NOTE 8 – LOANS AND ALLOWANCE FOR CREDIT LOSSES

Old National’s finance receivables 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, southeastern Illinois, western Kentucky and southwestern Michigan. Old National has no concentration of commercial loans in any single industry exceeding 10% of its portfolio.

The composition of loans by lending classification was as follows:


	June 30,			December 31,
(dollars in thousands)	2015			2014
Commercial (1)	$	1,775,954		$	1,629,600
Commercial real estate:
Construction		163,914			134,552
Other		1,603,427			1,576,558
Residential real estate		1,622,819			1,519,156
Consumer credit:
Heloc		369,961			360,320
Auto		955,859			846,969
Other		138,721			103,338
Covered loans		135,407			147,708

Total loans		6,766,062			6,318,201
Allowance for loan losses		(48,479	)		(44,297	)
Allowance for loan losses - covered loans		(1,712	)		(3,552	)

Net loans	$	6,715,871		$	6,270,352

(1)	Includes direct finance leases of $17.7 million at June 30, 2015 and $19.3 million at December 31, 2014.

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 short-term 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. As a general rule, Old National avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. 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 feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. 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, 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.

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 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 values. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

Covered loans

Covered loans represent loans acquired from the FDIC that are subject to loss share agreements whereby Old National is indemnified against 80% of losses up to $275.0 million, losses in excess of $275.0 million up to $467.2 million at 0% reimbursement, and 80% of losses in excess of $467.2 million. As of June 30, 2015, we do not expect losses to exceed $275.0 million. See Note 9 to the consolidated financial statements for further details on our covered loans.

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.

Effective January 1, 2015, we began using a probability of default (“PD”)/loss given default (“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 asset quality rating (“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 adopted the probability of default and loss given default model for commercial loans because we believe this approach has a tendency to react more quickly to credit cycle shifts (both positive and negative). Switching from migration analysis to the probability of default and loss given default model for our performing commercial and commercial real estate loans did not have a material effect on our allowance for loan losses at the date of adoption.

Prior to January 1, 2015, we used migration analysis as a tool to determine the adequacy of the allowance for loan losses for performing commercial and commercial real estate loans. Migration analysis is a statistical technique that attempts to estimate probable losses for existing pools of loans by matching actual losses incurred on loans back to their origination. Judgment is used to select and weight the historical periods which are most representative of the current environment.

We calculated migration analysis using several different scenarios based on varying assumptions to evaluate the widest range of possible outcomes. The migration-derived historical commercial loan loss rates were applied to the current commercial loan pools to arrive at an estimate of probable losses for the loans existing at the time of analysis. The amounts determined by migration analysis were adjusted for management’s best estimate of the effects of current economic conditions, loan quality trends, results from internal and external review examinations, loan volume trends, credit concentrations and various other factors.

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

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. Purchased credit impaired (“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. Impairment on PCI loans would be recognized in the current period as provision expense.

Old National’s activity in the allowance for loan losses for the three and six months ended June 30, 2015 and 2014 is as follows:


				Commercial
(dollars in thousands)	Commercial			Real Estate			Residential			Consumer			Unallocated		Total
Three Months Ended June 30, 2015
Balance at April 1, 2015	$	24,703		$	13,807		$	2,919		$	7,449		$	—	$	48,878
Charge-offs		(1,846	)		(265	)		(22	)		(1,494	)		—		(3,627	)
Recoveries		763			760			59			1,087			—		2,669
Provision		(186	)		2,023			(375	)		809			—		2,271

Balance at June 30, 2015	$	23,434		$	16,325		$	2,581		$	7,851		$	—	$	50,191


Three Months Ended June 30, 2014
Balance at April 1, 2014	$	19,506		$	19,310		$	3,359		$	5,378		$	—	$	47,553
Charge-offs		(926	)		(1,039	)		(220	)		(958	)		—		(3,143	)
Recoveries		794			480			27			841			—		2,142
Provision		(548	)		(987	)		407			728			—		(400	)

Balance at June 30, 2014	$	18,826		$	17,764		$	3,573		$	5,989		$	—	$	46,152


Six Months Ended June 30, 2015
Balance at January 1, 2015	$	20,670		$	17,348		$	2,962		$	6,869		$	—	$	47,849
Charge-offs		(1,802	)		445			(396	)		(3,098	)		—		(4,851	)
Recoveries		1,945			927			87			1,962			—		4,921
Provision		2,621			(2,395	)		(72	)		2,118			—		2,272

Balance at June 30, 2015	$	23,434		$	16,325		$	2,581		$	7,851		$	—	$	50,191


Six Months Ended June 30, 2014
Balance at January 1, 2014	$	16,565		$	22,401		$	3,239		$	4,940		$	—	$	47,145
Charge-offs		(2,073	)		(1,207	)		(199	)		(2,083	)		—		(5,562	)
Recoveries		1,586			1,575			109			1,662			—		4,932
Provision		2,748			(5,005	)		424			1,470			—		(363	)

Balance at June 30, 2014	$	18,826		$	17,764		$	3,573		$	5,989		$	—	$	46,152

The following table provides Old National’s recorded investment in financing receivables by portfolio segment at June 30, 2015 and December 31, 2014 and other information regarding the allowance:


			Commercial
(dollars in thousands)	Commercial		Real Estate		Residential		Consumer		Unallocated		Total
June 30, 2015
Allowance for loan losses:
Individually evaluated for impairment	$	8,793	$	4,138	$	—	$	—	$	—	$	12,931
Collectively evaluated for impairment		13,780		11,584		2,531		7,567		—		35,462
Noncovered loans acquired with deteriorated credit quality		443		603		14		79		—		1,139
Covered loans acquired with deteriorated credit quality		418		—		36		205		—		659

Total allowance for loan losses	$	23,434	$	16,325	$	2,581	$	7,851	$	—	$	50,191

Loans and leases outstanding:
Individually evaluated for impairment	$	73,632	$	49,418	$	—	$	—	$	—	$	123,050
Collectively evaluated for impairment		1,708,389		1,696,526		1,622,841		1,512,980		—		6,540,736
Loans acquired with deteriorated credit quality		2,536		28,769		130		5,303		—		36,738
Covered loans acquired with deteriorated credit quality		4,355		31,538		19,129		10,516		—		65,538

Total loans and leases outstanding	$	1,788,912	$	1,806,251	$	1,642,100	$	1,528,799	$	—	$	6,766,062


December 31, 2014
Allowance for loan losses:
Individually evaluated for impairment	$	7,280	$	2,945	$	—	$	—	$	—	$	10,225
Collectively evaluated for impairment		12,163		13,354		2,945		6,519		—		34,981
Noncovered loans acquired with deteriorated credit quality		406		1,049		17		67		—		1,539
Covered loans acquired with deteriorated credit quality		821		—		—		283		—		1,104

Total allowance for loan losses	$	20,670	$	17,348	$	2,962	$	6,869	$	—	$	47,849

Loans and leases outstanding:
Individually evaluated for impairment	$	38,485	$	45,335	$	—	$	—	$	—	$	83,820
Collectively evaluated for impairment		1,598,352		1,631,794		1,519,171		1,359,537		—		6,108,854
Loans acquired with deteriorated credit quality		2,770		37,394		133		7,073		—		47,370
Covered loans acquired with deteriorated credit quality		7,160		37,384		21,106		12,507		—		78,157

Total loans and leases outstanding	$	1,646,767	$	1,751,907	$	1,540,410	$	1,379,117	$	—	$	6,318,201

Credit Quality

Old National’s management monitors the credit quality of its financing receivables in an on-going manner. Internally, management assigns a credit quality grade to each non-homogeneous commercial and commercial real estate loan in the portfolio. The primary determinants of the credit quality grade are based upon the reliability of the primary source of repayment and the past, present, and projected financial condition of the borrower. The credit quality rating also reflects current economic and industry conditions. Major factors used in determining the grade 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.

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.

As of June 30, 2015 and December 31, 2014, the risk category of loans, excluding covered loans, by class of loans is as follows:


(dollars in thousands)
					Commercial Real Estate-				Commercial Real Estate-
	Commercial				Construction				Other
Corporate Credit Exposure Credit Risk Profile by Internally Assigned Grade	June 30, 2015		December 31, 2014		June 30, 2015		December 31, 2014		June 30, 2015		December 31, 2014
Grade:
Pass	$	1,597,390	$	1,442,904	$	154,353	$	119,958	$	1,409,446	$	1,374,191
Criticized		71,652		89,775		3,037		2,229		88,971		102,805
Classified - substandard		36,247		58,461		2,312		5,866		42,972		38,659
Classified - nonaccrual		69,777		38,003		4,212		6,499		61,760		59,771
Classified - doubtful		888		457		—		—		278		1,132

Total	$	1,775,954	$	1,629,600	$	163,914	$	134,552	$	1,603,427	$	1,576,558

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 as of June 30, 2015 and December 31, 2014, excluding covered loans:


	Residential		Consumer
(dollars in thousands)			Heloc		Auto		Other
June 30, 2015
Performing	$	1,608,761	$	367,245	$	954,616	$	137,291
Nonperforming		14,058		2,716		1,243		1,430

Total	$	1,622,819	$	369,961	$	955,859	$	138,721


December 31, 2014
Performing	$	1,505,188	$	357,205	$	845,708	$	101,811
Nonperforming		13,968		3,115		1,261		1,527

Total	$	1,519,156	$	360,320	$	846,969	$	103,338

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 troubled debt restructuring. 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 purchased credit impaired loans, is to recognize interest income on impaired loans unless the loan is placed on nonaccrual status. No additional funds are committed to be advanced in connection with these impaired loans.

The following table shows Old National’s impaired loans, excluding covered loans, which are individually evaluated as of June 30, 2015 and December 31, 2014, respectively. Of the loans purchased without FDIC loss share coverage, only those that have experienced subsequent impairment since the date acquired are included in the table below.


			Unpaid
	Recorded		Principal		Related
(dollars in thousands)	Investment		Balance		Allowance
June 30, 2015
With no related allowance recorded:
Commercial	$	33,660	$	34,031	$	—
Commercial Real Estate - Construction		1,880		1,883		—
Commercial Real Estate - Other		34,005		36,987		—
Residential		933		1,055		—
Consumer		962		1,060		—
With an allowance recorded:
Commercial		35,247		35,255		7,979
Commercial Real Estate - Construction		—		—		—
Commercial Real Estate - Other		13,526		14,960		4,138
Residential		1,463		1,463		73
Consumer		1,594		1,594		80

Total Loans	$	123,270	$	128,288	$	12,270


December 31, 2014
With no related allowance recorded:
Commercial	$	25,483	$	25,854	$	—
Commercial Real Estate - Construction		2,168		1,397		—
Commercial Real Estate - Other		28,637		30,723		—
Residential		588		658		—
Consumer		685		748		—
With an allowance recorded:
Commercial		7,471		10,488		4,883
Commercial Real Estate - Construction		98		98		11
Commercial Real Estate - Other		14,432		16,503		2,934
Residential		1,476		1,476		74
Consumer		1,543		1,543		77

Total Loans	$	82,581	$	89,488	$	7,979

The average balance of impaired loans, excluding covered loans, and interest income recognized on impaired loans during the three months ended June 30, 2015 and 2014 are included in the table below.


	Average		Interest
	Recorded		Income
(dollars in thousands)	Investment		Recognized (1)
Three Months Ended June 30, 2015
With no related allowance recorded:
Commercial	$	30,769	$	85
Commercial Real Estate - Construction		2,107		1
Commercial Real Estate - Other		38,758		189
Residential		920		1
Consumer		869		1
With an allowance recorded:
Commercial		25,069		355
Commercial Real Estate - Construction		117		—
Commercial Real Estate - Other		10,274		121
Residential		1,469		2
Consumer		1,518		29

Total Loans	$	111,870	$	784


Three Months Ended June 30, 2014
With no related allowance recorded:
Commercial	$	17,040	$	1
Commercial Real Estate - Construction		1,449		15
Commercial Real Estate - Other		19,537		106
Residential		98		—
Consumer		348		2
With an allowance recorded:
Commercial		11,764		54
Commercial Real Estate - Construction		—		—
Commercial Real Estate - Other		18,614		52
Residential		2,308		24
Consumer		1,248		14

Total Loans	$	72,406	$	268

(1)	The Company does not record interest on nonaccrual loans until principal is recovered.

The average balance of impaired loans, excluding covered loans, and interest income recognized on impaired loans during the six months ended June 30, 2015 and 2014 are included in the table below.


	Average		Interest
	Recorded		Income
(dollars in thousands)	Investment		Recognized (1)
Six Months Ended June 30, 2015
With no related allowance recorded:
Commercial	$	31,505	$	127
Commercial Real Estate - Construction		2,025		4
Commercial Real Estate - Other		32,402		274
Residential		761		1
Consumer		824		2
With an allowance recorded:
Commercial		21,359		403
Commercial Real Estate - Construction		49		—
Commercial Real Estate - Other		13,980		122
Residential		1,469		64
Consumer		1,568		49

Total Loans	$	105,942	$	1,046


Six Months Ended June 30, 2014
With no related allowance recorded:
Commercial	$	18,975	$	34
Commercial Real Estate - Construction		1,024		15
Commercial Real Estate - Other		19,402		160
Residential		102		—
Consumer		343		4
With an allowance recorded:
Commercial		10,002		108
Commercial Real Estate - Construction		—		—
Commercial Real Estate - Other		17,490		164
Residential		2,307		41
Consumer		1,127		26

Total Loans	$	70,772	$	552

(1)	The Company does not record interest on nonaccrual loans until principal is recovered.

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 are returned to accrual status when all the principal and interest amounts contractually due are brought current, remain current for six months 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 covered loan loss provision or prospective yield adjustments. Similar to noncovered loans, covered loans accounted for outside FASB ASC Topic 310-30 are classified as nonaccrual when, in the opinion of management, collection of principal or interest is doubtful. Information for covered loans accounted for both under and outside FASB ASC Topic 310-30 is included in the table below in the row labeled covered loans.

Old National’s past due financing receivables as of June 30, 2015 and December 31, 2014 are as follows:


(dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		Recorded Investment > 90 Days and Accruing		Nonaccrual		Total Past Due		Current
June 30, 2015
Commercial	$	704	$	1,107	$	325	$	70,665	$	72,801	$	1,703,153
Commercial Real Estate:
Construction		—		—		—		4,212		4,212		159,702
Other		1,005		301		—		62,038		63,344		1,540,083
Residential		10,055		1,878		88		14,058		26,079		1,596,740
Consumer:
Heloc		566		196		—		2,716		3,478		366,483
Auto		2,995		592		27		1,243		4,857		951,002
Other		500		174		158		1,430		2,262		136,459
Covered loans		657		407		—		11,440		12,504		122,903

Total loans	$	16,482	$	4,655	$	598	$	167,802	$	189,537	$	6,576,525


December 31, 2014
Commercial	$	649	$	813	$	33	$	38,460	$	39,955	$	1,589,645
Commercial Real Estate:
Construction		—		—		—		6,499		6,499		128,053
Other		3,834		1,468		138		60,903		66,343		1,510,215
Residential		11,606		3,959		1		13,968		29,534		1,489,622
Consumer:
Heloc		577		376		—		3,115		4,068		356,252
Auto		3,349		695		203		1,261		5,508		841,461
Other		969		129		83		1,527		2,708		100,630
Covered loans		1,477		584		—		15,124		17,185		130,523

Total loans	$	22,461	$	8,024	$	458	$	140,857	$	171,800	$	6,146,401

Loan Participations

Old National has loan participations, which qualify as participating interests, with other financial institutions. At June 30, 2015, these loans totaled $330.5 million, of which $170.0 million had been sold to other financial institutions and $160.5 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.

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 troubled debt restructuring (“TDR”) has occurred, which is when for economic or legal reasons related to a borrower’s financial difficulties, the 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 included 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. It is Old National’s policy to charge off small commercial loans scored through our small business credit center with contractual balances under $250,000 that have been placed on nonaccrual status or became 90 days or more delinquent, without regard to the collateral position. 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 troubled debt restructuring, the loan is written down to its collateral value less selling costs.

The following table presents activity in TDRs for the six months ended June 30, 2015 and 2014:


(dollars in thousands)	Commercial			Commercial Real Estate			Residential			Consumer			Total
Six Months Ended June 30, 2015
Balance at January 1, 2015	$	15,205		$	15,226		$	2,063		$	2,459		$	34,953
(Charge-offs)/recoveries		574			648			(15	)		(27	)		1,180
Payments		(3,505	)		(3,135	)		(85	)		(320	)		(7,045	)
Additions		5,573			3,321			419			681			9,994

Balance at June 30, 2015	$	17,847		$	16,060		$	2,382		$	2,793		$	39,082


Six Months Ended June 30, 2014
Balance at January 1, 2014	$	22,443		$	22,639		$	2,344		$	1,441		$	48,867
(Charge-offs)/recoveries		(252	)		167			1			(21	)		(105	)
Payments		(12,408	)		(4,220	)		(47	)		(229	)		(16,904	)
Additions		8,833			1,822			175			831			11,661

Balance at June 30, 2014	$	18,616		$	20,408		$	2,473		$	2,022		$	43,519

Approximately $25.5 million of the TDRs at June 30, 2015 were included with nonaccrual loans, compared to $22.1 million at December 31, 2014. Old National has allocated specific reserves to customers whose loan terms have been modified in TDRs totaling $0.9 million at June 30, 2015 and $2.8 million at December 31, 2014. As of June 30, 2015, Old National had committed to lend an additional $0.9 million to customers with outstanding loans that are classified as TDRs.

The pre-modification and post-modification outstanding recorded investments of loans modified as TDRs during the six months ended June 30, 2015 and 2014 are the same since the loan modifications did not involve the forgiveness of principal. Old National did not record any charge-offs at the modification date. The following table presents loans by class modified as TDRs that occurred during the six months ended June 30, 2015:

(dollars in thousands)

Number
of Loans

Pre-modification
Outstanding Recorded
Investment

Post-modification
Outstanding Recorded
Investment

Troubled Debt Restructuring:

Commercial

5,573

Commercial Real Estate - construction

1,162

Commercial Real Estate - other

2,159

Residential

419

Consumer - other

681

Total

9,994

The TDRs described above resulted in immaterial changes in the allowance for loan losses and charge-offs during the six months ended June 30, 2015.

The following table presents loans by class modified as TDRs that occurred during the six months ended June 30, 2014:


(dollars in thousands)	Number of Loans		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment
Troubled Debt Restructuring:
Commercial		13	$	8,833	$	8,833
Commercial Real Estate - construction		1		484		484
Commercial Real Estate - other		14		1,338		1,338
Residential		2		175		175
Consumer - other		13		831		831

Total		43	$	11,661	$	11,661

The TDRs described above resulted increased the allowance for loan losses by $0.8 million and resulted in immaterial charge-offs during the six months ended June 30, 2014.

A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms.

There were three commercial loans and four commercial real estate loans totaling $0.5 million that were modified as TDRs within the preceding twelve months, and for which there was a payment default during the six months ended June 30, 2015.

There were three commercial loans and two commercial real estate loans totaling $0.2 million that were modified as TDRs within the preceding twelve months, and for which there was a payment default during the six months ended June 30, 2014.

The terms of certain other loans were modified during the six months ended June 30, 2015 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 if the delay in a payment was 90 days or less.

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 purchased credit impaired loan is being accounted for as part of a pool, it will not be removed from the pool. As of June 30, 2015, 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, recent guidance also permits for loans to be removed from TDR status 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 Impaired Loans (noncovered 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 the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, net present value of cash flows expected to be received, among others. 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.

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 noncovered loans that meet the criteria of ASC 310-30 treatment, the carrying amount is as follows:


(dollars in thousands)	June 30, 2015		December 31, 2014
Commercial	$	2,536	$	2,770
Commercial real estate		28,769		37,394
Residential		130		133
Consumer		5,303		7,073

Carrying amount	$	36,738	$	47,370

Carrying amount, net of allowance	$	35,599	$	45,831

Allowance for loan losses	$	1,139	$	1,539

The outstanding balance of noncovered loans accounted for under ASC 310-30, including contractual principal, interest, fees and penalties, was $105.3 million at June 30, 2015 and $135.9 million at December 31, 2014.

The accretable difference on purchased loans acquired in a business combination 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 $8.2 million during the six months ended June 30, 2015 and $9.8 million during the six months ended June 30, 2014. Improvement in cash flow expectations has resulted in a reclassification from nonaccretable difference to accretable yield.

Accretable yield of noncovered loans, or income expected to be collected, is as follows:


(dollars in thousands)	Monroe			Integra Noncovered			IBT			Tower			United			LSB			Founders			Total
Balance at January 1, 2015	$	3,564		$	1,389		$	13,354		$	4,559		$	1,516		$	2,409		$	—		$	26,791
New loans purchased		—			—			—			—			—			—			1,812			1,812
Accretion of income		(1,513	)		(286	)		(4,410	)		(645	)		(476	)		(640	)		(236	)		(8,206	)
Reclassifications from (to) nonaccretable difference		(207	)		117			487			(224	)		858			2,506			1,023			4,560
Disposals/other adjustments		502			(85	)		961			32			240			—			—			1,650

Balance at June 30, 2015	$	2,346		$	1,135		$	10,392		$	3,722		$	2,138		$	4,275		$	2,599		$	26,607

Included in Old National’s allowance for loan losses is $1.1 million related to the purchased loans disclosed above at June 30, 2015, compared to $1.5 million at December 31, 2014. An immaterial amount of allowance for loan losses was reversed during 2014 related to these loans.

At acquisition, purchased loans, both covered and noncovered, for which it was probable at acquisition that all contractually required payments would not be collected were as follows:


(dollars in thousands)	Monroe			Integra Bank (1)			IBT			Tower			United			LSB			Founders
Contractually required payments	$	94,714		$	921,856		$	118,535		$	22,746		$	15,483		$	24,493		$	11,103
Nonaccretable difference		(45,157	)		(226,426	)		(53,165	)		(5,826	)		(5,487	)		(9,903	)		(2,684	)

Cash flows expected to be collected at acquisition		49,557			695,430			65,370			16,920			9,996			14,590			8,419
Accretable yield		(6,971	)		(98,487	)		(11,945	)		(4,065	)		(1,605	)		(2,604	)		(1,812	)

Fair value of acquired loans at acquisition	$	42,586		$	596,943		$	53,425		$	12,855		$	8,391		$	11,986		$	6,607

(1)	Includes covered and noncovered.

Income is not recognized on certain purchased loans if Old National cannot 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.