OLD NATIONAL BANCORP /IN/ (ONB) FY 2021 MD&A

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, 2021, 2020, and 2019, and financial condition as of December 31, 2021 and 2020.  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.  Our primary geographic markets are in Indiana, Kentucky, Michigan, Minnesota, and Wisconsin.  Old National, through Old National Bank, provides a wide range of banking 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.

CORPORATE DEVELOPMENTS IN FISCAL 2021

Old National had an outstanding financial year in 2021.  Key performance indicators experienced in 2021 included:

•net income of $277.5 million, or $1.67 per diluted share;

•high commercial loan production of $3.9 billion;

•wealth revenue (wealth management fees and investment product fees combined) of $65.0 million;

•net recoveries of $4.8 million;

•strong credit quality metrics including net charge-offs (recoveries) to average loans of (0.03)%;

•low cost of total deposits at 0.06% along with a loan to deposit ratio of 73%; and

•efficiency ratio of 59.65%.

Our net interest income increased slightly to $596.4 million during 2021, compared to $596.1 million in 2020.  Noninterest income decreased from $239.3 million in 2020 to $214.2 million in 2021 reflecting lower mortgage banking revenue and lower debt securities gains.  Our noninterest expenses remain well controlled, decreasing from $541.4 million in 2020 to $500.6 million in 2021 reflecting higher charges related to The ONB Way strategic initiative in 2020 and lower amortization of tax credit investments in 2021. The ONB Way charges totaled $42.6 million in 2020. These decreases in noninterest expenses were partially offset by $14.6 million of diligence and merger charges in 2021 associated with the anticipated First Midwest merger.

On May 30, 2021, Old National entered into a definitive merger agreement with First Midwest to combine in an all-stock merger of equals transaction. Under the terms of the merger agreement, which was unanimously approved by the Boards of Directors of both companies, First Midwest stockholders will receive 1.1336 shares of Old National common stock for each share of First Midwest common stock they own. Following completion of the transaction,

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former First Midwest stockholders are expected to collectively represent approximately 44% of the combined company. The new organization will operate under the Old National Bancorp and Old National Bank names, with headquarters and the main office located in Evansville, Indiana and commercial and consumer banking operations headquartered in Chicago, Illinois. During the third quarter of 2021, we received approval of the merger from the OCC and the shareholders of Old National and First Midwest. On January 25, 2022, the OCC granted us an extension of 60 days to April 20, 2022 for consummating the bank merger. On January 27, 2022, we received Federal Reserve approval for the merger. With all necessary regulatory approvals received, the merger is expected to occur after the close of business and after the end of regular trading hours on the NASDAQ Stock Market on February 15, 2022, subject to customary closing conditions.

Pandemic Update

As previously disclosed, the COVID-19 pandemic has created economic and financial disruptions that have adversely affected our operations during 2020 and 2021. Our historically careful underwriting practices, diverse and granular portfolios, and Midwest-based footprint has helped minimize any adverse impact to Old National. In addition, the combination of the vaccine rollout, government stimulus payments, and reduced spending during the pandemic are likely contributing factors mitigating the impact of the pandemic on the Company’s business, financial condition, results of operations, and its clients as of December 31, 2021. However, there are continuing concerns that indicate a slower return to pre-pandemic routines. Examples of these concerns relate to increases in new COVID-19 cases, hospitalizations and deaths leading to additional government imposed restrictions; refusals to receive the vaccine along with new strain concerns; supply chain issues remaining unresolved longer than anticipated; unemployment increases while consumer confidence and spending falls; and rising geopolitical tensions. Given the ongoing and dynamic nature of the circumstances surrounding the pandemic, it is difficult to predict the future adverse financial impact to Old National.

BUSINESS OUTLOOK

We saw a strong start to a strengthening economic recovery in 2021, which was damaged mid-year by the Delta COVID-19 variant and again late in 2021 by the Omicron variant. The Moody’s U.S. macroeconomic outlook predicts the pandemic to slowly recede, with each future wave of the virus expected to be less disruptive than the preceding wave as state and local governments and businesses skillfully mitigate the impact of the virus.

The Conference Board forecasted that GDP growth will approximate 6.0% in the fourth quarter of 2021 (vs. 2.3% growth in the third quarter of 2021), which is a 0.5% downgrade from earlier fourth quarter of 2021 GDP growth forecasts due to the rapid spread of the Omicron variant in December. The previous Conference Board forecasts had assumed that a new variant would dampen economic growth in the United States, but not until the first quarter of 2022. Since then, the Omicron variant has spread more rapidly than anticipated and is yielding record high new infections, yet appears to be less severe since hospitalizations and mortality rates have not spiked to the same degree as the initial COVID-19 virus. However, The Conference Board notes that mass infections are impacting labor supply as workers recover from illness or postpone reentering the workforce. This supply-side disruption could result in additional shortages and has resulted in an increase in the inflation forecast for early 2022. As expected, in mid-December the Federal Reserve indicated that it will conclude its large-scale asset purchase program as soon as March 2022 and that three 25 basis point rate hikes would follow in 2022. Additional Omicron-induced inflationary pressures could result in even more aggressive tightening, which is a downside risk to The Conference Board’s forecast. This forecast includes spending associated with the bipartisan infrastructure package approved in 2021. However, it does not incorporate the proposed Build Back Better social and climate package.

The 2021 annual growth is currently estimated to be 5.6% for the year and The Conference Board forecasts that the U.S. economy will grow by an estimated 3.5% in 2022 and an estimated 2.9% in 2023. If Omicron and other future variants evolve to be less severe, it could help the U.S. economy “return to normal” pre-pandemic levels. While we are cautiously optimistic about 2022 from a U.S. economic standpoint, risks related to supply chain disruption, slowing job growth, significant and persistent tightening in financial market conditions, inflation, and geopolitical tensions could halt this recovery.

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. Execution of these fundamentals will help us deliver meaningful positive operating leverage.

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Organic loan growth continues to be our priority.  As we enter into 2022, our commercial loan production and pipeline are at record high levels, yet we continue to adhere to our disciplined underwriting process. We believe our approach to downgrading troubled credits early and a patient approach to resolving issues results in better outcomes for our clients and ultimately lower costs for Old National Bank. Despite the lingering challenges due to the pandemic in 2021, overall credit quality remains healthy. Old National has not experienced any specific sector credit related weaknesses, yet we remain watchful for any credits that deserve extra attention as we slowly return to a pre-pandemic economic environment.

As we look ahead to 2022 and our anticipated partnership with First Midwest, we are positioned to close the merger after the close of business and after the end of regular trading hours on the NASDAQ Stock Market on February 15, 2022. We have established the organizational structure and leadership positions for all client segments and support areas and have communicated those decisions throughout the organization. Further, we also agreed upon our core processing system and supporting applications. Finally, we are initiating our recruiting process for talent in Chicago, as we anticipate that the Chicago and Minneapolis markets will be a significant focus in 2022.

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FINANCIAL HIGHLIGHTS

The following table sets forth certain financial highlights of Old National:

(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.

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 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

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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, 2021, included elsewhere in this report. Non-GAAP financial measures exclude certain items that are included in the financial results presented in accordance with GAAP. 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.

The following table presents GAAP to non-GAAP reconciliations.

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RESULTS OF OPERATIONS

The following table sets forth certain income statement information of Old National:

(1)    Beginning January 1, 2020, with the adoption of CECL, calculation is based on current expected credit 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 2021 and 2020

Net Interest Income

Net interest income is the most significant component of our earnings, comprising 74% of 2021 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. The path of the economy continues to depend on the course of COVID-19. Progress on vaccinations and an easing of supply constraints are expected to support continued gains on economic activity. Risks to the economic outlook remain, including from new variants of the virus.

Interest rates remained at near historic lows during 2021 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.

Net interest income was $596.4 million in 2021, a $0.3 million increase from $596.1 million in 2020.  Taxable equivalent net interest income was $610.3 million in 2021, a $0.6 million increase from $609.7 million in 2020.  The net interest margin on a fully taxable equivalent basis was 2.89% in 2021, a 29 basis point decrease compared to 3.18% in 2020.  The increase in net interest income in 2021 when compared to 2020 was primarily due to higher average earning assets and lower costs of average interest-bearing liabilities. Substantially offsetting these increases were lower yields on average earning assets.  Net interest income in both 2021 and 2020 included accretion income (interest income in excess of contractual interest income) associated with acquired loans.  Accretion income totaled $16.7 million in 2021, compared to $23.3 million in 2020.  We expect accretion income on loans to decrease over time, but this may be offset by future acquisitions. Net interest income in 2021 included $44.4 million of interest and net fees combined on PPP loans, compared to $38.0 million in 2020. Unamortized fees on remaining PPP loans totaled $6.4 million at December 31, 2021.

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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.

(1)Interest income is reflected on a fully taxable equivalent basis.

(2)Includes loans held for sale.

(3)Beginning January 1, 2020, with the adoption of CECL, calculation is based on current expected credit 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.

The yield on average earning assets decreased 44 basis points from 3.53% in 2020 to 3.09% in 2021 and the cost of interest-bearing liabilities decreased 19 basis points from 0.49% in 2020 to 0.30% in 2021.  Average earning assets increased by $1.994 billion, or 10%.  The increase in average earning assets consisted of a $1.297 billion increase in

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investment securities, a $421.0 million increase in loans, and a $275.7 million increase in money market and other interest-earning investments.  Average interest-bearing liabilities increased $623.3 million, or 5%.  The increase in average interest-bearing liabilities consisted of an $869.5 million increase in interest-bearing deposits, a $16.8 million increase in securities sold under agreements to repurchase, and a $26.8 million increase in other borrowings, partially offset by a $137.1 million decrease in federal funds purchased and interbank borrowings and a $152.7 million decrease in FHLB advances.  Average noninterest-bearing deposits increased by $1.218 billion.

The increase in average earning assets in 2021 compared to 2020 was due to increases in average investment securities, average loans, and average money market and other interest-earning investments.  The loan portfolio, including loans held for sale, which generally has an average yield higher than the investment portfolio, was 65% of average interest earning assets in 2021, compared to 70% in 2020.

Average loans including loans held for sale increased $421.0 million in 2021 compared to 2020 due to higher average commercial real estate loans, partially offset by lower average commercial loans, residential real estate loans, and consumer loans.  Excluding the $258.6 million decrease in average PPP loans, average commercial loans increased reflecting organic growth.

Average investments increased $1.297 billion in 2021 compared to 2020 reflecting excess liquidity.

Average non-interest-bearing deposits increased $1.218 billion in 2021 compared to 2020 primarily due to PPP funds on deposit.  Average interest-bearing deposits increased $869.5 million in 2021 compared to 2020.

Average borrowed funds decreased $246.2 million in 2021 compared to 2020 primarily due to decreases in FHLB advances and federal funds purchased and interbank borrowings, partially offset by increases in other borrowings and securities sold under agreements to repurchase.

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.

(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 $9.9 million and $4.0 million, respectively, in 2021; $8.9 million and $4.7 million, respectively, in 2020; and $7.7 million and $5.2 million, respectively, in 2019; using the federal statutory tax rate in effect of 21%.

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Provision for Credit Losses

Old National recorded a provision for credit losses recapture of $28.8 million in 2021, compared to an expense of $38.4 million in 2020.  Net recoveries totaled $4.8 million in 2021, compared to net charge-offs of $3.0 million in 2020.  The provision for credit losses recapture in 2021 reflected the improved economic forecast. The provision for credit losses expense in 2020 reflected the implementation of ASC 326 and the macroeconomic factors surrounding the COVID-19 pandemic. PPP loans were factored in the provision for credit losses in 2021 and 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 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.  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 26% in 2021 compared to 29% in 2020.

The following table details the components of noninterest income:

(1)Total revenue includes the effect of a taxable equivalent adjustment of $13.9 million in 2021, $13.6 million in 2020, and $12.9 million in 2019.

The decrease in noninterest income in 2021 compared to 2020 was primarily due to lower mortgage banking revenue and lower debt securities gains.

Wealth management fees increased $3.6 million in 2021 compared to 2020 primarily due to higher personal trust fees, fiduciary account fees, and corporate trust fees.

Mortgage banking revenue decreased $20.2 million in 2021 compared to 2020 reflecting lower refinance transactions related to higher rates in 2021, which caused pipeline levels to drop and gain on sale margins to partially normalize.

Investment product fees increased $3.0 million in 2021 compared to 2020 reflecting higher investment and advisor fees.

Debt securities gains (losses), net decreased $6.4 million in 2021 compared to 2020 primarily due to lower realized gains on sales of available-for-sale securities in 2021.

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Other income decreased $3.3 million in 2021 compared to 2020 primarily due to lower branded card incentives and $1.5 million of swap termination fees in 2021.

Noninterest Expense

The following table details the components of noninterest expense:

Noninterest expense decreased $40.8 million in 2021 compared to 2020 reflecting $42.6 million of charges in 2020 related to the ONB Way strategic initiative and lower amortization of tax credit investments in 2021. These decreases were partially offset by $14.6 million of diligence and merger charges in 2021 associated with the anticipated First Midwest merger.

Salaries and employee benefits is the largest component of noninterest expense.  Salaries and employee benefits decreased $9.5 million in 2021 compared to 2020. Personnel expenses related to the ONB Way strategic initiative totaling $8.3 million in 2020 were the primary driver of this decline.

Marketing expenses increased $1.8 million in 2021 compared to 2020 primarily due to higher advertising expenses.

Data processing expenses increased $6.0 million in 2021 compared to 2020 related to the modernization of our technology infrastructure.

Professional fees increased $4.3 million in 2021 compared to 2020. Professional fees in 2021 included $10.0 million related to the First Midwest merger. Professional fees in 2020 included $2.8 million of consulting fees related to the ONB Way strategic initiative.

Amortization of intangibles decreased $2.8 million in 2021 compared to 2020 primarily due to lower amortization of core deposit intangibles.

Amortization of tax credit investments decreased $12.0 million in 2021 compared to 2020.  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 10 to the consolidated financial statements for additional information on our tax credit investments.

Other expense decreased $27.9 million in 2021 compared to 2020 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.

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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 18.1% in 2021 compared to 11.4% in 2020.  The higher effective tax rate in 2021 compared to 2020 was primarily the result of an increase in pre-tax book income and lower federal tax credits available.  See Note 16 to the consolidated financial statements for additional details on Old National’s income tax provision.

Comparison of Fiscal Years 2020 and 2019

In 2020, we generated net income of $226.4 million and diluted net income per share of $1.36 compared to $238.2 million and diluted net income per share of $1.38, respectively, in 2019. The 2020 earnings included a $40.0 million increase in noninterest income and a $23.0 million decrease in income tax expense.  These favorable variances in net income were offset by an $8.2 million decrease in net interest income, a $32.9 million increase in noninterest expense, and a $33.6 million increase in provision for credit losses.  High commercial loan production and mortgage production, consistently strong credit quality metrics, and low cost of total deposits all contributed to favorable 2020 performance when compared to 2019.

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.  Average earning assets increased by $1.774 billion in 2020 and the yield on average earning assets decreased 75 basis points from 4.28% in 2019 to 3.53% in 2020.

The provision for credit losses was an expense of $38.4 million in 2020, compared to an expense of $4.7 million in 2019. The increase in provision for credit losses expense reflected the implementation of ASC 326 and the macroeconomic factors surrounding the COVID-19 pandemic. Charge-offs remained low during 2020 and we continued to see positive trends in credit quality.

Noninterest income increased $40.0 million in 2020 compared to 2019 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.

Noninterest expense increased $32.9 million in 2020 compared to 2019 reflecting higher charges related to the ONB Way and higher commissions and corporate incentives, partially offset by fewer employees at December 31, 2020.

The provision for income taxes was $29.1 million in 2020 compared to $52.2 million in 2019.  Old National’s 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.

FINANCIAL CONDITION

Overview

At December 31, 2021, our assets were $24.454 billion, a 7% increase compared to $22.961 billion at December 31, 2020.  The increase was primarily due to higher investment securities and organic loan growth, excluding the decline in PPP loans.

We have observed signs of an economic recovery in the United States since the onset of COVID-19, with jobs, consumer spending, manufacturing, and other indicators rebounding from their weakest levels. However, there have been concerns about the emergence of communicable strains of the virus, whether enough people will agree to be vaccinated, supply chain issues, labor supply constraints, and inflation. Economic uncertainty remains and bouts of elevated volatility are expected to continue.

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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 $21.851 billion at December 31, 2021, an increase of $1.538 billion compared to earning assets of $20.313 billion at December 31, 2020.

Investment Securities

We classify substantially all 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.

Equity securities are recorded at fair value and totaled $13.2 million at December 31, 2021 compared to $2.5 million at December 31, 2020. The increase in equity securities was primarily due to an increase in mutual funds.

At December 31, 2021, the investment securities portfolio, including equity securities, was $7.565 billion compared to $6.142 billion at December 31, 2020, an increase of $1.423 billion, or 23%.  Investment securities represented 35% of earning assets at December 31, 2021, compared to 30% at December 31, 2020.  Stronger commercial loan demand in the future could result in management’s decision to reduce the securities portfolio.  As of December 31, 2021, 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.

The investment securities available-for-sale portfolio had net unrealized losses of $6.0 million at December 31, 2021, compared to net unrealized gains of $186.3 million at December 31, 2020.  The change in net unrealized gains (losses) from December 31, 2020 to December 31, 2021 was primarily due to an increase in long-term interest rates impacting market values for mortgage-backed, U.S. government-sponsored entities and agencies, and tax exempt municipal securities.

The investment portfolio had an effective duration of 4.26 at December 31, 2021, compared to 4.08 at December 31, 2020.  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 2.10% in 2021 and 2.52% in 2020.

Loan Portfolio

We lend primarily to consumers and small to medium-sized commercial and commercial real estate clients in many diverse 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.

(1)Includes remaining PPP loans of $169.0 million at December 31, 2021, compared to $943.0 million at December 31, 2020.

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The following table presents the maturity distribution and rate sensitivity of loans at December 31, 2021 and an analysis of these loans that have predetermined and floating interest rates.

Commercial and Commercial Real Estate Loans

Commercial and commercial real estate loans are the largest classification within earning assets, representing 45% at December 31, 2021, compared to 49% at December 31, 2020. At December 31, 2021, commercial and commercial real estate loans were $9.772 billion, a decrease of $130.5 million compared to December 31, 2020 driven by a decline in PPP loans, partially offset by organic loan growth. As of December 31, 2021, total PPP loans were $169.0 million, compared to $943.0 million at December 31, 2020.

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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.

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The following table provides detail on commercial real estate loans classified by property type at December 31.

(1)    Other includes construction and land development properties, senior housing properties, religion properties, and mixed use properties.

Residential Real Estate Loans

Residential real estate loans held in our portfolio, primarily 1-4 family properties, increased $6.9 million at December 31, 2021 compared to December 31, 2020.  Future increases in interest rates could result in a decline in the level of refinancings and new originations of residential real estate loans.

Consumer Loans

Consumer loans, including automobile loans and personal and home equity loans and lines of credit, decreased $61.0 million, at December 31, 2021 compared to December 31, 2020 primarily due to decreases in consumer indirect and consumer direct loans.

Allowance for Credit Losses on Loans and Unfunded Commitments

Beginning January 1, 2020, with the adoption of CECL, 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, 2021, the allowance for credit losses was $107.3 million, compared to $131.4 million at December 31, 2020.  The decrease in the allowance for credit losses reflected the improved economic forecast. 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 be 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.

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 loan commitments totaled $10.9 million at December 31, 2021, compared to $11.7 million at December 31, 2020.

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 4 to the consolidated financial statements.

Loans Held for Sale

Mortgage loans held for immediate sale in the secondary market were $35.5 million at December 31, 2021, compared to $63.3 million at December 31, 2020.  Certain mortgage loans are committed for sale at or prior to

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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 for residential loans held for sale.  The aggregate fair value exceeded the unpaid principal balance by $1.3 million at December 31, 2021 and $3.5 million at December 31, 2020.

Other Assets

Other assets increased $26.6 million since December 31, 2020 primarily due to higher tax credit investments and net deferred tax assets related to net unrealized gains (losses) on investment securities. These increases were partially offset by lower derivative assets.

Funding

Total funding, comprised of deposits and wholesale borrowings, was $21.144 billion at December 31, 2021, an increase of $1.430 billion from $19.714 billion at December 31, 2020.  Total deposits were $18.569 billion, an increase of $1.532 billion compared to December 31, 2020.  Noninterest-bearing demand deposits increased $669.4 million from December 31, 2020 to December 31, 2021.  Interest-bearing checking and NOW deposits increased $361.0 million from December 31, 2020 to December 31, 2021, while savings deposits increased $402.7 million. Money market deposits increased $261.0 million from December 31, 2020 to December 31, 2021. Time deposits decreased $162.5 million.

We use wholesale funding to augment deposit funding and to help maintain our desired interest rate risk position.  At December 31, 2021, wholesale borrowings, including federal funds purchased and interbank borrowings, securities sold under agreements to repurchase, FHLB advances, and other borrowings, totaled $2.575 billion, a decrease of $101.3 million from December 31, 2020.  The decrease in wholesale funding from December 31, 2020 to December 31, 2021 was due to decreases in FHLB advances, securities sold under agreements to repurchase, and federal funds purchased and interbank borrowings, partially offset by an increase in other borrowings.  Wholesale funding as a percentage of total funding was 12% at December 31, 2021, compared to 14% at December 31, 2020.  See Notes 12, 13, and 14 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.

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At December 31, 2021, time deposits in excess of the FDIC insurance limit and estimated time deposits that are otherwise uninsured by maturity were as follows:

Accrued Expenses and Other Liabilities

Accrued expenses and other liabilities increased $33.5 million, or 18%, from December 31, 2020 primarily due to increases in unfunded commitments on low income housing tax credit investments and derivative liabilities.

Capital

Shareholders’ equity totaled $3.012 billion, or 12% of total assets, at December 31, 2021 and $2.973 billion, or 13% of total assets, at December 31, 2020.  The change in unrealized gains (losses) on available-for-sale investment securities decreased equity by $148.3 million during 2021.  Old National paid cash dividends of $0.56 per share in 2021, which reduced equity by $92.8 million. Old National’s Common Stock is traded on the NASDAQ under the symbol “ONB” with 36,320 shareholders of record at December 31, 2021.

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 24 to the consolidated financial statements.

Management views stress testing as an integral part of the Company’s risk management and strategic planning activities. Old National performs stress testing periodically throughout the year. 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/cybersecurity, talent management, regulatory/compliance/legal, and reputational.  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/cybersecurity, and regulatory/compliance/legal.

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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, 2021, we had pooled trust preferred securities with a fair value of $9.5 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 $4.3 million at December 31, 2021.  The fair value of these securities is expected to improve as we get closer to maturity, but may be adversely impacted by credit deterioration.

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 3 to the consolidated financial statements for additional details about our investment security portfolio.

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 $422.3 million at December 31, 2021.

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 clients 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

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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.

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 many diverse industries including manufacturing, agribusiness, transportation, mining, wholesaling, and retailing.  Old National manages concentrations of credit exposure by industry, product, geography, client relationship, and loan size.  At December 31, 2021, our average commercial loan size was approximately $205,000 and our average commercial real estate loan size was approximately $940,000. In addition, while loans to lessors of 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, 2021, 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 adverse impact from COVID-19 during 2020 and 2021; however, the depth of this crisis is ongoing and its effect is very broad-based. Management believes that trends in under-performing, criticized, and classified loans will be highly dependent on the distribution of vaccinations, as well as the length of time it will take consumers and businesses 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:

(1)Includes one pooled trust preferred security and two insurance policies at December 31, 2021.

(2)Loans exclude loans held for sale.

(3)Non-performing loans include nonaccrual loans and TDRs still accruing.

Under-performing assets totaled $127.1 million at December 31, 2021, compared to $166.6 million at December 31, 2020.  Under-performing assets as a percentage of total loans and other real estate owned at December 31, 2021 were 0.93%, a 28 basis point improvement from 1.21% at December 31, 2020.

Nonaccrual loans decreased $40.6 million from December 31, 2020 to December 31, 2021 primarily due to lower commercial real estate and commercial nonaccrual loans. As a percentage of nonaccrual loans, the allowance for credit losses was 100.61% at December 31, 2021, compared to 89.17% at December 31, 2020.

If nonaccrual and renegotiated loans outstanding at December 31, 2021 and 2020, respectively, had been accruing interest throughout the year in accordance with their original terms, interest income of approximately $5.1 million in 2021 and $5.8 million in 2020 would have been recorded on these loans. The amount of interest income actually recorded on nonaccrual and renegotiated loans was $1.3 million in 2021 and $2.9 million in 2020.

Total criticized and classified assets were $509.5 million at December 31, 2021, a decrease of $86.2 million from December 31, 2020.  Other classified assets include investment securities that fell below investment grade rating totaling $4.3 million at December 31, 2021, compared to $3.7 million at December 31, 2020.

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 includes 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.

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.

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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.  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, 2021, TDRs consisted of $7.4 million of commercial loans, $17.2 million of commercial real estate loans, $0.1 million of BBCC loans, $2.4 million of residential real estate loans, $2.7 million of direct consumer loans, and $0.2 million of home equity loans, totaling $30.0 million.  TDRs included within nonaccrual loans totaled $11.7 million at December 31, 2021.  At December 31, 2020, our 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.

Old National has allocated specific reserves to clients whose loan terms have been modified in TDRs totaling $0.7 million at December 31, 2021 and $1.6 million at December 31, 2020.  Old National had not committed to lend any additional funds to clients with outstanding loans that are classified as TDRs at December 31, 2021 or December 31, 2020.

The terms of certain other loans were modified during 2021 and 2020 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 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.

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

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the COVID-19 outbreak declared by the President of the United States under the National Emergencies Act terminates. 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. 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. After this date, we will follow the GAAP accounting treatment to determine if new modifications meet the definition of a TDR. In accordance with such guidance, during 2020 and throughout 2021 we offered short-term modifications in response to COVID-19 to borrowers who were current and otherwise not past due. These included 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 were insignificant. These loan deferrals totaled $6.4 million at December 31, 2021.

U.S. Small Business Administration Paycheck Protection Program

In 2020, 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 participated in the PPP as a lender. During 2020, Old National originated over 9,700 loans with balances of approximately $1.518 billion to new and existing clients through the PPP. As of December 31, 2021, we have received payment from the SBA on 9,502, or 97%, of these loans totaling $1.503 billion.

On December 27, 2020, the CAA was signed into law. The CAA, among other things, extended the life of the PPP, effectively creating a second round of PPP loans for eligible businesses. Old National participated in the CAA’s second round of PPP lending. During 2021, Old National originated approximately 6,200 loans totaling $583.7 million through the second round of the PPP. As of December 31, 2021, we have received payment from the SBA on 4,566, or 74%, of these loans totaling $424.1 million. Additionally, section 541 of the CAA extended the relief provided by the CARES Act for financial institutions to suspend the GAAP accounting treatment for troubled debt restructuring to January 1, 2022.

At December 31, 2021, remaining PPP loans totaled $169.0 million.

Allowance for Credit Losses on Loans and Unfunded Commitments

Beginning January 1, 2020, with the adoption of CECL, 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

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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 portfolio segment reclassifications follow:

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The following table details activity in our allowance for credit losses for loans for the years ended December 31:

(1)Loans exclude loans held for sale.

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The following table details net charge-offs to average loans outstanding by loan category for the years ended December 31:

(1)Average loans exclude loans held for sale.

The allowance for credit losses was $107.3 million at December 31, 2021, compared to $131.4 million at December 31, 2020.  The decrease in the allowance for credit losses reflected the improved economic forecast. There were no industry segments representing a significant share of total net charge-offs.  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 for the year ended December 31, 2019 was as follows:

(1)Loans exclude loans held for sale.

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.

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 loan commitments totaled $10.9 million at December 31, 2021, compared to $11.7 million at December 31, 2020.

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.

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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, client 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, 2021 and 2020:

Our asset sensitivity increased year over year primarily due to deposit growth, higher mix of floating rate loans, and changes in our hedging strategies.

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, 2021, 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 $1.3 million at December 31, 2021, compared to a net asset position with a fair value of $15.2 million at December 31, 2020.  See Note 20 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.

A maturity schedule for Old National Bank’s time deposits is shown in the following table at December 31, 2021.

Our ability to acquire funding at competitive prices is influenced by rating agencies’ views of our credit quality, liquidity, capital, and earnings.  Moody’s Investors Service places us in an investment grade that indicates a low risk of default.  For both Old National and Old National Bank:

•Moody’s Investors Service affirmed the Long-Term Rating of “A3” for Old National’s senior unsecured/issuer rating on February 17, 2021.

•Moody’s Investors Service affirmed Old National Bank’s long-term deposit rating of “Aa3” on February 17, 2021.  The bank’s short-term deposit rating was affirmed at “P-1” and the bank’s issuer rating was affirmed at “A3.”

Moody’s Investors Service concluded a rating review of Old National Bank on February 17, 2021. The rating outlook from Moody’s Investors Service was moved from “Stable” to “Ratings Under Review” on June 2, 2021 due to the merger announced June 1, 2021.

The credit ratings of Old National and Old National Bank at December 31, 2021 are shown in the following table.

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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, 2021, Old National and its subsidiaries had the following availability of liquid funds and borrowings:

*  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, 2021, Old National Bancorp’s other borrowings outstanding were $213.6 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 2020 or 2021 and is not currently required. At December 31, 2021, Old National Bank could pay dividends of $268.1 million without prior regulatory approval.

Operational/Technology/Cybersecurity Risk

Operational/technology/cybersecurity 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 cybersecurity risk including, but not limited to, cyber-attacks or other information security breaches that might allow unauthorized transactions or unauthorized access to client, team member, or company sensitive information.  Metrics and measurements are used by our management team in the management of day-to-day operations to ensure effective client service, minimization of service disruptions, and oversight of cybersecurity risk.  We continually monitor and report on operational, technology, and cybersecurity risks related to business disruptions and systems failures; cyber-attacks, information security or data breaches; clients, products, and business practices; damage to physical assets; employee and workplace safety; execution, delivery, and process management; and external and internal fraud.

The Enterprise Risk Management Committee of the Board of Directors is responsible for the oversight, guidance, and monitoring of risks, including operational/technology/cybersecurity 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

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Company. The Board of Directors expects that we will perform business in a manner compliant with applicable laws and/or regulations and expects issues to be identified, analyzed, and remediated in a timely and complete manner.

MATERIAL CONTRACTUAL OBLIGATIONS, COMMITMENTS, AND CONTINGENT LIABILITIES

The following table presents our material fixed and determinable contractual obligations and significant commitments at December 31, 2021.  Further discussion of each obligation or commitment is included in the referenced note to the consolidated financial statements.

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 20 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 21 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 and timing of any cash payments cannot be reasonably estimated.  Further discussion of income taxes and liabilities is included in Note 16 to the consolidated financial statements.

CRITICAL ACCOUNTING ESTIMATES

Our most significant accounting policies are described in Note 1 to the consolidated financial statements.  Certain of these 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, and we consider these policies to be our critical accounting estimates.  The judgment and assumptions made are based upon historical experience, future forecasts, 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.

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•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, 2021, 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 method. 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.

•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.

One of the most significant judgments used in determining the allowance for credit losses is the macroeconomic forecast provided by a third party. The economic indices sourced from the macroeconomic forecast and used in projecting loss rates include the national unemployment rate, changes in commercial real estate prices, changes in home values, and changes in the United States gross domestic product. The economic index used in the calculation to which the calculation may be most sensitive is the national unemployment rate. Each reporting period, several macroeconomic forecast scenarios are considered by

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management. Management selects the macroeconomic forecast that is most reflective of expectations at that point in time. Changes in the macroeconomic forecast, especially for the national unemployment rate, could significantly impact the calculated estimated credit losses.

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 16 to the consolidated financial statements for a further description of our provision and related income tax assets and liabilities.

•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.

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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.”