NOTE 21 – FAIR VALUE

FASB ASC 820-10 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820-10 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair values:

· Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

· Level 2 – Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

· Level 3 – Significant unobservable inputs that reflect a company's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Old National used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Trading securities: The fair value for trading securities is determined by quoted market prices (Level 1).

Investment securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using swap and libor curves plus spreads that adjust for loss severities, volatility, credit risk and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Residential loans held for sale: The fair value of loans held for sale is determined using quoted prices for a similar asset, adjusted for specific attributes of that loan (Level 2).

Derivative financial instruments: The fair values of derivative financial instruments are based on derivative valuation models using market data inputs as of the valuation date (Level 2).

Assets and liabilities measured at fair value on a recurring basis, including financial assets and liabilities for which the Company has elected the fair value option, are summarized below:


				Fair Value Measurements at September 30, 2011 Using
						Significant
				Quoted Prices in		Other		Significant
				Active Markets for		Observable		Unobservable
		Carrying		Identical Assets		Inputs		Inputs
(dollars in thousands)		Value		(Level 1)		(Level 2)		(Level 3)

Financial Assets
Trading securities	$	2,794	$	2,794	$	0	$	0
Investment securities available-for-sale:
U.S. Treasury		65,951		65,951		0		0
U.S. Government-sponsored entities and agencies		180,934		0		180,934		0
Mortgage-backed securities - Agency		1,346,534		0		1,346,534		0
Mortgage-backed securities - Non-agency		95,051		0		95,051		0
States and political subdivisions		391,202		0		391,202		0
Pooled trust preferred securities		7,530		0		0		7,530
Other securities		165,887		0		165,887		0
Residential loans held for sale		4,710		0		4,710		0
Derivative assets		47,209		0		47,209		0
Financial Liabilities
Derivative liabilities		39,599		0		39,599		0

There were no significant transfers into or out of Level 1, Level 2 or Level 3 assets or liabilities during the nine months ended September 30, 2011.


				Fair Value Measurements at December 31, 2010 Using
						Significant
				Quoted Prices in		Other		Significant
				Active Markets for		Observable		Unobservable
		Carrying		Identical Assets		Inputs		Inputs
(dollars in thousands)		Value		(Level 1)		(Level 2)		(Level 3)

Financial Assets
Investment securities available-for-sale:
U.S. Treasury	$	62,550	$	62,550	$	0	$	0
U.S. Government-sponsored entities and agencies		315,133		0		315,133		0
Mortgage-backed securities - Agency		944,446		0		944,446		0
Mortgage-backed securities - Non-agency		126,806		0		126,806		0
States and political subdivisions		348,924		0		348,924		0
Pooled trust preferred securities		8,400		0		0		8,400
Other securities		153,963		0		153,963		0
Residential loans held for sale		3,819		0		3,819		0
Derivative assets		34,082		0		34,082		0
Financial Liabilities
Derivative liabilities		29,721		0		29,721		0

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2011:


Fair Value Measurements using Significant Unobservable Inputs


		(Level 3)
Pooled Trust Preferred
Securities Available-
(dollars in thousands)		for-Sale
Beginning balance, January 1, 2011	$	8,400
Accretion/(amortization) of discount or premium		(49	)
Payments received		(5	)
Credit loss write-downs		0
Increase/(decrease) in fair value of securities		(816	)
Ending balance, September 30, 2011	$	7,530

Included in the income statement is $49 thousand of expense included in interest income from the amortization of premiums on securities. The increase in fair value is reflected in the balance sheet as an increase in the fair value of investment securities available-for sale, an increase in accumulated other comprehensive income, which is included in shareholders' equity, and a decrease in other assets related to the tax impact.

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2010:


Fair Value Measurements using Significant Unobservable Inputs


		(Level 3)
Pooled Trust Preferred
Securities Available-
(dollars in thousands)		for-Sale
Beginning balance, January 1, 2010	$	12,398
Accretion/(amortization) of discount or premium		(86	)
Payments received		(10	)
Credit loss write-downs		(311	)
Increase/(decrease) in fair value of securities		(3,575	)
Ending balance, September 30, 2010	$	8,416

Included in the income statement are $86 thousand of expense included in interest income from the amortization of premiums on securities and $311 thousand of credit losses included in noninterest income. The decrease in fair value is reflected in the balance sheet as a decrease in the fair value of investment securities available-for sale, a decrease in accumulated other comprehensive income, which is included in shareholders' equity, and an increase in other assets related to the tax impact.


Assets measured at fair value on a non-recurring basis are summarized below:

				Fair Value Measurements at September 30, 2011 Using
						Significant
				Quoted Prices in		Other		Significant
				Active Markets for		Observable		Unobservable
		Carrying		Identical Assets		Inputs		Inputs
(dollars in thousands)		Value		(Level 1)		(Level 2)		(Level 3)
Collateral Dependent Impaired Loans
Commercial loans	$	17,165	$	0	$	0	$	17,165
Commercial real estate loans		21,986		0		0		21,986

Impaired commercial and commercial real estate loans that are deemed collateral dependent are valued based on the fair value of the underlying collateral. These estimates are based on the most recently available real estate appraisals with certain adjustments made based on the type of property, age of appraisal, current status of the property and other related factors to estimate the current value of the collateral. These impaired commercial and commercial real estate loans had a principal amount of $55.4 million, with a valuation allowance of $16.3 million at September 30, 2011. Old National recorded $10.3 million of provision expense associated with these loans for the nine months ended September 30, 2011.


				Fair Value Measurements at December 31, 2010 Using
						Significant
				Quoted Prices in		Other		Significant
				Active Markets for		Observable		Unobservable
		Carrying		Identical Assets		Inputs		Inputs
(dollars in thousands)		Value		(Level 1)		(Level 2)		(Level 3)
Collateral Dependent Impaired Loans
Commercial loans	$	14,721	$	0	$	0	$	14,721
Commercial real estate loans		8,112		0		0		8,112

As of December 31, 2010, impaired commercial and commercial real estate loans had a principal amount of $36.4 million, with a valuation allowance of $13.6 million. Old National recorded $7.1 million of provision expense associated with these loans in 2010.

Financial instruments recorded using fair value option

Under FASB ASC 825-10, the Company may elect to report most financial instruments and certain other items at fair value on an instrument-by instrument basis with changes in fair value reported in net income. After the initial adoption, the election is made at the acquisition of an eligible financial asset, financial liability or firm commitment or when certain specified reconsideration events occur. The fair value election may not be revoked once an election is made.

The Company has elected the fair value option for residential mortgage loans held for sale. For these loans, interest income is recorded in the consolidated statements of income based on the contractual amount of interest income earned on the financial assets (except any that are on nonaccrual status). None of these loans are 90 days or more past due, nor are any on nonaccrual status. Included in the income statement are $41 thousand and $141 thousand of interest income for residential loans held for sale for the three and nine months ended September 30, 2011, respectively. Included in the income statement are $49 thousand and $172 thousand of interest income for residential loans held for sale for the three and nine months ended September 30, 2010, respectively.

Residential mortgage loans held for sale

Old National has elected the fair value option for newly originated conforming fixed-rate and adjustable-rate first mortgage loans held for sale. These loans are intended for sale and are hedged with derivative instruments. Old National has elected the fair value option to mitigate accounting mismatches in cases where hedge accounting is complex and to achieve operational simplification. The fair value option was not elected for loans held for investment.

As of September 30 2011, the difference between the aggregate fair value and the aggregate remaining principal balance for loans for which the fair value option has been elected is as follows. Accrued interest at period end is included in the fair value of the instruments.


		Aggregate				Contractual
(dollars in thousands)		Fair Value		Difference		Principal
Residential loans held for sale	$	4,710	$	158	$	4,552

The following table presents the amount of gains and losses from fair value changes included in income before income taxes for financial assets carried at fair value for the three and nine months ended September 30, 2011:

Changes in Fair Value for the Three Months ended September 30, 2011, for Items Measured at Fair Value Pursuant to Election of the Fair Value Option


									Total Changes
									in Fair Values
		Other							Included in
		Gains and			Interest		Interest		Current Period
(dollars in thousands)		(Losses)			Income		(Expense)		Earnings
Residential loans held for sale	$	(7	)	$	0	$	0	$	(7	)

Changes in Fair Value for the Nine Months ended September 30, 2011, for Items Measured at Fair Value Pursuant to Election of the Fair Value Option


									Total Changes
									in Fair Values
		Other							Included in
		Gains and		Interest		Interest			Current Period
(dollars in thousands)		(Losses)		Income		(Expense)			Earnings
Residential loans held for sale	$	179	$	0	$	(1	)	$	178

As of September 30, 2010, the difference between the aggregate fair value and the aggregate remaining principal balance for loans for which the fair value option has been elected was as follows. Accrued interest at period end is included in the fair value of the instruments.


		Aggregate				Contractual
(dollars in thousands)		Fair Value		Difference		Principal
Residential loans held for sale	$	3,512	$	81	$	3,431

Changes in Fair Value for the Three Months ended September 30, 2010, for Items Measured at Fair Value Pursuant to Election of the Fair Value Option Total Changes


									in Fair Values
		Other							Included in
		Gains and			Interest		Interest		Current Period
(dollars in thousands)		(Losses)			Income		(Expense)		Earnings
Residential loans held for sale	$	(136	)	$	2	$	0	$	(134	)

Changes in Fair Value for the Nine Months ended September 30, 2010, for Items Measured at Fair Value Pursuant to Election of the Fair Value Option


								Total Changes
								in Fair Values
		Other						Included in
		Gains and			Interest		Interest	Current Period
(dollars in thousands)		(Losses)			Income		(Expense)	Earnings
Residential loans held for sale	$	(206	)	$	3	$	0	$ (203)

The carrying amounts and estimated fair values of financial instruments, not previously presented in this note, at September 30, 2011 and December 31, 2010 are as follows:


		Carrying		Fair
(dollars in thousands)		Value		Value
September 30, 2011
Financial Assets
Cash, due from banks, federal funds sold
and money market investments	$	269,229	$	269,229
Investment securities held-to-maturity:
U.S. Government-sponsored entities and agencies		177,963		189,617
Mortgage-backed securities - Agency		91,622		95,372
State and political subdivisions		216,643		225,384
Other securities		7,054		7,054
Federal Home Loan Bank stock		34,870		34,870
Loans, net (including covered loans):
Commercial		1,376,700		1,425,792
Commercial real estate		1,465,571		1,531,385
Residential real estate		913,500		990,779
Consumer credit		1,030,033		1,082,806
FDIC indemnification asset		168,091		168,091
Accrued interest receivable		43,713		43,713
Financial Liabilities
Deposits:
Noninterest-bearing demand deposits	$	1,728,548	$	1,728,548
NOW, savings and money market deposits		3,447,992		3,447,992
Time deposits		1,690,723		1,734,907
Short-term borrowings:
Federal funds purchased		948		948
Repurchase agreements		328,720		328,716
Other short-term borrowings		11,336		11,336
Other borrowings:
Junior subordinated debenture		16,000		12,788
Subordinated notes		13,000		12,999
Repurchase agreements		50,000		54,848
Federal Home Loan Bank advances		211,006		227,938
Subordinated bank notes		150,000		150,000
Capital lease obligation		4,273		5,094
Accrued interest payable		10,366		10,366
FDIC true-up liability		14,090		14,090
Standby letters of credit		508		508
Off-Balance Sheet Financial Instruments
Commitments to extend credit	$	0	$	1,422


		Carrying		Fair
(dollars in thousands)		Value		Value
December 31, 2010
Financial Assets
Cash, due from banks, federal funds sold
and money market investments	$	251,552	$	251,552
Investment securities held-to-maturity:
U.S. Government-sponsored entities and agencies		303,265		301,809
Mortgage-backed securities - Agency		117,013		119,080
State and political subdivisions		217,381		204,379
Other securities		551		375
Federal Home Loan Bank stock		31,937		31,937
Loans, net (including impaired loans):
Commercial		1,185,194		1,220,464
Commercial real estate		909,742		952,885
Residential real estate		662,396		710,865
Consumer credit		913,810		969,263
Accrued interest receivable		42,971		42,971
Financial Liabilities
Deposits:
Noninterest-bearing demand deposits	$	1,276,024	$	1,276,024
NOW, savings and money market deposits		2,711,644		2,711,644
Time deposits		1,475,257		1,520,093
Short-term borrowings:
Federal funds purchased		1,663		1,663
Repurchase agreements		287,414		287,416
Other short-term borrowings		9,155		9,155
Other borrowings:
Junior subordinated debenture		8,000		7,998
Repurchase agreements		50,000		54,104
Federal Home Loan Bank advances		211,696		220,531
Subordinated bank notes		150,000		154,420
Capital lease obligation		4,307		5,138
Accrued interest payable		7,860		7,860
Standby letters of credit		518		518
Off-Balance Sheet Financial Instruments
Commitments to extend credit	$	0	$	1,311

The following methods and assumptions were used to estimate the fair value of each type of financial instrument.

Cash, due from banks, federal funds sold and resell agreements and money market investments: For these instruments, the carrying amounts approximate fair value.

Investment securities: Fair values for investment securities held-to-maturity are based on quoted market prices, if available. For securities where quoted prices are not available, fair values are estimated based on market prices of similar securities.

Federal Home Loan Bank Stock: Old National Bank is a member of the Federal Home Loan Bank 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 and periodically evaluated for impairment based on ultimate recovery of par value. The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.

Loans: The fair value of loans is estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Covered loans: Fair values for loans were based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and a discount rate reflecting current market rates for new originations of comparable loans adjusted for the risk inherent in the cash flow estimates. Loans were grouped together according to similar characteristics and were treated in the aggregate when applying various valuation techniques.

FDIC indemnification asset: The loss sharing asset was measured separately from the related covered assets as it is not contractually embedded in the assets and is not transferable with the assets should the Bank choose to dispose of the assets. Fair value was estimated using projected cash flows related to the loss sharing agreement based on the expected reimbursements for losses and the applicable loss sharing percentage. These expected reimbursements do not include reimbursable amounts related to future covered expenditures. These cash flows were discounted to reflect the uncertainty of the timing and receipt of the loss sharing reimbursement from the FDIC.

Accrued interest receivable: The carrying amount approximates fair value.

Deposits: The fair value of noninterest-bearing demand deposits and savings, NOW and money market deposits is the amount payable as of the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using rates currently offered for deposits with similar remaining maturities.

Short-term borrowings: Federal funds purchased and other short-term borrowings generally have an original term to maturity of 30 days or less and, therefore, their carrying amount is a reasonable estimate of fair value. The fair value of securities sold under agreements to repurchase is estimated by discounting future cash flows using current interest rates.

Other borrowings: The fair value of medium-term notes, subordinated debt and senior bank notes is determined using market quotes. The fair value of FHLB advances is determined using quoted prices for new FHLB advances with similar risk characteristics. The fair value of other debt is determined using comparable security market prices or dealer quotes.

FDIC true-up liability: The purchase and assumption agreement allows the FDIC to recover a portion of the loss share funds previously paid out under the loss sharing agreements in the event losses fail to reach the expected loss estimate ("FDIC True-Up Liability"). The calculation is based on the net present value of expected future cash payments to be made by the Bank to the FDIC at the conclusion of the loss share agreements. The discount rate used was based on current market rates. The expected cash flows were calculated in accordance with the loss share agreements and are based primarily on the expected losses on the covered assets.

Standby letters of credit: Fair values for standby letters of credit are based on fees currently charged to enter into similar agreements. The fair value for standby letters of credit was recorded in "Accrued expenses and other liabilities" on the consolidated balance sheet in accordance with FASB ASC 460-10 (FIN 45).

Off-balance sheet financial instruments: Fair values for off-balance sheet credit-related financial instruments are based on fees currently charged to enter into similar agreements. For further information regarding the amounts of these financial instruments, see Notes 18 and 19.