NOTE 17 - 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:

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 December 31, 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	$	2,816	$	2,816	$	0	$	0
Investment securities available-for-sale:
U.S. Treasury		65,769		65,769		0		0
U.S. Government-sponsored entities and agencies		173,185		0		173,185		0
Mortgage-backed securities - Agency		1,182,255		0		1,182,255		0
Mortgage-backed securities - Non-agency		85,900		0		85,900		0
States and political subdivisions		402,844		0		401,538		1,306
Pooled trust preferred securities		7,327		0		0		7,327
Other securities		153,996		0		153,996		0
Residential loans held for sale		4,528		0		4,528		0
Derivative assets		44,415		0		44,415		0
Financial Liabilities
Derivative liabilities		37,332		0		37,332		0


				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 twelve months ended December 31, 2011:


		Fair Value Measurements using
		Significant Unobservable Inputs
		(Level 3)
		Pooled Trust Preferred			State and
		Securities Available-			Political
(dollars in thousands)		for-Sale			Subdivisions
Beginning balance, January 1, 2011	$	8,400		$	0
Accretion/(amortization) of discount or premium		(72	)		0
Payments received		(992	)		0
Credit loss write-downs		(888	)		0
Increase/(decrease) in fair value of securities		879			0
Transfer in at December 31		0			1,306
Ending balance, December 31, 2011	$	7,327		$	1,306

Included in the income statement is $72 thousand of expense included in interest income from the amortization of premiums on securities and $888 thousand of credit losses included in noninterest income. 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.

$1.3 million of state and political subdivision securities were transferred to Level 3 as of December 31, 2011 because Old National could no longer obtain evidence of observable inputs.

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 twelve months ended December 31, 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		(101	)
Payments received		(163	)
Credit loss write-downs		(930	)
Increase/(decrease) in fair value of securities		(2,804	)
Ending balance, December 31, 2010	$	8,400

Included in the income statement are $101 thousand of expense included in interest income from the amortization of premiums on securities and $930 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 December 31, 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	$	23,150	0	0	$	23,150
Commercial real estate loans		14,894	0	0		14,894

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 $49.4 million, with a valuation allowance of $11.3 million at December 31, 2011. Old National recorded $7.5 million of provision expense associated with these loans in 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 is $173 thousand of interest income for residential loans held for sale for the year ended December 31, 2011. Included in the income statement is $214 thousand of interest income for residential loans held for sale for the year ended December 31, 2010.

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 December 31, 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	$	4,528	$	99	$	4,429

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 twelve months ended December 31, 2011:


Changes in Fair Value for the Twelve Months ended December 31, 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	$	120	$	0	$	(1	)	$ 119

As of December 31, 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	$	3,819	$	(20	)	$	3,839


Changes in Fair Value for the Twelve Months ended December 31, 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	$	(306	)	$	2	$	0	$ (304)

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


		Carrying		Fair
(dollars in thousands)		Value		Value

2011
Financial Assets
Cash, due from banks, federal funds sold
and money market investments	$	222,872	$	222,872
Investment securities held-to-maturity:
U.S. Government-sponsored entities and agencies		177,159		188,593
Mortgage-backed securities - Agency		84,075		87,380
State and political subdivisions		216,345		224,717
Other securities		7,011		7,009
Federal Home Loan Bank stock		30,835		30,835
Loans, net (including covered loans)
Commercial		1,321,445		1,366,316
Commercial real estate		1,366,311		1,421,941
Residential real estate		1,038,280		1,124,222
Consumer credit		983,107		1,014,807
FDIC indemnification asset		147,566		142,078
Accrued interest receivable		44,801		44,801

Financial Liabilities
Deposits:
Noninterest-bearing demand deposits	$	1,728,546	$	1,728,546
NOW, savings and money market deposits		3,435,353		3,435,353
Time deposits		1,447,664		1,481,854
Short-term borrowings
Federal funds purchased		103,010		103,010
Repurchase agreements		321,725		321,722
Other short-term borrowings		114		114
Other borrowings:
Junior subordinated debentures		16,000		12,697
Subordinated notes		13,000		12,999
Repurchase agreements		50,000		54,484
Federal Home Loan Bank advances		208,360		225,711
Capital lease obligation		4,261		5,079
Accrued interest payable		5,239		5,239
Standby letters of credit		431		431

Off-Balance Sheet Financial Instruments
Commitments to extend credit	$	0	$	1,720


		Carrying		Fair
(dollars in thousands)		Value		Value
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 debentures		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 originally estimated using projected cash flows related to the loss sharing agreement based on the expected reimbursements for losses and the applicable loss sharing percentage and these projected cash flows are updated with the cash flow estimates on covered assets. 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.

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 19 and 20.