NOTE 5 – LOANS AND ALLOWANCE FOR LOAN LOSSES

Old National’s loans 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, Kentucky, Michigan, Wisconsin, and Minnesota. Old National manages concentrations of credit exposure by industry, product, geography, customer relationship, and loan size, with no concentration of loans exceeding 10% of its portfolio.

The composition of loans at December 31 by lending classification was as follows:


	December 31,
(dollars in thousands)	2017			2016
Commercial (1)	$	2,717,269		$	1,917,099
Commercial real estate:
Construction (2)		374,306			357,802
Other (2)		3,980,246			2,773,051
Residential real estate		2,167,053			2,087,530
Consumer credit:
Home equity		507,507			476,439
Auto		1,148,672			1,167,737
Other		223,068			230,854

Total loans		11,118,121			9,010,512
Allowance for loan losses		(50,381	)		(49,808	)

Net loans	$	11,067,740		$	8,960,704

(1)	Includes direct finance leases of $29.5 million at December 31, 2017 and $10.8 million at December 31, 2016.

(2)	Certain commercial real estate construction loans were reclassified from commercial real estate - other due to a misclassification at December 31, 2016.

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 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. 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 independent appraisal reviews, sensitivity analysis of absorption and lease rates, financial analysis of the developers and property owners, and feasibility studies, if available. 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 (including Old National), 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.

The acquisition of Anchor (MN) on November 1, 2017 added $864.4 million of commercial real estate loans to our portfolio. At 206%, Old National Bank’s commercial real estate loans as a percentage of its risk-based capital remained well below the regulatory guideline limit of 300% at December 31, 2017.

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 generally 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. We assumed student loans in the acquisition of Anchor (WI) in May 2016. Student loans are guaranteed by the government from 97% to 100% and totaled $68.2 million at December 31, 2017, compared to $77.1 million at December 31, 2016. 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 or other collateral values. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

Related Party Loans

In the ordinary course of business, Old National grants loans to certain executive officers, directors, and significant subsidiaries (collectively referred to as “related parties”).

Activity in related party loans during 2017 is presented in the following table:


	Year Ended
(dollars in thousands)	December 31, 2017
Balance at beginning of period	$	8,494
New loans		6,041
Repayments		(4,885	)
Officer and director changes		(169	)

Balance at end of period	$	9,481

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.

We utilize a PD and 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 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 use historic loss ratios adjusted for 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. An allowance for loan losses will be established for any subsequent credit deterioration or adverse changes in expected cash flows.

Old National’s activity in the allowance for loan losses for the years ended December 31, 2017, 2016, and 2015 was as follows:


	Commercial
(dollars in thousands)	Commercial			Real Estate			Residential			Consumer			Total
2017
Allowance for loan losses:
Balance at beginning of period	$	21,481		$	18,173		$	1,643		$	8,511		$	49,808
Charge-offs		(1,108	)		(3,700	)		(985	)		(6,924	)		(12,717	)
Recoveries		2,281			3,777			255			3,927			10,240
Provision		(3,408	)		3,186			850			2,422			3,050

Balance at end of period	$	19,246		$	21,436		$	1,763		$	7,936		$	50,381

2016
Allowance for loan losses:
Balance at beginning of period	$	26,347		$	15,993		$	2,051		$	7,842		$	52,233
Charge-offs		(5,047	)		(2,632	)		(800	)		(6,131	)		(14,610	)
Recoveries		3,102			4,763			174			3,186			11,225
Provision		(2,921	)		49			218			3,614			960

Balance at end of period	$	21,481		$	18,173		$	1,643		$	8,511		$	49,808

2015
Allowance for loan losses:
Balance at beginning of period	$	20,670		$	17,348		$	2,962		$	6,869		$	47,849
Charge-offs		(3,513	)		(1,921	)		(1,039	)		(6,404	)		(12,877	)
Recoveries		5,218			4,685			354			4,081			14,338
Provision		3,972			(4,119	)		(226	)		3,296			2,923

Balance at end of period	$	26,347		$	15,993		$	2,051		$	7,842		$	52,233

The following table provides Old National’s recorded investment in loans by portfolio segment at December 31, 2017 and 2016 and other information regarding the allowance:


	Commercial
(dollars in thousands)	Commercial		Real Estate		Residential		Consumer		Total
December 31, 2017
Allowance for loan losses:
Individually evaluated for impairment	$	3,424	$	6,654	$	—	$	—	$	10,078
Collectively evaluated for impairment		15,790		14,782		1,763		7,802		40,137
Loans acquired with deteriorated credit quality		32		—		—		134		166

Total allowance for loan losses	$	19,246	$	21,436	$	1,763	$	7,936	$	50,381

Loans and leases outstanding:
Individually evaluated for impairment	$	26,270	$	66,061	$	—	$	—	$	92,331
Collectively evaluated for impairment		2,685,847		4,266,665		2,155,750		1,874,002		10,982,264
Loans acquired with deteriorated credit quality		5,152		21,826		11,303		5,245		43,526

Total loans and leases outstanding	$	2,717,269	$	4,354,552	$	2,167,053	$	1,879,247	$	11,118,121

December 31, 2016
Allowance for loan losses:
Individually evaluated for impairment	$	4,561	$	3,437	$	—	$	—	$	7,998
Collectively evaluated for impairment		16,838		14,717		1,643		8,334		41,532
Loans acquired with deteriorated credit quality		82		19		—		177		278

Total allowance for loan losses	$	21,481	$	18,173	$	1,643	$	8,511	$	49,808

Loans and leases outstanding:
Individually evaluated for impairment	$	45,960	$	57,230	$	—	$	—	$	103,190
Collectively evaluated for impairment		1,870,289		3,040,849		2,073,950		1,866,815		8,851,903
Loans acquired with deteriorated credit quality		850		32,774		13,580		8,215		55,419

Total loans and leases outstanding	$	1,917,099	$	3,130,853	$	2,087,530	$	1,875,030	$	9,010,512

Credit Quality

Old National’s management monitors the credit quality of its loans in an on-going manner. Internally, management assigns an AQR to each non-homogeneous commercial and commercial real estate loan in the portfolio, with the exception of certain FICO-scored small business loans. The primary determinants of the AQR are based upon the reliability of the primary source of repayment and the past, present, and projected financial condition of the borrower. The AQR will also consider current industry conditions. Major factors used in determining the AQR 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.

The risk category of commercial and commercial real estate loans by class of loans at December 31, 2017 and 2016 was as follows:


(dollars in thousands)					Commercial				Commercial
Corporate Credit Exposure					Real Estate -				Real Estate -
Credit Risk Profile by	Commercial				Construction				Other
Internally Assigned Grade	2017		2016		2017		2016		2017		2016
Grade:
Pass	$	2,577,824	$	1,750,922	$	357,438	$	347,325	$	3,762,896	$	2,669,890
Criticized		74,876		45,614		14,758		9,258		98,451		40,590
Classified - substandard		37,367		63,978		—		49		58,584		19,715
Classified - nonaccrual		24,798		53,063		2,110		1,170		30,108		33,833
Classified - doubtful		2,404		3,522		—		—		30,207		9,023

Total	$	2,717,269	$	1,917,099	$	374,306	$	357,802	$	3,980,246	$	2,773,051

Commercial loans as of December 31, 2017 in the table above include loans attributable to the acquisition of Anchor (MN) totaling $26.5 million in the criticized category, $7.3 million in the classified – substandard category, and $7.3 million in the classified – nonaccrual category. Construction commercial real estate loans as of December 31, 2017 in the table above include loans attributable to the acquisition of Anchor (MN) totaling $1.2 million in the classified – nonaccrual category. Other commercial real estate as of December 31, 2017 in the table above includes loans attributable to the acquisition of Anchor (MN) totaling $20.4 million in the criticized category, $3.6 million in the classified – substandard category, and $6.9 million in the classified – nonaccrual category.

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 December 31, 2017 and 2016:


(dollars in thousands)			Consumer
			Home
	Residential		Equity		Auto		Other
December 31, 2017
Performing	$	2,144,882	$	502,322	$	1,145,977	$	217,819
Nonperforming		22,171		5,185		2,695		5,249

Total	$	2,167,053	$	507,507	$	1,148,672	$	223,068

December 31, 2016
Performing	$	2,069,856	$	472,008	$	1,166,114	$	223,786
Nonperforming		17,674		4,431		1,623		7,068

Total	$	2,087,530	$	476,439	$	1,167,737	$	230,854

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 TDR. 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 PCI loans, is to recognize interest income on impaired loans unless the loan is placed on nonaccrual status.

The following table shows Old National’s impaired loans as of December 31, 2017 and 2016, respectively. Only purchased loans 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
December 31, 2017
With no related allowance recorded:
Commercial	$	20,557	$	21,483	$	—
Commercial Real Estate—Other		38,678		44,564		—
Residential		2,443		2,464		—
Consumer		1,685		2,105		—
With an allowance recorded:
Commercial		5,713		5,713		3,424
Commercial Real Estate—Construction		905		1,371		401
Commercial Real Estate—Other		26,478		26,902		6,253
Residential		870		870		44
Consumer		2,211		2,228		110

Total	$	99,540	$	107,700	$	10,232

December 31, 2016
With no related allowance recorded:
Commercial	$	29,001	$	29,634	$	—
Commercial Real Estate—Other		30,585		32,413		—
Residential		1,610		1,631		—
Consumer		827		946		—
With an allowance recorded:
Commercial		16,959		17,283		4,561
Commercial Real Estate—Construction		467		467		107
Commercial Real Estate—Other		26,178		26,710		3,330
Residential		1,081		1,081		54
Consumer		1,924		1,924		96

Total	$	108,632	$	112,089	$	8,148

The average balance of impaired loans for the years ended December 31, 2017 and 2016 are included in the table below.


	Years Ended December 31,
(dollars in thousands)	2017		2016
Average Recorded Investment
With no related allowance recorded:
Commercial	$	24,780	$	34,708
Commercial Real Estate—Other		34,632		28,793
Residential		2,415		1,355
Consumer		1,761		855
With an allowance recorded:
Commercial		7,002		16,669
Commercial Real Estate—Construction		453		352
Commercial Real Estate—Other		26,562		20,465
Residential		1,012		1,074
Consumer		2,155		2,367

Total	$	100,772	$	106,638

Old National does not record interest on nonaccrual loans until principal is recovered. Interest income recognized on impaired loans during 2017 and 2016 was immaterial.

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 may be returned to accrual status when all the principal and interest amounts contractually due are brought current, remain current for a prescribed period, 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 loan loss provision or prospective yield adjustments.

Old National’s past due loans as of December 31 were as follows:


					Recorded
					Investment >
	30-59 Days		60-89 Days		90 Days and				Total
(dollars in thousands)	Past Due		Past Due		Accruing		Nonaccrual		Past Due		Current
December 31, 2017
Commercial	$	986	$	360	$	144	$	27,202	$	28,692	$	2,688,577
Commercial Real Estate:
Construction		—		—		—		2,110		2,110		372,196
Other		2,247		89		—		60,315		62,651		3,917,595
Residential		18,948		3,416		—		22,171		44,535		2,122,518
Consumer:
Home equity		1,467		230		68		5,185		6,950		500,557
Auto		6,487		1,402		532		2,695		11,116		1,137,556
Other		3,967		1,514		150		5,249		10,880		212,188

Total	$	34,102	$	7,011	$	894	$	124,927	$	166,934	$	10,951,187

December 31, 2016
Commercial	$	847	$	279	$	23	$	56,585	$	57,734	$	1,859,365
Commercial Real Estate:
Construction		—		—		—		1,170		1,170		356,632
Other		1,652		150		—		42,856		44,658		2,728,393
Residential		17,786		3,770		2		17,674		39,232		2,048,298
Consumer:
Home equity		1,511		423		—		4,431		6,365		470,074
Auto		5,903		1,037		242		1,623		8,805		1,158,932
Other		3,561		1,919		61		7,068		12,609		218,245

Total	$	31,260	$	7,578	$	328	$	131,407	$	170,573	$	8,839,939

Loan Participations

Old National has loan participations, which qualify as participating interests, with other financial institutions. At December 31, 2017, these loans totaled $581.0 million, of which $290.4 million had been sold to other financial institutions and $290.6 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 TDR has occurred, which is when for economic or legal reasons related to a borrower’s financial difficulties, Old National 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 include 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. Generally, Old National charges off small commercial loans scored through our small business credit center with contractual balances under $250,000 that are 90 days or more delinquent and do not have adequate collateral support. 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 TDR, the loan is typically written down to its collateral value less selling costs.

The following table presents activity in TDRs for the years ended December 31, 2017, 2016, and 2015:


(dollars in thousands)	Commercial			Commercial Real Estate			Residential			Consumer			Total
2017
Balance at beginning of period	$	16,802		$	18,327		$	2,985		$	2,602		$	40,716
(Charge-offs)/recoveries		417			381			—			(294	)		504
Payments		(22,340	)		(12,183	)		(623	)		(1,038	)		(36,184	)
Additions		13,388			27,749			938			2,568			44,643
Interest collected on nonaccrual loans		3,821			431			15			57			4,324

Balance at end of period	$	12,088		$	34,705		$	3,315		$	3,895		$	54,003

2016
Balance at beginning of period	$	23,354		$	14,602		$	2,693		$	3,602		$	44,251
(Charge-offs)/recoveries		(1,982	)		953			42			(6	)		(993	)
Payments		(21,956	)		(10,157	)		(513	)		(1,381	)		(34,007	)
Additions		14,996			11,130			761			385			27,272
Interest collected on nonaccrual loans		2,390			1,799			2			2			4,193

Balance at end of period	$	16,802		$	18,327		$	2,985		$	2,602		$	40,716

2015
Balance at beginning of period	$	15,205		$	15,226		$	2,063		$	2,459		$	34,953
(Charge-offs)/recoveries		872			1,064			(64	)		3			1,875
Payments		(29,913	)		(6,273	)		(658	)		(1,168	)		(38,012	)
Additions		37,190			4,585			1,352			2,308			45,435

Balance at end of period	$	23,354		$	14,602		$	2,693		$	3,602		$	44,251

Approximately $34.0 million of the TDRs at December 31, 2017 were included with nonaccrual loans, compared to $26.3 million at December 31, 2016. Old National has allocated specific reserves to customers whose loan terms have been modified in TDRs totaling $5.7 million at December 31, 2017 and $4.0 million at December 31, 2016. As of December 31, 2017, Old National had committed to lend an additional $4.1 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 years ended December 31, 2017, 2016, and 2015 are the same except for when the loan modifications involve the forgiveness of principal. The following table presents loans by class modified as TDRs that occurred during the years ended December 31, 2017, 2016, and 2015:


(dollars in thousands)	Number of Loans		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment
2017
Troubled Debt Restructuring:
Commercial		11	$	13,388	$	13,388
Commercial Real Estate—Other		12		27,749		27,749
Residential		6		938		938
Consumer		7		2,568		2,568

Total		36	$	44,643	$	44,643

2016
Troubled Debt Restructuring:
Commercial		20	$	14,996	$	14,996
Commercial Real Estate—Other		10		11,130		11,130
Residential		6		761		761
Consumer		8		385		385

Total		44	$	27,272	$	27,272

2015
Troubled Debt Restructuring:
Commercial		42	$	37,190	$	37,190
Commercial Real Estate—Construction		5		1,162		1,162
Commercial Real Estate—Other		27		3,423		3,423
Residential		13		1,352		1,352
Consumer		32		2,308		2,308

Total		119	$	45,435	$	45,435

The TDRs that occurred during 2017 increased the allowance for loan losses by $2.7 million and resulted in $0.2 million of charge-offs during 2017. The TDRs that occurred during 2016 decreased the allowance for loan losses by $2.3 million due to a change in collateral position on a large commercial loan and resulted in $0.8 million of charge-offs during 2016. The TDRs that occurred during 2015 decreased the allowance for loan losses by $0.8 million and resulted in charge-offs of $0.2 million during 2015.

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

TDRs for which there was a payment default within twelve months following the modification during the year were insignificant in 2017, 2016, and 2015.

The terms of certain other loans were modified during 2017 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 the delay in a payment.

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 PCI loan is being accounted for as part of a pool, it will not be removed from the pool. As of December 31, 2017, 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, guidance also permits for loans to be removed from TDR status when subsequently restructured 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 Credit Impaired 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, among others, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, and net present value of cash flows expected to be received. 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 loans that meet the criteria of ASC 310-30 treatment, the carrying amount was as follows:


	December 31,
(dollars in thousands)	2017			2016
Commercial	$	5,152		$	850
Commercial real estate		21,826			32,774
Residential		11,303			13,580
Consumer		5,245			8,215

Carrying amount		43,526			55,419
Allowance for loan losses		(166	)		(278	)

Carrying amount, net of allowance	$	43,360		$	55,141

The outstanding balance of loans accounted for under ASC 310-30, including contractual principal, interest, fees and penalties, was $235.9 million at December 31, 2017 and $268.0 million at December 31, 2016.

The accretable difference on PCI loans 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 $15.2 million during 2017 and $23.4 million during 2016. Improvement in cash flow expectations has resulted in a reclassification from nonaccretable difference to accretable yield as shown in the table below.

Accretable yield of PCI loans, or income expected to be collected, was as follows:


	Years Ended December 31,
(dollars in thousands)	2017			2016			2015
Balance at beginning of period	$	33,603		$	45,310		$	62,533
New loans purchased		1,556			3,217			1,812
Accretion of income		(15,217	)		(23,447	)		(35,526	)
Reclassifications from (to) nonaccretable difference		7,614			10,589			14,189
Disposals/other adjustments		279			(2,066	)		2,302

Balance at end of period	$	27,835		$	33,603		$	45,310

Included in Old National’s allowance for loan losses is $0.2 million related to the purchased loans disclosed above at December 31, 2017, compared to $0.3 million at December 31, 2016.

PCI loans purchased during 2017 and 2016 for which it was probable at acquisition that all contractually required payments would not be collected were as follows:


(dollars in thousands)	Anchor (MN) (1)			Anchor (WI) (2)
Contractually required payments	$	16,898		$	29,544
Nonaccretable difference		(4,787	)		(6,153	)

Cash flows expected to be collected at acquisition		12,111			23,391
Accretable yield		(1,556	)		(3,217	)

Fair value of acquired loans at acquisition	$	10,555		$	20,174

(1)	Old National acquired Anchor (MN) effective November 1, 2017.

(2)	Old National acquired Anchor (WI) effective May 1, 2016.

Income would not be recognized on certain purchased loans if Old National could not 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.