NOTE 9 – COVERED LOANS

Covered loans represent loans acquired from the FDIC that are subject to loss share agreements. The carrying amount of covered loans was $171.1 million at June 30, 2014. The composition of covered loans by lending classification was as follows:

At June 30, 2014

Loans Accounted for

Loans excluded from

Under ASC 310-30

ASC 310-30 (1)

(Purchased Credit

(Not Purchased

Total Covered

(dollars in thousands)

Impaired)

Credit Impaired)

Purchased Loans

Commercial

8,889

12,755

21,644

Commercial real estate

47,432

3,582

51,014

Residential

24,840

152

24,992

Consumer

14,988

58,510

73,498

Covered loans

96,149

74,999

171,148

Allowance for loan losses

(1,484

)

(2,174

)

(3,658

)

Covered loans, net

94,665

72,825

167,490

(1)	Includes loans with revolving privileges which are scoped out of FASB ASC 310-30 and certain loans which Old National elected to treat under the cost recovery method of accounting.

Loans were recorded at fair value in accordance with FASB ASC 805, Business Combinations. No allowance for loan losses related to the acquired loans is recorded on the acquisition date as the fair value of the loans acquired incorporates assumptions regarding credit risk. Loans acquired are recorded at fair value in accordance with the fair value methodology prescribed in FASB ASC 820, exclusive of the loss share agreements with the FDIC. The fair value estimates associated with the loans include estimates related to expected prepayments and the amount and timing of undiscounted expected principal, interest and other cash flows.

The outstanding balance of covered loans accounted for under ASC 310-30, including contractual principal, interest, fees and penalties, was $290.6 million and $406.3 million as of June 30, 2014 and December 31, 2013, respectively.

The following table is a roll-forward of acquired impaired loans accounted for under ASC 310-30 for the six months ended June 30, 2014:

Contractual

Nonaccretable

Accretable

Carrying

(dollars in thousands)

Cash Flows (1)

Difference

Yield

Amount (2)

Balance at January 1, 2014

251,042

(46,793

)

(73,211

)

131,038

Principal reductions and interest payments

(56,475

)

(828

)

(940

)

(58,243

)

Accretion of loan discount

—

24,950

Changes in contractual and expected cash flows due to remeasurement

(6,170

)

23,017

(14,494

)

2,353

Removals due to foreclosure or sale

(6,138

)

1,670

(965

)

(5,433

)

Balance at June 30, 2014

182,259

(22,934

)

(64,660

)

94,665

(1)	The balance of contractual cash flows includes future contractual interest and is net of amounts charged off and interest collected on nonaccrual loans.

(2)	Carrying amount for this table is net of allowance for loan losses.

The following table is a roll-forward of acquired impaired loans accounted for under ASC 310-30 for the six months ended June 30, 2013:


	Contractual			Nonaccretable			Accretable			Carrying
(dollars in thousands)	Cash Flows (1)			Difference			Yield			Amount (2)
Balance at January 1, 2013	$	424,527		$	(90,996	)	$	(85,779	)	$	247,752
Principal reductions and interest payments		(78,174	)		—			—			(78,174	)
Accretion of loan discount		—			—			19,174			19,174
Changes in contractual and expected cash flows due to remeasurement		(14,514	)		23,521			(8,873	)		134
Removals due to foreclosure or sale		(7,764	)		948			(1,663	)		(8,479	)

Balance at June 30, 2013	$	324,075		$	(66,527	)	$	(77,141	)	$	180,407

(1)	The balance of contractual cash flows includes future contractual interest and is net of amounts charged off and interest collected on nonaccrual loans.

(2)	Carrying amount for this table is net of allowance for loan losses.

Over the life of the acquired loans, we continue to estimate cash flows expected to be collected on individual loans or on pools of loans sharing common risk characteristics which were treated in the aggregate when applying various valuation techniques. We evaluate at each balance sheet date whether the present value of its loans determined using the effective interest rates has decreased and if so, recognize a provision for loan losses. For any increases in cash flows expected to be collected, we adjust the amount of accretable yield recognized on a prospective basis over the loan’s or pool’s remaining life. Eighty percent of the prospective yield adjustments are offset as Old National will recognize a corresponding decrease in cash flows expected from the indemnification asset prospectively in a similar manner. The indemnification asset is adjusted over the shorter of the life of the underlying investment or the indemnification agreement.

Accretable yield, or income expected to be collected on the covered loans accounted for under ASC 310-30, is as follows:


(dollars in thousands)	2014			2013
Balance at January 1,	$	73,211		$	85,779
New loans purchased		—			—
Accretion of income		(24,950	)		(19,174	)
Reclassifications from (to) nonaccretable difference		14,494			8,873
Disposals/other adjustments		1,905			1,663

Balance at June 30,	$	64,660		$	77,141

At June 30, 2014, the $51.4 million loss sharing asset is comprised of a $45.9 million FDIC indemnification asset and a $5.5 million FDIC loss share receivable. The loss share receivable represents actual incurred losses where reimbursement has not yet been received from the FDIC. The indemnification asset represents future cash flows we expect to collect from the FDIC under the loss sharing agreements and the amount related to the estimated improvements in cash flow expectations that are being amortized over the same period for which those improved cash flows are being accreted into income. At June 30, 2014, $17.0 million of the FDIC indemnification asset is related to expected indemnification payments and $28.9 million is expected to be amortized and reported in noninterest income as an offset to future accreted interest income. At June 30, 2013, $63.8 million of the FDIC indemnification asset was related to expected indemnification payments and $25.8 million was expected to be amortized and reported in noninterest income as an offset to future accreted interest income.

For covered loans, we remeasure contractual and expected cash flows on a quarterly basis. When the quarterly re-measurement process results in a decrease in expected cash flows due to an increase in expected credit losses, impairment is recorded. As a result of this impairment, the indemnification asset is increased to reflect anticipated future cash flows to be received from the FDIC. Consistent with the loss sharing agreements between Old National and the FDIC, the amount of the increase to the indemnification asset is measured at 80% of the resulting impairment.

Alternatively, when the quarterly re-measurement results in an increase in expected future cash flows due to a decrease in expected credit losses, the nonaccretable difference decreases and the effective yield of the related loan portfolio is increased. As a result of the improved expected cash flows, the indemnification asset would be reduced first by the amount of any impairment previously recorded and, second, by increased amortization over the remaining life of the related loss sharing agreements or the remaining life of the indemnification asset, whichever is shorter.

The following table shows a detailed analysis of the FDIC loss sharing asset for the six months ended June 30, 2014 and 2013:


(dollars in thousands)	2014			2013
Balance at January 1,	$	88,513		$	116,624
Adjustments not reflected in income:
Cash received from FDIC		(20,306	)		(13,098	)
Loan expenses to be reimbursed		(103	)		911
Other		1,140			(270	)
Adjustments reflected in income:
(Amortization) accretion		(15,988	)		(3,782	)
Higher (lower) loan loss expectations		(18	)		95
Write-downs/(gain) on sale of other real estate		(1,807	)		1,093
Recovery amounts due to FDIC		—			(1,243	)
Other		—			61

Balance at June 30,	$	51,431		$	100,391