NOTE 9—COVERED LOANS

Covered loans represent loans acquired from the FDIC that are subject to loss share agreements. The carrying amount of covered loans was $250.8 million at September 30, 2013. The composition of covered loans by lending classification was as follows:


At September 30, 2013
(dollars in thousands)	Loans Accounted for Under ASC 310-30 (Purchased Credit Impaired)			Loans excluded from ASC 310-30 (1) (Not Purchased Credit Impaired)		Total Covered Purchased Loans
Commercial	$	14,818		$	20,486	$	35,304
Commercial real estate		88,526			15,010		103,536
Residential		30,009			137		30,146
Consumer		19,477			62,338		81,815

Covered loans		152,830			97,971		250,801
Allowance for loan losses		(5,012	)		—		(5,012	)

Covered loans, net	$	147,818		$	97,971	$	245,789

(1)	Includes loans with revolving privileges which are scoped out of FASB ASC 310-30 and certain loans which Old National elected to treat under the cost recovery method of accounting.

Loans were recorded at fair value in accordance with FASB ASC 805, Business Combinations. No allowance for loan losses related to the acquired loans is recorded on the acquisition date as the fair value of the loans acquired incorporates assumptions regarding credit risk. Loans acquired are recorded at fair value in accordance with the fair value methodology prescribed in FASB ASC 820, exclusive of the loss share agreements with the Federal Deposit Insurance Corporation (“FDIC”). The fair value estimates associated with the loans include estimates related to expected prepayments and the amount and timing of undiscounted expected principal, interest and other cash flows.

The outstanding balance of covered loans accounted for under ASC 310-30, including contractual principal, interest, fees and penalties, was $388.9 million and $529.2 million as of September 30, 2013 and December 31, 2012, respectively.

The following table is a roll-forward of acquired impaired loans accounted for under ASC 310-30 for the nine months ended September 30, 2013:


(dollars in thousands)	Contractual Cash Flows (1)			Nonaccretable Difference			Accretable Yield			Carrying Amount (2)
Balance at January 1, 2013	$	424,527		$	(90,996	)	$	(85,779	)	$	247,752
Principal reductions and interest payments		(119,564	)		—			—			(119,564	)
Accretion of loan discount		—			—			28,103			28,103
Changes in contractual and expected cash flows due to remeasurement		(20,348	)		37,597			(16,689	)		560
Removals due to foreclosure or sale		(8,586	)		746			(1,193	)		(9,033	)

Balance at September 30, 2013	$	276,029		$	(52,653	)	$	(75,558	)	$	147,818

(1)	The balance of contractual cash flows includes future contractual interest and is net of amounts charged off and interest collected on nonaccrual loans.

(2)	Carrying amount for this table is net of allowance for loan losses.

The following table is a roll-forward of acquired impaired loans accounted for under ASC 310-30 for the nine months ended September 30, 2012:


(dollars in thousands)	Contractual Cash Flows (1)			Nonaccretable Difference			Accretable Yield			Carrying Amount (2)
Balance at January 1, 2012	$	729,496		$	(180,655	)	$	(92,053	)	$	456,788
Principal reductions and interest payments		(153,170	)		—			—			(153,170	)
Accretion of loan discount		—			—			37,919			37,919
Changes in contractual and expected cash flows due to remeasurement		13,829			16,532			(35,678	)		(5,317	)
Removals due to foreclosure or sale		(27,373	)		11,137			(411	)		(16,647	)

Balance at September 30, 2012	$	562,782		$	(152,986	)	$	(90,223	)	$	319,573

(1)	The balance of contractual cash flows includes future contractual interest and is net of amounts charged off and interest collected on nonaccrual loans.

(2)	Carrying amount for this table is net of allowance for loan losses.

Over the life of the acquired loans, the Company continues to estimate cash flows expected to be collected on individual loans or on pools of loans sharing common risk characteristics which were treated in the aggregate when applying various valuation techniques. The Company evaluates at each balance sheet date whether the present value of its loans determined using the effective interest rates has decreased and if so, recognizes a provision for loan losses. For any increases in cash flows expected to be collected, the Company adjusts the amount of accretable yield recognized on a prospective basis over the loan’s or pool’s remaining life. Eighty percent of the prospective yield adjustments are offset as Old National will recognize a corresponding decrease in cash flows expected from the indemnification asset prospectively in a similar manner. The indemnification asset is adjusted over the shorter of the life of the underlying investment or the indemnification agreement.

Accretable yield, or income expected to be collected on the covered loans accounted for under ASC 310-30, is as follows:


(dollars in thousands)	2013			2012
Balance at January 1,	$	85,779		$	92,053
New loans purchased		—			—
Accretion of income		(28,103	)		(37,919	)
Reclassifications from (to) nonaccretable difference		16,689			35,678
Disposals/other adjustments		1,193			411

Balance at September 30,	$	75,558		$	90,223

At September 30, 2013, the $91.6 million loss sharing asset is comprised of an $81.6 million FDIC indemnification asset and a $10.0 million FDIC loss share receivable. The loss share receivable represents actual incurred losses where reimbursement has not yet been received from the FDIC. The indemnification asset represents future cash flows the Company expects to collect from the FDIC under the loss sharing agreements and the amount related to the estimated improvements in cash flow expectations that are being amortized over the same period for which those improved cash flows are being accreted into income. At September 30, 2013, $50.6 million of the FDIC indemnification asset is related to expected indemnification payments and $31.0 million is expected to be amortized and reported in noninterest income as an offset to future accreted interest income.

For covered loans, the Company remeasures contractual and expected cash flows on a quarterly basis. When the quarterly re-measurement process results in a decrease in expected cash flows due to an increase in expected credit losses, impairment is recorded. As a result of this impairment, the indemnification asset is increased to reflect anticipated future cash flows to be received from the FDIC. Consistent with the loss sharing agreements between the Company and the FDIC, the amount of the increase to the indemnification asset is measured at 80% of the resulting impairment.

Alternatively, when the quarterly re-measurement results in an increase in expected future cash flows due to a decrease in expected credit losses, the nonaccretable difference decreases and the effective yield of the related loan portfolio is increased. As a result of the improved expected cash flows, the indemnification asset would be reduced first by the amount of any impairment previously recorded and, second, by increased amortization over the remaining life of the related loss sharing agreements.

The following table shows a detailed analysis of the FDIC loss sharing asset for the nine months ended September 30, 2013 and 2012:


(dollars in thousands)	2013			2012
Balance at January 1,	$	116,624		$	168,881
Adjustments not reflected in income:
Established through acquisitions		—			—
Cash received from FDIC		(19,415	)		(38,736	)
Loan expenses to be reimbursed		1,469			2,437
Other		(1,204	)		(665	)
Adjustments reflected in income:
(Amortization) accretion		(6,814	)		(10,805	)
Impairment		115			187
Write-downs/sale of other real estate		1,965			7,854
Recovery amounts due to FDIC		(1,243	)		(1,914	)
Other		61			560

Balance at September 30,	$	91,558		$	127,799