NOTE 19 – INCOME TAXES

Following is a summary of the major items comprising the differences in taxes from continuing operations computed at the federal statutory rate and as recorded in the consolidated statements of income:


	Three Months Ended June 30,						Six Months Ended June 30,
(dollars in thousands)	2017			2016			2017			2016
Provision at statutory rate of 35%	$	17,303		$	24,477		$	33,572		$	37,304
Tax-exempt income		(4,349	)		(4,233	)		(8,746	)		(8,401	)
State income taxes		195			2,064			1,046			2,647
Interim period effective rate adjustment		(286	)		(37	)		(741	)		(185	)
Tax credit investments—federal		(1,877	)		(80	)		(3,753	)		(160	)
ONI nondeductible goodwill		—			8,305			—			8,305
Other, net		(402	)		316			(303	)		973

Income tax expense	$	10,584		$	30,812		$	21,075		$	40,483

Effective tax rate		21.4	%		44.1	%		22.0	%		38.0	%

In accordance with ASC 740-270, Accounting for Interim Reporting, the provision for income taxes was recorded at June 30, 2017 and 2016 based on the current estimate of the effective annual rate.

Tax credit investments are included in the Company’s estimate of the effective annual tax rate. The lower effective tax rate during the three and six months ended June 30, 2017 when compared to the three and six months ended June 30, 2016 is the result of an increase in federal tax credits available, as well as the sale of ONI in May 2016 and the associated tax expense of $8.3 million to record a deferred tax liability relating to ONI’s nondeductible goodwill.

Unrecognized Tax Benefits

The Company and its subsidiaries file a consolidated U.S. federal income tax return, as well as filing various state returns. Unrecognized state income tax benefits are reported net of their related deferred federal income tax benefit.

A reconciliation of the beginning and ending amounts of unrecognized tax benefits is as follows:


(dollars in thousands)	2017		2016
Balance at January 1,	$	777	$	124
Additions based on tax positions related to the current year		70		58
Additions based on tax positions related to prior years		—		584

Balance at June 30,	$	847	$	766

If recognized, approximately $0.8 million of unrecognized tax benefits, net of interest, would favorably affect the effective income tax rate in future periods.

Net Deferred Tax Assets

Significant components of net deferred tax assets (liabilities) were as follows at June 30, 2017 and December 31, 2016:


(dollars in thousands)	June 30, 2017			December 31, 2016
Deferred Tax Assets
Allowance for loan losses, net of recapture	$	19,902		$	19,773
Benefit plan accruals		17,066			23,846
Alternative minimum tax credit		22,210			19,523
Unrealized losses on benefit plans		184			205
Net operating loss carryforwards		57,483			66,917
Federal tax credits		2,589			35
Other-than-temporary impairment		2,184			3,606
Acquired loans		33,977			40,522
Lease exit obligation		2,319			2,060
Unrealized losses on available-for-sale investment securities		8,008			23,365
Unrealized losses on held-to-maturity investment securities		6,809			7,118
Unrealized losses on hedges		3,460			4,116
Other real estate owned		2,186			3,310
Other, net		2,813			2,675

Total deferred tax assets		181,190			217,071

Deferred Tax Liabilities
Accretion on investment securities		(740	)		(700	)
Purchase accounting		(16,532	)		(17,552	)
Loan servicing rights		(9,424	)		(9,627	)
Premises and equipment		(3,608	)		(4,800	)
Other, net		(4,106	)		(2,529	)

Total deferred tax liabilities		(34,410	)		(35,208	)

Net deferred tax assets	$	146,780		$	181,863

Through the acquisition of Anchor in the second quarter of 2016 and Lafayette Savings Bank in the fourth quarter of 2014, both former thrifts, Old National Bank’s retained earnings at June 30, 2017 include base-year bad debt reserves, created for tax purposes prior to 1988, totaling $52.8 million. Of this total, $50.9 million was acquired from Anchor, and $1.9 million was acquired from Lafayette Savings Bank. Base-year reserves are subject to recapture in the unlikely event that Old National Bank (1) makes distributions in excess of current and accumulated earnings and profits, as calculated for federal income tax purposes, (2) redeems its stock, or (3) liquidates. Old National Bank has no intention of making such a nondividend distribution. Accordingly, under current accounting principles, a related deferred income tax liability of $19.8 million has not been recognized.

No valuation allowance was recorded at June 30, 2017 or December 31, 2016 because, based on current expectations, Old National believes it will generate sufficient income in future years to realize deferred tax assets. Old National has federal net operating loss carryforwards totaling $136.8 million at June 30, 2017 and $162.9 million at December 31, 2016. This federal net operating loss was acquired from the acquisitions of Indiana Community Bancorp in 2012 and Anchor in 2016. If not used, the federal net operating loss carryforwards will begin to expire in 2028. Old National has alternative minimum tax credit carryforwards totaling $22.2 million at June 30, 2017 and $19.5 million at December 31, 2016. The alternative minimum tax credit carryforward does not expire. Old National has federal tax credit carryforwards of $2.6 million at June 30, 2017 and $35 thousand at December 31, 2016. The federal tax credits consist mainly of low income housing credits, research and development credits, and federal historic credits that, if not used, will expire from 2027 to 2037. Old National has state net operating loss carryforwards totaling $197.6 million at June 30, 2017 and $206.3 million at December 31, 2016. If not used, the state net operating loss carryforwards will expire from 2024 to 2037. Old National has state tax credits totaling $0.8 million at June 30, 2017. The state tax credits will not expire.