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ONB Old National Bancorp

Filed: 10 Feb 21, 11:15am
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
☑    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2020
 
☐    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number 1-15817
OLD NATIONAL BANCORP
(Exact name of the Registrant as specified in its charter)
Indiana35-1539838
(State or other jurisdiction of incorporation or organization)(I.R.S. Employer Identification No.)
  
One Main Street47708
Evansville,Indiana
(Address of principal executive offices)(Zip Code)
(800) 731-2265
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
 
Title of each classTrading
Symbol(s)
Name of each exchange on which registered
Common Stock, No Par ValueONBTheNASDAQStock Market LLC
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filerAccelerated filer
Non-accelerated filerSmaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No
The aggregate market value of the registrant’s voting common stock held by non-affiliates on June 30, 2020, was $2,248,155,309 (based on the closing price on that date of $13.76).  In calculating the market value of securities held by non-affiliates of the registrant, the registrant has treated as securities held by affiliates as of June 30, 2020, voting stock owned of record by its directors and principal executive officers, and voting stock held by the registrant's trust department in a fiduciary capacity for benefit of its directors and principal executive officers.  This calculation does not reflect a determination that persons are affiliates for any other purposes.
The number of shares outstanding of the registrant’s common stock, as of January 31, 2021, was 165,378,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held April 29, 2021 are incorporated by reference into Part III of this Form 10-K.



OLD NATIONAL BANCORP
2020 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
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GLOSSARY OF ABBREVIATIONS AND ACRONYMS

As used in this report, references to “Old National,” “the Company,” “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of Old National Bancorp and its wholly-owned subsidiaries. Old National Bancorp refers solely to the parent holding company, and Old National Bank refers to Old National Bancorp’s bank subsidiary.

The acronyms and abbreviations identified below are used throughout this report, including the Notes to Consolidated Financial Statements. You may find it helpful to refer to this page as you read this report.

ACH:  Automated Clearing House
Anchor (MN):  Anchor Bancorp, Inc.
Anchor (WI):  Anchor BanCorp Wisconsin Inc.
AOCI:  accumulated other comprehensive income (loss)
AQR:  asset quality rating
ARRC: Alternative Reference Rates Committee
ASC:  Accounting Standards Codification
ASU:  Accounting Standards Update
ATM:  automated teller machine
BBCC: business banking credit center (small business)
CAA: Consolidated Appropriations Act
CARES Act: Coronavirus Aid, Relief and Economic Security Act
CECL:  current expected credit loss
CFPB:  Consumer Financial Protection Bureau
Common Stock:  Old National Bancorp common stock, without par value
COVID-19: Novel coronavirus originating in Wuhan, China in December 2019
CReED:  Indiana Community Revitalization Enhancement District Tax Credit
DTI:  debt-to-income
FASB:  Financial Accounting Standards Board
FDIC:  Federal Deposit Insurance Corporation
FHLB:  Federal Home Loan Bank
FHLBI:  Federal Home Loan Bank of Indianapolis
FHTC:  Federal Historic Tax Credit
FICO:  Fair Isaac Corporation
GAAP:  U.S. generally accepted accounting principles
GDP:  gross domestic product
Klein:  Klein Financial, Inc.
LGD:  loss given default
LIBOR:  London Interbank Offered Rate
LIHTC:  Low Income Housing Tax Credit
LTV:  loan-to-value
N/A:  not applicable
NASDAQ:  The NASDAQ Stock Market LLC
NMTC: New Markets Tax Credit
NOW:  negotiable order of withdrawal
OCC:  Office of the Comptroller of the Currency
OTTI:  other-than-temporary impairment
PCD:  purchased with credit deterioration
PCI:  purchased credit impaired
PD:  probability of default
PPP: Paycheck Protection Program
Renewable Energy:  investment tax credits for solar projects
SAB:  Staff Accounting Bulletin
SBA:  Small Business Administration
SEC:  Securities and Exchange Commission
SOFR: secured overnight financing rate
TBA:  to be announced
TDR:  troubled debt restructuring
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OLD NATIONAL BANCORP
2020 ANNUAL REPORT ON FORM 10-K

FORWARD-LOOKING STATEMENTS

In this report, we have made various statements regarding current expectations or forecasts of future events, which speak only as of the date the statements are made.  These statements are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements are also made from time-to-time in press releases and in oral statements made by the officers of Old National Bancorp (“Old National” or the “Company”).  Forward-looking statements can be identified by the use of the words “expect,” “may,” “could,” “will,” “intend,” “project,” “estimate,” “believe,” “anticipate,” or the negative of those terms, and other words of similar meaning.  Forward-looking statements also include, but are not limited to, statements regarding estimated cost savings, plans and objectives for future operations, the Company’s business and growth strategies, including future acquisitions of banks, regulatory developments, and expectations about performance as well as economic and market conditions and trends.  

Such forward-looking statements are based on assumptions and estimates, which although believed to be reasonable, may turn out to be incorrect.  Therefore, undue reliance should not be placed upon these estimates and statements.  We cannot assure that any of these statements, estimates, or beliefs will be realized and actual results may differ from those contemplated in these “forward-looking statements.”  We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events, or otherwise.  You are advised to consult further disclosures we may make on related subjects in our filings with the SEC.  In addition to other factors discussed in this report, some of the important factors that could cause actual results to differ materially from those discussed in the forward-looking statements include the following:
the length, severity, magnitude, and duration of the COVID-19 pandemic and the direct and indirect impact of such pandemic, including its impact on the Company’s financial conditions and business operations;
changes in the economy, which could materially impact credit quality trends and the ability to generate loans and gather deposits, including the pace of recovery following the COVID-19 pandemic;
market, economic, operational, liquidity, credit, and interest rate risks associated with our business;
competition;
government legislation and policies, including changes to address the impact of COVID-19 through the CARES Act and other legislative and regulatory responses to the COVID-19 pandemic;
our ability to execute our business plan, including the anticipated impact from the ONB Way strategic plan that may differ from current estimates;
unanticipated changes in our liquidity position, including but not limited to changes in our access to sources of liquidity and capital to address our liquidity needs;
our ability to successfully manage our credit risk and the sufficiency of our allowance for credit losses;
uncertainty about the discontinued use of LIBOR and the transition to an alternative rate;
failure or circumvention of our internal controls;
failure or disruption of our information systems;
significant changes in accounting, tax, or regulatory practices or requirements, including the impact of the new CECL standard;
new legal obligations or liabilities or unfavorable resolutions of litigations;
disruptive technologies in payment systems and other services traditionally provided by banks; and
operational risks or risk management failures by us or critical third parties, including without limitation with respect to data processing, information systems, cyber-security, technological changes, vendor problems, business interruption, and fraud risks.

Investors should consider these risks, uncertainties, and other factors in addition to the factors under the heading “Risk Factors” included in this filing and our other filings with the SEC.

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PART I
ITEM 1.    BUSINESS
GENERAL
Old National is a financial holding company incorporated in the state of Indiana and maintains its principal executive office in Evansville, Indiana.  Through our wholly-owned banking subsidiary, we provide a wide range of services, including commercial and consumer loan and depository services, private banking, brokerage, trust, investment advisory, and other traditional banking services.
COMPANY PROFILE
Old National Bank, our wholly-owned banking subsidiary (“Old National Bank”), was founded in 1834 and is the oldest company in Evansville, Indiana.  In 1982, Old National Bancorp was formed; in 2001 we became a financial holding company and we are currently the largest financial holding company headquartered in the state of Indiana with consolidated assets of $23.0 billion at December 31, 2020.
At December 31, 2020, Old National Bank operated 162 banking centers located primarily in Indiana, Kentucky, Michigan, Minnesota, and Wisconsin. Each of the banking centers of Old National Bank provide a group of similar community banking services, including such products and services as commercial, real estate and consumer loans, time deposits, checking and savings accounts, cash management, brokerage, trust, and investment advisory services.  The individual banking centers located throughout our Midwest footprint have similar operating and economic characteristics.
We earn interest income on loans as well as fee income from the origination of loans.  Lending activities include loans to individuals, which primarily consist of home equity lines of credit, residential real estate loans and consumer loans, and loans to commercial clients, which include commercial loans, commercial real estate loans, letters of credit, and lease financing.  Residential real estate loans are either kept in our loan portfolio or sold to secondary investors, with gains or losses from the sales being recognized.
We strive to serve individuals and commercial clients by providing depository services that fit their needs at competitive rates.  We pay interest on the interest-bearing deposits and receive service fee revenue on various accounts.  Deposit accounts include products such as noninterest-bearing demand, interest-bearing checking and NOW, savings and money market, and time deposits.  Debit and ATM cards provide clients with access to their accounts 24 hours a day at any ATM location.  We also provide 24-hour telephone access and online banking as well as other electronic and mobile banking services.
In addition to the community banking services of lending and providing deposit services, we offer comprehensive wealth management, investment, and foreign currency services.  For businesses, we provide treasury management, merchant, health savings, and capital markets services as well as community development lending and equity investment solutions intended to produce jobs and revitalize our communities.
In January 2020, Old National commenced implementation of a strategic plan (“The ONB Way”), which has various detailed business objectives designed to keep the Company’s clients at the center of all we do.  The ONB Way includes:
Realigning the organization into clearly defined segments to align leaders and relationship managers with the client segment they can best serve (while not wavering on our commitment to community);
Deepening client relationships through integrated Commercial, Community Banking, and Wealth teams;
Simplifying and improving the end-to-end banking/borrowing journey while adhering to strong risk management principles;
Creating a new Wealth Division that combines wealth management, investments, and private banking for a simplified, highly consultative client experience firmly rooted in financial planning; and
Investing in our operational and information technology infrastructure to meet our clients “where they are” and ensure that we keep pace with technology and client digital expectations.

During 2020, we executed The ONB Way transformation, delivered on the run rate expense savings, and are transitioning into the implementation phase of our planned revenue initiatives. These revenue initiatives are underway for our technology, Commercial, Wealth, and Treasury Management areas; while our Community area initiatives are scheduled to commence throughout the remainder of 2021.
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In July 2020, Old National entered into a multi-year strategic partnership with Infosys Limited, which will enable faster adoption of digital solutions, modernize our technology infrastructure, and enhance both the employee and client experience.
HUMAN CAPITAL RESOURCES
At December 31, 2020, we employed 2,445 full-time equivalent team members. Old National respects, values, and invites diversity in our team members, customers, suppliers, marketplace, and community. We seek to recognize the unique contribution each individual brings to our company, and we are fully committed to supporting a rich culture of diversity as a cornerstone to our success. Old National provides professional development opportunities to team members and seeks to improve retention, development, and job satisfaction of team members from diverse groups by providing career skills training, peer mentoring, and opportunities to interact with senior leaders.
We are committed and focused on the health and safety of our team members, customers, and communities. The COVID-19 pandemic presented challenges to maintain team member and client safety while continuing to be open for business. Accordingly, we launched a proactive response to the escalating COVID-19 outbreak that included the creation of an internal coronavirus resource page to manage our pandemic response, including providing access to recent safety standards from the Centers for Disease Control and Prevention, the World Health Organization, and other agencies; as well as our workplace guidelines for non-customer and customer environments. In addition, current information is shared through regular emails and other digital communications with our team members and customers facing financial hardships due to COVID-19. Additional actions included adjusting our banking center hours, lobby usage, and encouraging team members to work remotely where possible during the pandemic. We continue to monitor our footprint for areas where there is a resurgence or regression of COVID-19 and adjust our banking center availability accordingly. Our banking centers are still open for business and we continue to lend to qualified businesses for working capital and general business purposes, while our online banking network is continuously available for digital banking transactions. Lastly, the availability of an effective COVID-19 vaccine may drive the re-opening plans of state and local economies in 2021. However, economic uncertainty remains high and bouts of elevated volatility are expected to continue.
Old National team members actively share their talents in their communities through volunteer activities in education, economic development, human and health services, and Community Reinvestment. Our ONe Community program allows each team member to be paid up to 24 hours per year, with supervisory approval, to volunteer for activities in their community during normal work hours. During 2020, team members donated nearly 30,000 hours in support of more than 1,500 organizations. Even through a pandemic, Old National team members found creative ways to give back to their communities by donating blood, making masks for healthcare workers, and serving on local boards, just to name a few. Team member volunteers are recognized for their efforts on our Corporate Portal. Team members with 25 hours or more of service each year join the “Volunteer Honor Roll” in Old National’s annual communications.
MARKET AREA
We own the largest bank headquartered in Indiana.  Operating from a home base in Evansville, Indiana, we have continued to grow our footprint in Indiana, Kentucky, Michigan, Minnesota, and Wisconsin.  Since the beginning of 2011, Old National has transformed its franchise by reducing low-return businesses and low-growth markets and investing in higher-growth markets.
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The following table reflects information on the top markets we currently serve, demonstrating that our largest metropolitan statistical areas compare favorably to the national average.
Metropolitan Statistical AreaPercent of
Old
National
Bank
Franchise
(%)
Deposits
Per
Branch
($M)
2010-2021
Population
Change
(%)
2021-2026
Projected
Population
Change
(%)
2021
Median
Household
Income
($)
2021-2026
Projected
Household
Income
Change
(%)
Minneapolis-St. Paul-Bloomington, MN-WI (1)21.9 112.0 10.7 4.0 86,382 10.0 
Evansville, IN-KY18.5 177.8 1.2 0.9 59,747 10.0 
Indianapolis-Carmel-Anderson, IN8.6 63.6 11.5 3.7 66,222 8.8 
Madison, WI (1)5.0 48.2 11.2 3.3 78,229 11.3 
Bloomington, IN (1)4.7 154.8 6.9 2.7 51,060 9.4 
Terre Haute, IN2.7 87.7 (2.1)(0.1)54,128 11.8 
Jasper, IN2.3 63.8 0.9 1.1 64,196 7.7 
Fort Wayne, IN (1)2.3 76.2 7.5 3.1 60,922 9.5 
Ann Arbor, MI (1)2.3 92.9 7.0 1.7 78,844 12.6 
Grand Rapids-Kentwood, MI (1)2.2 73.4 9.6 2.7 68,835 10.2 
National average7.2 2.9 67,761 9.0 
Weighted average or sum total
   Old National Bank top 5
58.6 103.2 10.5 3.7 68,328 10.0 
Weighted average or sum total
   Old National Bank top 10
70.5 97.8 9.8 3.4 66,857 10.2 
(1)  Expansion markets weighted average38.8 93.5 9.8 3.4 69,580 10.9 
Weighted average total Old National Bank5.2 2.0 66,680 9.4 
Source: S&P Global Market Intelligence
ACQUISITION AND DIVESTITURE STRATEGY
Since the formation of Old National in 1982, we have acquired over 50 financial institutions and other financial services businesses.  Future acquisitions and divestitures will be driven by a disciplined financial evaluation process and will be consistent with the existing basic banking strategy which focuses on community banking, client relationships, and consistent quality earnings.  Targeted geographic markets for acquisitions include mid-size markets with average to above average growth rates.
We anticipate that, as with previous acquisitions, the consideration paid by us in future acquisitions may be in the form of cash, debt, or Old National stock, or a combination thereof.  The amount and structure of such consideration is based on reasonable growth and cost savings assumptions and a thorough analysis of the impact on both long- and short-term financial results.
Our most recent acquisitions included the following:
Anchor BanCorp Wisconsin Inc. through a stock and cash consideration merger on May 1, 2016 that added 46 banking centers in the Madison, Milwaukee, and Fox Valley, Wisconsin triangle markets;
Anchor Bank, N.A., headquartered in the Twin Cities, through a stock and cash consideration merger on November 1, 2017 that added 17 banking centers in Minnesota; and
Minnesota-based Klein through a 100% stock consideration merger on November 1, 2018 that added 18 banking centers serving the Twin Cities and its western communities in Minnesota.
In regard to future partnerships, we are growing more confident in our ability to evaluate the fair value of a potential acquisition target’s loan portfolio in the current economic environment. However, we remain an active looker and a selective buyer.  We are patient and continue to wait for advantageous opportunities while we remain focused on execution of our strategies.
Divestitures
On May 31, 2016, the Company sold its insurance operations, ONB Insurance Group, Inc. (“ONI”).  The Company received approximately $91.8 million in cash resulting in a pre-tax gain of $41.9 million and an after-tax gain of
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$17.6 million.  Goodwill and intangible assets of approximately $47.5 million were eliminated as part of this transaction.  ONI was an ancillary business and did not meet the criteria to be treated as a discontinued operation as defined in Accounting Standards Update 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.”
On October 26, 2018, the Company divested ten banking centers in Wisconsin to Marine Credit Union of La Crosse, Wisconsin.  At closing, the purchasers assumed $230.6 million in deposits and no loans.  Old National recorded a net pre-tax gain of $14.0 million in connection with the sale, which included a deposit premium of $15.0 million, goodwill allocation of $0.6 million, and $0.4 million of other transaction expenses.
Since the beginning of 2011 through the end of 2020, we have consolidated or sold over 230 banking centers as part of our continued banking center rationalization.  Over the same period, we have more than tripled our assets and have increased our average total deposits per banking center from $34 million to approximately $105 million, while only increasing our number of banking centers by 1 to 162.
Another component of The ONB Way is the optimization of our banking center network. As part of The ONB Way, we consolidated 31 banking centers scattered throughout the footprint in April 2020, reflecting an ongoing shift among our clients toward digital banking solutions. Many of the facilities consolidated were in smaller markets, several of which were added in recent years through acquisition and partnership activity.
COMPETITION
The banking industry and related financial service providers operate in a highly competitive market.  Old National competes with financial service providers such as other commercial banks, savings and loan associations, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds, and other financial intermediaries.  In addition, Financial Technology, or “FinTech,” start-ups are emerging in key areas of banking.
Many of our nonfinancial institution competitors have fewer regulatory constraints, broader geographic service areas, greater capital, and, in some cases, lower cost structures.  In addition, competition for quality customers has intensified as a result of changes in regulation, mergers and acquisitions, advances in technology and product delivery systems, consolidation among financial service providers, bank failures, and the conversion of certain former investment banks to bank holding companies.
SUPERVISION AND REGULATION
Old National is subject to extensive regulation under federal and state laws.  The regulatory framework is intended primarily for the protection of depositors, federal deposit insurance funds, and the banking system as a whole and not for the protection of shareholders and creditors.
Significant elements of the laws and regulations applicable to Old National and its subsidiaries are described below.  The descriptions are not intended to be complete and are qualified in their entirety by reference to the full text of the statutes, regulations and policies that are described.  Also, such statutes, regulations and policies are continually under review by Congress and state legislatures and federal and state regulatory agencies and subject to change.  A change in statutes, regulations, or regulatory policies applicable to Old National and its subsidiaries, for which Old National cannot predict, could have a material effect on the business of the Company.
The Dodd-Frank Act.  On July 21, 2010, financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) was signed into law.  The Dodd-Frank Act significantly restructured the financial regulatory environment in the United States. The Dodd-Frank Act contains numerous provisions that affect all bank holding companies and banks, including Old National and Old National Bank, some of which are described in more detail below.  The scope and impact of many of the Dodd-Frank Act provisions were determined and issued over time. The impact of the Dodd-Frank Act on Old National has been substantial.  Provisions in the legislation affect the payment of interest on demand deposits, collection of interchange fees associated with certain deposits, and placed limits on certain revenues on those deposits.
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The Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Economic Growth Act”), which was enacted in May 2018, repealed or modified several provisions of the Dodd-Frank Act.  Certain key provisions of the Economic Growth Act and its implementing regulations include:
eliminating supervisory stress testing and company run stress testing for bank holding companies with less than $250 billion in assets;
prohibiting federal banking regulators from imposing higher capital standards on High Volatility Commercial Real Estate exposures unless they are for acquisition, development, or construction;
exempting from appraisal requirements certain transactions involving real property in rural areas and valued at less than $400,000; and
requiring the CFPB to provide guidance on how the Truth in Lending Act-Real Estate Settlement Procedures Act Integrated Disclosure applies to mortgage assumption transactions and construction-to-permanent home loans, as well as the extent to which lenders can rely on model disclosures that do not reflect recent regulatory changes.
The CARES Act and Initiatives Related to COVID-19.  In response to the COVID-19 pandemic, the CARES Act was signed into law on March 27, 2020 to provide national emergency economic relief measures. Many of the CARES Act’s programs are dependent upon the direct involvement of U.S. financial institutions, such as Old National and Old National Bank, and have been implemented through rules and guidance adopted by federal departments and agencies, including the U.S. Department of Treasury, the Federal Reserve and other federal banking agencies, including those with direct supervisory jurisdiction over Old National and Old National Bank. Furthermore, as the ongoing COVID-19 pandemic evolves, federal regulatory authorities continue to issue additional guidance with respect to the implementation, lifecycle, and eligibility requirements for the various CARES Act programs as well as industry-specific recovery procedures for COVID-19. In addition, it is possible that Congress will enact supplementary COVID-19 response legislation, including amendments to the CARES Act or new bills comparable in scope to the CARES Act. The Company continues to assess the impact of the CARES Act and other statutes, regulations and supervisory guidance related to the COVID-19 pandemic.
Paycheck Protection Program. Section 1102 of the CARES Act created the PPP, a program administered by the SBA to provide loans to small businesses for payroll and other basic expenses during the COVID-19 pandemic. Old National has participated in the PPP as a lender. These loans are eligible to be forgiven if certain conditions are satisfied and are fully guaranteed by the SBA. Additionally, loan payments will also be deferred for the first six months of the loan term. The PPP commenced on April 3, 2020 and was available to qualified borrowers through August 8, 2020. No collateral or personal guarantees were required. Neither the government nor lenders are permitted to charge the recipients any fees. It is anticipated that additional revisions to the SBA’s interim final rules on forgiveness and loan review procedures will be forthcoming to address these and related changes. On December 27, 2020, the President signed into law omnibus federal spending and economic stimulus legislation titled the “Consolidated Appropriations Act” that included the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “HHSB Act”). Among other things, the HHSB Act renewed the PPP, allocating $284.45 billion for both new first time PPP loans under the existing PPP and the expansion of existing PPP loans for certain qualified, existing PPP borrowers. In addition to extending and amending the PPP, the HHSB Act also creates a new grant program for “shuttered venue operators.” As a participating lender in the PPP, Old National Bank continues to monitor legislative, regulatory, and supervisory developments related thereto, including the most recent changes implemented by the HHSB Act.
Guidance on Non-TDR Loan Modifications due to COVID-19. On March 22, 2020, a statement was issued by our banking regulators and titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” (the “Interagency Statement”) that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19. Additionally, Section 4013 of the CARES Act further provides that a qualified loan modification is exempt by law from classification as a TDR as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak declared by the President of the United States under the National Emergencies Act terminates. Section 541 of the CAA extends this relief to the earlier of January 1, 2022 or 60 days after the national emergency termination date. The Interagency Statement was subsequently revised in April 2020 to clarify the interaction of the original guidance with Section 4013 of the CARES Act, as well as setting forth the banking regulators’ views on consumer protection considerations. In accordance with such guidance, Old National Bank is offering short-term modifications made in response to COVID-19 to borrowers who are current and otherwise not past due. These include short-term (180 days or less) modifications in the form of payment
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deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. See Note 3 to the consolidated financial statements for further information on non-TDR loan modifications.
Main Street Lending Program. The CARES Act encouraged the Federal Reserve, in coordination with the Secretary of the Treasury, to establish or implement various programs to help midsize businesses, nonprofits, and municipalities. On April 9, 2020, the Federal Reserve proposed the creation of the Main Street Lending Program to implement certain of these recommendations. Old National Bank continues to monitor developments related to the Main Street Lending Program.
Temporary Regulatory Capital Relief Related to Impact of CECL. Concurrent with enactment of the CARES Act, in March 2020, the OCC, the Board of Governors of the Federal Reserve System, and the FDIC published an interim final rule to delay the estimated impact on regulatory capital stemming from the implementation of CECL. The interim final rule maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period (five-year transition option). Old National is adopting the capital transition relief over the permissible five-year period.
The Volcker Rule.  Section 619 of the Dodd-Frank Act (the “Volcker Rule”) contains provisions prohibiting bank, bank holding companies and their affiliates from engaging in proprietary trading and from sponsoring or investing in private equity hedge funds and other “covered funds,” except as otherwise permitted by the Volcker Rule. Rules implementing the Volcker Rule were adopted in December 2013 and the Volcker Rule went into effect on April 1, 2014. Proprietary trading is defined as the trading of securities, derivatives, or futures (or options on any of the foregoing) as principal, where such trading is principally for the purpose of short-term resale, benefiting from actual or expected short-term price movements and realizing short-term arbitrage profits. The rule’s definition of proprietary trading specifically excludes, among other things, market-making-related activity, certain government issued securities trading and certain risk management activities.  Old National and Old National Bank do not engage in any prohibited proprietary trading activities.  During 2019, the federal financial agencies announced revisions to the Volcker Rule that will simplify and streamline compliance requirements for Old National Bank.
Bank Holding Company Regulation.  Old National is registered as a bank holding company and has elected to be a financial holding company.  It is subject to the supervision of, and regulation by, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHC Act”).  The Federal Reserve has issued regulations under the BHC Act requiring a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks.  It is the policy of the Federal Reserve that, pursuant to this requirement, a bank holding company should stand ready to use its resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity.  Under this requirement, Old National is expected to commit resources to support Old National Bank, including at times when Old National may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.
The BHC Act requires the prior approval of the Federal Reserve before a bank holding company can acquire more than a 5% voting interest of any bank or bank holding company.  Additionally, the BHC Act restricts Old National’s non-banking activities to those which are determined by the Federal Reserve to be closely related to banking and a proper incident thereto, as well as those that are permissible for a financial holding company.
Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” (as defined in FDICIA) with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal bank regulatory agency.
Capital and Liquidity Requirements. Bank holding companies are required to comply with the Federal Reserve’s risk-based capital guidelines.  The FDIC and the OCC have adopted risk-based capital ratio guidelines to which depository institutions under their respective supervision, including Old National Bank, are subject.  The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations.  Risk-based capital ratios are determined by allocating assets and specified off-balance sheet commitments to four risk-weighted categories, with higher levels of capital being required for the categories perceived as representing greater risk.  Old National Bank exceeded all risk-based
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minimum capital requirements of the FDIC and OCC as of December 31, 2020 and 2019.  For Old National’s regulatory capital ratios and regulatory requirements as of December 31, 2020 and 2019, see Note 23 to the consolidated financial statements.
The federal regulatory authorities’ current risk-based capital guidelines are based upon the Basel Committee on Banking Supervision (the “Basel Committee”).  The Basel Committee is a committee of international central banks and bank regulators responsible for establishing international supervisory guidelines for use in member jurisdictions to enhance and align bank regulation and promote financial stability on a global scale.  In December 2010 and January 2011, the Basel Committee published the final revisions to the international regulatory capital framework generally referred to as “Basel III,” as a response to deficiencies in the international regulatory standards identified during the global financial crisis.
Effective July 2, 2013, the Federal Reserve and the OCC approved final rules known as the “Basel III Capital Rules,” substantially revising the risk-based capital and leverage capital requirements applicable to bank holding companies and depository institutions, including Old National and Old National Bank. The Basel III Capital Rules address the components of capital and other issues affecting the numerator in banking institutions’ regulatory capital ratios.  The Basel III Capital Rules also implement the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal banking agencies’ rules. Certain of the Basel III Capital Rules came into effect for Old National and Old National Bank on January 1, 2015, subject to a phase-in period ending on December 31, 2018.
The Basel III Capital Rules introduced a new capital measure referred to as “Common Equity Tier 1” (“CET1”).  The rules specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements.  CET1 capital consists of common stock instruments that meet the eligibility criteria set forth in the final rules, retained earnings, accumulated other comprehensive income, and common equity Tier 1 minority interest.  The rules also define CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1, and not to the other components of capital.  They also expand the scope of the adjustments as compared to existing regulations.
As of January 1, 2019, the Basel III Capital Rules require banking organizations to maintain:
a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7.0%);
a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio, effectively resulting in a minimum Tier 1 capital ratio of 8.5%);
a minimum ratio of total capital (that is, Tier 1 plus Tier 2 capital) to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (which is added to the 8.0% total capital ratio, effectively resulting in a minimum total capital ratio of 10.5%); and
a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to adjusted average consolidated assets.
The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer will face limitations on the payment of dividends, common stock repurchases and discretionary cash payments to executive officers based on the amount of the shortfall.
The Basel III Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and investments in the capital of unconsolidated financial institutions be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1. Beginning in 2020, this framework for regulatory capital deductions to CET1 was simplified by increasing the deduction threshold to 25% at the individual level for each of the aforementioned categories.  Under current capital standards, the effects of accumulated other comprehensive income items included in capital are excluded for the purposes of determining regulatory capital ratios. Under the Basel III Capital Rules, Old National and Old National Bank are given a one-time election (the “Opt-out Election”) to filter certain AOCI components, comparable to the treatment under the current general risk-based capital rule. The Company chose the Opt-out Election on the March 31, 2015 Call Report and FR Y-9C for Old National Bank and Old National, respectively.
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Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and have been phased-in over a five-year period (20% per year). The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and was phased-in over a four-year period (increasing by that amount on each subsequent January 1, until it reached 2.5% on January 1, 2019).
The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and is not expected to have any current applicability to Old National or Old National Bank.
In addition, the Basel III Capital Rules revise the rules for calculating risk-weighted assets to enhance their risk sensitivity.  They establish a new framework under which mortgage-backed securities and other securitization exposures will be subject to risk-weights ranging from 20% to 1,250%.  The rules also establish adjusted risk-weights for credit exposures, including multi-family and commercial real estate exposures that are 90 days or more past due or on non-accrual, which will be subject to a 150% risk-weight, except in situations where qualifying collateral and/or guarantees are in place. The existing treatment of residential mortgage exposures will remain subject to either a 50% risk-weight (for prudently underwritten owner-occupied first liens that are current or less than 90 days past due) or a 100% risk-weight (for all other residential mortgage exposures including 90 days or more past due exposures).
Management believes that, as of December 31, 2020, Old National and Old National Bank meet all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis. Requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely impact the Company’s net income.
The Basel III Capital Rules also permit banks with less than $250 billion in assets to choose to continue excluding unrealized gains and losses on certain securities holdings for purposes of calculating regulatory capital.  As previously reported, Old National chose the Opt-out Election in its March 31, 2015 Call Report.
The liquidity framework under the Basel III Capital Rules (the “Basel III liquidity framework”) applies a balance sheet perspective to establish quantitative standards designed to ensure that a banking organization is appropriately positioned to satisfy its short- and long-term funding needs. One test to address short-term liquidity risk is referred to as the liquidity coverage ratio (“LCR”), designed to calculate the ratio of a banking entity’s high-quality liquid assets to its total net cashflows over a 30-day time horizon. The other test, referred to as the net stable funding ratio (“NSFR”), is designed to promote more medium- and long-term asset funding by incenting banking entities to increase their holdings of U.S. Treasury securities and other sovereign debt, as well as increase the use of long-term debt as a funding source. The Basel III liquidity framework was implemented as a minimum standard on January 1, 2015, with a phase-in period ending January 1, 2019.  However, the federal banking agencies have not proposed rules implementing the Basel III liquidity framework and have not determined to what extent it will apply to U.S. banks that are not large, internationally active banks.
Management believes that, as of December 31, 2020, Old National Bank would meet the LCR requirement under the Basel III liquidity framework on a fully phased-in basis if such requirements were currently effective. Management’s evaluation of the impact of the NSFR requirement is ongoing as of December 31, 2020.  Requirements to maintain higher levels of liquid assets could adversely impact the Company’s net income.
Prompt Corrective Action Regulations.  The Federal Deposit Insurance Act (the “FDIA”) requires, among other things, federal bank regulatory authorities to take “prompt corrective action” with respect to banks which do not meet minimum capital requirements.  Under current prompt corrective action regulations, a bank will be (i) “well capitalized” if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, and a leverage ratio of 5.0% or greater, and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if the institution has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater, and a leverage ratio of 4.0% or greater and is not “well capitalized”; (iii) “undercapitalized” if the institution has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0% or a leverage ratio of less than 4.0%; (iv) “significantly undercapitalized” if the institution has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0% or a leverage ratio of less than 3.0%; and (v) “critically undercapitalized” if the institution’s tangible equity is equal to or less than 2.0% of average quarterly tangible assets.  An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters.  A bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects for other purposes.
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The Basel III Capital Rules revised the “prompt corrective action” regulations pursuant to Section 38 of the FDIA, by:
introducing a CET1 ratio requirement at each level (other than critically undercapitalized), with the required CET1 ratio being 6.5% for well-capitalized status;
increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum Tier 1 risk-based capital ratio for well-capitalized status being 8.0% (as compared to the previous 6.0%); and
eliminating the provision that provides that a bank with a composite supervisory rating of 1 may have a 3.0% leverage ratio and still be well-capitalized.
The FDIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be “undercapitalized.”  “Undercapitalized” institutions are subject to growth limitations and are required to submit a capital restoration plan. The agencies may not accept such a plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. In addition, for a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with such capital restoration plan.  The bank holding company must also provide appropriate assurances of performance.  The aggregate liability of the parent holding company is limited to the lesser of (i) an amount equal to 5.0% of the depository institution’s total assets at the time it became undercapitalized and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan.  If a depository institution fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.”
“Significantly undercapitalized” depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks.  “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator.
Management believes that, as of December 31, 2020, Old National Bank was “well capitalized” based on the existing ratios and the ratios as modified by the Basel III Capital Rules.
Deposit Insurance.  Substantially all of the deposits of Old National Bank are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and Old National Bank is subject to deposit insurance assessments to maintain the DIF. Deposit insurance assessments are based on average consolidated total assets minus average tangible equity. Under the FDIC’s risk-based assessment system, insured institutions with at least $10 billion in assets, such as Old National Bank, are assessed on the basis of a scoring system that combines the institution’s regulatory ratings and certain financial measures.  The scoring system assesses risk measures to produce two scores, a performance score and a loss severity score, that will be combined and converted to an initial assessment rate.
The performance score measures an institution’s financial performance and its ability to withstand stress.  The loss severity score quantifies the relative magnitude of potential losses to the FDIC in the event of an institution’s failure.  Once the performance and loss severity scores are calculated, these scores will be converted to a total score.  An institution with a total score of 30 or less will pay the minimum base assessment rate, and an institution with a total score of 90 or more will pay the maximum initial base assessment rate.  For total scores between 30 and 90, initial base assessment rates will rise at an increasing rate as the total score increases.  The FDIC has the authority to raise or lower assessment rates, subject to limits, and to impose special additional assessments.
Under the FDIA, the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Safety and Soundness Regulations.  In accordance with the FDIA, the federal banking agencies adopted safety and soundness guidelines establishing general standards relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify, monitor, and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal shareholder. In addition, regulations adopted by the federal banking agencies authorize the
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agencies to require that an institution that has been given notice that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, the institution fails to submit an acceptable compliance plan or fails in any material respect to implement an accepted compliance plan, the agency must issue an order directing corrective actions and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the “prompt corrective action” provisions of FDIA. If the institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.
Incentive Compensation.  The Dodd-Frank Act requires the federal bank regulatory agencies and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities having at least $1 billion in total assets, such as Old National and Old National Bank, that encourage inappropriate risks by providing an executive officer, employee, director or principal shareholder with excessive compensation, fees, or benefits or that could lead to material financial loss to the entity. In addition, these regulators must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation arrangements. The agencies proposed such regulations in April 2011, but the regulations have not been finalized. If the regulations are adopted in the form initially proposed, they will impose limitations on the manner in which Old National may structure compensation for its executives.
In June 2010, the Federal Reserve, OCC, and FDIC issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees who have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. These three principles are incorporated into the proposed joint compensation regulations under the Dodd-Frank Act, discussed above.
The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as Old National, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions.
Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.
Loans to One Borrower.  Old National Bank generally may not make loans or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus. An additional amount may be loaned, up to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of December 31, 2020, Old National Bank was in compliance with the loans-to-one-borrower limitations.
Depositor Preference.  The FDIA provides that, in the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institution, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors, including depositors whose deposits are payable only outside of the United States and the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institution.
Community Reinvestment Act.  The Community Reinvestment Act of 1977 (“CRA”) requires depository institutions to assist in meeting the credit needs of their market areas consistent with safe and sound banking practice. Under the CRA, each depository institution is required to help meet the credit needs of its market areas by, among other things, providing credit to low- and moderate-income individuals and communities. Depository institutions are periodically examined for compliance with the CRA and are assigned ratings that must be publicly disclosed. In order for a financial holding company to commence any new activity permitted by the BHC Act, or to
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acquire any company engaged in any new activity permitted by the BHC Act, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the CRA. Furthermore, banking regulators take into account CRA ratings when considering approval of certain applications.  Old National Bank received a rating of “satisfactory” in its latest CRA examination.
Fair Lending Laws.  Fair Lending laws prohibit discrimination in banking services and include the Equal Credit Opportunity Act (“ECOA”) and the Fair Housing Act (“FHA”), which prohibit discrimination on the basis of race, gender, religion, or other prohibited factors in the extension of credit and residential real estate transactions. In May 2018, the U.S. Department of Justice (“DOJ”) and KleinBank entered into a public Settlement Agreement (the “Agreement”) regarding alleged violations of the FHA and the ECOA within the Minneapolis, Minnesota market. Old National Bank, as the legal successor in interest to KleinBank, has assumed the ongoing terms and obligations of the Agreement.
Financial Privacy.  The federal banking regulators adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. These regulations affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors.
Old National Bank is also subject to regulatory guidelines establishing standards for safeguarding customer information. These guidelines describe the federal banking agencies’ expectations for the creation, implementation and maintenance of an information security program, which would include administrative, technical and physical safeguards appropriate to the size and complexity of the institution and the nature and scope of its activities. The standards set forth in the guidelines are intended to ensure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of such records and protect against unauthorized access to or use of such records or information that could result in substantial harm or inconvenience to any customer.
Anti-Money Laundering and the USA Patriot Act. A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA Patriot Act of 2001 (the “USA Patriot Act”) substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations on financial institutions, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States.
The anti-money laundering (“AML”) rules codify within the Financial Crimes Enforcement Network (the “FinCEN”) regulations the “pillars” that must be included in a financial institution’s AML compliance program. Regulators have communicated their expectations with respect to five pillars: (1) the development of internal policies, procedures, and controls; (2) the designation of a compliance officer; (3) the establishment of an ongoing AML employee training program; (4) the implementation of an independent audit function to test AML programs; and (5) appropriate risk based procedures for conducting ongoing customer due diligence. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution, including substantial monetary penalties, extensive and expensive remedial requirements, and causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.
Office of Foreign Assets Control Regulation. The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others, which are administered by the U.S. Treasury Department Office of Foreign Assets Control. Failure to comply with these sanctions could have serious legal and reputational consequences, including substantial monetary penalties, extensive and expensive remedial requirements, and causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.
Transactions with Affiliates.  Transactions between Old National Bank and its affiliates are regulated by the Federal Reserve under sections 23A and 23B of the Federal Reserve Act and related regulations. These regulations limit the types and amounts of covered transactions that may be engaged in by Old National Bank and its affiliates and generally require those transactions to be on an arm’s-length basis. The term “affiliate” is defined to mean any company that controls or is under common control with Old National Bank and includes Old National and its non-bank subsidiaries. “Covered transactions” include a loan or extension of credit, as well as a purchase of securities
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issued by an affiliate, a purchase of assets (unless otherwise exempted by the Federal Reserve) from the affiliate, certain derivative transactions that create a credit exposure to an affiliate, the acceptance of securities issued by the affiliate as collateral for a loan, and the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. In general, these regulations require that any such transaction by Old National Bank (or its subsidiaries) with an affiliate, if permitted, must be secured by designated amounts of specified collateral and must be limited to certain thresholds on an individual and aggregate basis.
Federal law also limits Old National Bank’s authority to extend credit to its directors, executive officers and 10% or more shareholders, as well as to entities controlled by such persons. Among other things, extensions of credit to such insiders are required to be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons. Also, the terms of such extensions of credit may not involve more than the normal risk of repayment or present other unfavorable features and may not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Old National Bank’s capital.
Federal Home Loan Bank System.  Old National Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions. As a member of the FHLBI, Old National Bank is required to acquire and hold shares of capital stock of the FHLBI in an amount at least equal to the sum of the membership stock purchase requirement, determined on an annual basis at the end of each calendar year, and the activity-based stock purchase requirement, determined on a daily basis. For Old National Bank, the membership stock purchase requirement is 1.0% of the Mortgage-Related Assets, as defined by the FHLBI, which consists principally of residential mortgage loans and mortgage-backed securities, held by Old National Bank.  The activity-based stock purchase requirement is equal to the sum of: (1) a specified percentage ranging from 2.0% to 5.0%, which for Old National Bank is 5.0%, of outstanding borrowings from the FHLBI; (2) a specified percentage ranging from 0.0% to 5.0%, which for Old National Bank is 3.0%, of the outstanding principal balance of Acquired Member Assets, as defined by the FHLBI, and delivery commitments for Acquired Member Assets; (3) a specified dollar amount related to certain off-balance sheet items, which for Old National Bank is inapplicable; and (4) a specified percentage ranging from 0.0% to 5.0% of the carrying value on the FHLBI’s balance sheet of derivative contracts between the FHLBI and Old National Bank, which for Old National Bank is inapplicable. The FHLBI can adjust the specified percentages and dollar amount from time to time within the ranges established by the FHLBI capital plan. As of December 31, 2020, Old National Bank was in compliance with the minimum stock ownership requirement.
Federal Reserve System.  Federal Reserve regulations require depository institutions to maintain cash reserves against their transaction accounts (primarily NOW and demand deposit accounts). Effective March 26, 2020, the Federal Reserve Board reduced reserve requirement ratios to 0%. This action eliminated reserve requirements for all depository institutions. Prior to the change effective March 26, 2020, a reserve of 3% was to be maintained against aggregate transaction accounts between $12.4 million and $79.5 million (subject to adjustment by the Federal Reserve) plus a reserve of 10% (subject to adjustment by the Federal Reserve between 8% and 14%) against that portion of total transaction accounts in excess of $79.5 million. The first $12.4 million of otherwise reservable balances (subject to adjustment by the Federal Reserve) was exempt from the reserve requirements.
Other Regulations.  Old National Bank is subject to federal consumer protection statutes and regulations promulgated under those laws, including, but not limited to, the:
Truth-In-Lending Act and Regulation Z, governing disclosures of credit terms to consumer borrowers;
Home Mortgage Disclosure Act and Regulation C, requiring financial institutions to provide certain information about home mortgage and refinanced loans;
Fair Credit Reporting Act and Regulation V, governing the provision of consumer information to credit reporting agencies and the use of consumer information;
Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
Truth in Savings Act and Regulation DD, which requires disclosure of deposit terms to consumers;
Regulation CC, which relates to the availability of deposit funds to consumers;
Right to Financial Privacy Act, which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
Electronic Funds Transfer Act, governing automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of ATMs and other electronic banking services.
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The Dodd-Frank Act also significantly impacts the various consumer protection laws, rules and regulations applicable to financial institutions.  The statute rolls back the federal preemption of state consumer protection laws that was enjoyed by national banks by (1) requiring that a state consumer financial law prevent or significantly interfere with the exercise of a national bank’s powers before it can be preempted, (2) mandating that any preemption decision be made on a case by case basis rather than a blanket rule, and (3) ending the applicability of preemption to subsidiaries and affiliates of national banks.  As a result, we may now be subject to state consumer protection laws in each state where we do business, and those laws may be interpreted and enforced differently in each state.
The Dodd-Frank Act also created the CFPB, a consumer financial services regulator with supervisory authority over banks and their affiliates with assets of more than $10 billion, including Old National Bank, to carry out federal consumer protection laws. The CFPB also regulates financial products and services sold to consumers and has rulemaking authority with respect to federal consumer financial laws. Any new regulatory requirements promulgated by the CFPB or modifications in the interpretations of existing regulations could require changes to Old National’s consumer-facing businesses. The Dodd-Frank Act also gives the CFPB broad data collecting powers for fair lending for both small business and mortgage loans, as well as extensive authority to prevent unfair, deceptive, and abusive practices.
The rules issued by the CFPB have impacted our mortgage loan origination and servicing activities. Compliance with these rules will likely continue to increase our overall regulatory compliance costs.
Dividend Limitation.  Old National Bank is subject to the provisions of the National Bank Act, is supervised, regulated and examined by the OCC, and is subject to the rules and regulations of the OCC, the Federal Reserve and the FDIC.  A substantial portion of Old National’s cash revenue is derived from dividends paid to it by Old National Bank.  These dividends are subject to various legal and regulatory restrictions as summarized in Note 23 to the consolidated financial statements.
Legislative and Regulatory Initiatives. From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of Old National in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. Old National cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of Old National. A change in statutes, regulations or regulatory policies applicable to Old National or any of its subsidiaries could have a material effect on Old National’s business, financial condition and results of operations.
AVAILABLE INFORMATION
All reports filed electronically by Old National with the SEC, including the annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy and information statements, other information and amendments to those reports filed or furnished (as applicable), are accessible at no cost on Old National’s web site at www.oldnational.com as soon as reasonably practicable after electronically submitting such materials to the SEC.  The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, and Old National’s filings are accessible on the SEC’s web site at www.sec.gov.
ITEM 1A.    RISK FACTORS
There are a number of risks and uncertainties that could adversely affect Old National’s business, financial condition, results of operations or cash flows, and access to liquidity, thereby affecting an investment in our Common Stock.  Old National’s Enterprise Risk Management program is an enterprise-wide framework for identifying, managing, mitigating, monitoring, aggregating, and reporting risks.  The following major risks identified by Old National’s Enterprise Risk Management Program are described below: strategic, financial, and reputational; credit; market, interest rate, and liquidity; operational; and legal, regulatory, and compliance.

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Strategic, Financial, and Reputational Risks

The outbreak of COVID-19, or other such epidemic, pandemic, or outbreak of a highly contagious disease, occurring in the United States or in the geographies in which we conduct operations, could adversely affect Old National’s business operations, asset valuations, financial condition, and results of operations.

Old National’s business is dependent upon the willingness and ability of our customers to conduct banking and other financial transactions. The COVID-19 outbreak, or other highly contagious or infectious disease, could negatively impact the ability of our employees and customers to conduct such transactions and disrupt the business activities and operations of Old National’s customers in the geographic areas in which Old National operates. The spread of the COVID-19 virus had an impact on Old National’s operations during fiscal year 2020, and the Company expects that the virus will continue to have an impact on the business, financial condition, and results of operations of the Company and its customers during fiscal year 2021. The COVID-19 pandemic has caused changes in the behavior of customers, businesses, and their employees, including illness, quarantines, social distancing practices, cancellation of events and travel, business and school shutdowns, reduction in commercial activity and financial transactions, supply chain interruptions, increased unemployment, and overall economic and financial market instability. Future effects, including additional actions taken by federal, state, and local governments to contain COVID-19 or treat its impact, are unknown. Any sustained disruption to Old National’s operations is likely to negatively impact Old National’s financial condition and results of operations. Notwithstanding Old National’s contingency plans and other safeguards against pandemics or another contagious disease, the spread of COVID-19 could also negatively impact the availability of Old National’s personnel who are necessary to conduct Old National’s business operations, as well as potentially impact the business and operations of Old National’s third party service providers who perform critical services for Old National. If the response to contain COVID-19, or another highly infectious or contagious disease, is unsuccessful, Old National could experience a material adverse effect on our business operations, asset valuations, financial condition, and results of operations. Material adverse impacts may include all or a combination of valuation impairments on Old National's intangible assets, investments, loans, loan servicing rights, deferred tax assets, or counter-party risk derivatives.

Economic conditions have affected and could continue to adversely affect our revenues and profits.

Old National’s financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services that Old National offers, is highly dependent upon the business environment in the markets where Old National operates and in the United States as a whole. A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, low unemployment, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment; natural disasters; terrorist acts; or a combination of these or other factors.

An economic downturn, sustained high unemployment levels, or stock market volatility may negatively impact our operating results and have a negative effect on the ability of our borrowers to make timely repayments of their loans, increasing the risk of loan defaults and losses. If the forecasts of economic conditions and other economic predictions are not accurate, we may face challenges in accurately estimating the ability of our borrowers to repay their loans. Expectations of negative market and economic conditions will be reflected in the allowances for credit losses for loans and debt securities to the estimated extent they will impact the credit losses of new and existing loans and debt securities over their remaining lives. The provision for credit losses will report the entire increased credit loss expectations over the remaining lives of the loans and debt securities in the period in which the change in expectation arises. Further, because of the impact of such increased credit losses on earnings and capital, our ability to make loans and pay dividends may be substantially diminished.

Changes in economic or political conditions could adversely affect Old National’s earnings, if the ability of Old National’s borrowers to repay loans, or the value of the collateral securing such loans, declines.

Old National’s success depends, to a certain extent, upon economic or political conditions, local and national, as well as governmental monetary policies.  Conditions such as recession, unemployment, changes in interest rates, inflation, money supply, and other factors beyond Old National’s control may adversely affect its asset quality, deposit levels, and loan demand and, therefore, Old National’s earnings.  Because Old National has a significant amount of commercial real estate loans, decreases in real estate values could adversely affect the value of property
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used as collateral.  Adverse changes in the economy may also have a negative effect on the ability of Old National’s borrowers to make timely repayments of their loans, which would have an adverse impact on Old National’s earnings.  In addition, substantially all of Old National’s loans are to individuals and businesses in Old National’s market area.  Consequently, any economic decline in Old National’s primary market areas, which include Indiana, Kentucky, Michigan, Minnesota, and Wisconsin, could have an adverse impact on Old National’s earnings.

Acquisitions may not produce revenue enhancements or cost savings at levels or within timeframes originally anticipated and may result in unforeseen integration difficulties and dilution to existing shareholder value.

We have acquired, and expect to continue to acquire, other financial institutions or parts of those institutions in the future, and we may engage in de novo banking center expansion.  We may also consider and enter into new lines of business or offer new products or services.

We may incur substantial costs to expand, and we can give no assurance such expansion will result in the levels of profits we seek or expect.  There can be no assurance that integration efforts for any mergers or acquisitions will be successful or that, after giving effect to the merger or acquisition, we will achieve profits comparable to, or better than, our historical experience.  Also, we may issue equity securities in connection with acquisitions, which could cause ownership and economic dilution to our current shareholders.

Acquisitions and mergers involve a number of expenses and risks, including:

the time and costs associated with identifying potential new markets, as well as acquisition and merger targets;
the accuracy of the estimates and judgments used to evaluate credit, operations, management and market risks with respect to the target institution;
the time and costs of evaluating new markets, hiring experienced local management and opening new offices, and the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion;
our ability to finance an acquisition and possible dilution to our existing shareholders;
the diversion of our management’s attention to the negotiation and execution of a transaction, and the integration of the operations and personnel of the combined businesses;
entry into new markets where we lack experience;
the introduction of new products and services into our business;
the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on our results of operations;  
closing delays and increased expenses related to the resolution of lawsuits filed by shareholders of target institutions; and
the risk of loss of key employees and customers.

Old National must generally receive federal regulatory approval before it can acquire a bank or bank holding company.  Old National cannot be certain when or if, or on what terms and conditions, any required regulatory
approvals will be granted.  Old National may be required to sell banks or banking centers as a condition to receiving regulatory approval.

Future acquisitions could be material to Old National and it may issue additional shares of stock to pay for those acquisitions, which would dilute current shareholders’ ownership interests.

Our accounting estimates and risk management processes rely on analytical and forecasting models.

The processes that we use to estimate probable credit losses and to measure the fair value of assets carried on the balance sheet at fair value, as well as the processes used to estimate the effects of changing interest rates and other market measures on our financial condition and results of operations, depend upon the use of analytical and forecasting models. These models are complex and reflect assumptions that may not be accurate, particularly in times of market stress or other unforeseen circumstances and require us to make judgments about the effect of matters that are inherently uncertain. Different assumptions could have resulted in significant changes in valuation, which in turn could have a material adverse effect on our financial condition and results of operations.

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Old National operates in an extremely competitive market, and Old National’s business will suffer if Old National is unable to compete effectively.

In our market area, Old National encounters significant competition from other commercial banks, savings and loan associations, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds, and other financial intermediaries.  In addition, FinTech start-ups are emerging in key areas of banking.  Our competitors may have substantially greater resources and lending limits than Old National does and may offer services that Old National does not or cannot provide.  Many of our nonfinancial institution competitors have fewer regulatory constraints, broader geographic service areas, and, in some cases, lower cost structures.  Old National’s profitability depends upon our continued ability to compete successfully in our market area.

Our business could suffer if we fail to attract and retain skilled people.

Our success depends, in large part, on our ability to attract and retain key people. Competition for the best employees in most of the activities we engage in can be intense. We may not be able to hire the best people for key roles or to keep them. The loss of any of our key personnel or an inability to continue to attract, retain, and motivate key personnel could adversely affect our business.

We may not be able to pay dividends in the future in accordance with past practice.

Old National has traditionally paid a quarterly dividend to its common stockholders.  The payment of dividends is subject to legal and regulatory restrictions.  Any payment of dividends in the future will depend, in large part, on Old National’s earnings, capital requirements, financial condition, and other factors considered relevant by our Board of Directors.

Old National is an entity separate and distinct from Old National Bank.  Old National Bank conducts most of our operations and Old National depends upon dividends from Old National Bank to service its debt and to pay dividends to Old National’s shareholders.  The availability of dividends from Old National Bank is limited by various statutes and regulations.  It is possible, depending upon the financial condition including liquidity and capital adequacy of Old National Bank and other factors, that the OCC could assert that the payment of dividends or other payments is an unsafe or unsound practice. In addition, the payment of dividends by our other subsidiaries is also subject to the laws of the subsidiary’s state of incorporation, and regulatory capital and liquidity requirements applicable to such subsidiaries.  At December 31, 2020, Old National Bank could pay dividends of $212.1 million without prior regulatory approval.  In the event that Old National Bank was unable to pay dividends to us, we in turn would likely have to reduce or stop paying dividends on our Common Stock.  Our failure to pay dividends on our Common Stock could have a material adverse effect on the market price of our Common Stock.  See “Business – Supervision and Regulation – Dividend Limitations” and Note 23 to the consolidated financial statements.

Old National may not realize the expected benefits of its strategic imperatives.

Old National’s ability to compete depends on a number of factors, including, among others, its ability to develop and successfully execute strategic plans and imperatives.  Our strategic priorities include consistent quality earnings, enhanced management discipline, and strong risk management; greater confidence in decision making and appropriate levels of risk taking; fewer operational surprises, disruptions and losses; improved operational effectiveness and efficiency; more effective deployment of resources; and increased awareness and involvement in the achievement of strategic goals.  Our inability to execute on or achieve the anticipated outcomes of our strategic priorities may affect how the market perceives us and could impede our growth and profitability.

Credit Risk

If Old National’s actual credit losses for loans or debt securities exceed Old National’s allowance for credit losses for loans and debt securities, Old National’s net income will decrease. Also, future additions to Old National’s allowance for credit losses will reduce Old National’s future earnings.

Old National’s business depends on the creditworthiness of our customers. As with most financial institutions, we maintain allowances for credit losses for loans and debt securities to provide for defaults and nonperformance, which represent an estimate of expected losses over the remaining contractual lives of the loan and debt security portfolios. This estimate is the result of our continuing evaluation of specific credit risks and loss experience,
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current loan and debt security portfolio quality, present economic, political and regulatory conditions, industry concentrations, reasonable and supportable forecasts for future conditions, and other factors that may indicate losses. The determination of the appropriate levels of the allowances for loan and debt security credit losses inherently involves a high degree of subjectivity and judgment and requires us to make estimates of current credit risks and future trends, all of which may undergo material changes. Generally, our nonperforming loans and other real estate owned reflect operating difficulties of individual borrowers and weaknesses in the economies of the markets we serve. The allowances may not be adequate to cover actual losses, and future allowance for credit losses could materially and adversely affect our financial condition, results of operations, and cash flows.
Old National’s loan portfolio includes loans with a higher risk of loss.

Old National Bank originates commercial real estate loans, commercial loans, agricultural real estate loans, agricultural loans, consumer loans, and residential real estate loans primarily within Old National’s market areas.  Commercial real estate, commercial, consumer, and agricultural real estate and operating loans may expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans may not be sold as easily as residential real estate.  These loans also have greater credit risk than residential real estate for the following reasons:

Commercial Real Estate Loans.  Repayment is dependent upon income being generated in amounts sufficient to cover operating expenses and debt service.
Commercial Loans.  Repayment is dependent upon the successful operation of the borrower’s business.
Consumer Loans.  Consumer loans (such as personal lines of credit) are collateralized, if at all, with assets that may not provide an adequate source of payment of the loan due to depreciation, damage, or loss.
Agricultural Loans.  Repayment is dependent upon the successful operation of the business, which is greatly dependent on many things outside the control of either Old National Bank or the borrowers.  These factors include weather, input costs, commodity and land prices, and interest rates.

If Old National forecloses on collateral real property, Old National may be subject to the increased costs associated with the ownership of real property, resulting in reduced revenues.

Old National may have to foreclose on collateral real property to protect Old National’s investment and may thereafter own and operate such property, in which case Old National will be exposed to the risks inherent in the ownership of real estate.  The amount that Old National, as a mortgagee, may realize after a default is dependent upon factors outside of Old National’s control, including, but not limited to: (i) general or local economic conditions; (ii) neighborhood values; (iii) interest rates; (iv) real estate tax rates; (v) operating expenses of the mortgaged properties; (vi) environmental remediation liabilities; (vii) ability to obtain and maintain adequate occupancy of the properties; (viii) zoning laws; (ix) governmental rules, regulations and fiscal policies; and (x) acts of God.  Certain expenditures associated with the ownership of real estate, principally real estate taxes, insurance, and maintenance costs, may adversely affect the income from the real estate.  Therefore, the cost of operating real property may exceed the income earned from such property, and Old National may have to advance funds in order to protect Old National’s investment or dispose of the real property at a loss.  The foregoing expenditures and costs could adversely affect Old National’s ability to generate revenues, resulting in reduced levels of profitability.

The soundness of other financial institutions could adversely affect Old National.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, and other relationships.  Old National has exposure to many different industries and counterparties, and Old National and certain of its subsidiaries routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutions.  Many of these transactions expose Old National to credit risk in the event of default of its counterparty. In addition, Old National’s credit risk may be affected when collateral is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure. These types of losses could materially adversely affect Old National’s results of operations or financial condition.
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Market, Interest Rate, and Liquidity Risks

The price of Old National’s Common Stock may be volatile, which may result in losses for investors.

General market price declines or market volatility in the future could adversely affect the price of Old National’s Common Stock.  In addition, the following factors may cause the market price for shares of Old National’s Common Stock to fluctuate:

announcements of developments related to Old National’s business;
fluctuations in Old National’s results of operations;
sales or purchases of substantial amounts of Old National’s securities in the marketplace;
general conditions in Old National’s banking niche or the global or national economy;
a shortfall or excess in revenues or earnings compared to securities analysts’ expectations;
changes in analysts’ recommendations or projections; and
Old National’s announcement of new acquisitions or other projects.

Changes in interest rates could adversely affect Old National’s results of operations and financial condition.

Old National’s earnings depend substantially on Old National’s interest rate spread, which is the difference between (i) the rates Old National earns on loans, securities and other earning assets and (ii) the interest rates Old National pays on deposits and other borrowings. These rates are highly sensitive to many factors beyond Old National’s control, including general economic conditions and the policies of various governmental and regulatory authorities. If market interest rates rise, Old National will have competitive pressure to increase the rates that Old National pays on deposits, which could result in a decrease of Old National’s net interest income. If market interest rates decline, Old National could experience fixed-rate loan prepayments and higher investment portfolio cash flows, resulting in a lower yield on earning assets. Old National’s earnings can also be impacted by the spread between short-term and long-term market interest rates.

Following the COVID-19 outbreak and during 2020, market interest rates have declined significantly. The 10-year U.S. Treasury bond fell below 1.00% on March 3, 2020 for the first time and the Federal Open Market Committee reduced the federal funds rate to a target range of 0.00% to 0.25%. Additionally, the Federal Reserve announced it will take the following actions:

purchase U.S. Treasury bills;
initiate overnight repurchase agreement operations;
reinvest principal received on the Federal Reserve’s securities portfolio; and
reduce the interest paid on excess bank reserves held by the Federal Reserve.

These actions may materially and adversely affect Old National’s financial condition and results of operations, as well as negatively impact Old National’s customers and the respective suppliers, vendors, processors, and third party service providers for both Old National and its customers.

Changes to LIBOR may adversely impact the value of, and the return on, our financial instruments that are indexed to LIBOR.

The United Kingdom Financial Conduct Authority, which regulates LIBOR, announced in July 2017 that it will no longer persuade or compel banks to submit rates for the calculation of LIBOR to the administrator of LIBOR after 2021. This announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. In November 2020, the LIBOR administrator published a consultation regarding its intention to delay the date on which it will cease publication of U.S. dollar LIBOR from December 31, 2021 to June 30, 2023 for the most common tenors of U.S. dollar LIBOR, including the three-month LIBOR, but indicated no new contracts using U.S. dollar LIBOR should be entered into after December 31, 2021. Publication of non-U.S. dollar LIBOR would continue to cease after December 31, 2021. Notwithstanding the publication of this consultation, there is no assurance of how long LIBOR of any currency or tenor will continue to be published. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR, whether LIBOR rates will cease to be published before December 31, 2021 or June 30, 2023, as applicable, or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. Although the ARRC has announced SOFR as its recommended alternative to LIBOR, SOFR may not gain market acceptance or be widely used as a benchmark. Uncertainty as to the nature of such potential changes, alternative reference rates,
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the elimination or replacement of LIBOR, or other reforms may adversely affect the value of, and the return on our financial instruments.

Our wholesale funding sources may prove insufficient to replace deposits or support our future growth.

As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. These sources include brokered deposits, repurchase agreements, and federal funds purchased. Negative operating results or changes in industry conditions could lead to an inability to replace these additional funding sources at maturity. Our financial flexibility could be constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our results of operations and financial condition would be negatively affected.

A reduction in our credit rating could adversely affect our business and/or the holders of our securities.

The credit rating agencies rating our indebtedness regularly evaluate Old National and Old National Bank. Credit ratings are based on a number of factors, including our financial strength and ability to generate earnings, as well as factors not entirely within our control, including conditions affecting the financial services industry generally and the economy and changes in rating methodologies.  There can be no assurance that we will maintain our current credit ratings.  A downgrade of the credit ratings of Old National or Old National Bank could adversely affect our access to liquidity and capital, significantly increase our cost of funds, and decrease the number of investors and counterparties willing to lend to us or purchase our securities.  This could affect our growth, profitability, and financial condition, including liquidity.

Operational Risks

A failure or breach, including cyber-attacks, of our operational or security systems could disrupt our business, result in the disclosure of confidential information, damage our reputation, and create significant financial and legal exposure.

Although we devote significant resources to maintain and regularly upgrade our systems and processes that are designed to protect the security of our computer systems, software, networks, and other technology assets and the confidentiality, integrity, and availability of information belonging to us and our customers, there is no assurance that our security measures will provide absolute security.  Further, to access our products and services our customers may use computers and mobile devices that are beyond our security control systems.  In fact, many other financial services institutions and companies engaged in data processing have reported breaches in the security of their websites or other systems, some of which have involved sophisticated and targeted attacks intended to obtain unauthorized access to confidential information, destroy data, disable or degrade service, or sabotage systems, often through the introduction of computer viruses or malware, cyberattacks, and other means.  Certain financial institutions in the United States have also experienced attacks from technically sophisticated and well-resourced third parties that were intended to disrupt normal business activities by making internet banking systems inaccessible to customers for extended periods.  These “denial-of-service” attacks typically do not breach data security systems, but require substantial resources to defend, and may affect customer satisfaction and behavior.

Despite our efforts to ensure the integrity of our systems, it is possible that we may not be able to anticipate or to implement effective preventive measures against all security breaches, especially because the techniques used change frequently or are not recognized until launched, and because security attacks can originate from a wide variety of sources, including persons who are involved with organized crime or associated with external service providers or who may be linked to terrorist organizations or hostile foreign governments.  Those parties may also attempt to fraudulently induce employees, customers or other users of our systems to disclose sensitive information in order to gain access to our data or that of our customers or clients.  We have implemented employee and customer awareness training around phishing, malware, and other cyber risks.  These risks may increase in the future as we continue to increase our mobile payments and other internet-based product offerings and expand our internal usage of web-based products and applications.

If our security systems were penetrated or circumvented, it could cause serious negative consequences for us, including significant disruption of our operations, misappropriation of our confidential information or that of our customers, or damage our computers or systems and those of our customers and counterparties, and could result in
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violations of applicable privacy and other laws, financial loss to us or to our customers, loss of confidence in our security measures, customer dissatisfaction, significant litigation exposure, and harm to our reputation, all of which could have a material adverse effect on us.

We rely on third party vendors, which could expose Old National to additional cybersecurity risks.

Third party vendors provide key components of our business infrastructure, including certain data processing and information services.  Third parties may transmit confidential, propriety information on our behalf.  Although we require third party providers to maintain certain levels of information security, such providers may remain vulnerable to breaches, unauthorized access, misuse, computer viruses, or other malicious attacks that could ultimately compromise sensitive information.  While we may contractually limit our liability in connection with attacks against third party providers, Old National remains exposed to the risk of loss associated with such vendors.

In addition, a number of our vendors are large national entities with dominant market presence in their respective fields. Their services could prove difficult to replace in a timely manner if a failure or other service interruption were to occur. Failures of certain vendors to provide contracted services could adversely affect our ability to deliver products and services to our customers and cause us to incur significant expense.

Failure to keep pace with technological change could adversely affect Old National’s results of operations and financial condition.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services.  The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs.  Old National’s future success depends, in part, upon its ability to address customer needs by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in Old National’s operations.  Old National may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers.  Failure to successfully keep pace with technological change affecting the financial services industry could negatively affect Old National’s growth, revenue, and profit.

Changes in consumer use of banks and changes in consumer spending and savings habits could adversely affect Old National’s financial results.

Technology and other changes now allow many customers to complete financial transactions without using banks.  For example, consumers can pay bills and transfer funds directly without going through a bank.  This process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits.  In addition, changes in consumer spending and savings habits could adversely affect Old National’s operations, and Old National may be unable to timely develop competitive new products and services in response to these changes.

Old National’s controls and procedures may fail or be circumvented, and Old National’s methods of reducing risk exposure may not be effective.

Old National regularly reviews and updates its internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Old National also maintains an Enterprise Risk Management program designed to identify, manage, mitigate, monitor, aggregate, and report risks.  Any system of controls and any system to reduce risk exposure, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met.  Additionally, instruments, systems, and strategies used to hedge or otherwise manage exposure to various types of market compliance, credit, liquidity, operational, and business risks and enterprise-wide risk could be less effective than anticipated.  As a result, Old National may not be able to effectively mitigate its risk exposures in particular market environments or against particular types of risk.

Legal, Regulatory, and Compliance Risks

We have risk related to legal proceedings.

We are involved in judicial, regulatory, and arbitration proceedings concerning matters arising from our business activities and fiduciary responsibilities.  We establish reserves for legal claims when payments associated with the
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claims become probable and the costs can be reasonably estimated.  We may still incur legal costs for a matter even if we have not established a reserve.  In addition, the actual cost of resolving a legal claim may be substantially higher than any amounts reserved for that matter.  The ultimate resolution of a pending or future legal proceeding, depending on the remedy sought and granted, could materially adversely affect our results of operations and financial condition.

Old National operates in a highly regulated environment, and changes in laws and regulations to which Old National is subject may adversely affect Old National’s results of operations.

Old National operates in a highly regulated environment and is subject to extensive regulation, supervision, and examination by, among others, the OCC, the FDIC, the CFPB, the Federal Reserve, and the State of Indiana.  Such regulation and supervision is primarily intended for the protection of the depositors and federal deposit insurance funds. In addition, the U.S. Department of the Treasury (the “U.S. Treasury”) has certain supervisory and oversight duties and responsibilities. See “Business – Supervision and Regulation” herein. Applicable laws and regulations may change, and such changes may adversely affect Old National’s business. The Dodd-Frank Act, enacted in July 2010, mandated the most wide-ranging overhaul of financial industry regulation in decades. This legislation, among other things, weakened federal preemption of state consumer protection laws and established the CFPB with broad authority to administer and enforce a new federal regulatory framework of consumer financial regulation, including consumer mortgage banking. The scope and impact of many of the Dodd-Frank Act provisions were determined and issued over time. The impact of the Dodd-Frank Act on Old National has been substantial. Provisions in the legislation that affect the payment of interest on demand deposits and collection of interchange fees increased the costs associated with certain deposits and placed limitations on certain revenues those deposits generate. In addition, the Dodd-Frank Act required Old National to change certain of its business practices, intensified the regulatory supervision of Old National and the financial services industry generally, increased Old National’s capital requirements, and imposed additional assessments and costs on Old National. Requirements to maintain higher levels of capital or liquidity to address potential adverse stress scenarios could adversely impact the Company’s net income.

Regulatory authorities also have extensive discretion in connection with their supervisory and enforcement activities, including but not limited to the imposition of restrictions on the operation of an institution, the classification of assets by the institution, the adequacy of an institution’s Bank Secrecy Act/Anti-Money Laundering program management, and the adequacy of an institution’s allowance for credit losses for loans.  Any change in such regulation and oversight, whether in the form of restrictions on activities, regulatory policy, regulations, or legislation, including but not limited to changes in the regulations governing institutions, could have a material impact on Old National and its operations.

Old National Bank’s active participation in the PPP, or in other relief programs, may expose us to credit losses as well as litigation and compliance risk.

To support our customers, businesses, and communities, Old National Bank has participated in the PPP as a lender. The PPP commenced on April 3, 2020 and was available to qualified borrowers through August 8, 2020. As of December 31, 2020, Old National had originated over 9,700 loans with balances in excess of $1.5 billion to new and existing customers through the PPP. Old National Bank’s participation in the PPP, and participation in any other relief programs now or in the future, including those under the CARES Act, exposes us to certain credit, compliance, and other risks.

Among other regulatory requirements, PPP loans are subject to forbearance of loan payments for a six-month period to the extent that loans are not eligible for forgiveness. If PPP borrowers fail to qualify for loan forgiveness, including by failing to use the funds appropriately in order to qualify for forgiveness under the program, Old National Bank has a greater risk of holding these loans at unfavorable interest rates. In addition, because of the short time period between the passing of the CARES Act and the implementation of the PPP, there is ambiguity in the laws, rules, and guidance regarding the operation of the PPP, which exposes us to risks relating to noncompliance with the PPP. There is risk that the SBA or another governmental entity could conclude there is a deficiency in the manner in which Old National Bank originated, funded, or serviced PPP loans, which may or may not be related to the ambiguity in the CARES Act or the rules and guidance promulgated by the SBA and the U.S. Treasury regarding the operation of the PPP. In the event of such deficiency, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already made payment under the guaranty, seek recovery of any loss related to the deficiency from us.

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Since the commencement of the PPP, several other banks have been subject to litigation regarding the process and procedures that such banks followed in accepting and processing applications for the PPP. We may be exposed to the risk of similar litigation. Any financial liability, litigation costs, or reputational damage caused by PPP-related litigation could have a material adverse impact on our reputation, business, financial condition, and results of operations.

In addition, we may be subject to regulatory scrutiny regarding Old National Bank’s processing of PPP applications or its origination or servicing of PPP loans. While the SBA has said that in many instances, banks may rely on the certifications of borrowers regarding their eligibility for PPP loans, Old National Bank does have several obligations under the PPP, and if the SBA found that Old National Bank did not meet those obligations, the remedies the SBA may seek against Old National Bank, while unknown, may include not guarantying the PPP loans resulting in credit exposure to borrowers who may be unable to repay their loans. The PPP program may also attract significant interest from federal and state enforcement authorities, oversight agencies, regulators, and Congressional committees. State Attorneys General and other federal and state agencies may assert that they are not subject to the provisions of the CARES Act and the PPP regulations entitling Old National Bank to rely on borrower certifications, and take more aggressive action against us for alleged violations of the provisions governing Old National Bank’s participation in the PPP.

Changes in accounting policies, standards, and interpretations could materially affect how Old National reports its financial condition and results of operations.

The FASB periodically changes the financial accounting and reporting standards governing the preparation of Old National’s financial statements.  Additionally, those bodies that establish and/or interpret the financial accounting and reporting standards (such as the FASB, SEC, and banking regulators) may change prior interpretations on how these standards should be applied.  These changes can be difficult to predict and can materially affect how Old National records and reports its financial condition and results of operations.  In some cases, Old National could be required to retroactively apply a new or revised standard, resulting in changes to previously reported financial results.

If Old National fails to meet regulatory capital requirements which may require heightened capital levels, we may be forced to raise capital or sell assets.

Old National is subject to regulations that require us to satisfy certain capital ratios, such as the ratio of our Tier 1 capital to our risk-based assets.  Both the Dodd-Frank Act, which reformed the regulation of financial institutions in a comprehensive manner, and the Basel III regulatory capital reforms, which increased both the amount and quality of capital that financial institutions must hold, impact our capital requirements.  If we are unable to satisfy these heightened regulatory capital requirements, due to a decline in the value of our loan portfolio or otherwise, we will be required to improve such capital ratios by either raising additional capital or by disposing of assets.  If we choose to dispose of assets, we cannot be certain that we will be able to do so at prices that we believe to be appropriate, and our future operating results could be negatively affected.  If we choose to raise additional capital, we may accomplish this by selling additional shares of Common Stock, or securities convertible into or exchangeable for Common Stock, which could significantly dilute the ownership percentage of holders of our Common Stock and cause the market price of our Common Stock to decline. Additionally, events or circumstances in the capital markets generally may increase our capital costs and impair our ability to raise capital at any given time. See “Business – Supervision and Regulation” herein for further discussion on the Basel III regulatory capital reforms.

Our earnings could be adversely impacted by incidences of fraud and compliance failure.

Financial institutions are inherently exposed to fraud risk.  A fraud can be perpetrated by a customer of Old National, an employee, a vendor, or members of the general public.  We are most subject to fraud and compliance risk in connection with the origination of loans, ACH transactions, wire transactions, ATM transactions, and checking transactions.  Our largest fraud risk, associated with the origination of loans, includes the intentional misstatement of information in property appraisals or other underwriting documentation provided to us by third parties.  Compliance risk is the risk that loans are not originated in compliance with applicable laws and regulations and our standards.  There can be no assurance that we can prevent or detect acts of fraud or violation of law or our compliance standards by the third parties that we deal with.  Repeated incidences of fraud or compliance failures would adversely impact the performance of our loan portfolio.
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ITEM 1B.    UNRESOLVED STAFF COMMENTS
None.
ITEM 2.    PROPERTIES
As of December 31, 2020, Old National and its affiliates operated a total of 162 banking centers, primarily in the states of Indiana, Kentucky, Michigan, Minnesota, and Wisconsin.  Of these facilities, 108 were owned.  We lease 54 banking centers from unaffiliated third parties.  The remaining terms of these leases range from ten months to seventeen years and six months. See Note 6 to the consolidated financial statements.
Old National also has several administrative offices located throughout its footprint, including its executive offices located at 1 Main Street, Evansville, Indiana.  This building, which was previously leased, was purchased in 2016.

ITEM 3.    LEGAL PROCEEDINGS

None.

ITEM 4.    MINE SAFETY DISCLOSURES
Not applicable.

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PART II

ITEM 5.    MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Old National’s Common Stock is traded on the NASDAQ under the ticker symbol “ONB.”  There were 34,880 shareholders of record as of December 31, 2020. Old National did not sell any equity securities during 2020 that were not registered under the Securities Act.
The following table summarizes the purchases of Common Stock made by Old National during the fourth quarter of 2020:
PeriodTotal
Number
of Shares
Purchased
Average
Price
Paid Per
Share
Total Number
of Shares
Purchased as
Part of Publicly
Announced Plans
or Programs
Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans
or Programs
10/1/20 - 10/31/20383 $12.59 — 2,099,459 
11/1/20 - 11/30/20738 13.98 — 2,099,459 
12/1/20 - 12/31/202,132 16.21 — 2,099,459 
Total3,253 $15.27 — 2,099,459 
In the first quarter of 2020, the Board of Directors approved the repurchase of up to 7.0 million shares of the Company’s Common Stock to be repurchased, as conditions warrant, through January 31, 2021.  During the year ended December 31, 2020, Old National also repurchased a limited number of shares associated with employee share-based incentive programs.
On January 28, 2021, the Board of Directors declared a quarterly cash dividend of $0.14 per common share.  The Board of Directors also approved the adoption of a stock repurchase plan that authorizes the repurchase of up to $100 million of shares of Common Stock, as conditions warrant, through January 31, 2022.
EQUITY COMPENSATION PLAN INFORMATION
The following table contains information concerning the Amended and Restated 2008 Incentive Compensation Plan approved by the Company’s shareholders, as of December 31, 2020.
Number of securities to
be issued upon exercise
of outstanding options,
warrants, and rights
Weighted-average
exercise price of
outstanding options,
warrants, and rights
Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column (a))
Plan Category(a)(b)(c)
Equity compensation plans
   approved by security holders
1,509,777 $14.40 2,915,531 
Equity compensation plans not
   approved by security holders
— — — 
Total1,509,777 $14.40 2,915,531 
At December 31, 2020, 2.9 million shares remain available for issuance under the Amended and Restated 2008 Incentive Compensation Plan.
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The following table compares cumulative five-year total shareholder returns, assuming reinvestment of dividends, for our Common Stock to cumulative total returns of a broad-based equity market index and two published industry indices.  The comparison of shareholder returns (change in December year end stock price plus reinvested dividends) for each of the periods assumes that $100 was invested on December 31, 2015, in common stock of each of the Company, the S&P Small Cap 600 Index, the NYSE Financial Index and the SNL Bank and Thrift Index, with investment weighted on the basis of market capitalization.
onb-20201231_g1.jpg

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ITEM 6.    SELECTED FINANCIAL DATA
(dollars and shares in thousands, except per share data)20202019201820172016
Operating Results
Net interest income$596,094 $604,273 $537,602 $437,168 $402,703 
Taxable equivalent adjustment (1)13,586 12,940 11,394 23,091 21,293 
Net interest income - tax equivalent basis609,680 617,213 548,996 460,259 423,996 
Provision for loan losses (2)38,395 4,747 6,966 3,050 960 
Noninterest income239,274 199,317 195,305 183,382 252,830 
Noninterest expense541,417 508,487 517,261 448,836 454,147 
Net income226,409 238,206 190,830 95,725 134,264 
Common Share Data (3)
Weighted average diluted shares166,177 172,687 156,539 138,513 128,301 
Net income (diluted)$1.36 $1.38 $1.22 $0.69 $1.05 
Cash dividends0.56 0.52 0.52 0.52 0.52 
Common dividend payout ratio (4)41 %37 %42 %75 %50 %
Book value at year-end$17.98 $16.82 $15.36 $14.17 $13.42 
Stock price at year-end16.56 18.29 15.40 17.45 18.15 
Balance Sheet Data (at December 31)
Loans (5)$13,849,729 $12,164,422 $12,258,803 $11,136,051 $9,101,194 
Total assets22,960,622 20,411,667 19,728,435 17,518,292 14,860,237 
Deposits17,037,453 14,553,397 14,349,949 12,605,764 10,743,253 
Borrowings2,676,554 2,744,728 2,493,793 2,578,204 2,152,086 
Shareholders' equity2,972,656 2,852,453 2,689,570 2,154,397 1,814,417 
Performance Ratios
Return on average assets1.04 %1.19 %1.07 %0.63 %0.98 %
Return on average common shareholders' equity7.87 8.57 8.42 4.98 7.84 
Net interest margin (6)3.18 3.55 3.54 3.48 3.58 
Efficiency ratio (6)62.91 60.35 67.74 68.87 65.82 
Asset Quality (7)
Net charge-offs (recoveries) to average loans0.02 %0.05 %0.02 %0.03 %0.04 %
Allowance for loan losses to ending loans (2)0.95 0.45 0.45 0.45 0.55 
Allowance for loan losses (2)$131,388 $54,619 $55,461 $50,381 $49,808 
Underperforming assets (8)166,579 147,489 179,425 154,220 164,657 
Allowance for loan losses to nonaccrual loans (2)89.17 %43.21 %35.22 %40.33 %37.90 %
Other Data
Full-time equivalent employees2,445 2,709 2,892 2,801 2,733 
Banking centers162 192 191 191 203 
(1)Calculated using the federal statutory tax rate in effect of 21% for 2018 - 2020 and 35% for 2016 - 2017.
(2)Beginning January 1, 2020, calculation is based on current expected loss methodology. Prior to January 1, 2020, calculation is based on incurred loss methodology.
(3)Diluted data assumes the exercise of stock appreciation rights and the vesting of restricted stock.
(4)Cash dividends per share divided by net income per share (basic).
(5)Includes loans held for sale.
(6)Represents a non-GAAP financial measure.  Refer to the “Non-GAAP Financial Measures” section of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for reconciliations to GAAP financial measures.
(7)Excludes loans held for sale.
(8)Includes nonaccrual loans, TDRs still accruing, loans 90 days past due still accruing, and other real estate owned. 
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ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is an analysis of our results of operations for the fiscal years ended December 31, 2020, 2019, and 2018, and financial condition as of December 31, 2020 and 2019.  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 its traditional banking business including fiduciary and wealth management services, investment and brokerage services, investment consulting, and other financial services.  Our primary geographic markets are in Indiana, Kentucky, Michigan, Minnesota, and Wisconsin.

CORPORATE DEVELOPMENTS IN FISCAL 2020
Old National had an outstanding financial year in 2020.  Key performance indicators experienced in 2020 included:

net income of $226.4 million, or $1.36 per diluted share;
record high commercial loan production of $3.5 billion;
record mortgage production of $2.2 billion;
strong credit quality metrics including charge-offs to average loans of 0.02%;
low cost of total deposits at 0.18%; and
efficiency ratio of 62.91% in 2020.
Our net interest income decreased slightly to $596.1 million during 2020, compared to $604.3 million in 2019.  Noninterest income grew from $199.3 million in 2019 to $239.3 million in 2020 reflecting higher mortgage banking revenue, higher capital markets income, and higher debt securities gains.  These increases were partially offset by lower service charges on deposit accounts.  Our noninterest expenses remain well controlled, increasing from $508.5 million in 2019 to $541.4 million in 2020 reflecting higher charges related to The ONB Way strategic initiative in 2020. ONB Way charges totaled $42.6 million in 2020 compared to $11.4 million in 2019.
This year, Old National implemented The ONB Way, a strategic plan designed to keep the Company’s clients at the center of all we do.  The ONB Way includes realigning the geographic organization structure to streamline our operating model through integrated commercial, community banking, and wealth teams. We have successfully executed this transformation, delivered on the run rate expense savings, and are transitioning into the implementation phase of our planned revenue initiatives. These revenue initiatives are underway for our
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technology, Commercial, Wealth, and Treasury Management areas; while our Community area initiatives are scheduled to commence throughout the remainder of 2021.
On December 27, 2020, President Trump signed into law the CAA. The CAA, among other things, extends the life of the PPP, effectively creating a second round of PPP loans for eligible businesses. Old National is participating in the CAA’s second round of PPP lending. In mid-January we opened our lending portal and have begun processing PPP loan applications. Early indications support our belief that there will be a large volume of smaller sized loans. We anticipate the average loan size to be less than $150,000. Currently, we are focused on helping minority-owned business, women-owned business, not-for-profit entities, and existing first round PPP customers with the lending process. Additionally, section 541 of the CAA extends the relief provided by the CARES Act for financial institutions to suspend the GAAP accounting treatment for troubled debt restructuring to January 1, 2022.

Pandemic Update

As previously disclosed, the novel strain of coronavirus, COVID-19, which was first reported in Wuhan, China had an impact on our operations during 2020. This impact continues to be addressed by Old National as evidenced by our practice of occupying only 50% of our office buildings by rotating team members every 4 weeks for the foreseeable future. We remain committed and focused on the health and safety of our team members, customers, and communities. Our banking centers are still open for business and we continue to lend to qualified businesses for working capital and general business purposes, while our online banking network is continuously available for digital banking transactions. We believe our historically strong underwriting practices, diverse and granular portfolios, and Midwest-based footprint will help to mitigate any adverse impact to Old National.

The impact of the pandemic on the Company’s business, financial condition, results of operations, and its customers has not fully manifested in 2020. The fiscal stimulus and relief programs appear to have delayed any materially adverse financial impact to Old National. Once these stimulus programs have been exhausted, we believe our credit metrics will worsen and loan losses will ultimately materialize. Any potential loan losses will be contingent upon the resurgence of the virus, including any new strains, offset by the potency of the vaccine along with its extensive distribution, and the ability for customers and businesses to return to their pre-pandemic routines. However, economic uncertainty remains high and bouts of elevated volatility are expected to continue, which may have a future adverse financial impact on Old National.
BUSINESS OUTLOOK

As we emerge from 2020, we have observed signs of an economic recovery in the United States with jobs, consumer spending, manufacturing, and other indicators rebounding from their weakest levels. Additionally, progress toward an effective COVID-19 vaccine has been promising and the availability of that vaccine may drive the re-opening plans of state and local economies in 2021.

In 2020, the U.S. economy contracted approximately 3.5% as measured by the change in GDP due to the COVID-19 pandemic which caused a deep contraction in the first half of 2020, with somewhat of a rebound in the second half of 2020. The U.S economic outlook for 2021 estimates range between 6.4% and 0.8%, with a probable annual GDP expansion of 4.1%, indicating a return to pre-pandemic levels as early as April, 2021 to as late as sometime in 2022. The GDP estimates are heavily influenced by the severity and timing of when COVID-19 peaks coupled with how widespread lockdowns are implemented, length of period for vaccine distribution, resurgence or stabilization of unemployment levels which currently is 6.7% as of December 31, 2020, and the success of the fiscal stimulus package. The Federal Reserve monetary policy is very favorable for economic growth and is anticipated to remain so through 2022 at the earliest. Residential housing coupled with a savings cushion are viewed as tailwinds to assist in U.S. economic growth over the coming quarters. Additional global risks that could trigger a halt to the U.S. economic outlook include: a prolonged shutdown of global economies caused by COVID-19 and a potential resurgence of economic and political tensions with China.

With the execution of The ONB Way transformation, where we have migrated from a generalist relationship management approach based on geography, to a specialist relationship management approach based on business segmentations, we remain a community bank at heart, dedicated to serving and strengthening our communities. Our strategy evolution continues into a commercially-oriented regional bank that consistently delivers top quartile performance. This is accomplished by continuing to focus on the fundamentals of basic banking, which are loan growth, noninterest income growth, prudent capital deployment, and expense management. As the transformation phase finishes, we transition into the implementation phase of our planned revenue initiatives.
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Organic loan growth remains a priority. Our loan production and pipeline are at high levels as we enter into 2021, yet we continue to adhere to our disciplined underwriting process.  Our practice of recognizing underperforming credits early, along with active engagement with these borrowers ultimately leads to lower credit losses.  Despite the challenging economic environment in 2020, overall credit quality remains healthy, and we have not experienced any specific sector credit related weaknesses, yet we are watching a small number of credits and have identified certain industries that deserve extra attention in this current economic environment.
In regard to future partnerships, we are growing more confident in our ability to evaluate the fair value of a potential acquisition target’s loan portfolio in the current economic environment. However, our acquisition strategy is consistent as an active looker and a selective buyer.  We continue to wait patiently for advantageous opportunities while we remain focused on execution of our strategies.
As we look ahead to 2021, we remain committed to generating positive operating leverage.

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FINANCIAL HIGHLIGHTS
The following table sets forth certain financial highlights of Old National:
Three Months EndedYears Ended
(dollars and shares in thousands,December 31,September 30,December 31,December 31,
except per share data)20202020201920202019
Income Statement:
Net interest income$161,079 $145,573 $148,899 $596,094 $604,273 
Taxable equivalent adjustment (1)3,517 3,379 3,282 13,586 12,940 
Net interest income - tax equivalent basis164,596 148,952 152,181 609,680 617,213 
Provision for loan losses (4)(1,100)— 1,264 38,395 4,747 
Noninterest income58,552 64,759 47,726 239,274 199,317 
Noninterest expense142,318 120,234 134,743 541,417 508,487 
Net income74,120 77,944 49,185 226,409 238,206 
Per Common Share Data:
Weighted average diluted shares165,631 165,419 170,186 166,177 172,687 
Net income (diluted)$0.44 $0.47 $0.29 $1.36 $1.38 
Cash dividends0.14 0.14 0.13 $0.56 $0.52 
Common dividend payout ratio (2)31 %30 %45 %41 %37 %
Book value$17.98 $17.67 $16.82 $17.98 $16.82 
Stock price16.56 12.56 18.29 16.56 18.29 
Tangible common book value (3)11.43 11.10 10.35 11.43 10.35 
Performance Ratios:
Return on average assets1.30 %1.40 %0.97 %1.04 %1.19 %
Return on average common equity10.11 10.79 6.94 7.87 8.57 
Return on tangible common equity (3)16.20 17.56 11.89 12.54 14.30 
Return on average tangible common equity (3)16.57 17.88 12.03 13.27 14.97 
Net interest margin (3)3.26 3.03 3.46 3.18 3.55 
Efficiency ratio (3)62.37 55.93 65.57 62.91 60.35 
Net charge-offs (recoveries) to average loans(0.03)(0.09)0.12 0.02 0.05 
Allowance for loan losses to ending loans (4)0.95 0.95 0.45 0.95 0.45 
Non-performing loans to ending loans1.20 1.15 1.19 1.20 1.19 
Balance Sheet:
Total loans, excluding loans held for sale$13,786,479 $13,892,509 $12,117,524 $13,786,479 $12,117,524 
Total assets22,960,622 22,460,476 20,411,667 22,960,622 20,411,667 
Total deposits17,037,453 16,506,494 14,553,397 17,037,453 14,553,397 
Total borrowed funds2,676,554 2,725,731 2,744,728 2,676,554 2,744,728 
Total shareholders' equity2,972,656 2,921,149 2,852,453 2,972,656 2,852,453 
Capital Ratios:
Risk-based capital ratios:
Tier 1 common equity11.75 %11.84 %12.13 %11.75 %12.13 %
Tier 111.75 11.84 12.13 11.75 12.13 
Total12.69 12.81 12.99 12.69 12.99 
Leverage ratio (to average assets)8.20 8.15 8.88 8.20 8.88 
Total equity to assets (averages)12.83 12.97 14.01 13.20 13.88 
Tangible common equity to tangible assets (3)8.64 8.58 9.09 8.64 9.09 
Nonfinancial Data:
Full-time equivalent employees2,445 2,484 2,709 2,445 2,709 
Banking centers162 162 192 162 192 
(1)Calculated using the federal statutory tax rate in effect of 21% for all 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.
(4)Beginning January 1, 2020, calculation is based on current expected loss methodology. Prior to January 1, 2020, calculation is based on incurred loss methodology.
NON-GAAP FINANCIAL MEASURES
The non-GAAP financial measures presented below are used by our management and our Board of Directors on a regular basis in addition to our GAAP results to facilitate the assessment of our financial performance. Management believes these non-GAAP financial measures enhance an investor’s understanding of our financial results by
34


providing a meaningful basis for period-to-period comparisons, assisting in operating results analysis, and predicting future performance. This information supplements our GAAP reported results, and should not be viewed in isolation from, or as a substitute for, our GAAP results. Accordingly, this financial information should be read in conjunction with our consolidated financial statements and notes thereto for the year ended December 31, 2020, included elsewhere in this report. Non-GAAP financial measures exclude certain items that are included in the financial results presented in accordance with GAAP.
The following table presents GAAP to non-GAAP reconciliations.
Three Months EndedYears Ended
(dollars and shares in thousands,December 31,December 31,
except per share data)2020201920202019
Tangible common book value:
Shareholders' equity (GAAP)$2,972,656 $2,852,453 $2,972,656 $2,852,453 
Deduct:Goodwill1,036,994 1,036,994 1,036,994 1,036,994 
Intangible assets46,014 60,105 46,014 60,105 
Tangible shareholders' equity (non-GAAP)$1,889,648 $1,755,354 $1,889,648 $1,755,354 
Period end common shares165,367 169,616 165,367 169,616 
Tangible common book value11.43 10.35 11.43 10.35 
Return on tangible common equity:
Net income (GAAP)$74,120 $49,185 $226,409 $238,206 
Add:  Intangible amortization (net of tax)2,433 2,976 10,585 12,756 
Tangible net income (non-GAAP)$76,553 $52,161 $236,994 $250,962 
Tangible shareholders' equity (non-GAAP) (see above)$1,889,648 $1,755,354 $1,889,648 $1,755,354 
Return on tangible common equity16.20 %11.89 %12.54 %14.30 %
Return on average tangible common equity:
Tangible net income (non-GAAP) (see above)$76,553 $52,161 $236,994 $250,962 
Average shareholders' equity (GAAP)$2,932,590 $2,832,938 $2,875,460 $2,781,132 
Deduct:Average goodwill1,036,994 1,036,994 1,036,994 1,036,456 
 Average intangible assets47,536 61,963 52,740 68,244 
Average tangible shareholders' equity (non-GAAP)$1,848,060 $1,733,981 $1,785,726 $1,676,432 
Return on average tangible common equity16.57 %12.03 %13.27 %14.97 %
Net interest margin:
Net interest income (GAAP)$161,079 $148,899 $596,094 $604,273 
Taxable equivalent adjustment3,517 3,282 13,586 12,940 
Net interest income - taxable equivalent basis (non-GAAP)$164,596 $152,181 $609,680 $617,213 
Average earning assets$20,181,991 $17,577,821 $19,158,681 $17,385,180 
Net interest margin3.26 %3.46 %3.18 %3.55 %
Efficiency ratio:
Noninterest expense (GAAP)$142,318 $134,743 $541,417 $508,487 
Deduct:  Intangible amortization expense3,244 3,946 14,091 16,911 
Adjusted noninterest expense (non-GAAP)$139,074 $130,797 $527,326 $491,576 
Net interest income - taxable equivalent basis (non-GAAP)
(see above)
$164,596 $152,181 $609,680 $617,213 
Noninterest income58,552 47,726 239,274 199,317 
Deduct:  Debt securities gains (losses), net161 437 10,767 1,923 
Adjusted total revenue (non-GAAP)$222,987 $199,470 $838,187 $814,607 
Efficiency ratio62.37 %65.57 %62.91 %60.35 %
Tangible common equity to tangible assets:
Tangible shareholders' equity (non-GAAP) (see above)$1,889,648 $1,755,354 $1,889,648 $1,755,354 
Assets (GAAP)$22,960,622 $20,411,667 $22,960,622 $20,411,667 
Add:Trust overdrafts26 31 26 31 
Deduct:Goodwill1,036,994 1,036,994 1,036,994 1,036,994 
Intangible assets46,014 60,105 46,014 60,105 
Tangible assets (non-GAAP)$21,877,640 $19,314,599 $21,877,640 $19,314,599 
Tangible common equity to tangible assets8.64 %9.09 %8.64 %9.09 %
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.
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RESULTS OF OPERATIONS
The following table sets forth certain income statement information of Old National:
Years Ended December 31,
(dollars in thousands)202020192018
Income Statement Summary:
Net interest income$596,094 $604,273 $537,602 
Provision for loan losses (1)38,395 4,747 6,966 
Noninterest income239,274 199,317 195,305 
Noninterest expense541,417 508,487 517,261 
Other Data:
Return on average common equity7.87 %8.57 %8.42 %
Return on tangible common equity (2)12.54 %14.30 %12.83 %
Return on average tangible common equity (2)13.27 %14.97 %14.97 %
Efficiency ratio (2)62.91 %60.35 %67.74 %
Tier 1 leverage ratio8.20 %8.88 %9.17 %
Net charge-offs (recoveries) to average loans0.02 %0.05 %0.02 %
(1)    Beginning January 1, 2020, calculation is based on current expected loss methodology. Prior to January 1, 2020, calculation is based on incurred loss methodology.
(2)     Represents a non-GAAP financial measure.  Refer to “Non-GAAP Financial Measures” section for reconciliations to GAAP financial measures.
Comparison of Fiscal Years 2020 and 2019
Net Interest Income

Net interest income is the most significant component of our earnings, comprising 71% of 2020 revenues.  Net interest income and net interest 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 interest-earning assets and interest-bearing liabilities. We have observed signs of an economic recovery in the United States, with jobs, consumer spending, manufacturing, and other indicators rebounding from their weakest levels. Additionally, progress toward an effective COVID-19 vaccine has been promising and the availability of that vaccine may drive the re-opening plans of state and local economies in 2021. However, economic uncertainty remains high and bouts of elevated volatility are expected to continue.

Interest rates remained at near historic lows during the second half of 2020 after declining dramatically in the first half of 2020 due to the COVID-19 pandemic. The Federal Reserve’s Federal Funds range is currently in a target range of 0.00% to 0.25%, with the Effective Fed Funds Rate in the 0.05% to 0.10% range. If interest rates decline further, our interest rate spread could decline, which may result in a decrease in our net interest income. However, management has taken balance sheet restructuring, derivative, and deposit pricing actions to help mitigate this risk.

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 our mix of assets and funding, net interest income, and net interest margin.
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Net interest income is the excess of interest received from interest-earning assets over interest paid on interest-bearing liabilities.  For analytical purposes, net interest income is 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 all periods.  This analysis portrays the income tax benefits related to 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 better peer comparisons.
Years Ended December 31,
(dollars in thousands)202020192018
Net interest income$596,094 $604,273 $537,602 
Conversion to fully taxable equivalent13,586 12,940 11,394 
Net interest income - taxable equivalent basis$609,680 $617,213 $548,996 
Average earning assets$19,158,681 $17,385,180 $15,501,053 
Net interest margin3.11 %3.48 %3.47 %
Net interest margin - taxable equivalent basis3.18 %3.55 %3.54 %
Net interest income was $596.1 million in 2020, an $8.2 million decrease from $604.3 million in 2019.  Taxable equivalent net interest income was $609.7 million in 2020, a $7.5 million decrease from $617.2 million in 2019.  The net interest margin on a fully taxable equivalent basis was 3.18% in 2020, a 37 basis point decrease compared to 3.55% in 2019.  The decrease in net interest income in 2020 when compared to 2019 was primarily due to lower yields on average earning assets and lower accretion income. Partially offsetting these decreases were lower costs of average interest-bearing liabilities and interest and fees related to PPP loans.  Net interest income in both 2020 and 2019 included accretion income (interest income in excess of contractual interest income) associated with acquired loans.  Accretion income totaled $23.3 million in 2020, compared to $43.6 million in 2019.  We expect accretion income on loans to decrease over time, but this may be offset by future acquisitions. Net interest income in 2020 included $38.0 million of interest and net fees combined on PPP loans.
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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.
202020192018
(Tax equivalent basis,
dollars in thousands)
Average
Balance
Income (1)/
Expense
Yield/
Rate
Average
Balance
Income (1)/
Expense
Yield/
Rate
Average
Balance
Income (1)/
Expense
Yield/
Rate
Earning Assets
Money market and other interest-
   earning investments
$174,494 $568 0.33 %$67,069 $1,670 2.49 %$48,240 $630 1.31 %
Investment securities:
Treasury and government-
    sponsored agencies
547,054 12,124 2.22 657,233 16,091 2.45 673,171 14,433 2.14 
Mortgage-backed securities3,246,520 70,611 2.17 2,866,600 73,835 2.58 1,707,646 41,493 2.43 
States and political subdivisions1,347,490 47,034 3.49 1,202,210 44,716 3.72 1,153,315 42,326 3.67 
Other securities485,430 11,990 2.47 495,847 16,138 3.25 490,464 15,633 3.19 
Total investment securities5,626,494 141,759 2.52 5,221,890 150,780 2.89 4,024,596 113,885 2.83 
Loans: (2)
Commercial3,843,089 140,473 3.66 3,023,421 141,215 4.67 2,924,878 131,471 4.49 
Commercial real estate5,477,562 234,670 4.28 5,044,623 275,853 5.47 4,536,897 235,876 5.20 
Residential real estate loans2,352,444 94,202 4.00 2,281,047 96,613 4.24 2,195,078 89,888 4.09 
Consumer1,684,598 65,222 3.87 1,747,130 77,196 4.42 1,771,364 71,689 4.05 
Total loans13,357,693 534,567 4.00 12,096,221 590,877 4.88 11,428,217 528,924 4.63 
Total earning assets19,158,681 $676,894 3.53 %17,385,180 $743,327 4.28 %15,501,053 $643,439 4.15 %
Less: Allowance for loan losses (3)(115,321)(56,624)(52,316)
Non-Earning Assets
Cash and due from banks327,053 251,857 210,716 
Other assets2,414,602 2,453,001 2,130,588 
Total assets$21,785,015 $20,033,414 $17,790,041 
Interest-Bearing Liabilities
Checking and NOW accounts$4,464,027 $5,449 0.12 %$3,902,765 $15,598 0.40 %$3,146,309 $4,973 0.16 %
Savings accounts3,113,435 3,156 0.10 2,878,135 8,142 0.28 2,995,484 7,464 0.25 
Money market accounts1,866,196 4,585 0.25 1,789,065 14,130 0.79 1,225,220 4,424 0.36 
Other time deposits1,337,269 14,013 1.05 1,748,552 27,400 1.57 1,654,548 21,012 1.27 
Brokered deposits85,041 966 1.14 173,439 4,094 2.36 185,426 3,404 1.84 
Total interest-bearing deposits10,865,968 28,169 0.26 10,491,956 69,364 0.66 9,206,987 41,277 0.45 
Federal funds purchased and
   interbank borrowings
138,257 1,296 0.94 241,618 5,656 2.34 238,408 4,793 2.01 
Securities sold under agreements
to repurchase
375,961 854 0.23 342,654 2,517 0.73 344,964 1,962 0.57 
FHLB advances2,055,155 27,274 1.33 1,775,987 37,452 2.11 1,665,689 34,925 2.10 
Other borrowings242,642 9,621 3.96 251,194 11,125 4.43 249,832 11,486 4.60 
Total borrowed funds2,812,015 39,045 1.39 2,611,453 56,750 2.17 2,498,893 53,166 2.13 
Total interest-bearing liabilities$13,677,983 $67,214 0.49 %$13,103,409 $126,114 0.96 %$11,705,880 $94,443 0.81 %
Noninterest-Bearing Liabilities
   and Shareholders' Equity
Demand deposits4,945,506 3,887,470 3,657,234 
Other liabilities286,066 261,403 159,600 
Shareholders' equity2,875,460 2,781,132 2,267,327 
Total liabilities and shareholders'
   equity
$21,785,015 $20,033,414 $17,790,041 
Net interest rate spread3.04 %3.32 %3.34 %
Net interest margin (4)3.18 3.55 3.54 
Taxable equivalent adjustment$13,586 $12,940 $11,394 
(1)Interest income is reflected on a fully taxable equivalent basis.
(2)Includes loans held for sale.
(3)Beginning January 1, 2020, calculation is based on current expected loss methodology. Prior to January 1, 2020, calculation was based on incurred loss model.
(4)Net interest margin is defined as net interest income on a tax equivalent basis as a percentage of average earning assets.
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The yield on average earning assets decreased 75 basis points from 4.28% in 2019 to 3.53% in 2020 and the cost of interest-bearing liabilities decreased 47 basis points from 0.96% in 2019 to 0.49% in 2020.  Average earning assets increased by $1.774 billion, or 10%.  The increase in average earning assets consisted of a $404.6 million increase in investment securities, a $1.261 billion increase in loans, and a $107.4 million increase in money market and other interest-earning investments.  Average interest-bearing liabilities increased $574.6 million, or 4%.  The increase in average interest-bearing liabilities consisted of a $374.0 million increase in interest-bearing deposits, a $33.3 million increase in securities sold under agreements to repurchase, and a $279.2 million increase in FHLB advances, partially offset by a $103.4 million decrease in federal funds purchased and interbank borrowings and an $8.5 million decrease in other borrowings.  Average noninterest-bearing deposits increased by $1.058 billion. The continued spread and impact of the COVID-19 pandemic may offset the recent positive economic momentum and government stimulus programs, and could negatively impact net interest margin. Accordingly, there is still much uncertainty regarding the economy.
The increase in average earning assets in 2020 compared to 2019 was due to increases in average loans and average investment securities.  The loan portfolio, including loans held for sale, which generally has an average yield higher than the investment portfolio, was 70% of average interest earning assets in 2020 and 2019.
Average loans including loans held for sale increased $1.261 billion in 2020 compared to 2019 due to increases in average commercial loans, commercial real estate loans, and residential real estate loans, partially offset by lower average consumer loans.  The increase in average commercial loans reflected strong PPP loan production, which began in April 2020. Average PPP loans for the year ended December 31, 2020 totaled $957.9 million.

Average investments increased $404.6 million in 2020 compared to 2019 reflecting higher fair values and excess liquidity.
Average non-interest-bearing deposits increased $1.058 billion in 2020 compared to 2019 primarily due to PPP funds on deposit.  Average interest-bearing deposits increased $374.0 million in 2020 compared to 2019.
Average borrowed funds increased $200.6 million in 2020 compared to 2019 primarily due to increases in FHLB advances and securities sold under agreements to repurchase, partially offset by a decrease in federal funds purchased and interbank borrowings.
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The following table presents 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 2019 to 2020From 2018 to 2019
TotalAttributed toTotalAttributed to
(dollars in thousands)Change (1)VolumeRateChange (1)VolumeRate
Interest Income
Money market and other interest-earning
   investments
$(1,102)$1,511 $(2,613)$1,040 $358 $682 
Investment securities (2)(9,021)10,938 (19,959)36,895 34,226 2,669 
Loans (2)(56,310)56,052 (112,362)61,953 31,774 30,179 
Total interest income(66,433)68,501 (134,934)99,888 66,358 33,530 
Interest Expense
Checking and NOW deposits(10,149)1,464 (11,613)10,625 2,110 8,515 
Savings deposits(4,986)452 (5,438)678 (312)990 
Money market deposits(9,545)399 (9,944)9,706 3,245 6,461 
Other time deposits(13,387)(5,377)(8,010)6,388 1,309 5,079 
Brokered deposits(3,128)(1,545)(1,583)690 (92)782 
Federal funds purchased and interbank
   borrowings
(4,360)(1,694)(2,666)863 70 793 
Securities sold under agreements to
   repurchase
(1,663)160 (1,823)555 (15)570 
Federal Home Loan Bank advances(10,178)4,796 (14,974)2,527 2,320 207 
Other borrowings(1,504)(359)(1,145)(361)61 (422)
Total interest expense(58,900)(1,704)(57,196)31,671 8,696 22,975 
Net interest income$(7,533)$70,205 $(77,738)$68,217 $57,662 $10,555 
(1)    The variance not solely due to rate or volume is allocated equally between the rate and volume variance.
(2)    Interest on investment securities and loans includes the effect of taxable equivalent adjustments of $8.9 million and $4.7 million, respectively, in 2020; $7.7 million and $5.2 million, respectively, in 2019; and $7.1 million and $4.3 million, respectively, in 2018; using the federal statutory tax rate in effect of 21%.
Provision for Loan Losses
The provision for loan losses was an expense of $38.4 million in 2020, compared to an expense of $4.7 million in 2019.  Net charge-offs totaled $3.0 million in 2020, compared to net charge-offs of $5.6 million in 2019.  The higher provision for loan losses was driven by the implementation of ASC 326 and its current expected loss methodology, which uses an economic forecast that now includes the impact of the COVID-19 pandemic. PPP loans were factored in the provision for credit losses in 2020; however due to the SBA guaranty and our borrowers’ adherence to the PPP terms, the provision impact was insignificant. 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. Additionally, with the adoption of ASC 326 beginning on January 1, 2020, provision expense may become more volatile due to changes in CECL model assumptions of credit quality, macroeconomic factors and conditions, and loan composition, which drive the allowance for credit losses balance.  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 29% in 2020 compared to 25% in 2019.
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The following table details the components of noninterest income:
Years Ended December 31,% Change From
Prior Year
(dollars in thousands)20202019201820202019
Wealth management fees$36,806 $37,072 $36,863 (0.7)%0.6 %
Service charges on deposit accounts35,081 44,915 44,026 (21.9)2.0 
Debit card and ATM fees20,178 21,652 20,216 (6.8)7.1 
Mortgage banking revenue62,775 26,622 17,657 135.8 50.8 
Investment product fees21,614 21,785 20,539 (0.8)6.1 
Capital markets income22,480 13,270 4,934 69.4 169.0 
Company-owned life insurance12,031 11,539 10,584 4.3 9.0 
Debt securities gains (losses), net10,767 1,923 2,060 459.9 (6.7)
Net gain on banking center divestitures13,989 N/M  (100.0)
Other income17,542 20,539 24,437 (14.6)(16.0)
Total noninterest income$239,274 $199,317 $195,305 20.0 %2.1 %
Noninterest income to total revenue (1)28.2 %24.4 %26.2 %
(1)Total revenue includes the effect of a taxable equivalent adjustment of $13.6 million in 2020, $12.9 million in 2019, and $11.4 million in 2018.
The increase in noninterest income in 2020 compared to 2019 was primarily due to higher mortgage banking revenue, higher capital markets income, and higher debt securities gains.  These increases were partially offset by lower service charges on deposit accounts.
Service charges and overdraft fees decreased $9.8 million in 2020 compared to 2019 reflecting lower overdraft fees due to the impact of the COVID-19 pandemic.
Debit card and ATM fees decreased $1.5 million in 2020 compared to 2019 reflecting lower interchange income due to the impact of the COVID-19 pandemic.
Mortgage banking revenue increased $36.2 million in 2020 compared to 2019 primarily due to increased mortgage originations, sales, and strong pipeline growth in 2020.
Capital markets income is comprised of customer interest rate swap fees, debt placement fees, foreign currency exchange fees, net gains (losses) on foreign currency adjustments, and tax credit fee income.  Capital markets income increased $9.2 million in 2020 compared to 2019 primarily due to higher customer interest rate swap fees.
Debt securities gains (losses), net had a favorable variance of $8.8 million in 2020 compared to 2019 primarily due to higher realized gains on sales of available-for-sale securities and lower realized losses on sales of available-for-sale debt securities in 2020.
Other income decreased $3.0 million in 2020 compared to 2019 primarily due to lower branded card incentives, unfavorable variance in net gains (losses) on derivatives, and lower insurance income.
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Noninterest Expense
The following table details the components of noninterest expense:
Years Ended December 31,% Change From
Prior Year
(dollars in thousands)20202019201820202019
Salaries and employee benefits$293,590 $289,452 $281,275 1.4 %2.9 %
Occupancy55,316 55,255 51,941 0.1 6.4 
Equipment16,690 16,903 14,861 (1.3)13.7 
Marketing10,874 15,898 15,847 (31.6)0.3 
Data processing41,086 37,589 36,170 9.3 3.9 
Communication9,731 10,702 10,846 (9.1)(1.3)
Professional fees15,755 22,854 14,503 (31.1)57.6 
FDIC assessment6,722 6,030 10,638 11.5 (43.3)
Amortization of intangibles14,091 16,911 14,442 (16.7)17.1 
Amortization of tax credit investments18,788 2,749 22,949 583.4 (88.0)
Other expense58,774 34,144 43,789 72.1 (22.0)
Total noninterest expense$541,417 $508,487 $517,261 6.5 %(1.7)%
Noninterest expense increased $32.9 million in 2020 compared to 2019 reflecting higher charges related to The ONB Way strategic initiative in 2020. ONB Way charges totaled $42.6 million in 2020 compared to $11.4 million in 2019.
Salaries and employee benefits is the largest component of noninterest expense.  Salaries and employee benefits increased $4.1 million in 2020 compared to 2019 primarily due to higher commissions, personnel expenses related to The ONB Way, and higher corporate incentives, partially offset by fewer employees at December 31, 2020.

Marketing expenses decreased $5.0 million in 2020 compared to 2019 primarily due to lower advertising expenses, public relations, and business development expenses.

Professional fees decreased $7.1 million in 2020 compared to 2019 reflecting higher consulting fees incurred in 2019 related to The ONB Way.
Amortization of intangibles decreased $2.8 million in 2020 compared to 2019 primarily due to lower amortization of core deposit intangibles.
Amortization of tax credit investments increased $16.0 million in 2020 compared to 2019.  The recognition of tax credit amortization expense is contingent upon the successful completion of the 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.  See Note 9 to the consolidated financial statements for additional information on our tax credit investments.
Other expense increased $24.6 million in 2020 compared to 2019 primarily due to lease termination charges and impairments on long-lived assets related to banking center consolidations that were part of the ONB Way strategic initiative totaling $27.1 million in 2020.
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 11.4% in 2020 compared to 18.0% in 2019.  The lower effective tax rate in 2020 compared to 2019 was primarily the result of an increase in federal tax credits available.  See Note 15 to the consolidated financial statements for additional details on Old National’s income tax provision.
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Comparison of Fiscal Years 2019 and 2018
In 2019, we generated net income of $238.2 million and diluted net income per share of $1.38 compared to $190.8 million and diluted net income per share of $1.22, respectively, in 2018. The 2019 earnings included a $66.7 million increase in net interest income, an $8.8 million decrease in noninterest expense, a $4.0 million increase in noninterest income, and a $2.2 million decrease in provision for loan losses.  These favorable variances in net income were partially offset by a $34.3 million increase in income tax expense.  Record high commercial loan production, record mortgage production, consistently strong credit quality metrics, and well controlled noninterest expenses all contributed to favorable 2019 performance when compared to 2018.
Net interest income was $604.3 million in 2019, a $66.7 million increase from $537.6 million in 2018.  Taxable equivalent net interest income was $617.2 million in 2019, a 12% increase from $549.0 million in 2018.  Average earning assets increased by $1.884 billion in 2019 and the yield on average earning assets increased 13 basis points from 4.15% in 2018 to 4.28% in 2019.
The provision for loan losses was an expense of $4.7 million in 2019, compared to an expense of $7.0 million in 2018. Charge-offs remained low during 2019 and we continued to see positive trends in credit quality.
Noninterest income increased $4.0 million in 2019 compared to 2018 primarily due to higher mortgage banking revenue, higher capital markets income, and higher noninterest income attributable to the full year impact of the Klein partnership as compared to 2018, which only reflected two months of Klein operations. These increases were partially offset by a $14.0 million gain on the sale of ten Wisconsin banking centers in the fourth quarter of 2018.
Noninterest expense decreased $8.8 million in 2019 compared to 2018 reflecting a decrease in amortization of tax credit investments and lower charitable contributions. These decreases were partially offset by higher professional fees, higher salaries and employee benefits, and higher operating expenses and acquisition and integration costs associated with the full year impact of the Klein partnership.
The provision for income taxes was $52.2 million in 2019 compared to $17.9 million in 2018.  Old National’s effective tax rate was 18.0% in 2019 compared to 8.6% in 2018.  The higher effective tax rate in 2019 compared to 2018 was primarily the result of a decrease in federal tax credits available as well as an increase in pre-tax book income.
FINANCIAL CONDITION
Overview
At December 31, 2020, our assets were $22.961 billion, a 12% increase compared to $20.412 billion at December 31, 2019.  The increase was primarily due to higher commercial loans driven by strong PPP loan production in the second quarter of 2020. As of December 31, 2020, PPP loans totaled $943.0 million. The increase in assets also reflected higher commercial real estate loans and investment securities.
We have observed signs of an economic recovery in the United States with jobs, consumer spending, manufacturing, and other indicators rebounding from their weakest levels. Additionally, progress toward an effective COVID-19 vaccine has been promising and the availability of that vaccine may drive the re-opening plans of state and local economies in 2021. However, economic uncertainty remains high and bouts of elevated volatility are expected to continue.
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 $20.313 billion at December 31, 2020, an increase of $2.551 billion compared to earning assets of $17.762 billion at December 31, 2019.
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.
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Equity securities are recorded at fair value and totaled $2.5 million at December 31, 2020 compared to $6.8 million at December 31, 2019.
At December 31, 2020, the investment securities portfolio, including equity securities, was $6.142 billion compared to $5.556 billion at December 31, 2019, an increase of $586.1 million, or 11%.  Investment securities represented 30% of earning assets at December 31, 2020, compared to 31% at December 31, 2019.  Stronger commercial loan demand in the future could result in management’s decision to reduce the securities portfolio.  As of December 31, 2020, 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 prior to their anticipated recovery.
The investment securities available-for-sale portfolio had net unrealized gains of $186.3 million at December 31, 2020, compared to net unrealized gains of $71.9 million at December 31, 2019.  Net unrealized gains (losses) increased from December 31, 2019 to December 31, 2020 reflecting higher net unrealized gains on mortgage-backed and tax exempt municipal securities due to a decline in long-term interest rates.
The investment portfolio had an effective duration of 4.08 at December 31, 2020, compared to 3.86 at December 31, 2019.  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 investment securities, on a taxable equivalent basis, were 2.52% in 2020 and 2.89% in 2019.
At December 31, 2020, Old National had a concentration of investment securities issued by certain states and their political subdivisions with the following aggregate market values: $515.6 million issued by Indiana, which represented 17.3% of shareholders’ equity, and $194.3 million issued 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, Minnesota, and Wisconsin.
The following table presents the composition of the loan portfolio at December 31.
(dollars in thousands)20202019201820172016Four-Year
Growth Rate
Commercial$3,956,422 $2,890,296 $3,232,970 $2,717,269 $1,917,099 19.9 %
Commercial real estate5,946,512 5,166,792 4,958,851 4,354,552 3,130,853 17.4 
Consumer1,635,123 1,726,147 1,803,667 1,879,247 1,875,030 (3.4)
Total loans excluding residential
   real estate
11,538,057 9,783,235 9,995,488 8,951,068 6,922,982 13.6 
Residential real estate2,248,422 2,334,289 2,248,404 2,167,053 2,087,530 1.9 
Total loans13,786,479 12,117,524 12,243,892 11,118,121 9,010,512 11.2 %
Less: Allowance for loan losses (1)131,388 54,619 55,461 50,381 49,808 
Net loans$13,655,091 $12,062,905 $12,188,431 $11,067,740 $8,960,704 
(1)Beginning January 1, 2020, calculation is based on current expected loss methodology. Prior to January 1, 2020, calculation was based on incurred loss model.
Commercial and Commercial Real Estate Loans
Commercial and commercial real estate loans are the largest classification within earning assets, representing 49% at December 31, 2020, compared to 45% at December 31, 2019. At December 31, 2020, commercial and commercial real estate loans were $9.903 billion, an increase of $1.846 billion, or 23%, compared to December 31, 2019. The increase was driven by strong PPP loan production in the second quarter of 2020. As of December 31, 2020, PPP loans totaled $943.0 million.
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The following table presents the maturity distribution and rate sensitivity of commercial and commercial real estate loans at December 31, 2020 and an analysis of these loans that have predetermined and floating interest rates.
(dollars in thousands)Within
1 Year
1 - 5
Years
Beyond
5 Years
Total% of
Total
Commercial
Interest rates:
Predetermined$261,417 $1,718,319 $668,196 $2,647,932 67 %
Floating492,427 426,817 389,246 1,308,490 33 
Total$753,844 $2,145,136 $1,057,442 $3,956,422 100 %
Commercial Real Estate
Interest rates:
Predetermined$178,478 $1,507,302 $900,370 $2,586,150 43 %
Floating378,941 1,501,491 1,479,930 3,360,362 57 
Total$557,419 $3,008,793 $2,380,300 $5,946,512 100 %
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The following table provides detail on commercial loans by industry classification (as defined by the North American Industry Classification System) and by loan size at December 31.
20202019
(dollars in thousands)OutstandingExposureNonaccrualOutstandingExposureNonaccrual
By Industry:
Manufacturing$586,074 $1,019,149 $11,036 $470,922 $745,638 $13,384 
Construction462,140 903,604 1,036 211,007 551,100 2,548 
Health care and social assistance412,807 604,493 691 171,682 307,013 872 
Public administration299,748 371,846  245,849 308,993 — 
Wholesale trade241,432 483,253 3,647 194,119 393,282 1,440 
Educational services245,896 418,277 1,428 204,334 279,629 1,451 
Other services194,822 307,205 2,363 166,254 213,147 2,989 
Professional, scientific, and
technical services
182,228 320,983 864 81,227 170,503 3,548 
Finance and insurance186,079 246,551 57 154,299 198,706 4,022 
Retail trade151,869 329,160 1,788 130,018 274,626 2,646 
Real estate rental and leasing169,935 356,169 759 197,487 297,158 48 
Transportation and warehousing139,398 216,495 1,397 134,727 188,949 2,076 
Administrative and support and
waste management and
remediation services
119,220 173,538 383 84,517 128,598 724 
Agriculture, forestry, fishing,
and hunting
145,624 192,602 358 152,201 209,886 1,040 
Accommodation and food services105,560 118,497 3,239 39,911 50,241 676 
Utilities88,607 98,996  83,793 94,826 18 
Arts, entertainment, and recreation82,305 111,729 2,590 45,469 55,407 715 
Information61,883 95,774 2,286 48,472 71,802 839 
Mining57,142 77,067 19 48,972 60,260 — 
Management of companies and
enterprises
13,605 28,276  4,407 9,668 — 
Other10,048 10,086  20,629 20,697 — 
Total$3,956,422 $6,483,750 $33,941 $2,890,296 $4,630,129 $39,036 
By Loan Size:
Less than $200,00011 %8 %10 %%%10 %
$200,000 to $1,000,00020 18 40 23 23 42 
$1,000,000 to $5,000,00034 32 50 34 34 48 
$5,000,000 to $10,000,00015 15  15 15 — 
$10,000,000 to $25,000,00014 16  14 13 — 
Greater than $25,000,0006 11  — 
Total100 %100 %100 %100 %100 %100 %

Residential Real Estate Loans
Residential real estate loans held in our portfolio, primarily 1-4 family properties, decreased $85.9 million at December 31, 2020 compared to December 31, 2019.  Future increases in interest rates could result in a decline in the level of refinancings and new originations of residential real estate loans.
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Consumer Loans
Consumer loans, including automobile loans and personal and home equity loans and lines of credit, decreased $91.0 million, at December 31, 2020 compared to December 31, 2019 primarily due to decreases in consumer direct and indirect loans.
Allowance for Credit Losses on Loans and Unfunded Commitments
Beginning January 1, 2020, we calculated allowance for credit losses using current expected credit losses methodology. As of January 1, 2020, Old National increased the allowance for credit losses for loans by $41.3 million and increased the allowance for credit losses for unfunded loan commitments by $4.5 million, since the ASU covers credit losses over the expected life of a loan as well as considering future changes in macroeconomic conditions. The increase related to the acquired loan portfolio totaled $27.1 million.
At December 31, 2020, the allowance for credit losses was $131.4 million.  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.  Additionally, with the adoption of CECL beginning on January 1, 2020, provision expense may become more volatile due to changes in CECL model assumptions of credit quality, macroeconomic factors and conditions, and loan composition, which drive the allowance for credit losses balance.
Prior to January 1, 2020, we calculated allowance for loan losses using incurred losses methodology. At December 31, 2019, the allowance for loan losses was $54.6 million.
We maintain an allowance for credit 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 credit losses for loans, modified to take into account the probability of a drawdown on the commitment.  The allowance for credit losses on unfunded loan commitments is classified as a liability account on the balance sheet within accrued expenses and other liabilities, while the corresponding provision for these credit losses is recorded as a component of other expense.  The allowance for credit losses on unfunded commitments was $11.7 million at December 31, 2020.
Prior to January 1, 2020, we calculated allowance for losses on unfunded loan commitments using incurred losses methodology. At December 31, 2019, the allowance for unfunded commitments was $2.7 million.
Additional information about our Allowance for Credit 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 3 to the consolidated financial statements.
Loans Held for Sale
Mortgage loans held for immediate sale in the secondary market were $63.3 million at December 31, 2020, compared to $46.9 million at December 31, 2019.  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 prospectively for residential loans held for sale.  The aggregate fair value exceeded the unpaid principal balance by $3.5 million at December 31, 2020 and $1.5 million at December 31, 2019.
Other Assets
Other assets increased $93.5 million since December 31, 2019 primarily due to an increase in derivative assets.
Funding
Total funding, comprised of deposits and wholesale borrowings, was $19.714 billion at December 31, 2020, an increase of $2.416 billion from $17.298 billion at December 31, 2019.  Total deposits were $17.037 billion, an increase of $2.484 billion compared to December 31, 2019.  Noninterest-bearing demand deposits increased
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$1.591 billion from December 31, 2019 to December 31, 2020.  Interest-bearing checking and NOW deposits increased $727.4 million from December 31, 2019 to December 31, 2020, while savings deposits increased $550.3 million. Money market deposits increased $74.3 million from December 31, 2019 to December 31, 2020. Other time deposits decreased $486.7 million, while brokered deposits increased $27.3 million.
We use wholesale funding to augment deposit funding and to help maintain our desired interest rate risk position.  At December 31, 2020, wholesale borrowings, including federal funds purchased and interbank borrowings, securities sold under agreements to repurchase, FHLB advances, and other borrowings, totaled $2.677 billion, a decrease of $68.2 million from December 31, 2019.  The decrease in wholesale funding from December 31, 2019 to December 31, 2020 was due to a decrease in federal funds purchased and interbank borrowings, partially offset by increases in FHLB advances, securities sold under agreements to repurchase, and other borrowings.  Wholesale funding as a percentage of total funding was 14% at December 31, 2020, compared to 16% at December 31, 2019.  See Notes 11, 12, and 13 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)20202019201820202019
Demand deposits$4,945,506 $3,887,470 $3,657,234 27.2 %6.3 %
Interest-bearing checking and NOW deposits4,464,027 3,902,765 3,146,309 14.4 24.0 
Savings deposits3,113,435 2,878,135 2,995,484 8.2 (3.9)
Money market deposits1,866,196 1,789,065 1,225,220 4.3 46.0 
Other time deposits1,337,269 1,748,552 1,654,548 (23.5)5.7 
Brokered deposits85,041 173,439 185,426 (51.0)(6.5)
Total deposits15,811,474 14,379,426 12,864,221 10.0 11.8 
Federal funds purchased and interbank borrowings138,257 241,618 238,408 (42.8)1.3 
Securities sold under agreements to repurchase375,961 342,654 344,964 9.7 (0.7)
Federal Home Loan Bank advances2,055,155 1,775,987 1,665,689 15.7 6.6 
Other borrowings242,642 251,194 249,832 (3.4)0.5 
Total funding sources$18,623,489 $16,990,879 $15,363,114 9.6 %10.6 %
The following table presents a maturity distribution for certificates of deposit with denominations of $100,000 or more at December 31.
Maturity Distribution
(dollars in thousands)Year-End
Balance
1-90
Days
91-180
Days
181-365
Days
Beyond
1 Year
2020$575,055 $212,671 $129,273 $146,453 $86,658 
2019983,598 445,434 214,412 209,075 114,677 
20181,133,130 397,990 265,232 280,402 189,506 
Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities increased $25.8 million, or 16%, from December 31, 2019 primarily due to increases in accrued incentive payments, allowance for credit losses on unfunded commitments, and derivative liabilities.
Capital
Shareholders’ equity totaled $2.973 billion, or 13% of total assets, at December 31, 2020 and $2.852 billion, or 14% of total assets, at December 31, 2019.  Old National repurchased 4.9 million shares of Common Stock in 2020 under a stock repurchase plan that was approved by the Company’s Board of Directors, which reduced equity by $78.7 million, and 0.2 million shares of Common Stock associated with employee share-based incentive programs reducing equity by $3.6 million.  We suspended the stock repurchase plan approved by the Company's Board of Directors in 2020 given the uncertain economic conditions. We also paid cash dividends of $0.56 per share in 2020,
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which reduced equity by $92.9 million. The change in unrealized gains (losses) on available-for-sale investment securities increased equity by $89.2 million during 2020.  Old National’s Common Stock is traded on the NASDAQ under the symbol “ONB” with 34,880 shareholders of record at December 31, 2020.
Capital Adequacy
Old National and the banking industry generally 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 23 to the consolidated financial statements.
Management views stress testing as an integral part of the Company’s risk management and strategic planning activities. The primary objective of the stress test is to ensure that Old National has a robust, forward-looking stress testing process and maintains sufficient capital to continue operations throughout times of economic and financial stress. Management also uses the stress testing framework to evaluate decisions relating to pricing, loan concentrations, capital deployment, and mergers and acquisitions to ensure that strategic decisions align with Old National’s risk appetite statement. Old National’s stress testing process incorporates key risks that include strategic, market, liquidity, credit, operational, regulatory, compliance, legal, and reputational risks. Old National’s stress testing policy outlines steps that will be taken if stress test results do not meet internal thresholds under severely adverse economic scenarios.
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.
During the COVID-19 pandemic, we are committed and focused on the health and safety of our team members, clients, and communities. We will continue to evaluate and adjust our banking center hours, lobby usage, and return to work efforts as necessary depending on the path of the virus across our footprint. We are occupying only 50% of our office buildings by rotating team members every 4 weeks. Our banking centers are still open for business and we continue to lend to qualified businesses for working capital and general business purposes, while our online banking network is continuously available for digital banking transactions.
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, 2020, we had pooled trust preferred securities with a fair value of $7.9 million, or less than 1% of the available-for-sale securities portfolio.  These securities remained classified as available-for-sale and the unrealized loss on our pooled trust preferred securities was $5.9 million at December 31, 2020.  The fair value of these securities should improve as we get closer to maturity, but not in all cases.
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 2 to the consolidated financial statements for additional details about our investment security portfolio.
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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 $425.1 million at December 31, 2020.
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 is 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, Minnesota, and Wisconsin.  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, 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 indexed rates such as prime.  We do not offer payment-option facilities, sub-prime loans, or any product with negative amortization.

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Home equity loans are secured primarily by second mortgages on residential property of the borrower.  The underwriting terms for the home equity product generally permit 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 the primary consideration, the underwriting process also includes a comparison of the value of the collateral security to the proposed loan amount.

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 independent 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 our policy 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, 2020, our average commercial loan size (excluding PPP loans) was under $355,000 and our average commercial real estate loan size was under $820,000.  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, 2020, 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, Minnesota, and Wisconsin.  We have experienced an impact from COVID-19 during 2020; however, the depth of this crisis is ongoing and its effect is anticipated to be very broad-based. Management believes that trends in under-performing, criticized, and classified loans will be highly dependent on both the ability to roll out vaccinations in an efficient and timely manner, as well as the length of time it will take consumers to return to their pre-pandemic spending routines.
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The following table presents a summary of under-performing, criticized, and classified assets at December 31:
(dollars in thousands)20202019201820172016
Total nonaccrual loans$147,339 $126,412 $157,484 $124,927 $131,407 
TDRs still accruing17,749 18,338 17,356 19,589 14,376 
Total past due loans (90 days or more and still
accruing)
167 570 1,353 894 328 
Other real estate owned1,324 2,169 3,232 8,810 18,546 
Total under-performing assets$166,579 $147,489 $179,425 $154,220 $164,657 
Classified loans (includes nonaccrual, TDRs
still accruing, past due 90 days, and other
   problem loans)
$304,782 $296,671 $334,785 $226,583 $220,429 
Other classified assets (1)3,706 2,933 2,820 4,556 7,063 
Criticized loans287,192 234,841 238,752 188,085 95,462 
Total criticized and classified assets$595,680 $534,445 $576,357 $419,224 $322,954 
Asset Quality Ratios:
Non-performing loans/total loans (2) (3)1.20 %1.19 %1.43 %1.30 %1.62 %
Under-performing assets/total loans and
   other real estate owned (2) (4)
1.21 1.22 1.47 1.39 1.82 
Under-performing assets/total assets0.73 0.72 0.91 0.88 1.11 
Allowance/under-performing assets (4) (5)78.87 37.03 30.91 32.67 30.25 
Allowance/nonaccrual loans (5)89.17 43.21 35.22 40.33 37.90 
(1)Includes one pooled trust preferred security and two insurance policies at December 31, 2020.
(2)Loans exclude loans held for sale.
(3)Non-performing loans include nonaccrual loans and TDRs still accruing.
(4)Includes acquired loans that were recorded at fair value at the date of acquisition. As such, the credit risk was incorporated in the fair value recorded and no allowance for loan losses was recorded prior to 2020.
(5)Beginning January 1, 2020, the allowance is based on current expected loss methodology. Prior to January 1, 2020, the allowance was based on incurred loss methodology.
Under-performing assets totaled $166.6 million at December 31, 2020, compared to $147.5 million at December 31, 2019.  Under-performing assets as a percentage of total loans and other real estate owned at December 31, 2020 were 1.21%, a 1 basis point improvement from 1.22% at December 31, 2019.
Nonaccrual loans increased $20.9 million from December 31, 2019 to December 31, 2020 primarily due to an increase in commercial real estate nonaccrual loans. As a percentage of nonaccrual loans, the allowance was 89.17% at December 31, 2020, compared to 43.21% at December 31, 2019.  Beginning January 1, 2020, the allowance is based on current expected loss methodology. Prior to January 1, 2020, the allowance was based on current expected loss methodology.
If nonaccrual and renegotiated loans outstanding at December 31, 2020 and 2019, respectively, had been accruing interest throughout the year in accordance with their original terms, interest income of approximately $5.8 million in 2020 and $4.4 million in 2019 would have been recorded on these loans. The amount of interest income actually recorded on nonaccrual and renegotiated loans was $2.9 million in 2020 and $2.8 million in 2019.
Total criticized and classified assets were $595.7 million at December 31, 2020, an increase of $61.2 million from December 31, 2019.  Other classified assets include investment securities that fell below investment grade rating totaling $3.7 million at December 31, 2020, compared to $2.9 million at December 31, 2019.
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.
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Loans modified in a TDR are typically placed on nonaccrual status until we determine that 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 credit losses for the difference between the carrying value of the loan and its computed value.  To determine the computed 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, 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, 2020, TDRs consisted of $11.1 million of commercial loans, $17.6 million of commercial real estate loans, $0.1 million of BBCC loans, $2.8 million of residential real estate loans, $0.8 million of direct consumer loans, and $0.3 million of home equity loans, totaling $32.7 million.  TDRs included within nonaccrual loans totaled $14.9 million at December 31, 2020.  At December 31, 2019, our TDRs consisted of $12.4 million of commercial loans, $14.2 million of commercial real estate loans, $0.6 million of BBCC loans, $3.1 million of residential real estate loans, $1.0 million of direct consumer loans, and $0.4 million of home equity loans, totaling $31.7 million.  TDRs included within nonaccrual loans totaled $13.8 million at December 31, 2019.
Old National has allocated specific reserves to customers whose loan terms have been modified in TDRs totaling $1.6 million at December 31, 2020 and $0.9 million at December 31, 2019.  At December 31, 2020, Old National had not committed to lend any additional funds to customers with outstanding loans that are classified as TDRs, compared to $2.3 million at December 31, 2019.
The terms of certain other loans were modified during 2020 and 2019 that did not meet the definition of a TDR.  It is our process to review all classified and criticized loans that, during the period, have been renewed, have entered into a forbearance agreement, have gone from principal and interest to interest only, or have extended the maturity date.  In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on its debt in the foreseeable future without the modification.  The evaluation is performed under our internal underwriting policy.  We also evaluate whether a concession has been granted or if we were adequately compensated through a market interest rate, additional collateral, or a bona fide guarantee.  We also consider whether the modification was insignificant relative to the other terms of the agreement or the delay in a payment.
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.
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We have developed relief programs to assist borrowers in financial need due to the effects of the COVID-19 pandemic. The Interagency Statement issued by our banking regulators encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19. Additionally, Section 4013 of the CARES Act further provides that a qualified loan modification is exempt by law from classification as a TDR as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak declared by the President of the United States under the National Emergencies Act terminates. Section 541 of the CAA extends this relief to the earlier of January 1, 2022 or 60 days after the national emergency termination date. The Interagency Statement was subsequently revised in April 2020 to clarify the interaction of the original guidance with Section 4013 of the CARES Act, as well as setting forth the banking regulators’ views on consumer protection considerations. In accordance with such guidance, we are offering short-term modifications made in response to COVID-19 to borrowers who are current and otherwise not past due. These include short-term (180 days or less) modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. The table below presents these loan deferrals by loan category:
(dollars in thousands)June 30, 2020
Deferrals
Balance
September 30, 2020
Deferrals
Balance
December 31, 2020
Deferrals
Balance (1)
December 31, 2020 Number of Deferrals
Commercial and commercial real estate$1,170,119 $125,603 $53,823 101 
Residential real estate78,639 1,654 1,855 6 
Consumer54,786 10,315 8,224 348 
Total$1,303,544 $137,572 $63,902 455 
(1)    Includes second deferrals between 90 and 180 days totaling $6.3 million of commercial and commercial real estate loans and $0.6 million of consumer loans.
U.S. Small Business Administration Paycheck Protection Program
Section 1102 of the CARES Act created the PPP, a program administered by the SBA to provide loans to small businesses for payroll and other basic expenses during the COVID-19 pandemic. Old National has participated in the PPP as a lender. These loans are eligible to be forgiven if certain conditions are satisfied and are fully guaranteed by the SBA. Additionally, loan payments will also be deferred for the first six months of the loan term. The PPP commenced on April 3, 2020 and was available to qualified borrowers through August 8, 2020. No collateral or personal guarantees are required. Neither the government nor lenders are permitted to charge the recipients any fees.
On December 27, 2020, President Trump signed into law the CAA. The CAA, among other things, extends the life of the PPP, effectively creating a second round of PPP loans for eligible businesses. Old National is participating in the CAA’s second round of PPP lending. In mid-January we opened our lending portal and have begun processing PPP loan applications. Early indications support our belief that there will be a large volume of smaller sized loans. We anticipate the average loan size to be less than $150,000. Currently, we are focused on helping minority-owned business, women-owned business, not-for-profit entities, and existing first round PPP customers with the lending process. Additionally, section 541 of the CAA extends the relief provided by the CARES Act for financial institutions to suspend the GAAP accounting treatment for troubled debt restructuring to January 1, 2022. As of January 31, 2021, we had received 2,740 applications under the CAA round of PPP lending, representing $348.0 million in funding.

As of December 31, 2020, Old National had originated over 9,700 loans with balances in excess of $1.5 billion to new and existing customers through the PPP. To the extent the PPP loans are forgiven, this represents outside funds to our borrowers; and, especially with respect to vulnerable industries, we believe these capital injections are going to be instrumental in assisting our borrowers in navigating through the pandemic. This capital injection, along with the level of capital each borrower had just prior to COVID-19 impacting them, are critical factors in determining the staying power of our borrowers. Upon receipt of interim financial results from our borrowers, we will use that information to update our understanding of the underlying strengths or weaknesses in each individual relationship and take actions, as appropriate. As of January 31, 2021, we have received payment from the SBA on 5,689 of our loans totaling $702.6 million.
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Allowance for Credit Losses on Loans and Unfunded Commitments
Beginning January 1, 2020, we calculated allowance for credit losses using current expected credit losses methodology. As of January 1, 2020, Old National increased the allowance for credit losses for loans by $41.3 million and increased the allowance for credit losses for unfunded loan commitments by $4.5 million, since the ASU covers credit losses over the expected life of a loan as well as considering future changes in macroeconomic conditions. The increase related to the acquired loan portfolio totaled $27.1 million.
Credit quality within the loans held for investment portfolio is continuously monitored by management and is reflected within the allowance for credit losses for loans. The allowance for credit losses is an estimate of expected losses inherent within the Company’s loans held for investment portfolio. Credit quality is assessed and monitored by evaluating various attributes and the results of those evaluations are utilized in underwriting new loans and in our process for estimating expected credit losses. Expected credit loss inherent in non-cancelable off-balance-sheet credit exposures is accounted for as a separate liability included in other liabilities on the balance sheet. The allowance for credit losses for loans held for investment is adjusted by a credit loss expense, which is reported in earnings, and reduced by the charge-off of loan amounts, net of recoveries. Accrued interest receivable is excluded from the estimate of credit losses.
The allowance for credit loss estimation process involves procedures to appropriately consider the unique characteristics of our loan portfolio segments. These segments are further disaggregated into loan classes based on the level at which credit risk of the loan is monitored. When computing the level of expected credit losses, credit loss assumptions are estimated using a model that categorizes loan pools based on loss history, delinquency status, and other credit trends and risk characteristics, including current conditions and reasonable and supportable forecasts about the future. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. In future periods, evaluations of the overall loan portfolio, in light of the factors and forecasts then prevailing, may result in significant changes in the allowance and credit loss expense in those future periods.
The allowance level is influenced by loan volumes, loan AQR migration or delinquency status, changes in historical loss experience, and other conditions influencing loss expectations, such as reasonable and supportable forecasts of economic conditions. The methodology for estimating the amount of expected credit losses reported in the allowance for credit losses has two basic components: first, an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans; and second, a pooled component for estimated expected credit losses for pools of loans that share similar risk characteristics.
The loan categories used to monitor and analyze interest income and yields are different than the portfolio segments used to determine the allowance for credit losses for loans. The allowance for credit losses was calculated by pooling loans of similar credit risk characteristics and credit monitoring procedures. The four loan portfolios are classified into seven segments of loans - commercial, commercial real estate, BBCC, residential real estate, indirect, direct, and home equity. The commercial and commercial real estate loan categories shown on the balance sheet include the same pool of loans as the commercial, commercial real estate, and BBCC portfolio segments. The consumer loan category shown on the balance sheet is comprised of the same loans in the indirect, direct, and home equity portfolio segments. The composition of loans by portfolio segment as of December 31, 2020 follows:
December 31, 2020SegmentDecember 31, 2020
StatementPortfolioAfter
(dollars in thousands)BalanceReclassificationsReclassifications
Loans:
Commercial$3,956,422 $(198,722)$3,757,700 
Commercial real estate5,946,512 (171,701)5,774,811 
BBCCN/A370,423 370,423 
Residential real estate2,248,422 — 2,248,422 
Consumer1,635,123 (1,635,123)N/A
IndirectN/A913,902 913,902 
DirectN/A164,807 164,807 
Home equityN/A556,414 556,414 
Total$13,786,479 $— $13,786,479 
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The activity in our allowance for credit losses for loans was as follows:
(dollars in thousands)2020
Balance at beginning of period$54,619 
Impact of adopting ASC 32641,347 
Loans charged-off:
Commercial5,593 
Commercial real estate4,323 
BBCC95 
Residential real estate824 
Indirect2,754 
Direct1,763 
Home equity201 
Total charge-offs15,553 
Recoveries on charged-off loans:
Commercial3,629 
Commercial real estate4,515 
BBCC140 
Residential real estate633 
Indirect1,922 
Direct819 
Home equity922 
Total recoveries12,580 
Net charge-offs (recoveries)2,973 
Provision for credit losses38,395 
Balance at end of period$131,388 
Average loans for the year (1)$13,341,677 
Asset Quality Ratios:
Allowance/year-end loans (1)0.95 %
Allowance/average loans (1)0.98 
Net charge-offs (recoveries)/average loans0.02 
(1)Loans exclude loans held for sale.
At December 31, 2020, the allowance for credit losses was $131.4 million.  There were no industry segments representing a significant share of total net charge-offs.  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.  Additionally, with the adoption of CECL beginning on January 1, 2020, provision expense may become more volatile due to changes in CECL model assumptions of credit quality, macroeconomic factors and conditions, and loan composition, which drive the allowance for credit losses balance.
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Prior to January 1, 2020, we calculated allowance for loan losses using incurred losses methodology. The activity in our allowance for loan losses was as follows:
(dollars in thousands)2019201820172016
Balance at beginning of period$55,461 $50,381 $49,808 $52,233 
Loans charged-off:
Commercial3,819 3,087 1,108 5,047 
Commercial real estate2,846 879 3,700 2,632 
Residential real estate661 1,100 985 800 
Consumer credit7,463 7,903 6,924 6,131 
Total charge-offs14,789 12,969 12,717 14,610 
Recoveries on charged-off loans:
Commercial1,650 1,519 2,281 3,102 
Commercial real estate3,774 2,740 3,777 4,763 
Residential real estate146 2,118 255 174 
Consumer credit3,630 4,706 3,927 3,186 
Total recoveries9,200 11,083 10,240 11,225 
Net charge-offs (recoveries)5,589 1,886 2,477 3,385 
Provision for loan losses4,747 6,966 3,050 960 
Balance at end of period$54,619 $55,461 $50,381 $49,808 
Average loans for the year (1)$12,087,429 $11,422,967 $9,525,888 $8,265,169 
Asset Quality Ratios:
Allowance/year-end loans (1)0.45 %0.45 %0.45 %0.55 %
Allowance/average loans (1)0.45 0.49 0.53 0.60 
Net charge-offs (recoveries)/average loans0.05 0.02 0.03 0.04 
(1)Loans exclude loans held for sale.
We maintain an allowance for credit 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 credit losses for loans, modified to take into account the probability of a drawdown on the commitment.  The allowance for credit losses on unfunded loan commitments is classified as a liability account on the balance sheet within accrued expenses and other liabilities, while the corresponding provision for these credit losses is recorded as a component of other expense.  The allowance for credit losses on unfunded commitments was $11.7 million at December 31, 2020.
Prior to January 1, 2020, we calculated allowance for losses on unfunded loan commitments using incurred losses methodology. At December 31, 2019, the allowance for unfunded commitments was $2.7 million.
The following table details the allowance for credit losses for loans by loan category and the percent of loans in each category compared to total loans at December 31, 2020.
2020
(dollars in thousands)Allowance
Amount
% of
Loans
to Total
Loans
Commercial$30,567 27.3 %
Commercial real estate75,810 41.9 
BBCC6,120 2.7 
Residential real estate12,608 16.3 
Indirect3,580 6.6 
Direct855 1.2 
Home equity1,848 4.0 
Total$131,388 100.0 %
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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.
2019201820172016
(dollars in thousands)Allowance
Amount
% of
Loans
to Total
Loans
Allowance
Amount
% of
Loans
to Total
Loans
Allowance
Amount
% of
Loans
to Total
Loans
Allowance
Amount
% of
Loans
to Total
Loans
Commercial$22,585 23.9 %$21,742 26.4 %$19,246 24.4 %$21,481 21.3 %
Commercial real estate21,588 42.6 23,470 40.5 21,436 39.2 18,173 34.7 
Residential real estate2,299 19.3 2,277 18.4 1,763 19.5 1,643 23.2 
Consumer credit8,147 14.2 7,972 14.7 7,936 16.9 8,511 20.8 
Total$54,619 100.0 %$55,461 100.0 %$50,381 100.0 %$49,808 100.0 %
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 our 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 likely impact of changing interest rates on Old National’s results of operations. 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. Interest rates are floored at 0.00% in the down 50 basis points scenario. 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, 2020 and 2019:
Immediate
Rate Decrease
Immediate Rate Increase
(dollars in thousands)-50
Basis Points
Base+100
Basis Points
+200
Basis Points
+300
Basis Points
December 31, 2020
Projected interest income:
Money market, other interest earning
   investments, and investment securities
$262,254 $276,027 $304,939 $325,867 $343,376 
Loans856,007 886,057 1,018,491 1,152,321 1,283,582 
Total interest income1,118,261 1,162,084 1,323,430 1,478,188 1,626,958 
Projected interest expense:
Deposits17,574 26,598 106,018 185,434 264,847 
Borrowings63,262 67,864 103,057 137,662 173,915 
Total interest expense80,836 94,462 209,075 323,096 438,762 
Net interest income$1,037,425 $1,067,622 $1,114,355 $1,155,092 $1,188,196 
Change from base$(30,197)$46,733 $87,470 $120,574 
% change from base(2.83)%4.38 %8.19 %11.29 %
December 31, 2019
Projected interest income:
Money market, other interest earning
   investments, and investment securities
$311,737 $327,770 $348,556 $361,001 $373,190 
Loans966,207 1,023,627 1,142,583 1,259,598 1,373,727 
Total interest income1,277,944 1,351,397 1,491,139 1,620,599 1,746,917 
Projected interest expense:
Deposits82,128 120,402 217,131 313,848 410,565 
Borrowings100,057 111,917 140,046 169,277 198,800 
Total interest expense182,185 232,319 357,177 483,125 609,365 
Net interest income$1,095,759 $1,119,078 $1,133,962 $1,137,474 $1,137,552 
Change from base$(23,319)$14,884 $18,396 $18,474 
% change from base(2.08)%1.33 %1.64 %1.65 %
Our asset sensitivity increased year over year primarily due to deposit pricing actions and changes in our hedging strategies, 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. 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, ramps, yield curve flattening, yield curve steepening, as well as forecasts of likely interest rate scenarios tested.  At December 31, 2020, 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 cash flow and fair value hedges, primarily interest rate swaps, collars, and floors, to mitigate interest rate risk. Derivatives designated as hedging instruments were in a net asset position with a fair value of $15.2 million at December 31, 2020, compared to a net asset position with a fair value of $6.1 million at December 31, 2019.  See Note 19 to the consolidated financial statements for further discussion of derivative financial instruments.
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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. On June 5, 2020, we filed an automatic shelf registration statement with the SEC that permits us to issue an unspecified amount of debt or equity securities.
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.
At December 31, 2020, brokered deposits consist of $100.0 million of demand deposits and $19.6 million of time deposits. A maturity schedule for Old National Bank’s total time deposits is shown in the following table at December 31, 2020.
(dollars in thousands)
Maturity BucketAmountRate
2021$825,822 0.54 %
2022139,466 0.83 
202382,288 1.24 
202437,280 1.61 
202530,947 0.72 
2026 and beyond7,067 1.50 
Total$1,122,870 0.68 %
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” for Old National’s senior unsecured/issuer rating on February 3, 2020.
Moody’s Investor Service affirmed Old National Bank’s long-term deposit rating of “Aa3” on February 3, 2020.  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 stable.  Moody’s Investor Service concluded a rating review of Old National Bank on February 3, 2020.
The credit ratings of Old National and Old National Bank at December 31, 2020 are shown in the following table.
Moody's Investor Service
Long-termShort-term
Old NationalA3N/A
Old National BankAa3P-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, 2020, Old National and its subsidiaries had the following availability of liquid funds and borrowings:
(dollars in thousands)Parent
Company
Subsidiaries
Available liquid funds:
Cash and due from banks$78,304 $511,408 
Unencumbered government-issued debt securities— 2,486,674 
Unencumbered investment grade municipal securities— 881,735 
Unencumbered corporate securities— 160,143 
Availability of borrowings:
Amount available from Federal Reserve discount window*— 462,435 
Amount available from Federal Home Loan Bank Indianapolis*— 401,286 
Total available funds$78,304 $4,903,681 
*  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, 2020, Old National Bancorp’s other borrowings outstanding were $213.2 million. Management believes the Company has the ability to generate and obtain adequate amounts of liquidity to meet its requirements in the short-term and the long-term.
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 2019 or 2020 and is not currently required. At December 31, 2020, Old National Bank could pay dividends of $212.1 million without prior regulatory approval.
Operational/Technology/Cyber Risk
Operational/technology/cyber risk is the danger that inadequate information systems, operational problems, breaches in internal controls, information security breaches, fraud, or unforeseen catastrophes will result in unexpected losses and other adverse impacts to Old National, such as reputational harm.  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 our management team 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 ongoing review of management reports, data on risks and policy limits, and consistent 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 that we will perform business in a manner compliant with applicable
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laws and/or regulations and expects issues to be identified, analyzed, and remediated in a timely and complete manner.
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 $3.720 billion and standby letters of credit totaled $86.9 million at December 31, 2020.  At December 31, 2020, approximately $3.463 billion of the loan commitments had fixed rates and $257.8 million had floating rates, with the floating interest rates ranging from 0% to 14%.  At December 31, 2019, loan commitments were $2.779 billion and standby letters of credit totaled $87.8 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 $54.3 million at December 31, 2020.
CONTRACTUAL OBLIGATIONS, COMMITMENTS, AND CONTINGENT LIABILITIES
The following table presents our significant fixed and determinable contractual obligations and significant commitments at December 31, 2020.  Further discussion of each obligation or commitment is included in the referenced note to the consolidated financial statements.
 
Payments Due In
(dollars in thousands)Note
Reference
One Year
or Less
One to
Three Years
Three to
Five Years
Over
Five Years
Total
Deposits without stated maturity$15,814,583 $ $ $ $15,814,583 
IRAs, consumer, and brokered
  certificates of deposit
10825,822 221,754 68,227 7,067 1,122,870 
Federal funds purchased and
  interbank borrowings
1,166    1,166 
Securities sold under agreements
  to repurchase
11431,166    431,166 
Federal Home Loan Bank advances1295,000 29,160 625,000 1,242,275 1,991,435 
Other borrowings131,025 2,205 177,368 72,189 252,787 
Fixed interest payments (1)35,103 67,931 54,941 60,375 218,350 
Operating leases614,245 22,775 16,482 50,462 103,964 
Other long-term liabilities (2)27,093 2,963 44 5 30,105 
(1)Our senior notes, subordinated notes, certain trust preferred securities, and certain FHLB advances have fixed rates ranging from 0.14% to 4.96%. All of our other long-term debt is at LIBOR based variable rates at December 31, 2020. The projected variable interest assumes no increase in LIBOR rates from December 31, 2020.
(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 6 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 19 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 20 to the consolidated financial statements.
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
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and timing of any cash payments cannot be reasonably estimated.  Further discussion of income taxes and liabilities is included in Note 15 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 such as goodwill, 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.  The carrying value of 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 financial statements as a whole and our banking subsidiary in which the goodwill resides.
Pandemic. A prolonged COVID-19 outbreak, or any other epidemic that harms the global economy, U.S. economy, or the economies in which we operate could adversely affect our operations. Based on the required annual impairment test as of August 31, 2020, we have concluded that our goodwill was not impaired. On a quarterly basis, we will continue to evaluate our qualitative assessment assumptions, which are subject to risks and uncertainties, including: (1) forecasted revenues, expenses, and cash flows; (2) current discount rates; (3) our market capitalization; (4) observable market transactions and multiples; (5) changes to the regulatory environment; and (6) the nature and amount of government support that has been and is expected to be provided in the future. A prolonged economic downturn or deterioration in the economic outlook may lead management to conclude that an interim quantitative impairment test of our goodwill is required prior to the annual impairment test conducted on August 31.
Allowance for Credit Losses for Loans
Description.  The allowance for credit losses for loans represents management’s estimate of all expected credit losses over the expected contractual life of our loan portfolio. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the then-existing loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for credit losses in those future periods.
The allowance for credit losses for loans, as reported in our consolidated statements of financial condition, is adjusted by an expense for credit losses, which is recognized in earnings, and reduced by the charge-off of loan amounts, net of recoveries.
Judgments and Uncertainties.  We utilize a discounted cashflow approach to determine the allowance for credit losses for performing loans and nonperforming loans. Expected cashflows are created for each loan and discounted using the effective yield. The discounted sum of expected cashflows is then compared to the
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amortized cost and any shortfall is recorded as reserve. Expected cashflows are created using a combination of contractual payment schedules, calculated PDs, LGD and prepayment assumptions as well as qualitative factors. For the commercial and commercial real estate loans, the PD is forecast using a regression model to determine the likelihood of a loan moving into nonaccrual within the time horizon. For residential and consumer loans, the PD is forecast using a regression model to determine the likelihood of a loan being charged-off within the time horizon. The regression models use combinations of variables to assess systematic and unsystematic risk. Variables used for unsystematic risk are borrower specific and help to gauge the risk of default from an individual borrower. Variables for systematic risk, risk inherent to all borrowers, come from the use of forward-looking economic forecasts and include variables such as unemployment rate, gross domestic product, and house price index. The LGD is defined as credit loss incurred when an obligor of the bank defaults. Qualitative factors include items such as changes in lending policies or procedures and economic uncertainty in forward-looking forecasts.
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.
The expense for credit loss recorded through earnings is the amount necessary to maintain the allowance for credit losses at the amount of expected credit losses inherent within the loans held for investment portfolio. The amount of expense and the corresponding level of allowance for credit losses for loans are based on our evaluation of the collectability of the loan portfolio based on historical loss experience, reasonable and supportable forecasts, and other significant qualitative and quantitative factors.
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, 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, 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 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 15 to the consolidated financial statements for a further description of our provision and related income tax assets and liabilities.
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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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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 
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REPORT OF MANAGEMENT
MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL REPORTING
Management is responsible for the preparation of the financial statements and related financial information appearing in this annual report on Form 10-K.  The financial statements and notes have been prepared in conformity with accounting principles generally accepted in the United States and include some amounts which are estimates based upon currently available information and management’s judgment of current conditions and circumstances.  Financial information throughout this annual report on Form 10-K is consistent with that in the financial statements.
Management maintains a system of internal accounting controls which is believed to provide, in all material respects, reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition, transactions are properly authorized and recorded, and the financial records are reliable for preparing financial statements and maintaining accountability for assets.  In addition, Old National has a Code of Business Conduct and Ethics, a Senior Financial and Executive Officer Code of Ethics and Corporate Governance Guidelines that outline high levels of ethical business standards.  Old National has also appointed a Chief Ethics Officer and had a third party perform an independent validation of our ethics program.  All systems of internal accounting controls are based on management’s judgment that the cost of controls should not exceed the benefits to be achieved and that no system can provide absolute assurance that control objectives are achieved.  Management believes Old National’s system provides the appropriate balance between cost of controls and the related benefits.
In order to monitor compliance with this system of controls, Old National maintains an extensive internal audit program.  Internal audit reports are issued to appropriate officers and significant audit exceptions, if any, are reviewed with management and the Audit Committee.
The Board of Directors, through an Audit Committee comprised solely of independent outside directors, oversees management’s discharge of its financial reporting responsibilities.  The Audit Committee meets regularly with Old National’s independent registered public accounting firm, Crowe LLP, and the managers of financial reporting, internal audit, and risk.  During these meetings, the committee meets privately with the independent registered public accounting firm as well as with financial reporting and internal audit personnel to review accounting, auditing, and financial reporting matters.  The appointment of the independent registered public accounting firm is made by the Audit Committee.
The consolidated financial statements in this annual report on Form 10-K have been audited by Crowe LLP, for the purpose of determining that the consolidated financial statements are presented fairly, in all material respects in conformity with accounting principles generally accepted in the United States.  Crowe LLP’s report on the financial statements follows.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Old National is responsible for establishing and maintaining adequate internal control over financial reporting.  A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Old National’s management assessed the effectiveness of Old National’s internal control over financial reporting as of December 31, 2020.  In making this assessment, management used the criteria established in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control - Integrated Framework.  Based on that assessment Old National has concluded that, as of December 31, 2020, Old National’s internal control over financial reporting is effective.  Old National’s independent registered public accounting firm has audited the effectiveness of Old National’s internal control over financial reporting as of December 31, 2020 as stated in their report which follows.

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onb-20201231_g2.jpg
Crowe LLP
Independent Member Crowe Global


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


Shareholders and the Board of Directors of Old National Bancorp
Evansville, Indiana


Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Old National Bancorp (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO.

Change in Accounting Principle

As discussed in Note 1 to the financial statements, the Company has changed its method of accounting for credit losses effective January 1, 2020 due to the adoption of Financial Accounting Standards Board (FASB) Accounting Standards Codification No. 326, Financial Instruments – Credit Losses (ASC 326). The Company adopted the new credit loss standard using the modified retrospective method such that prior period amounts are not adjusted and continue to be reported in accordance with previously applicable generally accepted accounting principles. The adoption of the new credit loss standard and its subsequent application is also communicated as a critical audit matter below.

Basis for Opinions

The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Assessment of Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that
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respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the account or disclosures to which it relates.

Allowance for Credit Losses and Provision Expense

In accordance with Accounting Standards Update (the “ASU”) 2016-13, Financial Instruments —Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, the Company adopted Accounting Standards Codification (“ASC”) 326 as of January 1, 2020 as described in Notes 1 and 3 of the consolidated financial statements using the modified retrospective method. See also the explanatory paragraph above. The allowance for credit losses (the “ACL”) is an accounting estimate of expected credit losses over the contractual life of financial assets carried at amortized cost and off-balance-sheet credit exposures. The ASU requires a financial asset (or a group of financial assets), including the Company's loan portfolio, measured at amortized cost to be presented at the net amount expected to be collected. Estimates of expected credit losses for loans are based on historical experience, current conditions and reasonable and supportable forecasts over the expected life of the loans. In order to estimate the expected credit losses, the Company implemented several new loss estimation models. The Company disclosed the impact of adoption of this standard on January 1, 2020 with a $41.3 million increase to the allowance for credit losses, a $4.5 million increase for unfunded loan commitments and a $31.1 million decrease to retained earnings for the cumulative effect adjustment recorded upon adoption. Provision expense for the year ending December 31, 2020 was $38.4 million and the Allowance for Credit Losses at December 31, 2020 was $131.4 million.

The Company utilizes a discounted cash flow (“DCF”) approach with probability of default (“PD”) methodology. The PD regression models use combinations of variables to assess risk including unsystematic risk to help gauge the risk of default from an individual borrower and variables for systematic risk applicable to all borrowers. Other assumptions used to determine the quantitative
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allowance include the loss given default (LGD), which is defined as credit loss incurred when an obligor of the bank defaults, and prepayment assumptions. Expected cashflows are created for each loan using reasonable and supportable forecasts and discounted using the loan’s effective yield. The discounted sum of expected cashflows is then compared to the amortized cost and any shortfall is recorded as a component of the ACL. Qualitative adjustments are applied to the quantitative component to adjust for factors such as current conditions.

The Allowance for Credit Losses was identified by us as a critical audit matter because of the extent of auditor judgment applied and significant audit effort to evaluate the significant subjective and complex judgments made by management throughout the initial adoption and subsequent application processes, including the need to involve our valuation services specialists. The principal considerations resulting in our determination included the following:

Significant auditor judgment and audit effort to evaluate the appropriateness of selection of the loss estimation models and PD regression models, appropriateness of loan segmentation, and the reasonableness of PD and LGD assumptions.
Significant auditor judgment in evaluating the selection and application of the reasonable and supportable forecast of economic variables.
Significant auditor judgement and effort were used in evaluating the qualitative factors used in the calculation.
Significant audit effort related to the completeness and accuracy of the high volume of data used to develop assumptions and in the model computation

The primary procedures performed to address the critical audit matter included:

Testing the effectiveness of management’s internal controls over the Company’s significant model assumptions and judgments, loan segmentation, reasonable and supportable forecasts, qualitative factor adjustments, information systems and model validation
Testing the effectiveness of controls over the completeness and accuracy of historical inputs used in the development of the PD models and LGD assumptions, data imputation, use of third-party data, and loan data used in the computation
Testing the effectiveness of controls over the Company’s preparation and review of the allowance for credit loss calculation, including data used as the basis for adjustments related to the qualitative factors, the development and reasonableness of qualitative factors and mathematical accuracy and appropriateness of the overall calculation;
With the assistance of our valuation specialists, evaluating the reasonableness of assumptions and judgments related to the PD, LGD and loan segmentation, the conceptual design of the credit loss estimation models, model assumption sensitivity analysis and the adequacy of the independent model validation
Evaluating management’s judgments in the selection and application of reasonable and supportable forecast of economic variables
Substantively testing management’s process for developing the qualitative factors and assessing reasonableness, relevance and reliability of data used to develop factors, including evaluating their judgments and assumptions for reasonableness.
Substantively testing the mathematical accuracy of the discounted cash flow model at a loan level with the assistance of valuation services, including the completeness and accuracy of loan data used in the model.

onb-20201231_g3.jpg
Crowe LLP
We have served as the Company's auditor since 2005, which is the year the engagement letter was signed for the audit of the 2006 financial statements.

Louisville, Kentucky
February 10, 2021
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OLD NATIONAL BANCORP
CONSOLIDATED BALANCE SHEETS
December 31,
(dollars and shares in thousands, except per share data)20202019
Assets
Cash and due from banks$268,208 $234,766 
Money market and other interest-earning investments321,504 41,571 
Total cash and cash equivalents589,712 276,337 
Equity securities, at fair value2,547 6,842 
Investment securities - available-for-sale, at fair value:
U.S. Treasury10,208 17,682 
U.S. government-sponsored entities and agencies841,988 592,984 
Mortgage-backed securities3,339,098 3,183,861 
States and political subdivisions1,492,162 1,275,643 
Other securities286,659 314,921 
Total investment securities - available-for-sale5,970,115 5,385,091 
Federal Home Loan Bank/Federal Reserve Bank stock, at cost169,433 164,099 
Loans held for sale, at fair value63,250 46,898 
Loans:
Commercial3,956,422 2,890,296 
Commercial real estate5,946,512 5,166,792 
Residential real estate2,248,422 2,334,289 
Consumer credit, net of unearned income1,635,123 1,726,147 
Total loans, net of unearned income13,786,479 12,117,524 
Allowance for loan losses (1)(131,388)(54,619)
Net loans13,655,091 12,062,905 
Premises and equipment, net464,408 490,925 
Operating lease right-of-use assets76,197 95,477 
Accrued interest receivable85,306 85,123 
Goodwill1,036,994 1,036,994 
Other intangible assets46,014 60,105 
Company-owned life insurance456,110 448,967 
Other assets345,445 251,904 
Total assets$22,960,622 $20,411,667 
Liabilities
Deposits:
Noninterest-bearing demand$5,633,672 $4,042,286 
Interest-bearing:
Checking and NOW4,877,046 4,149,639 
Savings3,395,747 2,845,423 
Money market1,908,118 1,833,819 
Other time deposits1,103,313 1,589,988 
Brokered deposits119,557 92,242 
Total deposits17,037,453 14,553,397 
Federal funds purchased and interbank borrowings1,166 350,414 
Securities sold under agreements to repurchase431,166 327,782 
Federal Home Loan Bank advances1,991,435 1,822,847 
Other borrowings252,787 243,685 
Operating lease liabilities86,598 99,500 
Accrued expenses and other liabilities187,361 161,589 
Total liabilities19,987,966 17,559,214 
Commitments and contingencies (Note 20)00
Shareholders' Equity
Preferred stock, series A, 2,000 shares authorized, 0 shares issued or outstanding
Common stock, $1.00 per share stated value, 300,000 shares authorized, 165,367
   and 169,616 shares issued and outstanding, respectively
165,367 169,616 
Capital surplus1,875,626 1,944,445 
Retained earnings783,892 682,185 
Accumulated other comprehensive income (loss), net of tax147,771 56,207 
Total shareholders' equity2,972,656 2,852,453 
Total liabilities and shareholders' equity$22,960,622 $20,411,667 
(1)Beginning January 1, 2020, calculation is based on current expected loss methodology. Prior to January 1, 2020, calculation was based on incurred loss methodology.
The accompanying notes to consolidated financial statements are an integral part of these statements.
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OLD NATIONAL BANCORP
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
(dollars and shares in thousands, except per share data)202020192018
Interest Income
Loans including fees:
Taxable$515,980 $569,718 $508,293 
Nontaxable13,908 15,919 16,299 
Investment securities:
Taxable98,953 113,832 80,168 
Nontaxable33,899 29,248 26,655 
Money market and other interest-earning investments568 1,670 630 
Total interest income663,308 730,387 632,045 
Interest Expense
Deposits28,169 69,364 41,277 
Federal funds purchased and interbank borrowings1,296 5,656 4,793 
Securities sold under agreements to repurchase854 2,517 1,962 
Federal Home Loan Bank advances27,274 37,452 34,925 
Other borrowings9,621 11,125 11,486 
Total interest expense67,214 126,114 94,443 
Net interest income596,094 604,273 537,602 
Provision for loan losses (1)38,395 4,747 6,966 
Net interest income after provision for loan losses557,699 599,526 530,636 
Noninterest Income
Wealth management fees36,806 37,072 36,863 
Service charges on deposit accounts35,081 44,915 44,026 
Debit card and ATM fees20,178 21,652 20,216 
Mortgage banking revenue62,775 26,622 17,657 
Investment product fees21,614 21,785 20,539 
Capital markets income22,480 13,270 4,934 
Company-owned life insurance12,031 11,539 10,584 
Debt securities gains (losses), net10,767 1,923 2,060 
Net gain on banking center divestitures0013,989 
Other income17,542 20,539 24,437 
Total noninterest income239,274 199,317 195,305 
Noninterest Expense
Salaries and employee benefits293,590 289,452 281,275 
Occupancy55,316 55,255 51,941 
Equipment16,690 16,903 14,861 
Marketing10,874 15,898 15,847 
Data processing41,086 37,589 36,170 
Communication9,731 10,702 10,846 
Professional fees15,755 22,854 14,503 
FDIC assessment6,722 6,030 10,638 
Amortization of intangibles14,091 16,911 14,442 
Amortization of tax credit investments18,788 2,749 22,949 
Other expense58,774 34,144 43,789 
Total noninterest expense541,417 508,487 517,261 
Income before income taxes255,556 290,356 208,680 
Income tax expense29,147 52,150 17,850 
Net income$226,409 $238,206 $190,830 
Net income per common share - basic1.37 1.39 1.23 
Net income per common share - diluted1.36 1.38 1.22 
Weighted average number of common shares outstanding - basic165,509 171,907 155,675 
Weighted average number of common shares outstanding - diluted166,177 172,687 156,539 
Dividends per common share0.56 0.52 0.52 
(1)Beginning January 1, 2020, calculation is based on current expected loss methodology. Prior to January 1, 2020, calculation was based on incurred loss methodology.
The accompanying notes to consolidated financial statements are an integral part of these statements.
72


OLD NATIONAL BANCORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31,
(dollars in thousands)202020192018
Net income$226,409 $238,206 $190,830 
Other comprehensive income (loss):
Change in debt securities available-for-sale:
Unrealized holding gains (losses) for the period125,214 123,006 (4,769)
Reclassification for securities transferred to held-to-maturity0 14,007 
Reclassification adjustment for securities (gains) losses realized
in income
(10,767)(1,923)(2,060)
Income tax effect(25,243)(27,604)(1,386)
Unrealized gains (losses) on available-for-sale debt securities89,204 93,479 5,792 
Change in securities held-to-maturity:
Adjustment for securities transferred to available-for-sale0 8,200 19,412 
Adjustment for securities transferred from available-for-sale0 0(14,007)
Amortization of unrealized losses on securities transferred
    from available-for-sale
0 2,812 2,181 
Income tax effect0 (2,497)(1,394)
Changes from securities held-to-maturity0 8,515 6,192 
Cash flow hedges:
Net unrealized derivative gains (losses) on cash flow hedges8,261 (543)5,145 
Reclassification adjustment for (gains) losses realized in net income(5,153)(596)150 
Income tax effect(764)280 (1,298)
Changes from cash flow hedges2,344 (859)3,997 
Defined benefit pension plans:
Amortization of net loss recognized in income21 30 191 
Income tax effect(5)(8)(47)
Changes from defined benefit pension plans16 22 144 
Other comprehensive income (loss), net of tax91,564 101,157 16,125 
Comprehensive income$317,973 $339,363 $206,955 
The accompanying notes to consolidated financial statements are an integral part of these statements.

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OLD NATIONAL BANCORP
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(dollars in thousands, except per share data)Common
Stock
Capital
Surplus
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Total
Shareholders'
Equity
Balance,  December 31, 2017$152,040 $1,639,499 $413,130 $(50,272)$2,154,397 
Cumulative effect of change in accounting principles(4,127)(52)(4,179)
Balance, January 1, 2018152,040 1,639,499 409,003 (50,324)2,150,218 
Reclassification of certain tax effects related
   to the Tax Cuts and Jobs Act of 2017
10,751 (10,751)— 
Net income190,830 190,830 
Other comprehensive income (loss)16,125 16,125 
Acquisition of Klein Financial, Inc.22,772 383,702 406,474 
Dividends - common stock ($0.52 per share)(82,161)(82,161)
Common stock issued29 468 497 
Common stock repurchased(104)(1,701)(1,805)
Share-based compensation expense8,118 8,118 
Stock activity under incentive compensation plans404 1,609 (739)1,274 
Balance, December 31, 2018175,141 2,031,695 527,684 (44,950)2,689,570 
Cumulative effect of change in accounting principles6,322 6,322 
Balance, January 1, 2019175,141 2,031,695 534,006 (44,950)2,695,892 
Net income238,206 238,206 
Other comprehensive income (loss)101,157 101,157 
Dividends - common stock ($0.52 per share)(89,474)(89,474)
Common stock issued36 531 567 
Common stock repurchased(6,174)(96,239)(102,413)
Share-based compensation expense7,993 7,993 
Stock activity under incentive compensation plans613 465 (553)525 
Balance, December 31, 2019169,616 1,944,445 682,185 56,207 2,852,453 
Cumulative effect of change in accounting
   principles (Note 1)
(31,150)(31,150)
Balance, January 1, 2020169,616 1,944,445 651,035 56,207 2,821,303 
Net income226,409 226,409 
Other comprehensive income (loss)91,564 91,564 
Dividends - common stock ($0.56 per share)(92,946)(92,946)
Common stock issued43 534 577 
Common stock repurchased(5,115)(77,243)(82,358)
Share-based compensation expense7,707 7,707 
Stock activity under incentive compensation plans823 183 (606)400 
Balance, December 31, 2020$165,367 $1,875,626 $783,892 $147,771 $2,972,656 
The accompanying notes to consolidated financial statements are an integral part of these statements.

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OLD NATIONAL BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
(dollars in thousands)202020192018
Cash Flows From Operating Activities
Net income$226,409 $238,206 $190,830 
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation28,911 26,719 23,773 
Amortization of other intangible assets14,091 16,911 14,442 
Amortization of tax credit investments18,788 2,749 22,949 
Net premium amortization on investment securities18,798 19,210 14,384 
Accretion income related to acquired loans(23,331)(42,772)(40,598)
Share-based compensation expense7,707 7,993 8,118 
Excess tax (benefit) expense on share-based compensation(766)(1,069)401 
Provision for loan losses38,395 4,747 6,966 
Debt securities (gains) losses, net(10,767)(1,923)(2,060)
Net gain on banking center divestitures0 0(13,989)
Net (gains) losses on sales of loans and other assets(23,787)(7,370)(2,290)
Increase in cash surrender value of company-owned life insurance(12,031)(11,539)(10,584)
Residential real estate loans originated for sale(1,432,488)(854,848)(501,999)
Proceeds from sales of residential real estate loans1,455,067 834,024 514,891 
(Increase) decrease in interest receivable(183)4,340 2,038 
(Increase) decrease in other assets(105,203)23,322 8,578 
Increase (decrease) in accrued expenses and other liabilities20,210 (24,944)(1,443)
Net cash flows provided by (used in) operating activities219,820 233,756 234,407 
Cash Flows From Investing Activities
Cash received (paid) from acquisitions, net0060,759 
Payments related to banking center divestitures00(210,659)
Purchases of investment securities available-for-sale(2,803,406)(2,366,089)(663,338)
Purchases of Federal Home Loan Bank/Federal Reserve Bank stock(10,025)(21,142)(23,066)
Proceeds from maturities, prepayments, and calls of investment securities
   available-for-sale
1,990,383 1,175,272 419,270 
Proceeds from sales of investment securities available-for-sale299,885 424,140 139,364 
Proceeds from maturities, prepayments, and calls of investment securities held-to-maturity0 115,648 55,520 
Proceeds from sales of investment securities held-to-maturity0 9,921 0
Proceeds from sales of Federal Home Loan Bank/Federal Reserve Bank stock4,691 23 2,409 
Proceeds from sales of equity securities39,296 130 128 
Proceeds from sale of student loan portfolio0070,674 
Loan originations and payments, net(1,644,119)163,551 (102,928)
Proceeds from company-owned life insurance death benefits4,888 6,796 6,501 
Proceeds from sale of premises and equipment and other assets7,826 3,769 7,341 
Purchases of premises and equipment and other assets(30,871)(37,423)(33,391)
Net cash flows provided by (used in) investing activities(2,141,452)(525,404)(271,416)
Cash Flows From Financing Activities
Net increase (decrease) in:
Deposits2,484,056 203,448 261,551 
Federal funds purchased and interbank borrowings(349,248)80,279 (64,898)
Securities sold under agreements to repurchase103,384 (34,512)(41,997)
Other borrowings4,171 (4,377)(1,505)
Payments for maturities of Federal Home Loan Bank advances(751,505)(377,978)(1,001,888)
Payments for modification of Federal Home Loan Bank advances(31,124)
Proceeds from Federal Home Loan Bank advances950,000 575,000 995,000 
Cash dividends paid on common stock(92,946)(89,474)(82,161)
Common stock repurchased(82,358)(102,413)(1,805)
Proceeds from exercise of stock options0 280 948 
Common stock issued577 567 497 
Net cash flows provided by (used in) financing activities2,235,007 250,820 63,742 
Net increase (decrease) in cash and cash equivalents313,375 (40,828)26,733 
Cash and cash equivalents at beginning of period276,337 317,165 290,432 
Cash and cash equivalents at end of period$589,712 $276,337 $317,165 
The accompanying notes to consolidated financial statements are an integral part of these statements.

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OLD NATIONAL BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NATURE OF OPERATIONS
Old National Bancorp, a financial holding company headquartered in Evansville, Indiana, operates primarily in Indiana, Kentucky, Michigan, Minnesota, and Wisconsin.  Its principal subsidiary is Old National Bank.  Through its bank and non-bank affiliates, Old National Bancorp provides to its clients an array of financial services including loan, deposit, wealth management, investment consulting, and investment products.
NOTE 1 – BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements include the accounts of Old National Bancorp and its wholly-owned affiliates (hereinafter collectively referred to as “Old National”) and have been prepared in conformity with accounting principles generally accepted in the United States of America and prevailing practices within the banking industry.  Such principles require management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and the disclosures of contingent assets and liabilities at the date of the financial statements and amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.
All significant intercompany transactions and balances have been eliminated. Certain prior year amounts have been reclassified to conform to the current presentation.  Such reclassifications had no effect on prior year net income or shareholders’ equity and were insignificant amounts.
Equity Securities
Equity securities consist of mutual funds held in trusts associated with deferred compensation plans for former directors and executives.  These mutual funds are recorded as equity securities at fair value.  Gains and losses are included in other income in 2020 and 2019 and net securities gains in 2018.
Investment Securities
Old National classified all of its debt investment securities as available-for-sale at December 31, 2020.  Debt securities classified as available-for-sale are recorded at fair value with the unrealized gains and losses, net of tax effect, recorded in other comprehensive income.  Realized gains and losses affect income and the prior fair value adjustments are reclassified within shareholders’ equity.  Prior to the fourth quarter of 2019, Old National also had debt securities classified as held-to-maturity.  Debt securities classified as held-to-maturity, which management had the intent and ability to hold to maturity, were reported at amortized cost.  Interest income included amortization of purchase premiums or discounts.  Premiums and discounts were amortized on the level-yield method.  Anticipated prepayments were considered when amortizing premiums and discounts on mortgage backed securities.  Gains and losses on the sale of available-for-sale debt securities are determined using the specific-identification method.
Available-for-sale debt securities in unrealized loss positions are evaluated for impairment related to credit losses at least quarterly. For available-for sale debt securities in an unrealized loss position, we first assess whether we intend to sell, or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For available-for-sale debt securities that do not meet the criteria, we evaluate whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security and the issuer, among other factors. If this assessment indicates that a credit loss exists, we compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis for the security, a credit loss exists and an allowance for credit losses is recorded, limited to the amount that the fair value of the security is less than its amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income, net of applicable taxes. Accrued interest receivable on available-for-sale debt securities is excluded from the estimate of credit losses.
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Federal Home Loan Bank Stock
Old National is a member of the FHLB system.  Members are required to own a certain amount of stock based on the level of borrowings and other factors and may invest in additional amounts.  FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value.  Both cash and stock dividends are reported as income.
Loans Held for Sale
Loans that Old National has originated with an intent to sell are classified as loans held for sale and are recorded at fair value, determined individually, as of the balance sheet date.  The loan’s fair value includes the servicing value of the loans as well as any accrued interest. Conventional mortgage production is sold on a servicing retained basis.  Certain loans, such as government guaranteed mortgage loans are sold on servicing released basis. Mortgage loans held for immediate sale in the secondary market were $63.3 million at December 31, 2020, compared to $46.9 million at December 31, 2019.
Loans
Loans that Old National intends to hold for investment purposes are classified as portfolio loans.  Portfolio loans are carried at the principal balance outstanding, net of earned interest, purchase premiums or discounts, deferred loan fees and costs, and an allowance for credit losses.  Interest income is accrued on the principal balances of loans outstanding.  For all loan classes, a loan is generally placed on nonaccrual status when principal or interest becomes 90 days past due unless it is well secured and in the process of collection, or earlier when concern exists as to the ultimate collectability of principal or interest. Interest accrued but not received is reversed against earnings. Cash interest received on these loans is applied to the principal balance until the principal is recovered or until the loan returns to accrual status. Loans may be returned to accrual status when all the principal and interest amounts contractually due are brought current, remain current for a prescribed period, and future payments are reasonably assured.
Old National has purchased loans, some of which have experienced more than insignificant credit deterioration since origination. PCD loans are recorded at the amount paid. An allowance for credit losses is determined using the same methodology as other loans held for investment. The initial allowance for credit losses determined on a collective basis is allocated to individual loans. The sum of the loan’s purchase price and initial allowance for credit losses becomes its initial amortized cost basis. The difference between the initial amortized cost basis and the par value of the loan is a noncredit discount or premium, which is accreted or amortized into interest income over the life of the loan. Subsequent changes to the allowance for credit losses are recorded through provision for credit losses.

Allowance for Credit Losses for Loans
Credit quality within the loans held for investment portfolio is continuously monitored by management and is reflected within the allowance for credit losses for loans. The allowance for credit losses is an estimate of expected losses inherent within the Company’s loans held for investment portfolio. Credit quality is assessed and monitored by evaluating various attributes and the results of those evaluations are utilized in underwriting new loans and in our process for estimating expected credit losses. Expected credit loss inherent in non-cancelable off-balance-sheet credit exposures is accounted for as a separate liability included in other liabilities on the balance sheet. The allowance for credit losses for loans held for investment is adjusted by a credit loss expense, which is reported in earnings, and reduced by the charge-off of loan amounts, net of recoveries. We have made a policy election to report accrued interest receivable as a separate line item on the balance sheet.
The allowance for credit loss estimation process involves procedures to appropriately consider the unique characteristics of the loan portfolio segments. These segments are further disaggregated into loan classes based on the level at which credit risk is monitored. When computing the level of expected credit losses, credit loss assumptions are estimated using a model that categorizes loan pools based on loss history, delinquency status, and other credit trends and risk characteristics, including current conditions and reasonable and supportable forecasts about the future. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. In future periods evaluations of the overall loan portfolio, in light of the factors and forecasts then prevailing, may result in significant changes in the allowance and credit loss expense in those future periods.
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The allowance level is influenced by loan volumes, loan AQR migration or delinquency status, changes in historical loss experience, and other conditions influencing loss expectations, such as reasonable and supportable forecasts of economic conditions. The methodology for estimating the amount of expected credit losses reported in the allowance for credit losses has two basic components: first, an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans; and second, a pooled component for estimated expected credit losses for pools of loans that share similar risk characteristics.
We utilize a discounted cashflow approach to determine the allowance for credit losses for performing loans and nonperforming loans. Expected cashflows are created for each loan and discounted using the effective yield. The discounted sum of expected cashflows is then compared to the amortized cost and any shortfall is recorded as reserve. Expected cashflows are created using a combination of contractual payment schedules, calculated PDs, LGD, and prepayment assumptions as well as qualitative factors. For the commercial and commercial real estate loans, the PD is forecast using a regression model to determine the likelihood of a loan moving into nonaccrual within the time horizon. For residential and consumer loans, the PD is forecast using a regression model to determine the likelihood of a loan being charged-off within the time horizon. The regression models use combinations of variables to assess systematic and unsystematic risk. Variables used for unsystematic risk are borrower specific and help to gauge the risk of default from an individual borrower. Variables for systematic risk, risk inherent to all borrowers, come from the use of forward-looking economic forecasts and include variables such as unemployment rate, gross domestic product, and house price index. The LGD is defined as credit loss incurred when an obligor of the bank defaults. Qualitative factors include items such as changes in lending policies or procedures and economic uncertainty in forward-looking forecasts.
Further information regarding Old National’s policies and methodology used to estimate the allowance for credit losses for loans is presented in Note 3.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.  Land is stated at cost.  Depreciation is charged to operating expense over the useful lives of the assets, principally on the straight-line method.  Useful lives for premises and equipment are as follows: buildings and building improvements – 15 to 39 years; and furniture and equipment – 3 to 7 years.  Leasehold improvements are depreciated over the lesser of their useful lives or the term of the lease.  Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized.  Interest costs on construction of qualifying assets are capitalized.
Premises and equipment are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows.  If impaired, the assets are adjusted to fair value.  Such impairments are included in other expense.
Goodwill and Other Intangible Assets
The excess of the cost of acquired entities over the fair value of identifiable assets acquired less liabilities assumed is recorded as goodwill.  Amortization of goodwill and indefinite-lived assets is not recorded.  However, the recoverability of goodwill and other intangible assets are tested annually for impairment.  Other intangible assets, including core deposits and customer business relationships, are amortized primarily on an accelerated basis over their estimated useful lives, generally over a period of 5 to 15 years.
Company-Owned Life Insurance
Old National has purchased, as well as obtained through acquisitions, life insurance policies on certain key executives.  Old National records company-owned life insurance at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
Loan Servicing Rights
When loans are sold with servicing retained, servicing rights are initially recorded at fair value with the income statement effect recorded in gain on sales of loans.  Fair value is based on market prices for comparable servicing contracts, when available or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income.  All classes of servicing assets are subsequently measured using the
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amortization method which requires servicing rights to be amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. Loan servicing rights are included in other assets on the balance sheet.
Loan servicing rights are evaluated for impairment based upon the fair value of the rights as compared to carrying amount.  Impairment is determined by stratifying rights into groupings based on predominant risk characteristics, such as interest rate, loan type, term, and investor type.  Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair value is less than the carrying amount.  If Old National later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance may be recorded as an increase to income.  Changes in valuation allowances are reported with mortgage banking revenue on the income statement.  The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses. Servicing fee income, which is reported on the income statement as mortgage banking revenue, is recorded for fees earned for servicing loans.  The fees are based on a contractual percentage of the outstanding principal, or a fixed amount per loan and are recorded as income when earned.
Derivative Financial Instruments
As part of Old National’s overall interest rate risk management, Old National uses derivative instruments, including TBA forward agreements and interest rate swaps, collars, caps, and floors.  All derivative instruments are recognized on the balance sheet at their fair value. At the inception of the derivative contract, Old National designates the derivative as (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), or (3) an instrument with no hedging designation (“stand-alone derivative”).  For a fair value hedge, the change in value of the derivative, as well as the offsetting change in value of the hedged item attributable to the hedged risk, are recognized in current earnings during the period of the change in fair values.  For a cash flow hedge, the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings.  Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, in noninterest income.
Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged. Net cash settlements on derivatives that do not qualify for hedge accounting are reported in noninterest income.
Old National formally documents all relationships between derivatives and hedged items, as well as the risk-management objective and strategy for undertaking various hedge transactions.  This documentation includes linking fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions.  Old National also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of the hedged items.  Old National discontinues hedge accounting prospectively when it is determined that (1) the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item; (2) the derivative expires, is sold, or terminated; (3) the derivative instrument is de-designated as a hedge because the forecasted transaction is no longer probable of occurring; (4) a hedged firm commitment no longer meets the definition of a firm commitment; or (5) management otherwise determines that designation of the derivative as a hedging instrument is no longer appropriate.
When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as noninterest income.  When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability.  When a cash flow hedge is discontinued but the hedged cash flows or forecasted transaction is still expected to occur, changes in value that were accumulated in other comprehensive income are amortized or accreted into earnings over the same periods which the hedged transactions will affect earnings.
Old National enters into various stand-alone mortgage-banking derivatives in order to hedge the risk associated with the fluctuation of interest rates.  Changes in fair value are recorded as mortgage banking revenue.  Old National also enters into various stand-alone derivative contracts to provide derivative products to customers which are carried at fair value with changes in fair value recorded as other noninterest income.
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Old National is exposed to losses if a counterparty fails to make its payments under a contract in which Old National is in the net receiving position.  Old National anticipates that the counterparties will be able to fully satisfy their obligations under the agreements.  In addition, Old National obtains collateral above certain thresholds of the fair value of its hedges for each counterparty based upon their credit standing.  All of the contracts to which Old National is a party settle monthly, quarterly, or semiannually.  Further, Old National has netting agreements with the dealers with which it does business.
Credit-Related Financial Instruments
In the ordinary course of business, Old National’s bank subsidiary has entered into credit-related financial instruments consisting of commitments to extend credit, commercial letters of credit, and standby letters of credit.  The notional amount of these commitments is not reflected in the consolidated financial statements until they are funded. Old National maintains an allowance for credit 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 credit losses for loans, modified to take into account the probability of a drawdown on the commitment. The allowance for credit losses on unfunded loan commitments is classified as a liability account on the balance sheet and is adjusted as a provision for credit loss expense included in other expense.
Repossessed Collateral
Other real estate owned and repossessed personal property are initially recorded at the fair value of the property less estimated cost to sell and are included in other assets on the balance sheet.  Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of foreclosure or when the borrower conveys all interest in the property to satisfy the loan through the completion of a deed in lieu of foreclosure or through a similar legal agreement.  Any excess recorded investment over the fair value of the property received is charged to the allowance for credit losses.  Any subsequent write-downs are recorded in noninterest expense, as are the costs of operating the properties.  Gains or losses resulting from the sale of collateral are recognized in noninterest expense at the date of sale.
Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to Repurchase
We purchase certain securities, generally U.S. government-sponsored entity and agency securities, under agreements to resell.  The amounts advanced under these agreements represent short-term secured loans and are reflected as assets in the accompanying consolidated balance sheets.  We also sell certain securities under agreements to repurchase.  These agreements are treated as collateralized financing transactions.  These secured borrowings are reflected as liabilities in the accompanying consolidated balance sheets and are recorded at the amount of cash received in connection with the transaction.  Short-term securities sold under agreements to repurchase generally mature within one to four days from the transaction date.  Securities, generally U.S. government and federal agency securities, pledged as collateral under these financing arrangements can be repledged by the secured party.  Additional collateral may be required based on the fair value of the underlying securities.

Share-Based Compensation
Compensation cost is recognized for stock options, stock appreciation rights, and restricted stock awards and units issued to employees based on the fair value of these awards at the date of grant.  A Black-Scholes model is utilized to estimate the fair value of stock options and appreciation rights, while the market price of our Common Stock at the date of grant is used for restricted stock awards. A third party provider is used to value certain restricted stock units where the performance measure is based on total shareholder return.  Compensation expense is recognized over the required service period.  Forfeitures are recognized as they occur.
Income Taxes
Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities.  Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates.  A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
We recognize a tax position as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur.  The amount recognized is the largest amount
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of tax benefit that is greater than 50% likely of being realized on examination.  For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.
We recognize interest and/or penalties related to income tax matters in income tax expense.
Old National is a limited partner in several tax-advantaged limited partnerships whose purpose is to invest in approved qualified affordable housing, renewable energy, or other renovation or community revitalization projects. These investments are included in other assets on the balance sheet, with any unfunded commitments included with other liabilities.  Certain of these assets qualify for the proportional amortization method and are amortized over the period that Old National expects to receive the tax credits, with the expense included within income tax expense on the consolidated statements of income.  The other investments are accounted for under the equity method, with the expense included within noninterest expense on the consolidated statements of income.  All of our tax credit investments are evaluated for impairment at the end of each reporting period.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the normal course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.  See Note 20 to the consolidated financial statements for further disclosure.
Cash Equivalents and Cash Flows
For the purpose of presentation in the accompanying consolidated statement of cash flows, cash and cash equivalents are defined as cash, due from banks, federal funds sold and resell agreements, and money market investments, which have maturities less than 90 days.  Cash flows from loans, either originated or acquired, are classified at that time according to management’s intent to either sell or hold the loan for the foreseeable future. When management’s intent is to sell the loan, the cash flows of that loan are presented as operating cash flows. When management’s intent is to hold the loan for the foreseeable future, the cash flows of that loan are presented as investing cash flows.

The following table summarizes supplemental cash flow information:
Years Ended December 31,
(dollars in thousands)202020192018
Cash payments:
Interest$70,043 $127,713 $91,813 
Income taxes (net of refunds)24,436 5,494 (2,505)
Noncash Investing and Financing Activities:
Securities transferred from held-to-maturity to available-for-sale0 381,992 447,026 
Securities transferred from available-for-sale to held-to-maturity0 323,990 
Transfer of premises and equipment to assets held for sale16,661 2,689 9,634 
Operating lease right-of-use assets obtained in exchange for lease obligations(116)113,498 
Finance lease right-of-use assets obtained in exchange for lease obligations5,225 7,871 
The following table summarizes the common shares issued and resultant value of total shareholders’ equity associated with acquisitions:
(dollars and shares in thousands)Shares of
Common Stock
Total
Shareholders'
Equity
Year Ended December 31, 2018
Acquisition of Klein22,772 $406,474 
There were no acquisitions during 2020 or 2019.

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Business Combinations

Old National accounts for business combinations using the acquisition method of accounting.  The accounts of an acquired entity are included as of the date of acquisition, and any excess of purchase price over the fair value of the net assets acquired is capitalized as goodwill.  Old National typically issues Common Stock and/or pays cash for an acquisition, depending on the terms of the acquisition agreement.  The value of Common Stock issued is determined based on the market price of the stock as of the closing of the acquisition.  Acquisition costs are expensed when incurred.
Impact of Accounting Changes

Accounting Guidance Adopted in 2020

FASB ASC 326 – In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and all related subsequent amendments thereto (“ASC 326” or “Topic 326”). The main objective of this amendment is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments within its scope, including loans held for investment purposes and other commitments to extend credit held by a reporting entity at each reporting date. The amendment requires the measurement of all expected credit losses for the in-scope financial assets at the date of origination or acquisition, and at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to enhance their credit loss estimates. The amendment requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The current expected credit loss measurement will be used to estimate the allowance for credit losses over the life of the financial assets. The amendments in this update became effective for annual periods and interim periods within those annual periods beginning after December 15, 2019.

As previously disclosed, Old National formed a cross-functional committee to oversee the adoption of the ASU at the effective date. A working group was also formed to develop a project plan focused on understanding the ASU, researching issues, identifying data needs for modeling inputs, technology requirements, modeling considerations, and ensuring overarching governance was achieved for each objective and milestone. The working group identified 7 distinct loan portfolios for which a model to estimate credit losses has been developed. For all 7 loan portfolios, the data sets have been identified, populated, and internally validated. Old National has completed data and model validation testing. During the last half of 2019, the project plan targeted parallel processing of our existing allowance for loan losses model compared to the CECL model, as well as model sensitivity analysis, determination of qualitative adjustments, supporting analytics, and execution of the governance and approval process. Internal controls related to the CECL process were finalized prior to adoption on January 1, 2020.

The CECL modeling measurements for estimating the current expected life-time credit losses for loans and debt securities includes the following major items:
Initial loss forecast – using a forecast period of one year for all allowance portfolio segments and off-balance-sheet credit exposures, using forward-looking economic scenarios of expected losses.
Historical loss forecast – for a period incorporating the remaining contractual life, adjusted for prepayments, and the changes in various economic variables during representative historical and recessionary periods.
Reversion period – using two years, which links the initial loss forecast to the historical loss forecast based on economic conditions at the measurement date.
Discounted cash flow aggregator – using the items above to estimate the life-time credit losses for all portfolios and losses for loans modified as a TDR.

Old National adopted CECL on January 1, 2020 using the modified retrospective method for all financial assets measured at amortized cost and off-balance-sheet credit exposures. Results for the reporting periods after January 1, 2020 are presented under Topic 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. As of that date, Old National increased the allowance for credit losses for loans by $41.3 million and increased the allowance for credit losses for unfunded loan commitments by $4.5 million, since the ASU covers credit losses over the expected life of a loan as well as considering future changes in macroeconomic conditions. The increase related to the acquired loan portfolio totaled $27.1 million. Under the
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previously applicable accounting guidance, any remaining unamortized loan discount on an individual loan could be used to offset a charge-off for that loan, so the allowance for loan losses needed for the acquired loans was reduced by the remaining loan discounts. ASU 2016-13 requires an allowance for credit losses to be recognized in addition to the loan discount. The impact of adopting the ASU, and at each subsequent reporting period, is highly dependent on credit quality, macroeconomic forecasts and conditions, composition of our loans and available-for-sale securities portfolio, along with other management judgements. As of January 1, 2020, Old National recorded a cumulative-effect adjustment of $31.2 million to decrease retained earnings.

Old National did not record an allowance for credit losses on its available-for-sale debt securities under the newly codified available-for-sale debt security impairment model, as the majority of these securities are government agency-backed securities for which the risk of loss is minimal.

We adopted CECL using the prospective transition approach for financial assets purchased with credit deterioration that were previously classified as purchased credit impaired and accounted for under ASC 310-30. In accordance with the standard, we did not reassess whether PCI assets met the definition of PCD assets as of the date of adoption. On January 1, 2020, the amortized cost basis of the PCD assets were adjusted to reflect the addition of $4.5 million to the allowance for credit losses for loans. The remaining noncredit discount in the amount of $11.8 million (based on the adjusted amortized cost basis) will be accreted into interest income at the effective interest rate as of January 1, 2020.

The loan categories used to monitor and analyze interest income and yields are different than the portfolio segments used to determine the allowance for credit losses for loans. The allowance for credit losses was calculated by pooling loans of similar credit risk characteristics and credit monitoring procedures. The 4 loan portfolios are classified into 7 segments of loans - commercial, commercial real estate, BBCC, residential real estate, indirect, direct, and home equity. The commercial and commercial real estate loan categories shown on the balance sheet include the same pool of loans as the commercial, commercial real estate, and BBCC portfolio segments. The consumer loan category shown on the balance sheet is comprised of the same loans in the indirect, direct, and home equity portfolio segments. The composition of loans by portfolio segment as of December 31, 2019 follows:
(dollars in thousands)December 31, 2019
Statement
Balance
Segment
Portfolio
Reclassifications
December 31, 2019
After
Reclassifications
Loans:
Commercial$2,890,296 $(75,142)$2,815,154 
Commercial real estate5,166,792 (277,539)4,889,253 
BBCCN/A352,681 352,681 
Residential real estate2,334,289 2,334,289 
Consumer1,726,147 (1,726,147)N/A
IndirectN/A935,584 935,584 
DirectN/A228,524 228,524 
Home equityN/A562,039 562,039 
Total$12,117,524 $— $12,117,524 
Allowance:
Commercial$(22,585)$1,226 $(21,359)
Commercial real estate(21,588)1,053 (20,535)
BBCCN/A(2,279)(2,279)
Residential real estate(2,299)(2,299)
Consumer(8,147)8,147 N/A
IndirectN/A(5,319)(5,319)
DirectN/A(1,863)(1,863)
Home equityN/A(965)(965)
Total$(54,619)$— $(54,619)

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The following table illustrates the impact of adoption of the ASU:
(dollars in thousands)December 31, 2019
After
Reclassifications
Impact of
ASC 326
Adoption
January 1, 2020
Post-ASC 326
Adoption
Assets:
Loans, net of unearned income:
Commercial$2,815,154 $2,679 $2,817,833 
Commercial real estate4,889,253 1,637 4,890,890 
BBCC352,681 33 352,714 
Residential real estate2,334,289 105 2,334,394 
Indirect935,584 10 935,594 
Direct228,524 228,526 
Home equity562,039 12 562,051 
Total12,117,524 4,478 12,122,002 
Allowance:
Commercial(21,359)(7,150)(28,509)
Commercial real estate(20,535)(25,548)(46,083)
BBCC(2,279)(3,702)(5,981)
Residential real estate(2,299)(6,986)(9,285)
Indirect(5,319)1,669 (3,650)
Direct(1,863)1,059 (804)
Home equity(965)(689)(1,654)
Total allowance for credit losses on loans(54,619)(41,347)(95,966)
Net loans$12,062,905 $(36,869)$12,026,036 
Net deferred tax assets$29,705 $10,268 $39,973 
Liabilities:
Allowance for credit losses on unfunded loan commitments$2,656 $4,549 $7,205 
Shareholders' equity:
Retained earnings$682,185 $(31,150)$651,035 
In December 2018, the OCC, the Board of Governors of the Federal Reserve System, and the FDIC approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard. In March 2020, the OCC, the Board of Governors of the Federal Reserve System, and the FDIC published an interim final rule to delay the estimated impact on regulatory capital stemming from the implementation of CECL. The interim final rule maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period (five-year transition option). Old National is adopting the capital transition relief over the permissible five-year period.

FASB ASC 350 – In January 2017, the FASB issued ASU No. 2017-04, Intangibles: Goodwill and Other: Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, the amendments eliminate Step 2 from the goodwill impairment test. The annual, or interim, goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition, the income tax effects of tax deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss, if applicable. The amendments also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform Step 2 of the goodwill impairment test. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The amendments should be applied on a prospective basis. The nature of and reason for the change in accounting principle should be disclosed upon transition. The amendments in this update became effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019 and did not have a material impact on the financial statements.

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FASB ASC 820 – In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. The updated guidance improves the disclosure requirements on fair value measurements. The ASU removes certain disclosures required by Topic 820 related to transfers between Level 1 and Level 2 of the fair value hierarchy; the policy for timing of transfers between levels; the valuation processes for Level 3 fair value measurements; and for nonpublic entities, the changes in unrealized gains and losses for the period included in earnings for recurring Level 3 fair value measurements held at the end of the reporting period. The ASU modifies certain disclosures required by Topic 820 related to disclosure of transfers into and out of Level 3 of the fair value hierarchy and purchases and issues of Level 3 assets and liabilities for nonpublic entities; the requirement to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly for investments in certain entities that calculate net asset value; and clarification that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date. The ASU adds certain disclosure requirements related to changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. The amendments in this update became effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2019 and did not have a material impact on the financial statements.

FASB ASC 350 – In August 2018, the FASB issued ASU No. 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract. The amendments in this update align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The amendments in this update became effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years and did not have a material impact on the financial statements.

FASB ASC 842 – In March 2019, the FASB issued ASU No. 2019-01, Leases (Topic 842): Codification Improvements. The amendments in ASU No. 2019-01 align the guidance for fair value of the underlying asset by lessors that are not manufacturers or dealers in Topic 842 with that of existing guidance. As a result, the fair value of the underlying asset at lease commencement is its cost, reflecting any volume or trade discounts that may apply. However, if there has been a significant lapse of time between when the underlying asset is acquired and when the lease commences, the definition of fair value in Topic 820, Fair Value Measurement should be applied. ASU No. 2019-01 also requires lessors within the scope of Topic 942, Financial Services—Depository and Lending, to present all “principal payments received under leases” within investing activities. The amendments in this update became effective for annual periods and interim periods within those annual periods beginning after December 15, 2019 and did not have a material impact on the financial statements.

FASB ASC 326, 815, and 825 – In April 2019, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. The amendments related to Topic 326 address accrued interest, transfers between classifications or categories for loans and debt securities, recoveries, vintage disclosures, and contractual extensions and renewal options and became effective for annual periods and interim periods within those annual periods beginning after December 15, 2019. The improvements and clarifications related to Topic 815 address partial-term fair value hedges of interest-rate risk, amortization, and disclosure of fair value hedge basis adjustments and consideration of hedged contractually specified interest rate under the hypothetical method and became effective for the annual reporting period beginning January 1, 2020. The amendments related to Topic 825 contain various improvements to ASU 2016-01, including scope; held-to-maturity debt securities fair value disclosures; and remeasurement of equity securities at historical exchange rates and became effective for fiscal years and interim periods beginning after December 15, 2019. The amendments in this update did not have a material impact on the financial statements.

FASB ASC 326 – In May 2019, the FASB issued ASU No. 2019-05, Financial Instruments—Credit Losses (Topic 326): Targeted Transition Relief. These amendments provide targeted transition relief allowing entities to irrevocably elect the fair value option, on an instrument-by-instrument basis, for certain financial assets (excluding held-to-maturity debt securities) previously measured at amortized cost.

In November 2019, the FASB issued 2019-11, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, to make improvements to the credit losses standard. Most significantly, the standard clarifies
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guidance around how to report expected recoveries for PCD assets. “Expected recoveries” describes a situation in which an organization recognizes a full or partial write-off of the amortized cost basis of a financial asset, but then later determines that the amount written off, or a portion of that amount, will in fact be recovered. This ASU permits organizations to record expected recoveries on PCD assets. In addition to other narrow technical improvements, the ASU also reinforces existing guidance that prohibits organizations from recognizing negative allowances for available-for-sale debt securities.

The amendments in these updates became effective for annual periods and interim periods within those annual periods beginning after December 15, 2019 and did not have a material impact on the consolidated financial statements.

FASB ASC 718 – In November 2019, the FASB issued ASU No. 2019-08, Compensation – Stock Compensation (Topic 718) and Revenue from Contracts with Customers (Topic 606): Codification Improvements—Share-Based Consideration Payable to a Customer. This ASU requires companies to measure and classify (on the balance sheet) share-based payments to customers by applying the guidance in Topic 718, Compensation—Stock Compensation. As a result, the amount recorded as a reduction in revenue would be measured based on the grant-date fair value of the share-based payment. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2019 and did not have a material impact on the consolidated financial statements.

FASB ASC 326 and 842 – In February 2020, the FASB issued ASU No. 2020-02, Financial Instruments—Credit Losses (Topic 326) and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842). This ASU inserts a paragraph to address the November 2019 issuance of SEC SAB 119, Accounting for Loan Losses by Registrants Engaged in Lending Activities Subject to FASB ASC Topic 326. The SAB updates existing staff guidance on developing a systematic methodology for estimating credit losses, and it explains the documentation the staff typically would expect from registrants in support of estimates of current expected credit losses for lending activities, when material. The amendments in this update became effective upon issuance and did not have a material impact on the consolidated financial statements.

FASB ASC 848 – In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provides temporary, optional guidance to ease the potential burden in accounting for, or recognizing the effects of, the transition away from the LIBOR or other interbank offered rate on financial reporting. To help with the transition to new reference rates, the ASU provides optional expedients and exceptions for applying GAAP to affected contract modifications and hedge accounting relationships. The main provisions include:
A change in a contract’s reference interest rate would be accounted for as a continuation of that contract rather than as the creation of a new one for contracts, including loans, debt, leases, and other arrangements, that meet specific criteria.
When updating its hedging strategies in response to reference rate reform, an entity would be allowed to preserve its hedge accounting.
The guidance is applicable only to contracts or hedge accounting relationships that reference LIBOR or another reference rate expected to be discontinued. Because the guidance is meant to help entities through the transition period, it will be in effect for a limited time and will not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, except for hedging relationships existing as of December 31, 2022, for which an entity has elected certain optional expedients that are retained through the end of the hedging relationship. The amendments in this ASU are effective March 12, 2020 through December 31, 2022.
ASU 2020-04 permits relief solely for reference rate reform actions and permits different elections over the effective date for legacy and new activity. Accordingly, Old National is evaluating and reassessing the elections on a quarterly basis. For current elections in effect regarding the assertion of the probability of forecasted transactions, Old National elects the expedient to assert the probability of the hedged interest payments and receipts regardless of any expected modification in terms related to reference rate reform.
Old National believes the adoption of this guidance on activities subsequent to December 31, 2020 through December 31, 2022 will not have a material impact on the consolidated financial statements.
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Codification Improvements to Financial Instruments – In March 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments. This ASU was issued to clarify and improve various financial instruments Topics. The amendments include the following improvements:
Issue 1 – Clarifies that all entities are required to provide fair value option disclosures.
Issue 2 – Clarifies the applicability of the portfolio exception in measuring fair value for nonfinancial items accounted for as derivatives.
Issue 3 – Clarifies that disclosure requirements in Topic 320 apply to disclosure requirements in Topic 942 for depository and lending institutions.
Issue 4 – Added cross-reference of line-of-credit or revolving-debt arrangements guidance to guidance in accounting for fees between debtor and creditor and third-party costs directly related to exchanges or modifications of debt instruments.
Issue 5 – Clarifies that fair value measurement disclosure requirements do not apply to entities using the net asset value per share practical expedient.
Issue 6 – Aligns the contractual term to measure expected credit losses for a net investment in a lease under the Credit Loss Standard (Topic 326) with the lease term determined under the Leases Standard (Topic 842).
Issue 7 – Clarifies that when an entity regains control of financial assets sold, an allowance for credit losses should be recorded in accordance with Topic 326.
For Issue 1, Issue 2, Issue 4, and Issue 5, the amendments are effective upon issuance and did not have a material impact on the consolidated financial statements. For Issue 3, the amendments to ASU 2016-01 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years and did not have a material impact on the consolidated financial statements. For Issues 6 and 7, the amendments to ASU 2016-13 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years and did not have a material impact on the consolidated financial statements.
Guidance on Non-TDR Loan Modifications due to COVID-19 – On March 22, 2020, a statement was issued by our banking regulators and titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” (the “Interagency Statement”) that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19. Additionally, Section 4013 of the CARES Act that passed on March 27, 2020 further provides that a qualified loan modification is exempt by law from classification as a TDR as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak declared by the President of the United States under the National Emergencies Act terminates. Section 541 of the CAA extends this relief to the earlier of January 1, 2022 or 60 days after the national emergency termination date. The Interagency Statement was subsequently revised in April 2020 to clarify the interaction of the original guidance with Section 4013 of the CARES Act, as well as setting forth the banking regulators’ views on consumer protection considerations. In accordance with such guidance, we are offering short-term modifications made in response to COVID-19 to borrowers who are current and otherwise not past due. These include short-term (180 days or less) modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. See Note 6 for further information on non-TDR loan modifications.
Accounting Guidance Issued But Not Yet Adopted 
FASB ASC 715 – In August 2018, the FASB issued ASU No. 2018-14, Compensation – Retirement Benefits – Defined Benefit Plans – General (Subtopic 715-20): Disclosure Framework – Changes to the Disclosure Requirements for Defined Benefit Plans. The amendments in this update modify the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. The amendments in this update become effective for fiscal years ending after December 15, 2020 and will not have a material impact on the consolidated financial statements.

FASB ASC 740 – In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This ASU removes specific exceptions to the general principles in Topic 740 in GAAP. It eliminates the need for an organization to analyze whether the following apply in a given period: (1) exception to the incremental approach for intraperiod tax allocation; (2) exceptions to accounting for basis differences when there are ownership changes in foreign investments; and (3) exception in interim period income tax accounting for year-to-date losses that exceed anticipated losses. The ASU also improves financial statement preparers’ application of income tax-related guidance and simplifies GAAP for: (1) franchise taxes that are partially based on income; (2) transactions with a government that result in a step up in the tax basis of goodwill; (3) separate financial statements of legal entities that are not subject to tax; and (4) enacted changes in tax laws in interim
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periods. The amendments in this update become effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. Old National is currently evaluating the impact of adopting the new guidance on the consolidated financial statements.

FASB ASC 321, 323, and 815 – In January 2020, the FASB issued ASU No. 2020-01, Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions Between Topic 321, Topic 323, and Topic 815 (a Consensus of the Emerging Issues Task Force). The ASU clarifies the interaction between ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities and the ASU on equity method investments. ASU 2016-01 provides companies with an alternative to measure certain equity securities without a readily determinable fair value at cost, minus impairment, if any, unless an observable transaction for an identical or similar security occurs. ASU 2020-01 clarifies that for purposes of applying the Topic 321 measurement alternative, an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting under Topic 323, immediately before applying or upon discontinuing the equity method. In addition, the new ASU provides direction that a company should not consider whether the underlying securities would be accounted for under the equity method or the fair value option when it is determining the accounting for certain forward contracts and purchased options, upon either settlement or exercise. The amendments in this update become effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted, and the amendments are to be applied prospectively. Old National is currently evaluating the impact of adopting the new guidance on the consolidated financial statements.

FASB ASC 470 and 815 – In August 2020, the FASB issued ASU 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging— Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity, to clarify the accounting for certain financial instruments with characteristics of liabilities and equity. The amendments in this update reduce the number of accounting models for convertible debt instruments and convertible preferred stock by removing the cash conversion model and the beneficial conversion feature model. Limiting the accounting models will result in fewer embedded conversion features being separately recognized from the host contract. Convertible instruments that continue to be subject to separation models are (1) those with embedded conversion features that are not clearly and closely related to the host contract, that meet the definition of a derivative, and that do not qualify for a scope exception from derivative accounting and (2) convertible debt instruments issued with substantial premiums for which the premiums are recorded as paid-in-capital. In addition, this ASU improves disclosure requirements for convertible instruments and earnings-per-share guidance. The ASU also revises the derivative scope exception guidance to reduce form-over-substance-based accounting conclusions driven by remote contingent events. The amendments in this update are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. Early adoption will be permitted, but no earlier than for fiscal years beginning after December 15, 2020. Old National is currently evaluating the impact of adopting the new guidance on the consolidated financial statements.

Acquisitions and Dispositions of Businesses and Related Pro Forma Information – In May 2020, the SEC issued a final rule that revises the circumstances that require financial statements and related pro forma information for acquisitions and dispositions of businesses. The intent of the rule is to allow for more meaningful conclusions on when an acquired or disposed business is significant as well as to improve the related disclosure requirements. The changes are intended to improve the financial information about acquired or disposed businesses, facilitate more timely access to capital, and reduce the complexity and costs to prepare the disclosure. The final rule is effective January 1, 2021; however, voluntary early compliance is permitted.
FASB ASC 310 – In October 2020, the FASB issued ASU No. 2020-08, Codification Improvements to Subtopic 310-20, Receivables—Nonrefundable Fees and Other Costs, to clarify that an entity should reevaluate whether a callable debt security is within the scope of ASC paragraph 310-20-35-33 for each reporting period. The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020, and early application is not permitted. Old National is currently evaluating the impact of adopting the new guidance on the consolidated financial statements.
FASB ASC 470 – In October 2020, the FASB issued ASU No. 2020-09, Debt (Topic 470) Amendments to SEC Paragraphs Pursuant to SEC Release No. 33-10762, which amends and supersedes various SEC paragraphs to reflect SEC Release No. 33-10762. That release amends the financial disclosure requirements applicable to registered debt offerings that include credit enhancements, such as subsidiary guarantees. These changes are intended to both improve the quality of disclosure and increase the likelihood that issuers will conduct debt offerings on a registered basis. The final rules are effective on January 4, 2021. Voluntary compliance with the final
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amendments in advance of January 4, 2021, will be permitted. The amendments will not have a material impact on the consolidated financial statements.
Codification Improvements – In October 2020, the FASB issued ASU No. 2020-10, Codification Improvements. The amendments improve codification by having all disclosure-related guidance available in the disclosure sections of the codification. Prior to this ASU, various disclosure requirements or options to present information on the face of the financial statements or as a note to the financial statements were not included in the appropriate disclosure sections of the codification. The codification improvements also contain various other minor amendments to codification that are not expected to have a significant effect on current accounting practice. The amendments are effective for annual periods beginning after December 15, 2020, and early application is permitted.
NOTE 2 – INVESTMENT SECURITIES
The following table summarizes the amortized cost and fair value of the available-for-sale investment securities portfolio and the corresponding amounts of unrealized gains, unrealized losses, and basis adjustments recognized in accumulated other comprehensive income (loss):
(dollars in thousands)Amortized
Cost
Unrealized
Gains
Unrealized
Losses
Basis AdjustmentsFair
Value
December 31, 2020
Available-for-Sale
U.S. Treasury$9,909 $299 $0 $0 $10,208 
U.S. government-sponsored entities and agencies841,133 5,744 (3,921)(968)841,988 
Mortgage-backed securities - Agency3,249,002 91,086 (990)0 3,339,098 
States and political subdivisions1,405,868 86,325 (31)0 1,492,162 
Pooled trust preferred securities13,763 0 (5,850)0 7,913 
Other securities265,079 14,260 (593)0 278,746 
Total available-for-sale securities$5,784,754 $197,714 $(11,385)$(968)$5,970,115 
December 31, 2019
Available-for-Sale
U.S. Treasury$17,567 $117 $(2)$$17,682 
U.S. government-sponsored entities and agencies596,595 1,027 (4,638)592,984 
Mortgage-backed securities - Agency3,151,550 41,363 (9,052)3,183,861 
States and political subdivisions1,232,497 44,193 (1,047)1,275,643 
Pooled trust preferred securities13,811 (5,589)8,222 
Other securities301,189 6,842 (1,332)306,699 
Total available-for-sale securities$5,313,209 $93,542 $(21,660)$$5,385,091 
During the fourth quarter of 2019, Old National inadvertently sold 6 held-to-maturity classified municipal bond investment securities valued at $9.7 million for a gain of $0.3 million.  After the trade settled, Old National determined the sale of the held-to-maturity investment securities was not one of the permissible sale exceptions afforded by the current accounting guidance.  Accordingly, Old National reclassified the entire held-to-maturity portfolio totaling $382.0 million into the available-for-sale portfolio, which increased capital by $19.4 million.  The increase in capital included $13.0 million of unrealized holding gains at the date of transfer, net of tax, which is included on the consolidated statement of comprehensive income in unrealized holding gains (losses) on available-for-sale debt securities of $93.5 million for the year ended December 31, 2019.  Management does not expect to use the held-to-maturity category for at least two years from the date of the sale.
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Proceeds from sales or calls of available-for-sale investment securities, the resulting realized gains and realized losses, and other securities gains or losses were as follows:
Years Ended December 31,
(dollars in thousands)202020192018
Proceeds from sales of available-for-sale debt securities$299,885 $424,140 $139,364 
Proceeds from calls of available-for-sale debt securities465,179 441,851 32,437 
Total$765,064 $865,991 $171,801 
Realized gains on sales of available-for-sale debt securities$11,172 $4,620 $3,259 
Realized gains on calls of available-for-sale debt securities121 93 283 
Realized losses on sales of available-for-sale debt securities(500)(2,760)(1,469)
Realized losses on calls of available-for-sale debt securities(26)(30)(63)
Other securities gains (losses) (1)0 50 
Debt securities gains (losses), net$10,767 $1,923 $2,060 
(1)Other securities gains (losses) in 2018 included realized gains and losses of equity securities previously classified as trading securities.  For 2020 and 2019, gains (losses) on equity securities are included in other income.
Investment securities pledged to secure public and other funds had a carrying value of $2.427 billion at December 31, 2020 and $2.104 billion at December 31, 2019.
At December 31, 2020, Old National had a concentration of investment securities issued by certain states and their political subdivisions with the following aggregate market values: $515.6 million issued by Indiana, which represented 17.3% of shareholders’ equity, and $194.3 million issued 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.
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All of the mortgage-backed securities in the investment portfolio are residential mortgage-backed securities.  The amortized cost and fair value of the investment securities portfolio are shown by contractual maturity.  Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.  Weighted average yield is based on amortized cost.
At December 31, 2020
(dollars in thousands)Amortized
Cost
Fair
Value
Weighted
Average
Yield
Maturity
Available-for-Sale
Within one year$353,414 $358,852 2.61 %
One to five years2,828,719 2,922,695 2.27 %
Five to ten years1,029,340 1,049,684 1.98 %
Beyond ten years1,573,281 1,638,884 2.90 %
Total$5,784,754 $5,970,115 2.41 %
The following table summarizes the available-for-sale investment securities with unrealized losses for which an allowance for credit losses has not been recorded by aggregated major security type and length of time in a continuous unrealized loss position:
Less than 12 months12 months or longerTotal
(dollars in thousands)Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized Losses
December 31, 2020
Available-for-Sale
U.S. government-sponsored entities
   and agencies
$355,528 $(3,921)$0 $0 $355,528 $(3,921)
Mortgage-backed securities - Agency275,833 (895)3,572 (95)279,405 (990)
States and political subdivisions3,497 (31)0 0 3,497 (31)
Pooled trust preferred securities00 7,913 (5,850)7,913 (5,850)
Other securities19,404 (70)24,871 (523)44,275 (593)
Total available-for-sale$654,262 $(4,917)$36,356 $(6,468)$690,618 $(11,385)
December 31, 2019
Available-for-Sale
U.S. Treasury$999 $(2)$$$999 $(2)
U.S. government-sponsored entities
   and agencies
357,647 (4,638)357,647 (4,638)
Mortgage-backed securities - Agency786,245 (6,122)212,056 (2,930)998,301 (9,052)
States and political subdivisions120,166 (1,016)7,006 (31)127,172 (1,047)
Pooled trust preferred securities008,222 (5,589)8,222 (5,589)
Other securities30,765 (182)87,066 (1,150)117,831 (1,332)
Total available-for-sale$1,295,822 $(11,960)$314,350 $(9,700)$1,610,172 $(21,660)
Available-for-sale debt securities in unrealized loss positions are evaluated for impairment related to credit losses at least quarterly. For available-for sale debt securities in an unrealized loss position, we first assess whether we intend to sell, or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For available-for sale debt securities that do not meet the criteria, we evaluate whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security and the issuer, among other factors. If this assessment indicates that a credit loss exists, we compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis for the security, a credit loss exists and an allowance for credit losses is recorded, limited to the amount that the fair value of the security is less than its amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income, net of applicable taxes. No allowance for credit losses for available-for-sale debt securities
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was needed at December 31, 2020. Accrued interest receivable on available-for-sale debt securities totaled $27.0 million at December 31, 2020 and is excluded from the estimate of credit losses.
The U.S. government sponsored entities and agencies and mortgage-backed securities – agency are either explicitly or implicitly guaranteed by the U.S. government, are highly rated by major credit rating agencies, and have a long history of no credit losses. Therefore, for those securities, we do not record expected credit losses.
Prior to the adoption of ASC 326, we did 0t record OTTI in 2019 or 2018.
At December 31, 2020, Old National’s securities portfolio consisted of 1,918 securities, 69 of which were in an unrealized loss position.  The unrealized losses attributable to our U.S. government-sponsored entities and agencies, agency mortgage-backed securities, states and political subdivisions, and other securities are the result of fluctuations in interest rates.  Our pooled trust preferred securities are discussed below.  At December 31, 2020, we had no intent to sell any securities that were in an unrealized loss position nor is it expected that we would be required to sell the securities prior to their anticipated recovery.
Pooled Trust Preferred Securities
At December 31, 2020, our securities portfolio contained 2 pooled trust preferred securities with a fair value of $7.9 million and unrealized losses of $5.9 million.  These securities are evaluated using collateral-specific assumptions to estimate the expected future interest and principal cash flows.  For the years ended December 31, 2020 and 2019, we did 0t recognize any losses on these securities.
The table below summarizes the relevant characteristics of our pooled trust preferred securities as well as our single issuer trust preferred securities that are included in the “other securities” category in this footnote.  Each of the pooled trust preferred securities support a more senior tranche of security holders.  Both pooled trust preferred securities have experienced credit defaults.  However, we believe that the value of the instruments lies in the full and timely interest payments that will be received through maturity, the steady amortization that will be experienced until maturity, and the full return of principal by the final maturity of the collateralized debt obligations.
(dollars in thousands)ClassLowest
Credit
Rating (1)
Amortized
Cost
Fair
Value
Unrealized
Gain/
(Loss)
# of Issuers
Currently
Performing/
Remaining
Actual
Deferrals
and Defaults
as a % of
Original
Collateral
Expected
Defaults as
a % of
Remaining
Performing
Collateral
Excess
Subordination
as a % of
Current
Performing
Collateral
December 31, 2020
Pooled trust preferred securities:
Pretsl XXVII LTDBB$4,223 $2,331 $(1,892)32/4114.4 %10.8%35.1%
Trapeza Ser 13AA2ABBB9,540 5,582 (3,958)39/414.5 %6.4%52.0%
13,763 7,913 (5,850)
Single Issuer trust preferred securities:
JP Morgan Chase & CoBBB-4,809 4,463 (346)
Total$18,572 $12,376 $(6,196)
(1)    Lowest rating for the security provided by any nationally recognized credit rating agency.
Equity Securities
Old National’s equity securities with readily determinable fair values totaled $2.5 million at December 31, 2020 and $6.8 million at December 31, 2019.  There were gains on equity securities of $1.4 million during 2020, $0.7 million during 2019, and $0.1 million during 2018.  Old National also has equity securities without readily determinable fair values that are included in other assets that totaled $105.8 million at December 31, 2020 and $91.4 million at December 31, 2019.  These are illiquid investments that consist of partnerships, limited liability companies, and other ownership interests that support affordable housing, economic development, and community revitalization initiatives in low-to-moderate income neighborhoods.  There were impairments on these securities totaling $117 thousand during 2020 and 0 impairments or adjustments in 2019 or 2018.
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NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES
Loans
Old National’s loans consist primarily of loans made to consumers and commercial clients in various industries including manufacturing, agribusiness, transportation, mining, wholesaling, and retailing.  Most of Old National’s lending activity occurs within our principal geographic markets of Indiana, Kentucky, Michigan, Minnesota, and Wisconsin.  Old National manages concentrations of credit exposure by industry, product, geography, customer relationship, and loan size.  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.
The loan categories used to monitor and analyze interest income and yields are different than the portfolio segments used to determine the allowance for credit losses for loans. The allowance for credit losses was calculated by pooling loans of similar credit risk characteristics and credit monitoring procedures. The 4 loan portfolios are classified into 7 segments of loans - commercial, commercial real estate, BBCC, residential real estate, indirect, direct, and home equity. The commercial and commercial real estate loan categories shown on the balance sheet include the same pool of loans as the commercial, commercial real estate, and BBCC portfolio segments. The consumer loan category shown on the balance sheet is comprised of the same loans in the indirect, direct, and home equity portfolio segments. The composition of loans by portfolio segment as of December 31, 2020 follows:

December 31, 2020SegmentDecember 31, 2020
StatementPortfolioAfter
(dollars in thousands)BalanceReclassificationsReclassifications
Loans:
Commercial$3,956,422 $(198,722)$3,757,700 
Commercial real estate5,946,512 (171,701)5,774,811 
BBCCN/A370,423 370,423 
Residential real estate2,248,422 2,248,422 
Consumer1,635,123 (1,635,123)N/A
IndirectN/A913,902 913,902 
DirectN/A164,807 164,807 
Home equityN/A556,414 556,414 
Total$13,786,479 $— $13,786,479 
The composition of loans by portfolio segment follows:
(dollars in thousands)December 31,
2020
January 1,
2020
Commercial (1) (2)$3,757,700 $2,817,833 
Commercial real estate5,774,811 4,890,890 
BBCC370,423 352,714 
Residential real estate2,248,422 2,334,394 
Indirect913,902 935,594 
Direct164,807 228,526 
Home equity556,414 562,051 
Total loans13,786,479 12,122,002 
Allowance for credit losses(131,388)(95,966)
Net loans$13,655,091 $12,026,036 
(1)    Includes direct finance leases of $32.3 million at December 31, 2020 and $47.2 million at January 1, 2020.
(2)    Includes remaining PPP loans of $943.0 million at December 31, 2020.

The risk characteristics of each loan portfolio segment are as follows:
Commercial
Commercial loans are classified primarily on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower.  The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value.  Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee;
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however, some loans may be made on an unsecured basis.  In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
Section 1102 of the CARES Act created the PPP, a program administered by the SBA to provide loans to small businesses for payroll and other basic expenses during the COVID-19 pandemic. Old National has participated in the PPP as a lender. These loans are eligible to be forgiven if certain conditions are satisfied and are fully guaranteed by the SBA. Additionally, loan payments will also be deferred for the first six months of the loan term. The PPP commenced on April 3, 2020 and was available to qualified borrowers through August 8, 2020. No collateral or personal guarantees were required. Neither the government nor lenders are permitted to charge the recipients any fees. During 2020, Old National originated over 9,700 loans with balances in excess of $1.5 billion to new and existing customers through the PPP. At December 31, 2020, remaining PPP loans totaled $943.0 million.
On December 27, 2020, President Trump signed into law the CAA. The CAA, among other things, extends the life of the PPP, effectively creating a second round of PPP loans for eligible businesses. Old National is participating in the CAA’s second round of PPP lending. In mid-January Old National opened its lending portal and began processing PPP loan applications. Currently, Old National is focused on helping minority-owned business, women-owned business, not-for-profit entities, and existing first round PPP customers with the lending process. Additionally, section 541 of the CAA extends the relief provided by the CARES Act for financial institutions to suspend the GAAP accounting treatment for troubled debt restructuring to January 1, 2022.
Commercial Real Estate
Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate.  Commercial real estate lending typically involves higher loan principal amounts, and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan.  Commercial real estate loans may be adversely affected by conditions in the real estate markets or in the general economy.  The properties securing Old National’s commercial real estate portfolio are diverse in terms of type and geographic location.  Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.
Included with commercial real estate are construction loans, which are underwritten utilizing independent appraisal reviews, sensitivity analysis of absorption and lease rates, financial analysis of the developers and property owners, and feasibility studies, if available.  Construction loans are generally based on estimates of costs and value associated with the complete project.  These estimates may be inaccurate.  Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project.  Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders (including Old National), sales of developed property, or an interim loan commitment from Old National until permanent financing is obtained.  These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions, and the availability of long-term financing.
At 222%, Old National Bank’s commercial real estate loans as a percentage of its risk-based capital remained well below the regulatory guideline limit of 300% at December 31, 2020.
BBCC
BBCC loans are typically granted to small businesses with gross revenues of less than $5 million and aggregate debt of less than $1 million. Old National has established minimum debt service coverage ratios, minimum FICO scores for owners and guarantors, and the ability to show relatively stable earnings as criteria to help mitigate risk. Repayment of these loans depends on the personal income of the borrowers and the cash flows of the business. These factors can be affected by changes in economic conditions such as unemployment levels.
Residential
With respect to residential loans that are secured by 1-4 family residences and are generally owner occupied, Old National typically establishes a maximum loan-to-value ratio and generally requires private mortgage insurance if that ratio is exceeded.  Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels.  Repayment can
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also be impacted by changes in residential property values.  Portfolio risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.
Indirect
Indirect loans are secured by automobile collateral, generally new and used cars and trucks from auto dealers that operate within our footprint. Old National typically mitigates the risk of indirect loans by establishing minimum FICO scores, maximum loan-to-value ratios, and maximum debt-to-income ratios. Repayment of these loans depends largely on the personal income of the borrowers which can be affected by changes in economic conditions such as unemployment levels. Portfolio risk is mitigated by the fact that the loans are of smaller amounts spread over many borrowers, conservative credit policies, and ongoing reviews of dealer relationships.

Direct
Direct loans are typically secured by collateral such as auto or real estate or are unsecured. Old National has established conservative underwriting standards such as minimum FICO scores, maximum loan-to-value ratios, and maximum debt-to-income ratios. Repayment of these loans depends largely on the personal income of the borrowers which can be affected by changes in economic conditions such as unemployment levels. Portfolio risk is mitigated by the fact that the loans are of smaller amounts spread over many borrowers along with conservative credit policies.
Home Equity
Home equity loans are generally secured by 1-4 family residences that are owner occupied. Old National has established conservative underwriting standards such as minimum FICO scores, maximum loan-to-value ratios, and maximum debt-to-income ratios. Repayment of these loans depends largely on the personal income of the borrowers which can be affected by changes in economic conditions such as unemployment levels. Portfolio risk is mitigated by the fact that the loans are of smaller amounts spread over many borrowers, along with conservative credit policies as well as monitoring of updated borrower credit scores.
Related Party Loans
In the ordinary course of business, Old National grants loans to certain executive officers, directors, and significant subsidiaries (collectively referred to as “related parties”).
Activity in related party loans is presented in the following table:
Years Ended December 31,
(dollars in thousands)202020192018
Balance at beginning of period$2,345 $9,310 $9,481 
New loans1,848 1,218 9,152 
Repayments(1,715)(2,063)(8,721)
Officer and director changes(34)(6,120)(602)
Balance at end of period$2,444 $2,345 $9,310 
Allowance for Credit Losses
Loans
Credit quality within the loans held for investment portfolio is continuously monitored by management and is reflected within the allowance for credit losses for loans. The allowance for credit losses is an estimate of expected losses inherent within the Company’s loans held for investment portfolio. Credit quality is assessed and monitored by evaluating various attributes and the results of those evaluations are utilized in underwriting new loans and in our process for estimating expected credit losses. Expected credit loss inherent in non-cancelable off-balance-sheet credit exposures is accounted for as a separate liability included in other liabilities on the balance sheet. The allowance for credit losses for loans held for investment is adjusted by a credit loss expense, which is reported in earnings, and reduced by the charge-off of loan amounts, net of recoveries. Old National has made a policy election to report accrued interest receivable as a separate line item on the balance sheet. Accrued interest receivable on loans totaled $57.3 million at December 31, 2020 and is excluded from the estimate of credit losses.
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The allowance for credit loss estimation process involves procedures to appropriately consider the unique characteristics of its loan portfolio segments. These segments are further disaggregated into loan classes based on the level at which credit risk is monitored. When computing the level of expected credit losses, credit loss assumptions are estimated using a model that categorizes loan pools based on loss history, delinquency status, and other credit trends and risk characteristics, including current conditions and reasonable and supportable forecasts about the future. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. In future periods evaluations of the overall loan portfolio, in light of the factors and forecasts then prevailing, may result in significant changes in the allowance and credit loss expense in those future periods.
The allowance level is influenced by loan volumes, loan AQR migration or delinquency status, changes in historical loss experience, and other conditions influencing loss expectations, such as reasonable and supportable forecasts of economic conditions. The methodology for estimating the amount of expected credit losses reported in the allowance for credit losses has two basic components: first, an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans; and second, a pooled component for estimated expected credit losses for pools of loans that share similar risk characteristics. See Note 1 for more information about CECL for loans and unfunded loan commitments.
The allowance for credit losses increased for the year ended December 31, 2020 primarily due to the implementation of ASC 326 and the macroeconomic factors surrounding the COVID-19 pandemic. The forecast scenario includes elevated unemployment, which is forecasted to increase slightly through the second quarter of 2021. The scenario also shows a slight decrease in nominal gross domestic product with a return to growth by the third quarter of 2021. In addition to these quantitative inputs, several qualitative factors were considered, including the risk that the economic decline, specifically unemployment and gross domestic product, prove to be more severe and/or prolonged than our baseline forecast. Also, the efficacy, distribution, and consumption of the vaccine along with new variants of the virus pose additional risk. The mitigating impact of any additional fiscal stimulus, including direct payments to individuals, increased unemployment benefits, as well as the various government sponsored loan programs, was also considered. Old National’s activity in the allowance for credit losses for loans by portfolio segment was as follows:
(dollars in thousands)Balance at
Beginning of
Period
Impact of
Adopting
ASC 326
Sub-TotalCharge-offsRecoveriesProvision
for Credit
Losses
Balance at
End of
Period
Year Ended
December 31, 2020
Allowance for credit losses:
Commercial$21,359 $7,150 $28,509 $(5,593)$3,629 $4,022 $30,567 
Commercial real estate20,535 25,548 46,083 (4,323)4,515 29,535 75,810 
BBCC2,279 3,702 5,981 (95)140 94 6,120 
Residential real estate2,299 6,986 9,285 (824)633 3,514 12,608 
Indirect5,319 (1,669)3,650 (2,754)1,922 762 3,580 
Direct1,863 (1,059)804 (1,763)819 995 855 
Home equity965 689 1,654 (201)922 (527)1,848 
Total allowance for credit losses$54,619 $41,347 $95,966 $(15,553)$12,580 $38,395 $131,388 
PPP loans were factored in the provision for credit losses for the year ended December 31, 2020; however, due to the SBA guaranty and our borrowers’ adherence to the PPP terms, the provision impact was insignificant.
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Unfunded Loan Commitments
Old National maintains an allowance for credit 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 credit losses for loans, modified to take into account the probability of a drawdown on the commitment. The allowance for credit losses on unfunded loan commitments is classified as a liability account on the balance sheet. Old National’s activity in the allowance for credit losses on unfunded loan commitments was as follows:
(dollars in thousands)Year Ended
December 31, 2020
Allowance for credit losses on unfunded loan commitments:
Balance at beginning of period$2,656 
Impact of adopting ASC 3264,549 
Sub-Total7,205 
Expense (reversal of expense) for credit losses4,484 
Balance at end of period$11,689 
Credit Quality
Old National’s management monitors the credit quality of its loans on an ongoing basis with the AQR for commercial loans reviewed annually or at renewal and the performance of its residential and consumer loans based upon the accrual status refreshed at least quarterly.  Internally, management assigns an AQR to each non-homogeneous commercial, commercial real estate, and BBCC loan in the portfolio.  The primary determinants of the AQR are the reliability of the primary source of repayment and the past, present, and projected financial condition of the borrower.  The AQR will also consider current industry conditions.  Major factors used in determining the AQR can vary based on the nature of the loan, but commonly include factors such as debt service coverage, internal cash flow, liquidity, leverage, operating performance, debt burden, FICO scores, occupancy, interest rate sensitivity, and expense burden.  Old National uses the following definitions for risk ratings:
Criticized.  Special mention loans that have a potential weakness that deserves management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
Classified – Substandard.  Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Classified – Nonaccrual.  Loans classified as nonaccrual have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection in full, on the basis of currently existing facts, conditions, and values, in doubt.
Classified – Doubtful.  Loans classified as doubtful have all the weaknesses inherent in those classified as nonaccrual, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Pass rated loans are those loans that are other than criticized, classified – substandard, classified – nonaccrual, or classified – doubtful.
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The following table summarizes the risk category of commercial, commercial real estate, and BBCC loans by loan portfolio segment and class of loan:
Risk Rating
(dollars in thousands)PassCriticizedClassified -
Substandard
Classified -
Nonaccrual
Classified -
Doubtful
Total
December 31, 2020
Commercial:
Term Loans at Amortized Cost by Origination Year:
Prior to 2016$262,538 $5,369 $8,441 $4,379 $610 $281,337 
2016124,041 3,383 2,774 49 296 130,543 
2017227,710 9,508 9,836 6,951 2,748 256,753 
2018171,228 15,003 10,077 4,701 1,016 202,025 
2019420,736 9,603 6,369 3,754 440,462 
20201,675,964 23,982 6,501 2,600 1,709,047 
Revolving Loans549,849 10,307 15,344 778 576,278 
Revolving to Term Loans148,508 2,685 3,049 7,013 161,255 
Total$3,580,574 $79,840 $62,391 $30,225 $4,670 $3,757,700 
Commercial real estate:
Term Loans at Amortized Cost by Origination Year:
Prior to 2016$513,658 $33,490 $8,665 $12,564 $3,274 $571,651 
2016496,086 17,648 5,308 1,635 19,283 539,960 
2017677,119 46,994 26,691 9,456 18,926 779,186 
2018749,102 26,464 13,565 5,393 794,524 
20191,041,305 49,271 4,700 2,054 1,832 1,099,162 
20201,537,226 6,874 11,451 1,408 1,556,959 
Revolving Loans28,122 28,122 
Revolving to Term Loans382,219 19,804 2,911 313 405,247 
Total$5,424,837 $200,545 $73,291 $32,823 $43,315 $5,774,811 
BBCC:
Term Loans at Amortized Cost by Origination Year:
Prior to 2016$5,327 $