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 $136.8 million at March 31, 2015, compared to $147.7 million at December 31, 2014. The composition of covered loans by lending classification was as follows:

At March 31, 2015

(dollars in thousands)

Loans Accounted for
Under ASC 310-30
(Purchased Credit
Impaired)

Loans excluded from
ASC 310-30 (1)
(Not Purchased Credit
Impaired)

Total Covered
Purchased Loans

Commercial

5,255

8,574

13,829

Commercial real estate

33,540

2,959

36,499

Residential

20,101

147

20,248

Consumer

11,671

54,593

66,264

Covered loans

70,567

66,273

136,840

Allowance for loan losses

(802

)

(1,401

)

(2,203

)

Covered loans, net

69,765

64,872

134,637

(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 $233.4 million at March 31, 2015 and $241.9 million at December 31, 2014.

The following table is a roll-forward of acquired impaired loans accounted for under ASC 310-30 for the three months ended March 31, 2015 and 2014:


(dollars in thousands)	Contractual Cash Flows (1)			Nonaccretable Difference			Accretable Yield			Carrying Amount (2)
2015
Balance at January 1, 2015	$	124,809		$	(12,014	)	$	(35,742	)	$	77,053
Principal reductions and interest payments		(9,566	)		(702	)		—			(10,268	)
Accretion of loan discount		—			—			3,344			3,344
Changes in contractual and expected cash flows due to remeasurement		(498	)		3,695			(3,132	)		65
Removals due to foreclosure or sale		(433	)		133			(129	)		(429	)

Balance at March 31, 2015	$	114,312		$	(8,888	)	$	(35,659	)	$	69,765


2014
Balance at January 1, 2014	$	251,042		$	(46,793	)	$	(73,211	)	$	131,038
Principal reductions and interest payments		(25,353	)		(221	)		—			(25,574	)
Accretion of loan discount		—			—			11,339			11,339
Changes in contractual and expected cash flows due to remeasurement		(3,159	)		18,105			(13,412	)		1,534
Removals due to foreclosure or sale		(3,133	)		1,302			(2,006	)		(3,837	)

Balance at March 31, 2014	$	219,397		$	(27,607	)	$	(77,290	)	$	114,500

(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)	2015			2014
Balance at January 1,	$	35,742		$	73,211
Accretion of income		(3,344	)		(11,339	)
Reclassifications from (to) nonaccretable difference		3,132			13,412
Disposals/other adjustments		129			2,006

Balance at March 31,	$	35,659		$	77,290

At March 31, 2015, the $20.0 million loss sharing asset is comprised of a $16.6 million FDIC indemnification asset and a $3.4 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 March 31, 2015, $8.1 million of the FDIC indemnification asset is related to expected indemnification payments and $8.5 million is expected to be amortized and reported in noninterest income as an offset to future accreted interest income. At March 31, 2014, $22.4 million of the FDIC indemnification asset was related to expected indemnification payments and $38.2 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 three months ended March 31, 2015 and 2014:


(dollars in thousands)	2015			2014
Balance at January 1,	$	20,603		$	88,513
Adjustments not reflected in income:
Cash received from FDIC		—			(15,989	)
Other		389			518
Adjustments reflected in income:
(Amortization) accretion		(1,986	)		(5,203	)
Higher (lower) loan loss expectations		—			(412	)
Write-downs/(gain) on sale of other real estate		1,018			(1,728	)

Balance at March 31,	$	20,024		$	65,699