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							Nine Months Ended
	September 30,							September 30,
(dollars in thousands)		2018				2017			2018				2017
Provision at statutory rate (1)	$	11,901			$	17,791		$	33,171			$	51,363
Tax-exempt income:
Tax-exempt interest		(2,179	)			(3,658	)		(6,607	)			(11,032	)
Section 291/265 interest disallowance		84				76			220				197
Company-owned life insurance income		(621	)			(708	)		(1,679	)			(2,201	)
Tax-exempt income		(2,716	)			(4,290	)		(8,066	)			(13,036	)
State income taxes		2,091				506			4,307				1,553
Interim period effective rate adjustment		(81	)			(861	)		944				(1,602	)
Tax credit investments - federal		(5,483	)			(1,684	)		(16,224	)			(5,431	)
Other, net		(387	)			(3	)		495				(313	)
Income tax expense	$	5,325			$	11,459		$	14,627			$	32,534
Effective tax rate		9.4		%		22.5	%		9.3		%		22.2	%

In accordance with ASC 740-270, Accounting for Interim Reporting, the provision for income taxes was recorded at September 30, 2018 and 2017 based on the current estimate of the effective annual rate.

The lower effective tax rate during the three and nine months ended September 30, 2018 when compared to the three and nine months ended September 30, 2017 is primarily the result of the lowering of the federal corporate tax rate to 21% in 2018 and an increase in federal tax credits available. On December 22, 2017, the Tax Cuts and Jobs Act (“H.R. 1”) was enacted into legislation. Under ASC 740, the effects of changes in tax rates and laws are recognized in the period in which the new legislation is enacted. Accordingly, Old National recorded an estimated $39.3 million expense for the revaluation of Old National’s deferred tax assets in December 2017.

Shortly after the enactment date, the SEC issued SAB 118, which addresses the situations where the accounting for changes in tax laws is complete, incomplete but can be reasonably estimated, and incomplete and cannot be reasonably estimated. SAB 118 also permits a measurement period of up to one year from the date of enactment to refine the provisional accounting. Old National completed its analysis of H.R. 1 during the second quarter of 2018. During the six months ended June 30, 2018, immaterial adjustments made to the preliminary valuation of assets acquired and liabilities assumed in the acquisition of Anchor (MN) impacted the estimated revaluation of Old National’s deferred tax assets.

Old National 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 was as follows:

	Nine Months Ended
	September 30,
(dollars in thousands)	2018			2017
Balance at beginning of period	$	874		$	777
Additions based on tax positions related to the current year		-			109
Reductions due to statute of limitations expiring		(301	)		(174	)
Reductions based on tax positions related to prior years		(78	)		-
Balance at end of period	$	495		$	712

If recognized, approximately $0.5 million of unrecognized tax benefits, net of interest, would favorably affect the effective income tax rate in future periods. Old National expects the total amount of unrecognized tax benefits to decrease by approximately $0.3 million in the next twelve months.

Significant components of net deferred tax assets (liabilities) were as follows at September 30, 2018 and December 31, 2017:

	September 30,			December 31,
(dollars in thousands)	2018			2017
Deferred Tax Assets
Allowance for loan losses, net of recapture	$	13,489		$	12,958
Benefit plan accruals		14,094			11,080
Alternative minimum tax credit		2,545			25,084
Unrealized losses on benefit plans		88			108
Net operating loss carryforwards		32,126			39,631
Federal tax credits		12,142			5,516
Other-than-temporary impairment		36			1,424
Deferred gain on securities		1,994			-
Acquired loans		21,759			29,669
Lease exit obligation		1,159			1,337
Unrealized losses on available-for-sale investment securities		22,921			14,011
Unrealized losses on held-to-maturity investment securities		2,600			3,630
Unrealized losses on hedges		-			923
Tax credit investments		2,007			-
Other real estate owned		182			369
Other, net		480			829
Total deferred tax assets		127,622			146,569
Deferred Tax Liabilities
Accretion on investment securities		(467	)		(493	)
Purchase accounting		(15,608	)		(16,718	)
Loan servicing rights		(6,006	)		(6,058	)
Premises and equipment		(7,099	)		(10,052	)
Prepaid expenses		(1,283	)		(1,277	)
Tax credit investments		-			(168	)
Unrealized gains on hedges		(864	)		-
Other, net		(1,628	)		(946	)
Total deferred tax liabilities		(32,955	)		(35,712	)
Net deferred tax assets	$	94,667		$	110,857

Through the acquisition of Anchor (WI) 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 September 30, 2018 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 (WI), 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 $13.0 million has not been recognized.

No valuation allowance was recorded at September 30, 2018 or December 31, 2017 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 $104.5 million at September 30, 2018 and $130.7 million at December 31, 2017. This federal net operating loss was acquired from the acquisition of Anchor (WI) in 2016. If not used, the federal net operating loss carryforwards will expire from 2028 to 2033. Old National has alternative minimum tax (“AMT”) credit carryforwards totaling $24.0 million at September 30, 2018 and $25.1 million at December 31, 2017. The enactment of H.R. 1 eliminates the parallel tax system known as the AMT and allows any existing AMT credits to be used to reduce regular tax or be refunded from 2018 to 2021. ASC 740 allows for the reclassification of the AMT credit from a deferred tax asset to a current tax asset, except for the amount limited by section 382. Old National has $2.5 million of AMT credit carryforward subject to section 382 limitations. The $2.5 million is maintained in deferred tax assets and the remaining $21.5 million has been reclassified to a current tax asset. Old National has federal tax credit carryforwards of $12.1 million at September 30, 2018 and $5.5 million at December 31, 2017. The federal tax credits consist mainly of federal historic credits, energy efficient home credits, low income housing credits, and research and development credits that, if not used, will expire from 2025 to 2038. Old National has recorded state net operating loss carryforwards totaling $171.2 million at September 30, 2018 and $203.6 million at December 31, 2017. If not used, the state net operating loss carryforwards will expire from 2024 to 2033.

The federal and recorded state net operating loss carryforwards are subject to an annual limitation under Internal Revenue Code section 382. Old National believes that all of the recorded net operating loss carryforwards will be used prior to expiration.