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Fair Value
 12 Months Ended
Dec. 31, 2013
Fair Value Disclosures [Abstract]  
Fair Value

NOTE 18—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 we have elected the fair value option, are summarized below:

 

            Fair Value Measurements at December 31, 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

    $ 3,566       $ 3,566       $ —         $ —     

Investment securities available-for-sale:

            

U.S. Treasury

      13,113         13,113         —           —     

U.S. Government-sponsored entities and agencies

      435,588         —           435,588         —     

Mortgage-backed securities—Agency

      1,289,258         —           1,289,258         —     

Mortgage-backed securities—Non-agency

      17,412         —           17,412         —     

States and political subdivisions

      268,795         —           268,126         669   

Pooled trust preferred securities

      8,037         —           —           8,037   

Other securities

      339,988         31,254         308,734         —     

Residential loans held for sale

      7,705         —           7,705         —     

Derivative assets

      22,087         —           22,087         —     

Financial Liabilities

            

Derivative liabilities

      19,723         —           19,723         —     
            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 twelve months ended December 31, 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

      17        5   

Sales/payments received

      (2,929 )      —     

Matured securities

      —          (320 ) 

Credit loss write-downs

      (1,000 )      —     

Increase/(decrease) in fair value of securities

      2,590        —     
  

 

 

    

 

 

  

Ending balance, December 31, 2013

    $ 8,037      $ 669   
  

 

 

    

 

 

  

Included in the income statement is $22,000 of income included in interest income from the accretion of discounts on securities and $1.0 million 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.

$32.8 million of mutual fund securities were transferred 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 twelve months ended December 31, 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

      17        7   

Payments received

      (87 )      —     

Matured securities

      —          (329 ) 

Increase/(decrease) in fair value of securities

      (476 )      —     

Transfer in at December 31

      2,578        —     
  

 

 

    

 

 

  

Ending balance, December 31, 2012

    $ 9,359      $ 984   
  

 

 

    

 

 

  

Included in the income statement is $24,000 of income included in interest income from the accretion of discounts on securities and $476,000 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.

 

$1.3 million of state and political subdivision securities were transferred to Level 3 as of December 31, 2011 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:

 

    Quantitative Information about Level 3 Fair Value Measurements
    Fair Value at     Valuation     Unobservable   Range (Weighted

(dollars in thousands)

   Dec. 31, 2013     Techniques     Input   Average)

Pooled trust preferred securities

   $ 8,037        Discounted cash flow      Constant prepayment rate (a)   0.00%
      Additional asset defaults (b)   1.9% – 9.6% (4.5%)
      Expected asset recoveries (c)   1.7% – 9.6% (3.2%)

State and political subdivision securities

     669        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 four 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 December 31, 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

    $ 9,224         —           —         $ 9,224   

Commercial real estate loans

      7,851         —           —           7,851   

Foreclosed Assets

            

Commercial real estate

      9,069         —           —           9,069   

Residential

      283         —           —           283   

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 $25.4 million, with a valuation allowance of $8.3 million at December 31, 2013. Old National recorded $6.9 million of provision expense associated with these loans in 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 $9.4 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. There were write-downs of other real estate owned of $2.4 million in 2013.

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

 

            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 tables below provide 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)

   Dec. 31, 2013     Techniques   Input   Average)

Collateral Dependent Impaired Loans

        

Commercial loans

   $ 9,224      Fair value of
collateral		   Discount for type of property,
age of appraisal and current
status		   0% – 75% (24%)

Commercial real estate loans

     7,851      Fair value of
collateral		   Discount for type of property,
age of appraisal and current
status		   10% – 54% (30%)

Foreclosed Assets

        

Commercial real estate

     9,069      Fair value of
collateral		   Discount for type of property,
age of appraisal and current
status		   10% – 40% (25%)

Residential

     283      Fair value of
collateral		   Discount for type of property,
age of appraisal and current
status		   10% – 45% (25%)

 

     Quantitative Information about Level 3 Fair Value Measurements  
     Fair Value at      Valuation    Unobservable    Range (Weighted  

(dollars in thousands)

    Dec. 31, 2012      Techniques    Input    Average)  

Collateral Dependent Impaired Loans

            

Commercial loans

    $ 14,159       Fair value of
collateral		    Discount for type of property,
age of appraisal and current
status		      0% – 50% (25%)   

Commercial real estate loans

      13,111       Fair value of
collateral		    Discount for type of property,
age of appraisal and current
status		      10% – 40% (25%)   

Foreclosed Assets

            

Commercial real estate

      24,032       Fair value of
collateral		    Discount for type of property,
age of appraisal and current
status		      10% – 40% (25%)   

Residential

      471       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, we 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.

We have 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 is $365 thousand of interest income for residential loans held for sale for the year ended December 31, 2013. Included in the income statement is $193 thousand of interest income for residential loans held for sale for the year ended December 31, 2012.

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 December 31, 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

    $ 7,705       $ 128       $ 7,577   
  

 

 

     

 

 

     

 

 

  

 

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 twelve months ended December 31, 2013:

 

Changes in Fair Value for the Twelve Months ended December 31, 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

    $ (224 )    $ —         $ (2 )    $ (226 ) 
  

 

 

    

 

 

     

 

 

    

 

 

  

As of December 31, 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

    $ 12,591       $ 354       $ 12,237   
  

 

 

     

 

 

     

 

 

  

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 twelve months ended December 31, 2012:

 

Changes in Fair Value for the Twelve Months ended December 31, 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

    $ 253       $ 2       $ —         $ 255   
  

 

 

     

 

 

     

 

 

     

 

 

  

 

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

 

            Fair Value Measurements at December 31, 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)  

December 31, 2013

            

Financial Assets

            

Cash, due from banks, federal funds sold and money market investments

    $ 206,723       $ 206,723       $ —         $ —     

Investment securities held-to-maturity:

            

U.S. Government-sponsored entities and agencies

      170,621         —           178,370         —     

Mortgage-backed securities—Agency

      35,443         —           36,349         —     

State and political subdivisions

      556,607         —           566,039         —     

Federal Home Loan Bank stock

      40,584         —           40,584         —     

Loans, net (including covered loans):

            

Commercial

      1,386,185         —           —           1,414,184   

Commercial real estate

      1,220,417         —           —           1,273,070   

Residential real estate

      1,384,183         —           —           1,475,710   

Consumer credit

      1,045,034         —           —           1,058,021   

FDIC indemnification asset

      88,513         —           —           55,368   

Accrued interest receivable

      50,205         42         20,708         29,455   

Financial Liabilities

            

Deposits:

            

Noninterest-bearing demand deposits

    $ 2,026,490       $ 2,026,490       $ —         $ —     

NOW, savings and money market deposits

      4,166,438         4,166,438         —           —     

Time deposits

      1,017,975         —           1,028,043         —     

Short-term borrowings:

            

Federal funds purchased

      115,103         115,103         —           —     

Repurchase agreements

      347,229         347,226         —           —     

Other borrowings:

            

Junior subordinated debenture

      28,000         —           17,605         —     

Repurchase agreements

      50,000         —           52,633         —     

Federal Home Loan Bank advances

      447,856         —           —           485,759   

Capital lease obligation

      4,157         —           5,245         —     

Accrued interest payable

      1,877         —           1,877         —     

Standby letters of credit

      380         —           —           380   

Off-Balance Sheet Financial Instruments

            

Commitments to extend credit

    $ —         $ —         $ —         $ 1,648   

 

          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 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 and periodically evaluated for impairment based on ultimate recovery of par value. The carrying value of FHLB stock approximates fair value based on the redemption provisions of the FHLB (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 we 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 20 and 21.