 31, 2012. There were write-downs of other real estate owned of $15.3 million in 2012.

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

	Quantitative Information about Level 3 Fair Value Measurements
	Fair Value at		Valuation	Unobservable	Range (Weighted
(dollars in thousands)	June 30, 2013		Techniques	Input	Average)
Collateral Dependent Impaired Loans
Commercial loans	$	10,482	Fair value of collateral	Discount for type of property, age of appraisal and current status	0% - 50% (25%)
Commercial real estate loans		14,794	Fair value of collateral	Discount for type of property, age of appraisal and current status	10% - 40% (25%)
Foreclosed Assets
Commercial real estate		20,985	Fair value of collateral	Discount for type of property, age of appraisal and current status	10% - 40% (25%)
Residential		593	Fair value of collateral	Discount for type of property, age of appraisal and current status	10% - 45% (25%)

Collateral dependent loans, other real estate owned and other repossessed property are valued 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 appraisals are discounted depending on the type of property and the type of appraisal (market value vs. liquidation value).

Financial instruments recorded using fair value option

Under FASB ASC 825-10, the Company 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.

The Company has elected the fair value option for residential mortgage 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 are $105 thousand and $206 thousand of interest income for residential loans held for sale for the three and six months ended June 30, 2013, respectively. Included in the income statement are $34 thousand and $65 thousand of interest income for residential loans held for sale for the three and six months ended June 30, 2012, respectively.

Residential mortgage 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.

As of June 30, 2013, the difference between the aggregate fair value and the aggregate remaining principal balance for loans for which the fair value option has been elected is as follows. Accrued interest at period end is included in the fair value of the instruments.

	Aggregate					Contractual
(dollars in thousands)	Fair Value		Difference			Principal
Residential loans held for sale	$	13,572	$	(329	)	$	13,901

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 three and six months ended June 30, 2013:

Changes in Fair Value for the Three Months ended June 30, 2013, for Items
Measured at Fair Value Pursuant to Election of the Fair Value Option
									Total Changes
									in Fair Values
	Other								Included in
	Gains and			Interest		Interest			Current Period
(dollars in thousands)	(Losses)			Income		(Expense)			Earnings
Residential loans held for sale	$	(737	)	$	—	$	(3	)	$	(740	)
Changes in Fair Value for the Six Months ended June 30, 2013, for Items
Measured at Fair Value Pursuant to Election of the Fair Value Option
									Total Changes
									in Fair Values
	Other								Included in
	Gains and			Interest		Interest			Current Period
(dollars in thousands)	(Losses)			Income		(Expense)			Earnings
Residential loans held for sale	$	(683	)	$	—	$	—		$	(683	)

As of June 30, 2012, the difference between the aggregate fair value and the aggregate remaining principal balance for loans for which the fair value option has been elected was as follows. Accrued interest at period end is included in the fair value of the instruments.

	Aggregate				Contractual
(dollars in thousands)	Fair Value		Difference		Principal
Residential loans held for sale	$	4,366	$	136	$	4,230

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 three and six months ended June 30, 2012:

Changes in Fair Value for the Three Months ended June 30, 2012, for Items
Measured at Fair Value Pursuant to Election of the Fair Value Option
							Total Changes
							in Fair Values
	Other						Included in
	Gains and		Interest		Interest		Current Period
(dollars in thousands)	(Losses)		Income		(Expense)		Earnings
Residential loans held for sale	$	83	$	—	$	—	$	83
Changes in Fair Value for the Six Months ended June 30, 2012, for Items
Measured at Fair Value Pursuant to Election of the Fair Value Option
							Total Changes
							in Fair Values
	Other						Included in
	Gains and		Interest		Interest		Current Period
(dollars in thousands)	(Losses)		Income		(Expense)		Earnings
Residential loans held for sale	$	37	$	—	$	—	$	37

The carrying amounts and estimated fair values of financial instruments, not previously presented in this note, at June 30, 2013 and December 31, 2012 are as follows:

			Fair Value Measurements at June 30, 2013 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)
June 30, 2013
Financial Assets
Cash, due from banks, federal funds sold and money market investments	$	216,825	$	216,825	$	—	$	—
Investment securities held-to-maturity:
U.S. Government-sponsored entities and agencies		172,299		—		181,224		—
Mortgage-backed securities—Agency		44,286		—		45,985		—
State and political subdivisions		184,481		—		192,117		—
Federal Home Loan Bank stock		40,584		—		40,584		—
Loans, net (including covered loans):
Commercial		1,422,119		—		—		1,457,421
Commercial real estate		1,302,085		—		—		1,360,091
Residential real estate		1,428,853		—		—		1,542,833
Consumer credit		973,847		—		—		996,343
FDIC indemnification asset		100,391		—		—		70,630
Accrued interest receivable		48,516		41		21,589		26,886
Financial Liabilities
Deposits:
Noninterest-bearing demand deposits	$	1,881,440	$	1,881,440	$	—	$	—
NOW, savings and money market deposits		3,836,650		3,836,650		—		—
Time deposits		1,122,003		—		1,137,262		—
Short-term borrowings:
Federal funds purchased		105,190		105,190		—		—
Repurchase agreements		425,191		425,190		—		—
Other borrowings:
Junior subordinated debenture		28,000		—		16,855		—
Repurchase agreements		50,000		—		52,916		—
Federal Home Loan Bank advances		804,881		—		—		812,251
Capital lease obligation		4,184		—		5,201		—
Accrued interest payable		2,854		—		2,854		—
Standby letters of credit		314		—		—		314
Off-Balance Sheet Financial Instruments
Commitments to extend credit	$	—	$	—	$	—	$	1,563

			Fair Value Measurements at December 31, 2012 Using
(dollars in thousands)	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2012
Financial Assets
Cash, due from banks, federal funds sold and money market investments	$	264,060	$	264,060	$	—	$	—
Investment securities held-to-maturity:
U.S. Government-sponsored entities and agencies		173,936		—		188,263		—
Mortgage-backed securities—Agency		56,612		—		58,919		—
State and political subdivisions		169,282		—		183,021		—
Other securities		2,998		—		2,998		—
Federal Home Loan Bank stock		37,927		—		37,927		—
Loans, net (including covered loans):
Commercial		1,377,817		—		—		1,424,103
Commercial real estate		1,407,420		—		—		1,475,066
Residential real estate		1,356,922		—		—		1,458,672
Consumer credit		999,672		—		—		1,030,990
FDIC indemnification asset		116,624		—		—		106,976
Accrued interest receivable		46,979		43		20,701		26,235
Financial Liabilities
Deposits:
Noninterest-bearing demand deposits	$	2,007,770	$	2,007,770	$	—	$	—
NOW, savings and money market deposits		3,989,902		3,989,902		—		—
Time deposits		1,281,281		—		1,308,111		—
Short-term borrowings:
Federal funds purchased		231,688		231,688		—		—
Repurchase agreements		358,127		358,123		—		—
Other borrowings:
Junior subordinated debenture		28,000		—		16,255		—
Repurchase agreements		50,000		—		53,422		—
Federal Home Loan Bank advances		155,323		—		—		170,664
Capital lease obligation		4,211		—		5,657		—
Accrued interest payable		3,308		—		3,308		—
Standby letters of credit		357		—		—		357
Off-Balance Sheet Financial Instruments
Commitments to extend credit	$	—	$	—	$	—	$	2,305

The following methods and assumptions were used to estimate the fair value of each type of financial instrument.

Cash, due from banks, federal funds sold and resell agreements and money market investments: For these instruments, the carrying amounts approximate fair value (Level 1).

Investment securities: Fair values for investment securities held-to-maturity are based on quoted market prices, if available. For securities where quoted prices are not available, fair values are estimated based on market prices of similar securities (Level 2).

Federal Home Loan Bank Stock: Old National Bank is a member of the Federal Home Loan Bank 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 and periodically evaluated for impairment based on ultimate recovery of par value. The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank (Level 2).

Loans: The fair value of loans is estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities (Level 3).

Covered loans: Fair values for loans were based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and a discount rate reflecting current market rates for new originations of comparable loans adjusted for the risk inherent in the cash flow estimates. Loans were grouped together according to similar characteristics and were treated in the aggregate when applying various valuation techniques (Level 3).

FDIC indemnification asset: The loss sharing asset was measured separately from the related covered assets as it is not contractually embedded in the assets and is not transferable with the assets should the Bank choose to dispose of the assets. Fair value was originally estimated using projected cash flows related to the loss sharing agreement based on the expected reimbursements for losses and the applicable loss sharing percentage and these projected cash flows are updated with the cash flow estimates on covered assets. These cash flows were discounted to reflect the uncertainty of the timing and receipt of the loss sharing reimbursement from the FDIC (Level 3).

Accrued interest receivable and payable: The carrying amount approximates fair value and is aligned with the underlying assets or liabilities (Level 1, Level 2 or Level 3).

Deposits: The fair value of noninterest-bearing demand deposits and savings, NOW and money market deposits is the amount payable as of the reporting date (Level 1). The fair value of fixed-maturity certificates of deposit is estimated using rates currently offered for deposits with similar remaining maturities (Level 2).

Short-term borrowings: Federal funds purchased and other short-term borrowings generally have an original term to maturity of 30 days or less and, therefore, their carrying amount is a reasonable estimate of fair value (Level 1). The fair value of securities sold under agreements to repurchase is determined using end of day market prices (Level 1).

Other borrowings: The fair value of medium-term notes, subordinated debt and senior bank notes is determined using market quotes (Level 2). The fair value of FHLB advances is determined using calculated prices for new FHLB advances with similar risk characteristics (Level 3). The fair value of other debt is determined using comparable security market prices or dealer quotes (Level 2).

Standby letters of credit: Fair values for standby letters of credit are based on fees currently charged to enter into similar agreements. The fair value for standby letters of credit was recorded in “Accrued expenses and other liabilities” on the consolidated balance sheet in accordance with FASB ASC 460-10 (FIN 45) (Level 3).

Off-balance sheet financial instruments: Fair values for off-balance sheet credit-related financial instruments are based on fees currently charged to enter into similar agreements. For further information regarding the amounts of these financial instruments, see Notes 18 and 19.