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MarketScreener Homepage  >  Equities  >  Nasdaq  >  Old National Bancorp    ONB

OLD NATIONAL BANCORP

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OLD NATIONAL BANCORP : IN/ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-K)

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02/12/2019 | 03:04pm EDT

Page

  General Overview                                                         

30

  Corporate Developments in Fiscal 2018                                    30
  Business Outlook                                                         30
  Financial Highlights                                                     32
  Non-GAAP Financial Measures                                              32
  Results of Operations                                                    34
  Financial Condition                                                      41
  Risk Management                                                          46
  Off-Balance Sheet Arrangements                                           

57

Contractual Obligations, Commitments, and Contingent Liabilities 57

  Critical Accounting Policies and Estimates                               58









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The following discussion is an analysis of our results of operations for the
fiscal years ended December 31, 2018, 2017, and 2016, and financial condition as
of December 31, 2018 and 2017. This discussion and analysis should be read in
conjunction with our consolidated financial statements and related notes. This
discussion contains forward-looking statements concerning our business. Readers
are cautioned that, by their nature, forward-looking statements are based on
estimates and assumptions and are subject to risks, uncertainties, and other
factors. Actual results may differ materially from our expectations that are
expressed or implied by any forward-looking statement. The discussion in Item
1A, "Risk Factors," lists some of the factors that could cause our actual
results to vary materially from those expressed or implied by any
forward-looking statements, and such discussion is incorporated into this
discussion by reference.

GENERAL OVERVIEW


Old National is the largest financial holding company incorporated in the state
of Indiana and maintains its principal executive offices in Evansville,
Indiana. Old National, through Old National Bank, provides a wide range of
services, including commercial and consumer loan and depository services, and
other traditional banking services. Old National also provides services to
supplement the traditional banking business including fiduciary and wealth
management services, investment and brokerage services, investment consulting,
and other financial services.

Our basic mission is to be THE community bank in the cities and towns we
serve. We focus on establishing and maintaining long-term relationships with
customers, and are committed to serving the financial needs of the communities
in our market area. Old National provides financial services primarily in
Indiana, Kentucky, Michigan, Wisconsin, and Minnesota.



CORPORATE DEVELOPMENTS IN FISCAL 2018

In 2018, we increased our presence in Minnesota through our acquisition of Klein. The acquisition provides us not only additional opportunities in the large and rapidly growing Minneapolis-St. Paul market, but also enables greater scale economics across our entire five-state footprint. Other highlights experienced in 2018 include:

• highest loan production year in our history with a strong pipeline that

continues to build;

• organic commercial and commercial real estate loan growth of 4% (including

loans held for sale) in addition to $1.049 billion of loans from the Klein

partnership;

• cost of total deposits remained well controlled, with an increase of only

13 basis points to 0.32% and a deposit beta of 14.7%;

• strong credit quality metrics including charge-offs to average loans of

0.02%; and

• continued rationalization of our banking center network, resulting in the

sale of 10 branches at a gain of $14.0 million.



During 2018, our net interest income increased substantially to $537.6 million
compared to $437.2 million in 2017, an increase of 23%. Noninterest income grew
from $183.4 million in 2017 to $195.3 million in 2018 primarily due to the gain
on branch sales. We benefited from higher noninterest income attributable to a
full year of Anchor (MN) results in 2018 and the two months of Klein
contribution as compared to 2017, which only reflected two months of the Anchor
(MN) operations. Offsetting some of the benefit of the Anchor (MN) and Klein
results was a decline in gains from sales of investment securities. Our
noninterest expenses increased from $448.8 million in 2017 to $517.3 million in
2018 reflecting acquisition related expenses and divestiture costs. Net income
for 2018 was $190.8 million compared to $95.7 million in 2017. Diluted earnings
per share were $1.22 per share in 2018, compared to $0.69 per share in 2017. As
did other banks and U.S. corporations, our 2018 results benefited from the
reduction in the federal corporate tax rate to 21%, which became effective on
January 1, 2018. Net income in 2017 reflected a 35% federal tax rate and also
included a one-time $39.3 million tax expense recorded in December 2017 for the
revaluation of our deferred income tax asset.

BUSINESS OUTLOOK


The U.S. economy grew by approximately 3% in 2018 as measured by the change in
GDP.  The strong economic growth was aided by the federal tax cuts and other
fiscal measures. Other measures of economic health include the near record low
unemployment level of 3.7% despite an increase in the labor force participation
rate, increases in personal income of 2.7% year-over-year, increases in home
prices, lower household debt burdens, well-controlled inflation, and interest
rates that remain low relative to historical levels. It is anticipated that the
economy will

                                       30
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continue to achieve healthy growth in 2019 as a result of the stimulus effect of
the tax reductions but probably not as robust as experienced in 2018.  There are
ongoing threats to economic expansion in 2019 and beyond, including the
potential impact of the trade dispute with China, a slowdown in new home
construction, and the increasing federal and household debt burdens.

We will continue to focus on our core strategic principles of basic banking in 2019, which are loan growth, fee-based income, and expense management.


Organic loan growth is a priority and we expect our strong loan production to
continue. We will continue to adhere to our risk profile and disciplined
underwriting standards. We have not experienced any specific sector credit
related weaknesses, yet we remain particularly diligent in various commercial
real estate subsectors such as senior housing, retail, and multifamily.

Our fee-based businesses continue to build up their product sets in all of our
markets. We have made investments in these businesses and believe they are well
positioned for growth in 2019.

At the same time, we will continue to enhance our technology and operational
efficiency to improve the client experience. Since 2010, we have consolidated or
closed 201 branches and increased our average branch size from approximately $34
million to $75 million in deposits. We will continue to evaluate our franchise
for additional consolidation opportunities in 2019.

As we continue our measured growth strategy, our view toward additional
partnerships has not changed in this more challenging environment. We remain an
active looker in our target markets and a highly selective, disciplined
buyer. We continue to believe in our ability to bring a larger balance sheet
with better capital and an enhanced product set to a partner that will allow
them to better serve their clients.

On May 2, 2019, Bob Jones will retire as CEO and will continue to serve as the
Company's Chairman of the Board through January 2020. Our corporate board of
directors has appointed Jim Ryan, currently Old National's CFO, to succeed Mr.
Jones as CEO and has elected Brendon Falconer to succeed Mr. Ryan as the
Company's CFO. Mr. Jones' tenure has further strengthened the bank's culture of
transparency, ethics, and character. We believe this succession will continue
these attributes that define our bank's culture.

As we look ahead to 2019, we believe our increased scale will allow us to continue our focus on increasing positive operating leverage.




                                       31
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FINANCIAL HIGHLIGHTS


The following table sets forth certain financial highlights of Old National:



                                               Three Months Ended                            Years Ended
(dollars and shares in
thousands,                       December 31,    September 30,     December 31,             December 31,
except per share data)               2018             2018             2017             2018             2017
Income Statement:
Net interest income            $    146,225$    130,842$    118,556$    537,602$    437,168
Taxable equivalent
adjustment (1)                        3,049            2,753            6,139           11,394           23,091
Provision for loan losses             3,390              750            1,037            6,966            3,050
Noninterest income                   58,154           45,957           44,825          195,305          183,382
Noninterest expense                 150,268          119,376          140,432          517,261          448,836
Net income (loss)                    47,498           51,348          (18,493 )        190,830           95,725
Common Share Data:
Weighted average diluted
shares                              167,992          152,784          146,875          156,539          138,513
Net income (loss) (diluted)    $       0.28$       0.34$      (0.13 )$       1.22$       0.69
Cash dividends                         0.13             0.13             0.13     $       0.52$       0.52
Common dividend payout ratio                  %                %                %                %                %
(2)                                      46               38              N/M               42               75
Book value                     $      15.36$      14.58$      14.17$      15.36$      14.17
Stock price                           15.40            19.30            17.45            15.40            17.45
Tangible common book value
(3)                                    9.00             8.86             8.37             9.00             8.37
Performance Ratios:
Return on average assets               1.01   %         1.18   %        (0.45 ) %         1.07   %         0.63   %
Return on average common
equity                                 7.59             9.28            (3.51 )           8.42             4.98
Return on tangible common
equity (3)                            12.88            15.99            (5.12 )          12.83             8.12
Return on average tangible
common
  equity (3)                          13.84            16.10            (5.05 )          14.97             8.59
Net interest margin (3)                3.64             3.51             3.47             3.54             3.48
Efficiency ratio (3)                  70.33            64.71            81.60            67.74            68.87
Net charge-offs (recoveries)
to average
  loans                                0.02             0.06             0.03             0.02             0.03
Allowance for loan losses to
ending loans                           0.45             0.47             0.45             0.45             0.45
Non-performing loans to
ending loans                           1.43             1.47             1.30             1.43             1.30
Balance Sheet:
Total loans                    $ 12,243,892$ 11,292,659$ 11,118,121$ 12,243,892$ 11,118,121
Total assets                     19,728,435       17,567,759     $ 17,518,292       19,728,435       17,518,292
Total deposits                   14,349,949       12,598,200       12,605,764       14,349,949       12,605,764
Total borrowed funds              2,493,793        2,576,039        2,578,204        2,493,793        2,578,204
Total shareholders' equity        2,689,570        2,220,680        2,154,397        2,689,570        2,154,397
Nonfinancial Data:
Full-time equivalent
employees                             2,892            2,554            2,801            2,892            2,801
Banking centers                         191              182              191              191              191

(1) Calculated using the federal statutory tax rate in effect of 21% for the 2018

periods and 35% for the 2017 periods.

(2) Cash dividends per share divided by net income per share (basic).

(3) Represents a non-GAAP financial measure. Refer to the "Non-GAAP Financial

Measures" section for reconciliations to GAAP financial measures.

NON-GAAP FINANCIAL MEASURES


Non-GAAP financial measures exclude certain items that are included in the
financial results presented in accordance with GAAP. Management believes these
non-GAAP financial measures enhance an investor's understanding of the financial
results of Old National by providing a meaningful basis for period-to-period
comparisons, assisting in operating results analysis, and predicting future
performance.

                                       32

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The following table presents GAAP to non-GAAP reconciliations.




                                                    Three Months Ended                    Years Ended
(dollars and shares in thousands,                      December 31,                      December 31,
except per share data)                             2018             2017             2018             2017
Tangible common book value:
Shareholders' equity (GAAP)                  $  2,689,570$  2,154,397$  2,689,570$  2,154,397
Deduct:      Goodwill                           1,036,258          828,051  

1,036,258 828,051

             Intangible assets                     77,016           53,096           77,016           53,096

Tangible shareholders' equity (non-GAAP) $ 1,576,296$ 1,273,250

    $  1,576,296$  1,273,250
Period end common shares                          175,141          152,040          175,141          152,040
Tangible common book value                           9.00             8.37             9.00             8.37

Return on tangible common equity:
Net income (loss) (GAAP)                     $     47,498$    (18,493 )$    190,830$     95,725
Add: Intangible amortization (net of tax)           3,266            2,210           11,410            7,697

Tangible net income (loss) (non-GAAP) $ 50,764$ (16,283 )$ 202,240$ 103,422

Tangible shareholders' equity (non-GAAP)

  (see above)                                $  1,576,296$  1,273,250$  1,576,296$  1,273,250
Return on tangible common equity                    12.88   %        (5.12 

) % 12.83 % 8.12 %


Return on average tangible common equity:
Tangible net income (loss) (non-GAAP) (see
above)                                       $     50,764$    (16,283 )$    202,240$    103,422
Average shareholders' equity (GAAP)          $  2,503,835$  2,104,646$  2,267,327$  1,923,645
Deduct:      Average goodwill                     969,403          776,862  

864,079 685,729

             Average intangible assets             66,927           37,802           52,209           34,392

Average tangible shareholders' equity

  (non-GAAP)                                 $  1,467,505$  1,289,982$  1,351,039$  1,203,524
Return on average tangible common equity            13.84   %        (5.05 

) % 14.97 % 8.59 %


Net interest margin:
Net interest income (GAAP)                   $    146,225$    118,556$    537,602$    437,168
Taxable equivalent adjustment                       3,049            6,139           11,394           23,091
Net interest income - taxable equivalent
basis
  (non-GAAP)                                 $    149,274$    124,695$    548,996$    460,259
Average earning assets                       $ 16,398,288$ 14,389,502$ 15,501,053$ 13,237,906
Net interest margin                                  3.64   %         3.47   %         3.54   %         3.48   %

Efficiency ratio:
Noninterest expense (GAAP)                   $    150,268$    140,432$    517,261$    448,836
Deduct: Intangible amortization expense             4,134            3,399           14,442           11,841

Adjusted noninterest expense (non-GAAP) $ 146,134$ 137,033

    $    502,819$    436,995
Net interest income - taxable equivalent
basis
  (non-GAAP) (see above)                     $    149,274$    124,695$    548,996$    460,259
Noninterest income                                 58,154           44,825          195,305          183,382
Deduct: Net securities gains (losses)                (357 )          1,588            2,060            9,135
Adjusted total revenue (non-GAAP)            $    207,785$    167,932$    742,241$    634,506
Efficiency ratio                                    70.33   %        81.60   %        67.74   %        68.87   %




Non-GAAP financial measures have inherent limitations, are not required to be
uniformly applied, and are not audited. Although these non-GAAP financial
measures are frequently used by investors to evaluate a company, they have
limitations as analytical tools, and should not be considered in isolation, or
as a substitute for analyses of results as reported under GAAP. These non-GAAP
measures are not necessarily comparable to similar measures that may be
represented by other companies.

                                       33

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RESULTS OF OPERATIONS

The following table sets forth certain income statement information of Old National for the years ended December 31, 2018, 2017, and 2016:



                                                        Years Ended December 31,
(dollars in thousands)                              2018          2017          2016
Income Statement Summary:
Net interest income                             $ 537,602$ 437,168$ 402,703
Provision for loan losses                           6,966         3,050           960
Noninterest income                                195,305       183,382       252,830
Noninterest expense                               517,261       448,836       454,147
Other Data:
Return on average common equity                      8.42   %      4.98   %      7.84   %
Return on tangible common equity (1)                12.83   %      8.12   %     12.69   %
Return on average tangible common equity (1)        14.97   %      8.59   %     13.73   %
Efficiency ratio (1)                                67.74   %     68.87   %     65.82   %
Tier 1 leverage ratio                                9.17   %      8.28   %      8.43   %
Net charge-offs (recoveries) to average loans        0.02   %      0.03   %      0.04   %


        (1) Represents a non-GAAP financial measure. Refer to "Non-GAAP
            Financial Measures" section for reconciliations to GAAP
            financial measures.

Comparison of Fiscal Years 2018 and 2017

Net Interest Income


Net interest income is the most significant component of our earnings,
comprising 73% of 2018 revenues. Net interest income and margin are influenced
by many factors, primarily the volume and mix of earning assets, funding
sources, and interest rate fluctuations. Other factors include the level of
accretion income on purchased loans, prepayment risk on mortgage and
investment-related assets, and the composition and maturity of earning assets
and interest-bearing liabilities.

Short-term interest rates increased 100 basis points in 2018 as the Federal
Reserve increased the discount rate 25 basis points at their March, June,
September, and December meetings. The rate increases were driven by the Federal
Reserve's inflation and wage pressure expectations in conjunction with an
expanding economy. The Treasury yield curve flattened as short-term rates rose
while long-term interest rates remained flat. Collectively, these factors
marginally improved the outlook for our net interest income and margin.

Loans typically generate more interest income than investment securities with
similar maturities. Funding from client deposits generally costs less than
wholesale funding sources. Factors such as general economic activity, Federal
Reserve monetary policy, and price volatility of competing alternative
investments, can also exert significant influence on our ability to optimize the
mix of assets and funding and the net interest income and margin.

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Net interest income is the excess of interest received from earning assets over
interest paid on interest-bearing liabilities. For analytical purposes, net
interest income is also presented in the table that follows, adjusted to a
taxable equivalent basis to reflect what our tax-exempt assets would need to
yield in order to achieve the same after-tax yield as a taxable asset. We used
the federal statutory tax rate in effect of 21% for 2018 and 35% for 2017 and
2016. This analysis portrays the income tax benefits associated in tax-exempt
assets and helps to facilitate a comparison between taxable and tax-exempt
assets. Management believes that it is a standard practice in the banking
industry to present net interest margin and net interest income on a fully
taxable equivalent basis. Therefore, management believes these measures provide
useful information for both management and investors by allowing them to make
peer comparisons.



                                                              Years Ended December 31,
(dollars in thousands)                                 2018             2017             2016
Net interest income                              $    537,602$    437,168$    402,703
Conversion to fully taxable equivalent                 11,394           23,091           21,293
Net interest income - taxable equivalent basis   $    548,996$    460,259$    423,996

Average earning assets                           $ 15,501,053$ 13,237,906$ 11,840,967

Net interest margin                                      3.47   %         3.30   %         3.40   %
Net interest margin - taxable equivalent basis           3.54   %         3.48   %         3.58   %




Net interest income was $537.6 million in 2018, a $100.4 million increase from
$437.2 million in 2017. Taxable equivalent net interest income was $549.0
million in 2018, a 19% increase from $460.3 million in 2017. The net interest
margin on a fully taxable equivalent basis was 3.54% in 2018, a 6 basis point
increase compared to 3.48% in 2017. The increase in net interest income in 2018
when compared to 2017 was primarily due to higher average earning assets of
$2.263 billion in 2018. Partially offsetting higher average earning assets were
higher average interest-bearing liabilities of $1.585 billion. In addition,
interest income in 2018 included lower fully taxable equivalent interest income
resulting from the income tax rate decrease to 21% in 2018. Net interest income
in both 2018 and 2017 included accretion income (interest income in excess of
contractual interest income) associated with acquired loans. Accretion income
totaled $41.1 million in 2018, compared to $40.8 million in 2017. We expect
accretion income to decrease over time, but this may be offset by future
acquisitions.

                                       35

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The following table presents a three-year average balance sheet and for each
major asset and liability category, its related interest income and yield, or
its expense and rate for the years ended December 31.



                                                 2018                                       2017                                       2016
(tax equivalent basis,            Average         Income/      Yield/      

Average Income/ Yield/ Average Income/ Yield/ dollars in thousands)

             Balance         Expense       Rate         Balance         Expense       Rate         Balance         Expense       Rate
Earning Assets
Money market and other
interest-

earning investments (1) $ 48,240$ 630 1.31 % $ 35,584$ 258 0.72 % $ 32,697$ 130

        0.40   %
Investment securities: (2)
Treasury and government-
  sponsored agencies (3)           2,380,817        55,926        2.35      

2,085,317 42,235 2.03 1,968,408 37,381 1.90 States and political

  subdivisions (4)                 1,153,315        42,326        3.67      

1,134,532 53,359 4.70 1,125,713 53,003 4.71 Other securities

                     490,464        15,633        3.19      

450,127 11,863 2.64 438,832 10,391 2.37 Total investment securities 4,024,596 113,885 2.83

        3,669,976       107,457        2.93        3,532,953       100,775        2.85
Loans (including loans held for
sale): (5)
Commercial (4)                     2,924,878       131,471        4.49        2,083,779        85,747        4.11        1,835,317        70,591        3.85
Commercial real estate             4,536,897       235,876        5.20        3,426,757       171,483        5.00        2,648,911       150,592        5.69
Residential real estate            2,195,078        89,888        4.09        2,146,279        85,340        3.98        1,995,060        80,963        4.06
Consumer                           1,771,364        71,689        4.05        1,875,531        68,142        3.63        1,796,029        65,376        3.64
Total loans                       11,428,217       528,924        4.63        9,532,346       410,712        4.31        8,275,317       367,522        4.44
Total earning assets              15,501,053     $ 643,439        4.15   %   13,237,906     $ 518,427        3.92   %   11,840,967     $ 468,427        3.96   %
Less: Allowance for loan
losses                               (52,316 )                                  (50,845 )                                  (52,215 )
Non-Earning Assets
Cash and due from banks              210,716                                    207,677                                    192,401
Other assets                       2,130,588                                  1,907,963                                  1,661,200
Total assets                    $ 17,790,041$ 15,302,701$ 13,642,353
Interest-Bearing Liabilities
Checking and NOW accounts       $  3,146,309$   4,973        0.16   % $  2,676,760$   2,224        0.08   % $  2,389,143$   1,529        0.06   %
Savings accounts                   2,995,484         7,464        0.25        2,964,875         4,980        0.17        2,595,622         3,723        0.14
Money market accounts              1,225,220         4,424        0.36          762,540           831        0.11          763,909           840        0.11
Time deposits                      1,839,974        24,416        1.33        1,487,077        12,321        0.83        1,361,647        11,191        0.82
Total interest-bearing
  deposits                         9,206,987        41,277        0.45        7,891,252        20,356        0.26        7,110,321        17,283        0.24
Federal funds purchased and
  interbank borrowings               238,408         4,793        2.01          187,426         1,966        1.05          137,997           673        0.49
Securities sold under
  agreements to repurchase           344,964         1,962        0.57          336,539         1,270        0.38          368,757         1,509        0.41
Federal Home Loan
  Bank advances                    1,665,689        34,925        2.10        1,481,314        24,818        1.68        1,121,413        15,547        1.39
Other borrowings                     249,832        11,486        4.60          224,793         9,758        4.34          222,708         9,419        4.23
Total interest-bearing
liabilities                     $ 11,705,880$  94,443        0.81   % $ 10,121,324$  58,168        0.57   % $  8,961,196$  44,431        0.50   %
Noninterest-Bearing
Liabilities
Demand deposits                    3,657,234                                  3,111,672                                  2,776,140
Other liabilities                    159,600                                    146,060                                    192,443
Shareholders' equity               2,267,327                                  1,923,645                                  1,712,574
Total liabilities and
shareholders'
  equity                        $ 17,790,041$ 15,302,701$ 13,642,353
Interest Margin Recap
Interest income/average
earning
  assets                                         $ 643,439        4.15   %                  $ 518,427        3.92   %                  $ 468,427        3.96   %
Interest expense/average
earning
  assets                                            94,443        0.61                         58,168        0.44                         44,431        0.38
Net interest income and
margin                                           $ 548,996        3.54   %                  $ 460,259        3.48   %                  $ 423,996        3.58   %

(1) The 2018, 2017, and 2016 average balances include $31.0 million, $21.2

million, and $24.8 million, respectively, of required and excess balances

held at the Federal Reserve.

(2) Changes in fair value are reflected in the average balance; however, yield

information does not give effect to changes in fair value that are reflected

as a component of shareholders' equity.

(3) Includes U.S. government-sponsored entities and agency mortgage-backed

securities at December 31, 2018.

(4) Interest on state and political subdivision investment securities and

commercial loans includes the effect of taxable equivalent adjustments of

$7.1 million and $4.3 million, respectively, in 2018; $15.6 million and $7.5

million, respectively, in 2017; and $15.2 million and $6.1 million,

respectively, in 2016; using the federal statutory tax rate in effect of 21%

in 2018 and 35% in 2017 and 2016.

(5) Includes principal balances of nonaccrual loans. Interest income relating to

    nonaccrual loans is included only if received.


                                       36
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The yield on average earning assets increased 23 basis points from 3.92% in 2017
to 4.15% in 2018 and the cost of interest-bearing liabilities increased 24 basis
points from 0.57% in 2017 to 0.81% in 2018. Average earning assets increased by
$2.263 billion, or 17%. The increase in average earning assets consisted of a
$1.896 billion increase in loans, a $354.6 million increase in lower yielding
investment securities, and a $12.7 million increase in money market and other
interest-earning investments. Average interest-bearing liabilities increased
$1.585 billion, or 16%. The increase in average interest-bearing liabilities
consisted of a $1.316 billion increase in interest-bearing deposits, a $51.0
million increase in federal funds purchased and interbank borrowings, an $8.4
million increase in securities sold under agreements to repurchase, a $184.4
million increase in FHLB advances, and a $25.0 million increase in other
borrowings. Average noninterest-bearing deposits increased by $545.6 million.

The increase in average earning assets in 2018 compared to 2017 was primarily
due to our acquisitions of Anchor (MN) in November 2017 and Klein in November
2018. Including loans held for sale, the loan portfolio, which generally has an
average yield higher than the investment portfolio, was approximately 74% of
average interest earning assets in 2018 compared to 72% in 2017.

Average loans including loans held for sale increased $1.896 billion in 2018
compared to 2017 reflecting loans acquired from Anchor (MN) in November 2017 and
Klein in November 2018, along with organic loan growth. Loans including loans
held for sale attributable to the Anchor (MN) acquisition totaled $1.595 billion
as of the closing date of the acquisition, which was November 1, 2017. Loans
including loans held for sale attributable to the Klein acquisition totaled
$1.052 billion as of the closing date of the acquisition, which was November 1,
2018.

The increases in average investments and average deposits also reflected the Anchor (MN) and Klein acquisitions.

Average non-interest-bearing deposits increased $545.6 million in 2018 compared to 2017 reflecting the Anchor (MN) and Klein acquisitions. Average interest-bearing deposits increased $1.316 million in 2018 compared to 2017 reflecting the Anchor (MN) and Klein acquisitions.

Average borrowed funds increased $268.8 million in 2018 compared to 2017 primarily due to increased funding needed as a result of growth in our loan portfolio that outpaced deposit growth.

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The following table shows fluctuations in taxable equivalent net interest income
attributable to changes in the average balances of assets and liabilities and
the yields earned or rates paid for the years ended December 31.



                                         From 2017 to 2018                       From 2016 to 2017
                                  Total           Attributed to          Total           Attributed to
(dollars in thousands)           Change        Volume        Rate        Change       Volume        Rate
Interest Income
Money market and other
interest-earning
  investments                   $     372$    129$    243$    128$     16$     112
Investment securities (1)           6,428       10,208       (3,780 )      6,682        3,960         2,722
Loans (1)                         118,212       84,716       33,496       43,190       54,994       (11,804 )
Total interest income             125,012       95,053       29,959       50,000       58,970        (8,970 )
Interest Expense
Checking and NOW deposits           2,749          566        2,183          695          212           483
Savings deposits                    2,484           64        2,420        1,257          575           682
Money market deposits               3,593        1,087        2,506           (9 )         (1 )          (8 )
Time deposits                      12,095        3,804        8,291        1,130        1,035            95
Federal funds purchased and
interbank
  borrowings                        2,827          780        2,047        1,293          380           913
Securities sold under
agreements to
  repurchase                          692           40          652         (239 )       (127 )        (112 )
Federal Home Loan Bank
advances                           10,107        3,478        6,629        9,271        5,510         3,761
Other borrowings                    1,728        1,120          608          339           89           250
Total interest expense             36,275       10,939       25,336       13,737        7,673         6,064
Net interest income             $  88,737$ 84,114$  4,623$ 36,263$ 51,297$ (15,034 )

The variance not solely due to rate or volume is allocated equally between the rate and volume variances.

(1) Interest on investment securities and loans includes the effect of taxable

equivalent adjustments of $7.1 million and $4.3 million, respectively, in

2018; $15.6 million and $7.5 million, respectively, in 2017; and $15.2

million and $6.1 million, respectively, in 2016; using the federal statutory

tax rate in effect of 21% in 2018 and 35% in 2017 and 2016.

Provision for Loan Losses


The provision for loan losses was an expense of $7.0 million in 2018, compared
to an expense of $3.1 million in 2017. Net charge-offs totaled $1.9 million in
2018, compared to net charge-offs of $2.5 million in 2017. The higher provision
for loan losses is the result of an increase in specific reserves on loans
individually evaluated for impairment and loan growth, partially offset by lower
incurred loss rate expectations. Continued loan growth in future periods, a
decline in our current level of recoveries, or an increase in charge-offs could
result in an increase in provision expense. For additional information about
non-performing loans, charge-offs, and additional items impacting the provision,
refer to the "Risk Management - Credit Risk" section of Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

Noninterest Income


We generate revenues in the form of noninterest income through client fees,
sales commissions, and other gains and losses from our core banking franchise
and other related businesses, such as wealth management, investment consulting,
and investment products. This source of revenue as a percentage of total revenue
was 27% in 2018 compared to 30% in 2017.

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The following table details the components of noninterest income for the years
ended December 31.



                                                                                    % Change From
                                           Years Ended December 31,                   Prior Year
(dollars in thousands)                 2018          2017          2016         2018         2017
Wealth management fees               $  36,863$  37,316$  34,641        (1.2 ) %      7.7   %
Service charges on deposit
accounts                                44,026        41,331        41,578         6.5         (0.6 )
Debit card and ATM fees                 20,216        17,676        16,769        14.4          5.4
Mortgage banking revenue                17,657        18,449        20,240        (4.3 )       (8.8 )
Insurance premiums and commissions         399           617        20,527       (35.3 )      (97.0 )
Investment product fees                 20,539        20,977        18,822        (2.1 )       11.4
Capital markets income                   4,934         6,544         3,227       (24.6 )      102.8
Company-owned life insurance            10,584         8,654         8,479        22.3          2.1
Net securities gains (losses)            2,060         9,135         5,848       (77.4 )       56.2
Recognition of deferred gain on
sale
  leaseback transactions                 1,577         2,080        16,057       (24.2 )      (87.0 )
Net gain on branch divestitures         13,989             -             -         N/M          N/M
Gain on sale of ONB Insurance
Group, Inc.                                  -             -        41,864         N/M       (100.0 )
Other income                            22,461        20,603        24,778         9.0        (16.8 )
Total noninterest income             $ 195,305$ 183,382$ 252,830         6.5   %    (27.5 ) %

Noninterest income to total
revenue (1)                               26.2   %      28.5   %      37.4   %

(1) Total revenue includes the effect of a taxable equivalent adjustment of $11.4

million in 2018, $23.1 million in 2017, and $21.3 million in 2016.



The increase in noninterest income in 2018 when compared to 2017 was primarily
due to a $14.0 million gain on the sale of 10 Wisconsin branches and higher
noninterest income attributable to the Anchor (MN) and Klein partnerships. This
increase was partially offset by lower net securities gains and 2017 recoveries
on loans originated by AnchorBank (WI) that had been fully charged-off prior to
the acquisition totaling $4.0 million.

Service charges and overdraft fees increased $2.7 million in 2018 compared to
2017 primarily due to higher service charges and overdraft fees attributable to
the Anchor (MN) and Klein partnerships, partially offset by lower overdraft
charges.

Debit card and ATM fees increased $2.5 million in 2018 compared to 2017 primarily due to higher interchange income attributable to the Anchor (MN) and Klein partnerships.


Capital markets income is comprised of customer interest rate swap fees, debt
placement fees, foreign currency exchange fees, and net gains (losses) on
foreign currency adjustments. Capital markets income decreased $1.6 million in
2018 compared to 2017 primarily due to lower customer interest rate swap fees.

Company-owned life insurance income increased $1.9 million in 2018 compared to 2017 primarily due to higher settlements in 2018.

Net securities gains decreased $7.1 million in 2018 compared to 2017 primarily due to lower realized gains on sales of available-for-sale securities in 2018.


In 2018, we recorded a net gain of $14.0 million in connection with the October
2018 divestiture of 10 Wisconsin branches, which included a deposit premium of
$15.0 million, goodwill allocation of $0.6 million, and $0.4 million of other
transaction expenses.

Other income increased $1.9 million in 2018 when compared to 2017 reflecting a
$2.2 million gain on the sale of our student loan portfolio in the second
quarter of 2018 and higher other income attributable to the Anchor (MN) and
Klein partnerships, partially offset by 2017 recoveries on loans originated by
AnchorBank (WI) that had been fully charged-off prior to the acquisition
totaling $4.0 million.

                                       39

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Noninterest Expense


The following table details the components of noninterest expense for the years
ended December 31.



                                                                                        % Change From
                                               Years Ended December 31,                  Prior Year
(dollars in thousands)                     2018          2017          2016         2018        2017
Salaries and employee benefits           $ 281,275$ 246,738$ 252,892        14.0   %    (2.4 ) %
Occupancy                                   51,941        46,511        50,947        11.7        (8.7 )
Equipment                                   14,861        13,560        13,448         9.6         0.8
Marketing                                   15,847        13,172        14,620        20.3        (9.9 )
Data processing                             36,170        32,306        32,002        12.0         0.9
Communication                               10,846         9,284         9,959        16.8        (6.8 )
Professional fees                           14,503        16,840        15,705       (13.9 )       7.2
Loan expense                                 7,028         6,596         7,632         6.5       (13.6 )
Supplies                                     3,037         2,406         2,865        26.2       (16.0 )
FDIC assessment                             10,638         9,480         8,681        12.2         9.2
Other real estate owned expense                878         3,376         4,195       (74.0 )     (19.5 )
Amortization of intangibles                 14,442        11,841        12,486        22.0        (5.2 )
Amortization of tax credit investments      22,949        11,733             -        95.6         N/M
Other expense                               32,846        24,993        28,715        31.4       (13.0 )
Total noninterest expense                $ 517,261$ 448,836     $ 

454,147 15.2 % (1.2 ) %



Noninterest expense increased $68.4 million in 2018 when compared to 2017
primarily due to higher operating expenses and acquisition and integration costs
associated with Anchor (MN) and Klein. Also contributing to the increase in
noninterest expense was higher amortization of tax credit investments in 2018
reflecting the completion of investment tax credit projects, higher salaries and
benefits, and higher charitable contributions.

Salaries and benefits is the largest component of noninterest expense. Salaries
and benefits increased $34.5 million in 2018 compared to 2017. Impacting
salaries and benefits expense were the acquisitions of Anchor (MN) and
Klein. Also contributing to the increase in salaries and benefits were higher
incentive compensation expenses, hospitalization expenses, and profit sharing
expenses. The increase in profit sharing expenses reflected Old National's
increase in its 401(k) match to 75% of employee compensation deferral
contributions of the first 4% of compensation, and 50% of the next 4% of
compensation during the second quarter of 2018. The change was retroactive for
all of 2018. For 2017, we matched 50% of employee compensation deferral
contributions, up to 6% of compensation.

Occupancy expenses increased $5.4 million in 2018 compared to 2017 primarily due to higher occupancy expenses attributable to the Anchor (MN) and Klein partnerships and higher real estate taxes.


Marketing expense increased $2.7 million in 2018 compared to 2017 primarily due
to additional expenses associated with the Anchor (MN) and Klein partnerships
and higher public relations expense.

Data processing increased $3.9 million in 2018 compared to 2017 primarily due to
integration expenses associated with the Anchor (MN) and Klein partnerships and
higher software expenses.

Professional fees decreased $2.3 million in 2018 compared to 2017 primarily due
to $3.5 million in pre-tax expenses recorded in 2017 related to an initiative to
improve how we serve our clients and increase efficiency, partially offset by
professional fees associated with the Klein partnership.

Amortization of tax credit investments was $22.9 million in 2018 compared to
$11.7 million in 2017.  The recognition of tax credit amortization expense is
contingent upon the successful rehabilitation of a historic building or
completion of a solar project within the reporting period. Many factors
including weather, labor availability, building regulations, inspections, and
other unexpected construction delays related to a rehabilitation project can
cause a project to exceed its estimated completion date. Amortization of tax
credit investments is expected to be de minimis in 2019. See Note 10 to the
consolidated financial statements for additional information on our tax credit
investments.

                                       40
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Other expense increased $7.9 million in 2018 compared to 2017 primarily due to higher charitable contributions of $6.3 million and higher other expense associated with the Anchor (MN) and Klein partnerships.

Provision for Income Taxes


We record a provision for income taxes currently payable and for income taxes
payable or benefits to be received in the future, which arise due to timing
differences in the recognition of certain items for financial statement and
income tax purposes. The major difference between the effective tax rate applied
to our financial statement income and the federal statutory tax rate is caused
by a tax benefit from our tax credit investments and interest on tax-exempt
securities and loans. The effective tax rate was 8.6% in 2018 compared to 43.3%
in 2017. The lower effective tax rate in 2018 when compared to 2017 is the
result of $39.3 million of additional tax expense recorded in 2017 for the
revaluation of deferred tax assets due to the lowering of the federal corporate
tax rate to 21% and an increase in federal tax credits available. See Note 16 to
the consolidated financial statements for additional details on Old National's
income tax provision.

Comparison of Fiscal Years 2017 and 2016


In 2017, we generated net income of $95.7 million and diluted net income per
share of $0.69 compared to $134.3 million and diluted net income per share of
$1.05, respectively, in 2016. The 2017 earnings included a $69.4 million
decrease in noninterest income, a $6.7 million increase in income tax expense,
and a $2.1 million increase in provision for loan losses. These decreases to net
income were partially offset by a $34.5 million increase in net interest income
and a $5.3 million decrease in noninterest expense. The successful conversion
and integration of our acquisition of Anchor (MN) in 2017, strong commercial and
commercial real estate loan growth, consistently low credit metrics, and
well-controlled noninterest expenses all contributed to positive 2017
performance when compared to 2016.

Net interest income was $437.2 million in 2017, a $34.5 million increase from
$402.7 million in 2016. Taxable equivalent net interest income was $460.3
million in 2017, a 9% increase from $424.0 million in 2016. The net interest
margin on a fully taxable equivalent basis was 3.48% in 2017, a 10 basis point
decrease compared to 3.58% in 2016. Average earning assets increased by $1.397
billion during 2017 and the yield on average earning assets decreased 4 basis
points from 3.96% in 2016 to 3.92% in 2017. Average interest-bearing liabilities
increased $1.160 billion and the cost of interest-bearing liabilities increased
7 basis points from 0.50% in 2016 to 0.57% in 2017.

The provision for loan losses was an expense of $3.1 million in 2017, compared
to an expense of $1.0 million in 2016. Charge-offs remained low during 2017 and
we continued to see positive trends in credit quality.

Noninterest income decreased to $183.4 million in 2017 from $252.8 million in
2016 primarily due to a $41.9 million gain and lower insurance premiums and
commissions in 2016 resulting from the sale of ONI in May 2016, partially offset
by higher wealth management fees, investment product fees, and capital markets
income in 2017.

Noninterest expense decreased $5.3 million to $448.8 million in 2017 from $454.1
million in 2016 primarily due to the reduction of costs associated with the
divestiture of ONI in May 2016. Offsetting these decreases was $11.7 million of
amortization of tax credit investments in 2017. In addition, noninterest expense
in 2017 included $12.3 million of acquisition and integration costs associated
with Anchor (MN), compared to $15.9 million in 2016 of acquisition and
integration costs associated with Anchor (WI).

The provision for income taxes was $72.9 million in 2017 compared to $66.2
million in 2016. Old National's effective tax rate was 43.3% in 2017 compared to
33.0% in 2016. The higher effective tax rate in 2017 when compared to 2016 is
the result of $39.3 million of additional tax expense to estimate the
revaluation of deferred tax assets due to the lowering of the federal corporate
tax rate to 21%, partially offset by an increase in federal tax credits
available.

FINANCIAL CONDITION

Overview

At December 31, 2018, our assets were $19.728 billion, a 13% increase compared
to $17.518 billion at December 31, 2017. The increase was primarily due to the
acquisition of Klein in November 2018, which had $2.157 billion in

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assets as of the closing date of the acquisition, including goodwill of $208.0
million. Organic growth in our commercial loan portfolios also contributed to
the increase in assets.

Earning Assets

Our earning assets are comprised of investment securities, portfolio loans,
loans held for sale, money market investments, interest earning accounts with
the Federal Reserve, and equity securities. Earning assets were $17.070 billion
at December 31, 2018, an increase of 12% compared to $15.209 billion at December
31, 2017.

Investment Securities

We classify the majority of our investment securities as available-for-sale to
give management the flexibility to sell the securities prior to maturity if
needed, based on fluctuating interest rates or changes in our funding
requirements. However, we also have $74.0 million of U.S. government-sponsored
entities and agencies securities, $127.1 million of fixed-rate mortgage-backed
securities, and $305.2 million of state and political subdivision securities in
our held-to-maturity investment portfolio at December 31, 2018.

Equity securities, which consist of mutual funds held in trusts associated with
deferred compensation plans for former directors and executives, are recorded at
fair value and totaled $5.6 million at December 31, 2018 and December 31, 2017.

At December 31, 2018, the investment securities portfolio, including equity
securities, was $4.778 billion compared to $4.006 billion at December 31, 2017,
an increase of $772.8 million, or 19%. Investment securities attributable to the
Klein acquisition totaled $700.6 million as of the closing date of the
acquisition. Investment securities represented 28% of earning assets at December
31, 2018, compared to 26% at December 31, 2017. Stronger commercial loan demand
in the future and management's decision to deleverage the balance sheet could
result in a reduction in the securities portfolio. As of December 31, 2018,
management does not intend to sell any securities in an unrealized loss position
and does not believe we will be required to sell such securities.

The investment securities available-for-sale portfolio had net unrealized losses
of $49.2 million at December 31, 2018, compared to net unrealized losses of
$56.4 million at December 31, 2017. Net unrealized losses decreased from
December 31, 2017 to December 31, 2018 reflecting higher net unrealized gains on
state and political subdivision securities.

The investment portfolio had an effective duration of 4.00 at December 31, 2018,
compared 4.15 at December 31, 2017. Effective duration measures the percentage
change in value of the portfolio in response to a change in interest
rates. Generally, there is more uncertainty in interest rates over a longer
average maturity, resulting in a higher duration percentage. The weighted
average yields on available-for-sale investment securities were 2.89% in 2018
and 2.43% in 2017. The average yields on the held-to-maturity portfolio were
3.75% in 2018 and 5.44% in 2017.

At December 31, 2018, Old National had a concentration of investment securities
issued by certain states and their political subdivisions with the following
aggregate market values: $344.4 million by Indiana, which represented 12.8% of
shareholders' equity, and $176.0 million by Texas, which represented 6.5% of
shareholders' equity. Of the Indiana municipal bonds, 99% are rated "A" or
better, and the remaining 1% generally represent non-rated local interest bonds
where Old National has a market presence. All of the Texas municipal bonds are
rated "A" or better, and the majority of issues are backed by the "AAA" rated
State of Texas Permanent School Fund Guarantee Program.

Loan Portfolio


We lend primarily to consumers and small to medium-sized commercial and
commercial real estate clients in various industries including manufacturing,
agribusiness, transportation, mining, wholesaling, and retailing. Our policy is
to concentrate our lending activity in the geographic market areas we serve,
primarily Indiana, Kentucky, Michigan, Wisconsin, and Minnesota.

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The following table presents the composition of the loan portfolio at December
31.



                                                                                                                 Four- Year
(dollars in thousands)            2018             2017            2016            2015            2014         Growth Rate
Commercial                    $  3,232,970$  2,717,269$ 1,917,099$ 1,814,940$ 1,646,767             18.4   %
Commercial real estate           4,958,851        4,354,552       3,130,853       1,868,972       1,751,907             29.7
Consumer                         1,803,667        1,879,247       1,875,030       1,603,158       1,379,117              6.9
Total loans excluding
residential
  real estate                    9,995,488        8,951,068       6,922,982       5,287,070       4,777,791             20.3

Residential real estate 2,248,404 2,167,053 2,087,530

       1,661,335       1,540,410              9.9
Total loans                     12,243,892       11,118,121       9,010,512       6,948,405       6,318,201             18.0   %
Less: Allowance for loan
losses                              55,461           50,381          49,808          52,233          47,849
Net loans                     $ 12,188,431$ 11,067,740$ 8,960,704$ 6,896,172$ 6,270,352

Commercial and Commercial Real Estate Loans

At December 31, 2018, commercial and commercial real estate loans were $8.192 billion, an increase of $1.120 billion, or 16%, compared to December 31, 2017. Commercial and commercial real estate loans attributable to the Klein acquisition totaled $836.8 million as of the closing date of the acquisition. Excluding these acquired loans, commercial and commercial real estate loans grew 4% in 2018.


The following table presents the maturity distribution and rate sensitivity of
commercial loans at December 31, 2018 and an analysis of these loans that have
predetermined and floating interest rates.



                          Within          1 - 5         Beyond                        % of
(dollars in thousands)    1 Year          Years         5 Years         Total        Total
Interest rates:
Predetermined            $ 183,669$   866,138$ 619,329$ 1,669,136         52   %
Floating                   771,332         506,598       285,904       1,563,834         48
Total                    $ 955,001$ 1,372,736$ 905,233$ 3,232,970        100   %



Residential Real Estate Loans


Residential real estate loans, primarily 1-4 family properties, increased $81.4
million, or 4%, at December 31, 2018 compared to December 31, 2017. Residential
real estate loans attributable to the Klein acquisition totaled $77.7 million as
of the closing date of the acquisition. Future increases in interest rates could
result in a decline in the level of refinancings and new originations of
residential real estate loans.

Consumer Loans


Consumer loans, including automobile loans, personal and home equity loans and
lines of credit, and student loans, decreased $75.6 million at December 31, 2018
compared to December 31, 2017. Old National 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. Old
National sold the remaining student loan portfolio totaling $64.9 million during
the second quarter of 2018, resulting in a $2.2 million gain that is included in
other income on the income statement. Consumer loans attributable to the Klein
acquisition totaled $134.6 million as of the closing date of the acquisition. We
continue to see runoff in our less profitable indirect consumer loan portfolio.

Allowance for Loan Losses


To provide for the risk of loss inherent in extending credit, we maintain an
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. Additional
information about our Allowance for Loan Losses is included in the "Risk
Management - Credit Risk" section of Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and Notes 1 and 5 to
the consolidated financial statements.

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At December 31, 2018, the allowance for loan losses was $55.5 million, an
increase of $5.1 million compared to $50.4 million at December 31,
2017. Continued loan growth in future periods, a decline in our current level of
recoveries, or an increase in charge-offs could result in an increase in
provision expense. As a percentage of total loans excluding loans held for sale,
the allowance was 0.45% at December 31, 2018 and December 31, 2017. The Klein
acquisition added $1.049 billion of loans. In accordance with ASC 805, no
allowance for loan losses is recorded at the date of acquisition and a reserve
is only established to absorb any subsequent credit deterioration or adverse
changes in expected cash flows. The provision for loan losses was an expense of
$7.0 million in 2018 compared to an expense of $3.1 million in 2017.

For commercial loans, the allowance for loan losses increased by $2.5 million at
December 31, 2018 compared to December 31, 2017. The allowance for loan losses
as a percentage of the commercial loan portfolio decreased to 0.67% at December
31, 2018, from 0.71% at December 31, 2017.

For commercial real estate loans, the allowance for loan losses increased by
$2.0 million at December 31, 2018 compared to December 31, 2017. The allowance
for loan losses as a percentage of the commercial real estate loan portfolio
decreased to 0.47% at December 31, 2018, from 0.49% at December 31, 2017.

The allowance for loan losses for residential real estate loans as a percentage
of that portfolio increased to 0.10% at December 31, 2018, from 0.08% at
December 31, 2017. The allowance for loan losses for consumer loans as a
percentage of that portfolio increased to 0.44% at December 31, 2018, from 0.42%
at December 31, 2017.

Allowance for Losses on Unfunded Commitments


We maintain an allowance for losses on unfunded commercial lending commitments
and letters of credit to provide for the risk of loss inherent in these
arrangements. The allowance is computed using a methodology similar to that used
to determine the allowance for loan losses, modified to take into account the
probability of a drawdown on the commitment. This allowance is classified as a
liability on the balance sheet within accrued expenses and other liabilities,
while the corresponding provision for these loan losses is recorded as a
component of other expense. The allowance for losses on unfunded commitments was
$2.5 million at December 31, 2018, compared to $3.1 million at December 31,
2017.

Loans Held for Sale


Mortgage loans held for immediate sale in the secondary market were $14.9
million at December 31, 2018, compared to $17.9 million at December 31,
2017. Certain mortgage loans are committed for sale at or prior to origination
at a contracted price to an outside investor. Other mortgage loans held for
immediate sale are hedged with TBA forward agreements and committed for sale
when they are ready for delivery and remain on the Company's balance sheet for a
short period of time (typically 30 to 60 days). These loans are sold without
recourse, beyond customary representations and warranties, and Old National has
not experienced material losses arising from these sales. Mortgage originations
are subject to volatility due to interest rates and home sales, among other
factors.

We have elected the fair value option under FASB ASC 825-10 prospectively for
residential loans held for sale. The aggregate fair value exceeded the unpaid
principal balance by $0.5 million as of December 31, 2018 and December 31, 2017.

Goodwill and Other Intangible Assets

Goodwill and other intangible assets at December 31, 2018 totaled $1.113 billion, an increase of $232.1 million compared to $881.1 million at December 31, 2017. During 2018, we recorded $247.1 million of goodwill and other intangible assets associated with the acquisition of Klein.

Net Deferred Tax Assets


Net deferred tax assets decreased $23.8 million since December 31, 2017
primarily due to a decrease in alternative minimum tax credit deferred tax
assets. Old National reclassified $21.5 million from deferred tax assets related
to alternative minimum tax credits to accrued income taxes in 2018 as a result
of the enactment of the Tax Cuts and Jobs Act. Future changes in the corporate
tax rate could result in a change in value of Old National's deferred tax assets
and future income tax expense. See Note 16 to the consolidated financial
statements for additional information.

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Other Assets


Other assets increased $23.6 million, or 15%, since December 31, 2017 primarily
due to higher accrued income taxes. Old National reclassified $21.5 million from
deferred tax assets related to alternative minimum tax credits to accrued income
taxes in 2018 as a result of the enactment of the Tax Cuts and Jobs Act. See
Note 16 to the consolidated financial statements for additional information.

Funding


Total funding, comprised of deposits and wholesale borrowings, was $16.844
billion at December 31, 2018, an increase of $1.660 billion from $15.184 billion
at December 31, 2017. Total deposits were $14.350 billion, including $12.326
billion in transaction accounts and $2.024 billion in time deposits at December
31, 2018. Total deposits increased $1.744 billion, or 14%, compared to December
31, 2017. Deposits attributable to the Klein acquisition totaled $1.713 billion
as of the closing date of the acquisition. Noninterest-bearing demand deposits
increased $284.6 million from December 31, 2017 to December 31,
2018. Interest-bearing checking and NOW deposits increased $672.5 million from
December 31, 2017 to December 31, 2018, while savings deposits decreased $91.5
million. Money market deposits increased $488.8 million from December 31, 2017
to December 31, 2018, while time deposits increased $389.8 million.

We use wholesale funding to augment deposit funding and to help maintain our
desired interest rate risk position. At December 31, 2018, wholesale borrowings,
including federal funds purchased and interbank borrowings, securities sold
under agreements to repurchase, FHLB advances, and other borrowings, totaled
$2.494 billion, a decrease of $84.4 million, or 3%, from December 31, 2017. The
decrease in wholesale funding from December 31, 2017 to December 31, 2018 was
primarily due to a decrease in federal funds purchased and interbank borrowings
and securities sold under agreements to repurchase. Wholesale funding as a
percentage of total funding was 15% at December 31, 2018, compared to 17% at
December 31, 2017. See Notes 12, 13, and 14 to the consolidated financial
statements for additional details on our financing activities.

The following table details the average balances of all funding sources for the
years ended December 31.



                                                                                           % Change From
                                                                                            Prior Year
(dollars in thousands)                  2018             2017             2016            2018       2017
Demand deposits                     $  3,657,234$  3,111,672$  2,776,140       17.5   %   12.1   %
Interest-bearing checking and NOW
deposits                               3,146,309        2,676,760        2,389,143       17.5       12.0
Savings deposits                       2,995,484        2,964,875        2,595,622        1.0       14.2
Money market deposits                  1,225,220          762,540          763,909       60.7       (0.2 )
Time deposits                          1,839,974        1,487,077        1,361,647       23.7        9.2
Total deposits                        12,864,221       11,002,924        9,886,461       16.9       11.3
Federal funds purchased and
interbank borrowings                     238,408          187,426          137,997       27.2       35.8
Securities sold under agreements
to repurchase                            344,964          336,539          368,757        2.5       (8.7 )
Federal Home Loan Bank advances        1,665,689        1,481,314        1,121,413       12.4       32.1
Other borrowings                         249,832          224,793          222,708       11.1        0.9
Total funding sources               $ 15,363,114$ 13,232,996$ 11,737,336       16.1   %   12.7   %



The following table presents a maturity distribution for certificates of deposit with denominations of $100,000 or more at December 31.



                                                        Maturity Distribution
                          Year-End         1-90         91-180        181-365       Beyond
(dollars in thousands)     Balance         Days          Days          Days         1 Year
2018                     $ 1,133,130$ 397,990$ 265,232$ 280,402$ 189,506
2017                         727,496       265,872       109,584       171,877       180,163
2016                         544,803       142,806        91,704       115,151       195,142



Accrued Expenses and Other Liabilities

Accrued expenses and other liabilities increased $15.2 million, or 8%, from December 31, 2017 primarily due an increase in accrued expenses attributable to the Klein acquisition.


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Capital


Shareholders' equity totaled $2.690 billion, or 14% of total assets, at December
31, 2018 and $2.154 billion, or 12% of total assets, at December 31, 2017.
Shareholders' equity at December 31, 2018 included $406.5 million from the 22.8
million shares of Common Stock that were issued in conjunction with the
acquisition of Klein. We paid cash dividends of $0.52 per share in 2018, which
reduced equity by $82.2 million. Old National's Common Stock is traded on the
NASDAQ under the symbol "ONB" with 34,536 shareholders of record at December 31,
2018.

Capital Adequacy

Old National and the banking industry are subject to various regulatory capital
requirements administered by the federal banking agencies. Management routinely
analyzes Old National's capital to ensure an optimized capital
structure. Accordingly, such evaluations may result in Old National taking a
capital action. For additional information on capital adequacy see Note 25 to
the consolidated financial statements.

RISK MANAGEMENT

Overview


Old National has adopted a Risk Appetite Statement to enable the Board of
Directors, Executive Leadership Group, and Senior Management to better assess,
understand, and mitigate the risks of Old National. The Risk Appetite Statement
addresses the following major risks: strategic, market, liquidity, credit,
operational/technology/cyber, regulatory/compliance/legal, reputational, and
human resources. Our Chief Risk Officer is independent of management and reports
directly to the Chair of the Board's Enterprise Risk Management Committee. The
following discussion addresses these major risks: credit, market, liquidity,
operational/technology/cyber, and regulatory/compliance/legal.

Credit Risk


Credit risk represents the risk of loss arising from an obligor's inability or
failure to meet contractual payment or performance terms. Our primary credit
risks result from our investment and lending activities.

Investment Activities


We carry a higher exposure to loss in our pooled trust preferred securities,
which are collateralized debt obligations, due to illiquidity in that market and
the performance of the underlying collateral. At December 31, 2018, we had
pooled trust preferred securities with a fair value of $8.5 million, or less
than 1% of the available-for-sale securities portfolio. These securities
remained classified as available-for-sale and at December 31, 2018, the
unrealized loss on our pooled trust preferred securities was approximately $5.4
million. The fair value of these securities should improve as we get closer to
maturity, but not in all cases. During the first quarter of 2018, Old National
sold a pooled trust security for proceeds of $1.8 million, which resulted in a
loss of $0.9 million. There was no OTTI recorded in 2018 or 2017.

All of our mortgage-backed securities are backed by U.S. government-sponsored or
federal agencies. Municipal bonds, corporate bonds, and other debt securities
are evaluated by reviewing the credit-worthiness of the issuer and general
market conditions. See Note 3 to the consolidated financial statements for
additional details about our investment security portfolio.

Counterparty Exposure


Counterparty exposure is the risk that the other party in a financial
transaction will not fulfill its obligation. We define counterparty exposure as
nonperformance risk in transactions involving federal funds sold and purchased,
repurchase agreements, correspondent bank relationships, and derivative
contracts with companies in the financial services industry. Old National
manages exposure to counterparty risk in connection with its derivatives
transactions by generally engaging in transactions with counterparties having
ratings of at least A by Standard & Poor's Rating Service or A2 by Moody's
Investors Service. Total credit exposure is monitored by counterparty and
managed within limits that management believes to be prudent. Old National's net
counterparty exposure was an asset of $396.4 million at December 31, 2018.

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Lending Activities

Commercial

Commercial and industrial loans are made primarily for the purpose of financing
equipment acquisition, expansion, working capital, and other general business
purposes. Lease financing consists of direct financing leases and are used by
commercial customers to finance capital purchases ranging from computer
equipment to transportation equipment. The credit decisions for these
transactions are based upon an assessment of the overall financial capacity of
the applicant. A determination is made as to the applicant's ability to repay in
accordance with the proposed terms as well as an overall assessment of the risks
involved. In addition to an evaluation of the applicant's financial condition, a
determination is made of the probable adequacy of the primary and secondary
sources of repayment, such as additional collateral or personal guarantees, to
be relied upon in the transaction. Credit agency reports of the applicant's
credit history supplement the analysis of the applicant's creditworthiness.

Commercial mortgages and construction loans are offered to real estate
investors, developers, and builders primarily domiciled in the geographic market
areas we serve: Indiana, Kentucky, Michigan, Wisconsin, and Minnesota. These
loans are secured by first mortgages on real estate at LTV margins deemed
appropriate for the property type, quality, location, and
sponsorship. Generally, these LTV ratios do not exceed 80%. The commercial
properties are predominantly non-residential properties such as retail centers,
apartments, industrial properties and, to a lesser extent, more specialized
properties. Substantially all of our commercial real estate loans are secured by
properties located in our primary market area.

In the underwriting of our commercial real estate loans, we obtain appraisals
for the underlying properties. Decisions to lend are based on the economic
viability of the property and the creditworthiness of the borrower. In
evaluating a proposed commercial real estate loan, we primarily emphasize the
ratio of the property's projected net cash flows to the loan's debt service
requirement. The debt service coverage ratio normally is not less than 120% and
it is computed after deduction for a vacancy factor and property expenses as
appropriate. In addition, a personal guarantee of the loan or a portion thereof
is often required from the principal(s) of the borrower. In most cases, we
require title insurance insuring the priority of our lien, fire, and extended
coverage casualty insurance, and flood insurance, if appropriate, in order to
protect our security interest in the underlying property. In addition, business
interruption insurance or other insurance may be required.

Construction loans are underwritten against projected cash flows derived from
rental income, business income from an owner-occupant, or the sale of the
property to an end-user. We may mitigate the risks associated with these types
of loans by requiring fixed-price construction contracts, performance and
payment bonding, controlled disbursements, and pre-sale contracts or pre-lease
agreements.

Consumer

We offer a variety of first mortgage and junior lien loans to consumers within
our markets, with residential home mortgages comprising our largest consumer
loan category. These loans are secured by a primary residence and are
underwritten using traditional underwriting systems to assess the credit risks
of the consumer. Decisions are primarily based on LTV ratios, DTI ratios,
liquidity, and credit scores. A maximum LTV ratio of 80% is generally required,
although higher levels are permitted with mortgage insurance or other mitigating
factors. We offer fixed rate mortgages and variable rate mortgages with interest
rates that are subject to change every year after the first, third, fifth, or
seventh year, depending on the product and are based on fully-indexed rates such
as LIBOR. We do not offer payment-option facilities, sub-prime loans, or any
product with negative amortization.

Home equity loans are secured primarily by second mortgages on residential
property of the borrower. The underwriting terms for the home equity product
generally permits borrowing availability, in the aggregate, up to 90% of the
appraised value of the collateral property at the time of origination. We offer
fixed and variable rate home equity loans, with variable rate loans underwritten
at fully-indexed rates. Decisions are primarily based on LTV ratios, DTI ratios,
and credit scores. We do not offer home equity loan products with reduced
documentation.

Automobile loans include loans and leases secured by new or used automobiles. We
originate automobile loans and leases primarily on an indirect basis through
selected dealerships. We require borrowers to maintain collision insurance on
automobiles securing consumer loans, with us listed as loss payee. Our
procedures for underwriting automobile loans include an assessment of an
applicant's overall financial capacity, including credit history and the ability
to meet existing obligations and payments on the proposed loan. Although an
applicant's creditworthiness is

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the primary consideration, the underwriting process also includes a comparison of the value of the collateral security to the proposed loan amount.


Old National 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. Old National sold the remaining
student loan portfolio totaling $64.9 million during the second quarter of 2018,
resulting in a $2.2 million gain that is included in other income on the income
statement.

Asset Quality

Community-based lending personnel, along with region-based independent
underwriting and analytic support staff, extend credit under guidelines
established and administered by our Enterprise Risk Committee. This committee,
which meets quarterly, is made up of outside directors. The committee monitors
credit quality through its review of information such as delinquencies, credit
exposures, peer comparisons, problem loans, and charge-offs. In addition, the
committee reviews and approves recommended loan policy changes to assure it
remains appropriate for the current lending environment.

We lend to commercial and commercial real estate clients in various industries
including manufacturing, agribusiness, transportation, mining, wholesaling, and
retailing. Old National manages concentrations of credit exposure by industry,
product, geography, customer relationship, and loan size. At December 31, 2018,
our average commercial loan size was under $400,000 and our average commercial
real estate loan size was under $600,000. In addition, while loans to lessors of
both residential and non-residential real estate exceed 10% of total loans, no
individual sub-segment category within those broader categories reaches the 10%
threshold. At December 31, 2018, we had minimal exposure to foreign borrowers
and no sovereign debt. Our policy is to concentrate our lending activity in the
geographic market areas we serve, primarily Indiana, Kentucky, Michigan,
Wisconsin, and Minnesota. We are experiencing a slow and gradual improvement in
the economy of our principal markets. Management expects that trends in
under-performing, criticized, and classified loans will be influenced by the
degree to which the economy strengthens or weakens.

On November 1, 2018, Old National closed on its acquisition of Klein. As of the
closing date of the acquisition, loans totaled $1.049 billion and other real
estate owned totaled $1.0 million. In accordance with accounting for business
combinations, there was no allowance brought forward on any of the acquired
loans, as the credit losses evident in the loans were included in the
determination of the fair value of the loans at the acquisition date. Old
National reviewed the acquired loans and determined that as of December 31,
2018, $46.3 million met the definition of criticized and $56.6 million were
considered classified (of which $14.6 million are reported with nonaccrual
loans). Our current preference would be to work these loans and avoid
foreclosure actions unless additional credit deterioration becomes
apparent. These acquired impaired loans are included in our summary of
under-performing, criticized, and classified assets found below.

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Summary of under-performing, criticized, and classified assets at December 31:



(dollars in thousands)                2018          2017          2016          2015          2014
Nonaccrual loans:
Commercial                          $  38,648$  27,202$  56,585$  57,536$  38,460
Commercial real estate                 86,601        62,425        44,026        47,350        67,402
Residential real estate                24,954        22,171        17,674        14,953        13,968
Consumer                                7,281        13,129        13,122         5,198         5,903
Covered loans (1)                           -             -             -         7,336        15,124
Total nonaccrual loans (2)            157,484       124,927       131,407       132,373       140,857
Renegotiated loans not on
nonaccrual:
Noncovered loans                       17,356        19,589        14,376        14,147        12,710
Covered loans (1)                           -             -             -           138           148
Past due loans (90 days or more
and still accruing):
Commercial                                 52           144            23           565            33
Commercial real estate                     40             -             -             -           138
Residential real estate                   258             -             2           114             1
Consumer                                1,003           750           303           227           286
Covered loans (1)                           -             -             -            10             -
Total past due loans                    1,353           894           328           916           458
Other real estate owned                 3,232         8,810        18,546         7,594         7,241
Other real estate owned, covered
(1)                                         -             -             -         4,904         9,121
Total under-performing assets       $ 179,425$ 154,220$ 164,657$ 160,072$ 170,535
Classified loans (includes
nonaccrual,
  renegotiated, past due 90 days,
and
  other problem loans)              $ 334,785$ 226,583$ 220,429$ 204,710$ 233,486
Classified loans, covered (1)               -             -             -         8,584        17,413
Other classified assets (3)             2,820         4,556         7,063         6,857        14,752
Criticized loans                      238,752       188,085        95,462       132,898       194,809
Criticized loans, covered (1)               -             -             -         1,449         4,525
Total criticized and classified
assets                              $ 576,357$ 419,224$ 322,954$ 354,498$ 464,985
Asset Quality Ratios including
covered assets:
Non-performing loans/total loans                                                          %
(4) (5)                                  1.43   %      1.30   %      1.62   %      2.11          2.43   %
Under-performing assets/total
loans and
  other real estate owned (4)            1.47          1.39          1.82          2.30          2.69
Under-performing assets/total
assets                                   0.91          0.88          1.11          1.33          1.46
Allowance for loan losses/under-
  performing assets (6)                 30.91         32.67         30.25         32.63         28.06
Allowance for loan
losses/nonaccrual loans (2)             35.22         40.33         37.90         39.46         33.97

(1) Old National entered into separate loss sharing agreements with the FDIC

providing for specified credit loss protection for substantially all acquired

single family residential loans, commercial loans, and other real estate

owned. On June 22, 2016, Old National entered into an early termination

agreement with the FDIC that terminated all loss share agreements. Old

National reclassified all covered assets to noncovered assets effective June

22, 2016.

(2) Includes approximately $20.5 million, $12.6 million, $16.7 million, $15.9

million, and $41.2 million for 2018, 2017, 2016, 2015, and 2014,

respectively, of purchased credit impaired loans that are categorized as

nonaccrual for credit analysis purposes because the collection of principal

or interest is doubtful. However, these loans are accounted for under FASB

ASC 310-30 and accordingly treated as performing assets.

(3) Includes 1 pooled trust preferred securities and 1 insurance policy at

December 31, 2018.

(4) Loans exclude loans held for sale.

(5) Non-performing loans include nonaccrual and renegotiated loans.

(6) Because the acquired loans were recorded at fair value in accordance with ASC

805 at the date of acquisition, the credit risk is incorporated in the fair

value recorded. No allowance for loan losses is recorded on the acquisition

date.



Under-performing assets totaled $179.4 million at December 31, 2018, compared to
$154.2 million at December 31, 2017. Under-performing assets as a percentage of
total loans and other real estate owned at December 31, 2018 were 1.47%, an 8
basis point increase from 1.39% at December 31, 2017.

Nonaccrual loans increased $32.6 million from December 31, 2017 to December 31,
2018 primarily due to an increase in nonaccrual commercial and commercial real
estate loans. Nonaccrual loans at December 31, 2018 include $14.6 million of
loans related to the Klein acquisition. As a percentage of nonaccrual loans, the
allowance for loan losses was 35.22% at December 31, 2018, compared to 40.33% at
December 31, 2017. PCI loans that were included in the nonaccrual category
because the collection of principal or interest is doubtful totaled $20.5
million at December 31, 2018, compared to $12.6 million at December 31,
2017. However, they are accounted for under FASB ASC 310-30 and accordingly
treated as performing assets.

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Interest income of approximately $5.6 million and $6.7 million would have been
recorded on nonaccrual and renegotiated loans outstanding at December 31, 2018
and 2017, respectively, if such loans had been accruing interest throughout the
year in accordance with their original terms. Excluding PCI loans accounted for
under ASC 310-30, the amount of interest income actually recorded on nonaccrual
and renegotiated loans was $2.8 million in 2018 and $1.6 million in 2017. We had
$26.3 million of renegotiated loans which are included in nonaccrual loans at
December 31, 2018, compared to $34.0 million at December 31, 2017.

Total criticized and classified assets were $576.4 million at December 31, 2018,
an increase of $157.1 million from December 31, 2017. Other classified assets
include investment securities that fell below investment grade rating totaling
$2.8 million at December 31, 2018, compared to $4.6 million at December 31,
2017.

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.


At December 31, 2018, our TDRs consisted of $10.3 million of commercial loans,
$27.6 million of commercial real estate loans, $3.4 million of residential
loans, and $2.4 million of consumer loans totaling $43.7 million. Approximately
$26.3 million of the TDRs at December 31, 2018 were included with nonaccrual
loans. At December 31, 2017, our TDRs consisted of $12.1 million of commercial
loans, $34.7 million of commercial real estate loans, $3.3 million of
residential loans, and $3.9 million of consumer loans totaling $54.0
million. Approximately $34.0 million of the TDRs at December 31, 2017 were
included with nonaccrual loans.

Old National has allocated specific reserves to customers whose loan terms have
been modified in TDRs totaling $3.0 million at December 31, 2018 and $5.7
million at December 31, 2017. As of December 31, 2018, Old National had
committed to lend an additional $4.4 million to customers with outstanding loans
that are classified as TDRs.

The terms of certain other loans were modified during 2018 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

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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. At
December 31, 2018, 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.

To provide for the risk of loss inherent in extending credit, we maintain an
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 activity in our allowance for loan losses was as follows:




(dollars in thousands)                    2018            2017            2016            2015            2014
Balance at beginning of period      $     50,381$    49,808$    52,233$    47,849$    47,145
Loans charged-off:
Commercial                                 3,087           1,108           5,047           3,513           3,535
Commercial real estate                       879           3,700           2,632           1,921           3,647
Residential real estate                    1,100             985             800           1,039             793
Consumer credit                            7,903           6,924           6,131           6,404           4,675
Total charge-offs                         12,969          12,717          14,610          12,877          12,650
Recoveries on charged-off loans:
Commercial                                 1,519           2,281           3,102           5,218           3,125
Commercial real estate                     2,740           3,777           4,763           4,685           3,871
Residential real estate                    2,118             255             174             354             205
Consumer credit                            4,706           3,927           3,186           4,081           3,056
Total recoveries                          11,083          10,240          11,225          14,338          10,257
Net charge-offs (recoveries)               1,886           2,477           3,385          (1,461 )         2,393
Provision for loan losses                  6,966           3,050             960           2,923           3,097
Balance at end of period            $     55,461$    50,381$    49,808$    52,233$    47,849
Average loans for the year (1)      $ 11,422,967$ 9,525,888$ 8,265,169$ 6,756,135$ 5,703,294
Asset Quality Ratios:
Allowance/year-end loans (1)                0.45   %        0.45   %        0.55   %        0.75   %        0.76   %
Allowance/average loans (1)                 0.49            0.53            0.60            0.77            0.84
Net charge-offs
(recoveries)/average loans (2)              0.02            0.03            0.04           (0.02 )          0.04


(1) Loans exclude loans held for sale.

(2) Net charge-offs include write-downs on loans transferred to held for sale.




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The allowance for loan losses increased $5.1 million from December 31, 2017 to
December 31, 2018. Net charge-offs totaled $1.9 million in 2018 compared to net
charge-offs of $2.5 million in 2017. There were no industry segments
representing a significant share of total net charge-offs. Net charge-offs
(recoveries) to average loans was 0.02% in 2018 compared to 0.03% in 2017. Over
the last twelve months, net charge-offs have remained low. Continued loan growth
in future periods, a decline in our current level of recoveries, or an increase
in charge-offs could result in an increase in provision expense.

As a percentage of total loans, the allowance ranged from 0.45% to 0.76% for the
last five years, and was 0.45% at December 31, 2018. Our ratio of allowance for
loan losses to total loans remained the same as of December 31, 2018 compared to
December 31, 2017. The addition of Klein added $1.049 billion to the loan
portfolio. In accordance with ASC 805, no allowance for loan losses is recorded
at the date of acquisition and a reserve is only established to absorb any
subsequent credit deterioration or adverse changes in expected cash flows.

The following table provides additional details of the components of the
allowance for loan losses, including ASC 450, Contingencies, for loans
collectively evaluated for impairment, ASC 310-10, Receivables, for loans
individually evaluated for impairment, and ASC 310-30, Loans and Debt Securities
Acquired with Deteriorated Credit Quality, for loans acquired with deteriorated
credit quality:



                                Collectively       Individually       Acquired with
                               Evaluated for      Evaluated for       Deteriorated
(dollars in thousands)           Impairment         Impairment       Credit Quality         Total

Originated loans               $    8,805,227$       87,219     $             -     $  8,892,446
Acquired loans                      3,369,245             35,013              68,452        3,472,710
Total loans                    $   12,174,472$      122,232$        68,452$ 12,365,156
Remaining purchase discount           (93,487 )           (3,718 )           (24,059 )       (121,264 )
Loans, net of discount         $   12,080,985$      118,514$        44,393$ 12,243,892

Allowance, January 1, 2018     $       40,137$       10,078     $           166     $     50,381
Charge-offs                            (8,979 )           (3,927 )               (63 )        (12,969 )
Recoveries                              6,736              4,045                 302           11,083
Provision expense                       2,748              4,145                  73            6,966
Allowance, December 31, 2018   $       40,642$       14,341     $           478     $     55,461




We maintain an allowance for losses on unfunded commercial lending commitments
and letters of credit to provide for the risk of loss inherent in these
arrangements. The allowance is computed using a methodology similar to that used
to determine the allowance for loan losses, modified to take into account the
probability of a drawdown on the commitment. The reserve for unfunded loan
commitments is classified as a liability account on the balance sheet and
totaled $2.5 million at December 31, 2018, compared to $3.1 million at December
31, 2017.

The following table details the allowance for loan losses by loan category and
the percent of loans in each category compared to total loans at December 31.



                                     2018                            2017                            2016                            2015                            2014
                                             % of                            % of                            % of                            % of                            % of
                                            Loans                           Loans                           Loans                           Loans                           Loans
                           Allowance       to Total        Allowance       to Total        Allowance       to Total        Allowance       to Total        Allowance       to Total
(dollars in thousands)      Amount          Loans           Amount          Loans           Amount          Loans           Amount          Loans           Amount          Loans
Commercial                $    21,742           26.4   %  $    19,246           24.4   %  $    21,481           21.3   %  $    25,568           26.0   %  $    17,401           25.8   %
Commercial real estate         23,470           40.5           21,436           39.2           18,173           34.7           15,993           26.6           17,348           27.1
Residential real estate         2,277           18.4            1,763           19.5            1,643           23.2            2,051           23.7            2,962           24.1
Consumer credit                 7,972           14.7            7,936           16.9            8,511           20.8            7,684           22.2            6,586           20.7
Covered loans                       -              -                -              -                -              -              937            1.5            3,552            2.3
Total                     $    55,461          100.0   %  $    50,381          100.0   %  $    49,808          100.0   %  $    52,233          100.0   %  $    47,849          100.0   %




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Market Risk


Market risk is the risk that the estimated fair value of our assets,
liabilities, and derivative financial instruments will decline as a result of
changes in interest rates or financial market volatility, or that our net income
will be significantly reduced by interest rate changes.

The objective of our interest rate management process is to maximize net interest income while operating within acceptable limits established for interest rate risk and maintaining adequate levels of funding and liquidity.


Potential cash flows, sales, or replacement value of many of our assets and
liabilities, especially those that earn or pay interest, are sensitive to
changes in the general level of interest rates. This interest rate risk arises
primarily from our normal business activities of gathering deposits and
extending loans. Many factors affect our exposure to changes in interest rates,
such as general economic and financial conditions, customer preferences,
historical pricing relationships, and re-pricing characteristics of financial
instruments. Our earnings can also be affected by the monetary and fiscal
policies of the U.S. Government and its agencies, particularly the Federal
Reserve.

In managing interest rate risk, we, through the Funds Management Committee, a
committee of the Board of Directors, establish guidelines, for asset and
liability management, including measurement of short and long-term sensitivities
to changes in interest rates. Based on the results of our analysis, we may use
different techniques to manage changing trends in interest rates including:

• adjusting balance sheet mix or altering interest rate characteristics of

assets and liabilities;

• changing product pricing strategies;

• modifying characteristics of the investment securities portfolio; or

• using derivative financial instruments, to a limited degree.



A key element in our ongoing process is to measure and monitor interest rate
risk using a model to quantify the impact of changing interest rates on Old
National. The model quantifies the effects of various possible interest rate
scenarios on projected net interest income. The model measures the impact on net
interest income relative to a base case scenario. The base case scenario assumes
that the balance sheet and interest rates are held at current levels. The model
shows our projected net interest income sensitivity based on interest rate
changes only and does not consider other forecast assumptions.

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The following table illustrates our projected net interest income sensitivity over a two-year cumulative horizon based on the asset/liability model as of December 31, 2018 and 2017:




                                  Immediate
                                Rate Decrease                                    Immediate Rate Increase
                                     -50                                +100               +200               +300
(dollars in thousands)          Basis Points          Base          Basis Points       Basis Points       Basis Points
December 31, 2018
Projected interest income:
Money market, other interest
earning
  investments, and
investment securities          $       300,290$   308,302$      322,252$      335,523$      347,517
Loans                                1,074,017       1,133,140          1,253,101          1,368,890          1,484,341
Total interest income                1,374,307       1,441,442          1,575,353          1,704,413          1,831,858
Projected interest expense:
Deposits                                87,031         127,300            217,029            306,754            396,473
Borrowings                             113,737         130,971            165,406            199,865            234,336
Total interest expense                 200,768         258,271            382,435            506,619            630,809
Net interest income            $     1,173,539$ 1,183,171$    1,192,918$    1,197,794$    1,201,049
Change from base               $        (9,632 )$        9,747$       14,623$       17,878
% change from base                       -0.81 %                             0.82 %             1.24 %             1.51 %

December 31, 2017
Projected interest income:
Money market, other interest
earning
  investments, and
investment securities          $       225,619$   234,618$      247,478$      259,531$      272,707
Loans                                  856,693         914,205          1,026,924          1,138,107          1,248,623
Total interest income                1,082,312       1,148,823          1,274,402          1,397,638          1,521,330
Projected interest expense:
Deposits                                33,625          60,527            135,504            210,475            285,441
Borrowings                              84,359         101,521            135,861            170,210            204,542
Total interest expense                 117,984         162,048            271,365            380,685            489,983
Net interest income            $       964,328$   986,775$    1,003,037$    1,016,953$    1,031,347
Change from base               $       (22,447 )$       16,262$       30,178$       44,572
% change from base                       -2.27 %                             1.65 %             3.06 %             4.52 %



Our asset sensitivity decreased year over year primarily due to changes in our balance sheet mix, investment duration, and prepayment speed behavior.


A key element in the measurement and modeling of interest rate risk is the
re-pricing assumptions of our transaction deposit accounts, which have no
contractual maturity dates. We assume this deposit base is comprised of both
core and more volatile balances and consists of both noninterest-bearing and
interest-bearing accounts. Core deposit balances are assumed to be less interest
rate sensitive and provide longer term funding. Volatile balances are assumed to
be more interest rate sensitive and shorter in term. As part of our semi-static
balance sheet modeling, we assume interest rates paid on the volatile deposits
move in conjunction with changes in interest rates, in order to retain these
deposits. This may include current noninterest-bearing accounts.

Because the models are driven by expected behavior in various interest rate
scenarios and many factors besides market interest rates affect our net interest
income, we recognize that model outputs are not guarantees of actual
results. For this reason, we model many different combinations of interest rates
and balance sheet assumptions to understand our overall sensitivity to market
interest rate changes, including shocks, yield curve flattening, yield curve
steepening, as well as forecasts of likely interest rate scenarios. At December
31, 2018, our projected net interest income sensitivity based on the
asset/liability models we utilize was within the limits of our interest rate
risk policy for the scenarios tested.

We use derivative instruments, primarily interest rate swaps, to mitigate
interest rate risk, including certain cash flow hedges on variable-rate debt
with a notional amount of $725 million at December 31, 2018. Our derivatives had
an estimated fair value gain of $16.5 million at December 31, 2018, compared to
an estimated fair value loss of

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$2.2 million at December 31, 2017. See Note 21 to the consolidated financial statements for further discussion of derivative financial instruments.

Liquidity Risk


Liquidity risk arises from the possibility that we may not be able to satisfy
current or future financial commitments, or may become unduly reliant on
alternative funding sources. The Funds Management Committee of the Board of
Directors establishes liquidity risk guidelines and, along with the Balance
Sheet Management Committee, monitors liquidity risk. The objective of liquidity
management is to ensure we have the ability to fund balance sheet growth and
meet deposit and debt obligations in a timely and cost-effective
manner. Management monitors liquidity through a regular review of asset and
liability maturities, funding sources, and loan and deposit forecasts. We
maintain strategic and contingency liquidity plans to ensure sufficient
available funding to satisfy requirements for balance sheet growth, properly
manage capital markets' funding sources and to address unexpected liquidity
requirements.

Loan repayments and maturing investment securities are a relatively predictable
source of funds. However, deposit flows, calls of investment securities and
prepayments of loans and mortgage-related securities are strongly influenced by
interest rates, the housing market, general and local economic conditions, and
competition in the marketplace. We continually monitor marketplace trends to
identify patterns that might improve the predictability of the timing of deposit
flows or asset prepayments.

A time deposit maturity schedule for Old National Bank is shown in the following table at December 31, 2018.



(dollars in thousands)
Maturity Bucket            Amount         Rate
2019                     $ 1,505,694       1.68   %
2020                         277,142       1.45
2021                         109,890       1.43
2022                          52,697       1.47
2023                          54,637       1.73
2024 and beyond               24,196       1.79
Total                    $ 2,024,256       1.64   %




Our ability to acquire funding at competitive prices is influenced by rating
agencies' views of our credit quality, liquidity, capital, and earnings. Moody's
Investor Service places us in an investment grade that indicates a low risk of
default. For both Old National and Old National Bank:

• Moody's Investor Service affirmed the Long-Term Rating of A3 of Old

National's senior unsecured/issuer rating on February 2, 2018.

• Moody's Investor Service affirmed Old National Bank's long-term deposit

rating of Aa3 on February 2, 2018. The bank's short-term deposit rating

was affirmed at P-1 and the bank's issuer rating was affirmed at A3.

The rating outlook from Moody's Investor Service is negative. Moody's Investor Service concluded a rating review of Old National Bank on February 2, 2018.

The credit ratings of Old National and Old National Bank at December 31, 2018 are shown in the following table.



                     Moody's Investor Service
                     Long-term      Short-term
Old National            A3             N/A
Old National Bank       Aa3            P-1




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Old National Bank maintains relationships in capital markets with brokers and
dealers to issue certificates of deposit and short-term and medium-term bank
notes as well. At December 31, 2018, Old National and its subsidiaries had the
following availability of liquid funds and borrowings:



                                                               Parent
(dollars in thousands)                                         Company        Subsidiaries
Available liquid funds:
Cash and due from banks                                      $    94,122$      223,043
Unencumbered government-issued debt securities                         -    

1,551,735

Unencumbered investment grade municipal securities                     -    

532,240

Unencumbered corporate securities                                      -    

137,539

Availability of borrowings:
Amount available from Federal Reserve discount window*                 -    

477,108

Amount available from Federal Home Loan Bank Indianapolis*             -            660,052
Total available funds                                        $    94,122$    3,581,717

* Based on collateral pledged




Old National Bancorp has routine funding requirements consisting primarily of
operating expenses, dividends to shareholders, debt service, net derivative cash
flows, and funds used for acquisitions. Old National Bancorp can obtain funding
to meet its obligations from dividends and management fees collected from its
subsidiaries, operating line of credit, and through the issuance of debt
securities. Additionally, Old National Bancorp has a shelf registration in place
with the SEC permitting ready access to the public debt and equity markets. At
December 31, 2018, Old National Bancorp's other borrowings outstanding were
$231.4 million.

Federal banking laws regulate the amount of dividends that may be paid by
banking subsidiaries without prior approval. Prior regulatory approval is
required if dividends to be declared in any year would exceed net earnings of
the current year plus retained net profits for the preceding two years. Prior
regulatory approval to pay dividends was not required in 2017 or 2018 and is not
currently required.

Operational/Technology/Cyber Risk


Operational/technology/cyber risk is the potential that inadequate information
systems, operational problems, breaches in internal controls, information
security breaches, fraud, or unforeseen catastrophes will result in unexpected
losses. We maintain frameworks, programs, and internal controls to prevent or
minimize financial loss from failure of systems, people, or processes. This
includes specific programs and frameworks intended to prevent or limit the
effects of cyber risks including cyber-attacks or other information security
breaches that might allow unauthorized transactions or unauthorized access to
customer, associate, or company sensitive information. Metrics and measurements
are used by Executive Leaders in the management of day-to-day operations to
ensure effective customer service, minimization of service disruptions, and
oversight of operational and cyber risk. We continually monitor and report on
operational, technology, and cyber risks related to clients, products, and
business practices; external and internal fraud; business disruptions and
systems failures; cyber-attacks, information security or data breaches; damage
to physical assets; and execution, delivery, and process management.

The Enterprise Risk Management Committee of the Board of Directors is
responsible for the oversight, guidance, and monitoring of risks, including
operational/technology/cyber risks, being taken by the Company. The monitoring
is accomplished through on-going review of management reports, data on risks,
policy limits and discussion on enterprise risk management strategies, policies,
and risk assessments.

Regulatory/Compliance/Legal Risk


Regulatory/compliance/legal risk is the risk that the Company violated or was
not in compliance with applicable laws, regulations or practices, industry
standards, or ethical standards. The legal portion assesses the risk that
unenforceable contracts, lawsuits, or adverse judgments can disrupt or otherwise
negatively impact the Company. The Board of Directors expects we will perform
business in a manner compliant with applicable laws and/or regulations and
expects issues to be identified, analyzed, and remediated in a timely and
complete manner.





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OFF-BALANCE SHEET ARRANGEMENTS


Off-balance sheet arrangements include commitments to extend credit and
financial guarantees. Commitments to extend credit and financial guarantees are
used to meet the financial needs of our customers. Our banking affiliates have
entered into various agreements to extend credit, including loan commitments of
$3.566 billion and standby letters of credit of $319.0 million at December 31,
2018. At December 31, 2018, approximately $3.348 billion of the loan commitments
had fixed rates and $218.1 million had floating rates, with the floating
interest rates ranging from 1% to 16%. At December 31, 2017, loan commitments
were $3.144 billion and standby letters of credit of $68.7 million. The term of
these off-balance sheet arrangements is typically one year or less.

Old National is a party in risk participation transactions of interest rate swaps, which had total notional amount of $38.7 million at December 31, 2018.

CONTRACTUAL OBLIGATIONS, COMMITMENTS, AND CONTINGENT LIABILITIES


The following table presents our significant fixed and determinable contractual
obligations and significant commitments at December 31, 2018. Further discussion
of each obligation or commitment is included in the referenced note to the
consolidated financial statements.



                                                                Payments Due In
                              Note        One Year          One to           Three to          Over
(dollars in thousands)      Reference     or Less         Three Years      
Five Years      Five Years         Total
Deposits without stated
maturity                                $ 12,325,693     $           -     $          -     $         -     $ 12,325,693
IRAs, consumer, and
brokered
 certificates of deposit           11      1,505,694           387,032          107,334          24,196        2,024,256
Federal funds purchased
and
 interbank borrowings                        270,135                 -                -               -          270,135
Securities sold under
agreements
 to repurchase                     12        362,294                 -                -               -          362,294
Federal Home Loan Bank
advances                           13        326,474           120,000           57,169       1,109,838        1,613,481
Other borrowings                   14            137               307              368         247,071          247,883
Fixed interest payments
(1)                                           44,894            82,780           78,248         122,218          328,140
Operating leases                    7         19,480            35,816           24,866          65,612          145,774
Other long-term
liabilities (2)                               32,593             5,879               28              48           38,548

(1) Our senior notes, subordinated notes, certain trust preferred securities, and

certain FHLB advances have fixed rates ranging from 1.50% to 6.08%. All of

our other long-term debt is at LIBOR based variable rates at December 31,

2018. The projected variable interest assumes no increase in LIBOR rates from

December 31, 2018.

(2) Includes unfunded commitments on qualified affordable housing projects and

other tax credit investments.



We rent certain premises and equipment under operating leases. See Note 7 to the
consolidated financial statements for additional information on long-term lease
arrangements.

We are party to various derivative contracts as a means to manage the balance
sheet and our related exposure to changes in interest rates, to manage our
residential real estate loan origination and sale activity, and to provide
derivative contracts to our clients. Since the derivative liabilities recorded
on the balance sheet change frequently and do not represent the amounts that may
ultimately be paid under these contracts, these liabilities are not included in
the table of contractual obligations presented above. Further discussion of
derivative instruments is included in Note 21 to the consolidated financial
statements.

In the normal course of business, various legal actions and proceedings are
pending against us and our affiliates which are incidental to the business in
which they are engaged. Further discussion of contingent liabilities is included
in Note 22 to the consolidated financial statements.

                                       57

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In addition, liabilities recorded under FASB ASC 740-10 (FASB Interpretation No.
48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB
Statement No. 109) are not included in the table because the amount and timing
of any cash payments cannot be reasonably estimated. Further discussion of
income taxes and liabilities recorded under FASB ASC 740-10 is included in Note
16 to the consolidated financial statements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES


Our accounting policies are described in Note 1 to the consolidated financial
statements. Certain accounting policies require management to use significant
judgment and estimates, which can have a material impact on the carrying value
of certain assets and liabilities. We consider these policies to be critical
accounting policies. The judgment and assumptions made are based upon historical
experience or other factors that management believes to be reasonable under the
circumstances. Because of the nature of the judgment and assumptions, actual
results could differ from estimates, which could have a material effect on our
financial condition and results of operations.

The following accounting policies materially affect our reported earnings and
financial condition and require significant judgments and estimates. Management
has reviewed these critical accounting estimates and related disclosures with
our Audit Committee.

Goodwill

• Description. For acquisitions, we are required to record the assets

acquired, including identified intangible assets, and the liabilities

assumed at their fair value. These often involve estimates based on third

        party valuations, such as appraisals, or internal valuations based on
        discounted cash flow analyses or other valuation techniques that may

include estimates of attrition, inflation, asset growth rates, or other

relevant factors. Under FASB ASC 350, Intangibles - Goodwill and Other,

goodwill recorded must be reviewed for impairment on an annual basis, as

well as on an interim basis if events or changes indicate that the asset

might be impaired. An impairment loss must be recognized for any excess of

carrying value over fair value of the goodwill.

• Judgments and Uncertainties. The determination of fair values is based on

valuations using management's assumptions of future growth rates, future

        attrition, discount rates, multiples of earnings or other relevant
        factors.

• Effect if Actual Results Differ From Assumptions. Changes in these

factors, as well as downturns in economic or business conditions, could

have a significant adverse impact on the carrying value of goodwill and

could result in impairment losses affecting our financials as a whole and

our banking subsidiary in which the goodwill resides.

Allowance for Loan Losses

• Description. The allowance for loan losses is maintained at a level

believed adequate by management to absorb probable incurred losses 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 represents management's best estimate, but significant downturns

in circumstances relating to loan quality and economic conditions could

result in a requirement for additional allowance. Likewise, an upturn in

loan quality and improved economic conditions may allow a reduction in the

required allowance. In either instance, unanticipated changes could have a

significant impact on results of operations.



The allowance is increased through a provision charged to operating
expense. Uncollectible loans are charged-off through the allowance. Recoveries
of loans previously charged-off are added to the allowance. 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. Our policy for recognizing income on impaired loans is to accrue
interest unless a loan is placed on nonaccrual status. 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. We
monitor the quality of our loan portfolio on an on-going basis and use a
combination of detailed credit assessments by relationship managers and credit
officers, historic loss trends, and economic and business environment factors in
determining the allowance for loan losses. We

                                       58

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record provisions for loan losses based on current loans outstanding, grade changes, mix of loans, and expected losses. A detailed loan loss evaluation on an individual loan basis for our highest risk loans is performed quarterly. Management follows the progress of the economy and how it might affect our borrowers in both the near and the intermediate term. We have a formalized and disciplined independent loan review program to evaluate loan administration, credit quality, and compliance with corporate loan standards. This program includes periodic, regular reviews of problem loan reports, delinquencies and charge-offs.

• Judgments and Uncertainties. We utilize a PD/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.

• Effect if Actual Results Differ From Assumptions. The allowance represents

management's best estimate, but significant downturns in circumstances

relating to loan quality and economic conditions could result in a

requirement for additional allowance. Likewise, an upturn in loan quality

and improved economic conditions may allow a reduction in the required

allowance. In either instance, unanticipated changes could have a

significant impact on results of operations.



Management's analysis of probable losses in the portfolio at December 31, 2018
resulted in a range for allowance for loan losses of $16.2 million. The range
pertains to general (FASB ASC 450, Contingencies) reserves for both retail and
performing commercial loans. Specific (FASB ASC 310, Receivables) reserves do
not have a range of probable loss. Due to the risks and uncertainty associated
with the economy and our projection of loss rates inherent in the portfolio, we
establish a range of probable outcomes (a high-end estimate and a low-end
estimate) and evaluate our position within this range. The potential effect to
net income based on our position in the range relative to the high and low
endpoints is a decrease of $1.8 million and an increase of $10.5 million,
respectively, after taking into account the tax effects. These sensitivities are
hypothetical and may not represent actual results.

Derivative Financial Instruments

• Description. As part of our overall interest rate risk management, we use

derivative instruments to reduce exposure to changes in interest rates and

        market prices for financial instruments. The application of the hedge
        accounting policy requires judgment in the assessment of hedge
        effectiveness, identification of similar hedged item groupings and
        measurement of changes in the fair value of derivative financial
        instruments and hedged items. To the extent hedging relationships are
        found to be effective, as determined by FASB ASC 815, Derivatives and
        Hedging ("ASC Topic 815"), changes in fair value of the derivatives are

offset by changes in the fair value of the related hedged item or recorded

to other comprehensive income. Management believes hedge effectiveness is

evaluated properly in preparation of the financial statements. All of the

        derivative financial instruments we use have an active market and
        indications of fair value can be readily obtained. We are not using the
        "short-cut" method of accounting for any fair value derivatives.

• Judgments and Uncertainties. The application of the hedge accounting

policy requires judgment in the assessment of hedge effectiveness,

identification of similar hedged item groupings and measurement of changes

        in the fair value of derivative financial instruments and hedged items.


    •   Effect if Actual Results Differ From Assumptions. To the extent hedging

relationships are found to be effective, as determined by ASC Topic 815,

changes in fair value of the derivatives are offset by changes in the fair

value of the related hedged item or recorded to other comprehensive

income. However, if in the future the derivative financial instruments

        used by us no longer qualify for hedge accounting treatment, all


                                       59
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changes in fair value of the derivative would flow through the

consolidated statements of income in other noninterest income, resulting

in greater volatility in our earnings.

Income Taxes

• Description. We are subject to the income tax laws of the U.S., its

states, and the municipalities in which we operate. These tax laws are

complex and subject to different interpretations by the taxpayer and the

relevant government taxing authorities. We review income tax expense and

the carrying value of deferred tax assets quarterly; and as new

information becomes available, the balances are adjusted as

appropriate. FASB ASC 740-10 (FIN 48) prescribes a recognition threshold

of more-likely-than-not, and a measurement attribute for all tax positions

taken or expected to be taken on a tax return, in order for those tax

positions to be recognized in the financial statements. See Note 16 to the

        consolidated financial statements for a further description of our
        provision and related income tax assets and liabilities.

• Judgments and Uncertainties. In establishing a provision for income tax

expense, we must make judgments and interpretations about the application

of these inherently complex tax laws. We must also make estimates about

when in the future certain items will affect taxable income in the various

tax jurisdictions. Disputes over interpretations of the tax laws may be

subject to review/adjudication by the court systems of the various tax

jurisdictions or may be settled with the taxing authority upon examination

or audit.

• Effect if Actual Results Differ From Assumptions. Although management

        believes that the judgments and estimates used are reasonable, actual
        results could differ and we may be exposed to losses or gains that could
        be material. To the extent we prevail in matters for which reserves have
        been established, or are required to pay amounts in excess of our

reserves, our effective income tax rate in a given financial statement

period could be materially affected. An unfavorable tax settlement would

result in an increase in our effective income tax rate in the period of

resolution. A favorable tax settlement would result in a reduction in our

effective income tax rate in the period of resolution.

Management has discussed the development and selection of these critical accounting estimates with the Audit Committee and the Audit Committee has reviewed our disclosure relating to it in this "Management's Discussion and Analysis of Financial Condition and Results of Operations."

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information contained under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations - Market Risk" of this Form 10-K is incorporated herein by reference in response to this item.

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