Income Taxes

3 Months Ended

Mar. 31, 2020

INCOME TAXES

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


	Three Months Ended March 31,
(dollars in thousands)	2020			2019
Provision at statutory rate of 21%	$	5,372		$	14,570
Tax-exempt income:
Tax-exempt interest	(2,632)			(2,531)
Section 291/265 interest disallowance	73			111
Company-owned life insurance income	(647)			(669)
Tax-exempt income	(3,206)			(3,089)
State income taxes	(8)			1,999
Interim period effective rate adjustment	3,267			688
Tax credit investments - federal	(1,902)			(420)
Other, net	(584)			(644)
Income tax expense	$	2,939		$	13,104
Effective tax rate	11.5		%	18.9		%

In accordance with ASC 740-270, Accounting for Interim Reporting, the provision for income taxes was recorded at March 31, 2020 and 2019 based on the current estimate of the effective annual rate.

The lower effective tax rate during the three months ended March 31, 2020 when compared to the three months ended March 31, 2019 is primarily the result of an increase in federal tax credits available.

Unrecognized Tax Benefits

Old National has an immaterial amount of unrecognized tax benefits. Old National is currently under audit by the Internal Revenue Service. Old National expects the total amount of unrecognized tax benefits to be reduced to zero after the audit is finalized.

Net Deferred Tax Assets

Significant components of net deferred tax assets (liabilities) were as follows:


(dollars in thousands)	March 31, 2020		December 31, 2019
Deferred Tax Assets
Allowance for loan losses, net of recapture	$	28,603	$	14,179
Benefit plan accruals	13,268		19,673
Alternative minimum tax credit	1,272		1,272
Net operating loss carryforwards	21,575		25,336
Federal tax credits	3,238		—
Deferred gain on securities	3,339		3,754
Acquired loans	15,341		16,784
Operating lease liabilities	25,591		26,503



Tax credit investments and other partnerships	2,808		1,765
Other real estate owned	143		141
Other, net	790		591
Total deferred tax assets	115,968		109,998
Deferred Tax Liabilities

Purchase accounting	(18,187)		(17,564)
Loan servicing rights	(5,989)		(6,289)
Premises and equipment	(8,139)		(12,167)
Prepaid expenses	(973)		(973)
Operating lease right-of-use assets	(23,285)		(25,448)
Unrealized gains on available-for-sale investment securities	(38,162)		(15,751)
Unrealized gains on hedges	(1,889)		(78)
Other, net	(1,768)		(2,023)
Total deferred tax liabilities	(98,392)		(80,293)
Net deferred tax assets	$	17,576	$	29,705

Through the acquisition of Anchor (WI) in the second quarter of 2016 and Lafayette Savings Bank in the fourth quarter of 2014, both former thrifts, Old National Bank’s retained earnings at March 31, 2020 include base-year bad debt reserves, created for tax purposes prior to 1988, totaling $52.8 million. Of this total, $50.9 million was acquired from Anchor (WI), and $1.9 million was acquired from Lafayette Savings Bank. Base-year reserves are subject to recapture in the unlikely event that Old National Bank (1) makes distributions in excess of current and accumulated earnings and profits, as calculated for federal income tax purposes, (2) redeems its stock, or (3) liquidates. Old National Bank has no intention of making such a nondividend distribution. Accordingly, under current accounting principles, a related deferred income tax liability of $13.0 million has not been recognized.

No valuation allowance was recorded at March 31, 2020 or December 31, 2019 because, based on current expectations, Old National believes it will generate sufficient income in future years to realize deferred tax assets. Old National has federal net operating loss carryforwards totaling $60.1 million at March 31, 2020 and $78.5 million at December 31, 2019. This federal net operating loss was acquired from the acquisition of Anchor (WI) in 2016. If not used, the federal net operating loss carryforwards will expire from 2029 to 2033. Old National has alternative minimum tax credit carryforwards subject to section 382 limitations and included in net deferred tax assets totaling $1.3 million at March 31, 2020 and $1.3 million at December 31, 2019. The enactment of H.R. 1 eliminated the parallel tax system known as the alternative minimum tax and allowed any existing alternative minimum tax credits to be used to reduce regular tax or be refunded from 2018 to 2021. Old National has recorded state net operating loss carryforwards totaling $150.3 million at March 31, 2020 and $148.4 million at December 31, 2019. If not used, the state net operating loss carryforwards will expire from 2024 to 2035. Old National had federal tax credit carryforwards of $3.2 million at March 31, 2020.

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