OLD NATIONAL BANCORP /IN/ (ONB) FY 2022 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, 2022, 2021, and 2020, and financial condition as of December 31, 2022 and 2021.  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 headquartered in the state of Indiana and the sixth largest Midwestern bank by asset size. The Company’s corporate headquarters and principal executive office are located in Evansville, Indiana with commercial and consumer banking operations headquartered in Chicago, Illinois. Old National, through Old National Bank, provides a wide range of banking services throughout the Midwest region, 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 2022

Old National had a transformational year in 2022, evidenced by our merger with First Midwest, successful completion of all related systems conversions, solid client growth, and strong talent retention and attraction.  Key performance indicators experienced in 2022 included:

•net income applicable to common shareholders of $414.2 million, or $1.50 per diluted common share;

•net interest margin expansion of 58 basis points, reflective of strong loan growth and the higher rate environment;

•robust, broad-based loan growth of 12%;

•maintenance of a stable, low-cost deposit base along with a loan to deposit ratio of 89%;

•disciplined expense management; and

•excellent credit and capital metrics including net charge-offs to average loans of 0.06%.

Our net interest income increased to $1.3 billion during 2022, compared to $596.4 million in 2021 driven by the First Midwest merger, loan growth, and the higher rate environment.  Noninterest income increased from $214.2 million in 2021 to $399.8 million in 2022 reflecting the First Midwest merger and a $90.7 million gain on the sale of health savings accounts in the fourth quarter of 2022, partially offset by lower mortgage banking revenue, which was impacted by the higher rate environment, and, accordingly, lower production and gain on sale margins.  Our noninterest expenses increased from $501.4 million in 2021 to $1.0 billion in 2022 reflective of the additional operating costs associated with the First Midwest merger, as well as $120.9 million of merger-related expenses and $26.8 million for property optimization. In addition, higher incentive accruals resulting from strong performance contributed to the increase.

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On February 15, 2022, Old National completed its previously announced merger of equals transaction with First Midwest. At closing, Old National acquired $21.9 billion of assets, including $14.3 billion of loans, and assumed $17.2 billion of deposits. Old National completed branding and all systems conversions in the third quarter of 2022.

On November 18, 2022, Old National completed its previously announced transaction with UMB, pursuant to which UMB acquired Old National’s business of acting as a qualified custodian for, and administering, health savings accounts. Old National served as custodian for health savings accounts comprised of both investment accounts and deposit accounts. At closing, the health savings accounts held in deposit accounts that were transferred totaled approximately $382 million and the transaction resulted in a $90.7 million pre-tax gain.

During the fourth quarter of 2022, Old National initiated certain property optimization actions that included the closure and consolidation of certain branches as well as other real estate repositioning across our footprint. These actions resulted in pre-tax charges of $26.8 million that are associated with valuation adjustments related to these locations and are recorded in noninterest expense.

In early December of 2022, Old National implemented several enhancements to its overdraft protection programs to provide clients with more flexibility. The changes included the elimination of the non-sufficient fund (“NSF”) fee when an item is returned, among other modifications that benefit consumers that will impact service charges on deposit accounts.

Pandemic Update

As previously disclosed, the COVID-19 pandemic has created economic and financial disruptions that continued to adversely affect our operations during 2022. Our historically disciplined underwriting practices, diverse and granular portfolios, and Midwest-based footprint have helped minimize the adverse impact to Old National. The pandemic has become less disruptive to the Company’s business, financial condition, results of operations, and its clients as of December 31, 2022 than in prior periods.

BUSINESS OUTLOOK

In 2022, Old National benefited from the tailwinds of the Federal Reserve’s target interest rate increases in general, and we enter 2023 proactively managing our balance sheet for a potential downshift in interest rates. Old National’s peer leading deposit franchise adds value in any economic cycle as deposits typically cost less than other types of funding. Our healthy commercial loan pipeline heading into 2023 bodes well for future organic growth, which remains a top priority for the Company.

Our transformational merger with First Midwest accelerated our evolution into a commercially-oriented regional bank that expects to consistently deliver top quartile performance. The accomplishment of merger-related cost saves and our enduring focus on the fundamentals of basic banking, including loan growth, expansion of revenue-generating businesses, prudent capital deployment, and expense management, will help us to deliver meaningful, positive operating leverage.

Organic loan growth continues to be our priority.  As we enter into 2023, our commercial loan production and pipeline are at robust 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. Old National credit quality remains strong, and we have not experienced any specific sector credit related weaknesses, yet we will remain diligent in adhering to our risk profile and underwriting standards.

As we look ahead to 2023, we believe our increased scale, relationship banking approach, skilled team members, geographic reach, strong balance sheet, including our peer leading deposit franchise, and operating efficiency will allow us to continue to create value for our shareholders and drive positive operating leverage.

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FINANCIAL HIGHLIGHTS

The following table sets forth certain financial highlights of Old National for the previous five quarters:

(1)Calculated using the federal statutory tax rate in effect of 21% for all periods.

(2)Provision for unfunded loan commitments is included in the provision for credit losses. The reclassification of the provision for unfunded loan commitments out of other expense as a component of noninterest expense was made to prior period amounts to conform to the current period presentation.

(3)Cash dividends per share divided by net income per share (basic).

(4)Represents a non-GAAP financial measure.  Refer to the “Non-GAAP Financial Measures” section for reconciliations to GAAP financial measures.

(5)Presented as calculated prior to December 31, 2022, which included the provision for unfunded loan commitments in noninterest expense. Management believes that removing the provision for unfunded loan commitments from this metric enhances comparability for peer comparison purposes.

(6)Includes the allowance for credit losses on loans and unfunded loan commitments.

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The following table sets forth certain financial highlights of Old National for the year-to-date periods:

(1)Calculated using the federal statutory tax rate in effect of 21% for all periods.

(2)Provision for unfunded loan commitments is included in the provision for credit losses. The reclassification of the provision for unfunded loan commitments out of other expense as a component of noninterest expense was made to prior period amounts to conform to the current period presentation.

(3)Cash dividends per share divided by net income per share (basic).

(4)Represents a non-GAAP financial measure.  Refer to the “Non-GAAP Financial Measures” section for reconciliations to GAAP financial measures.

(5)Presented as calculated prior to December 31, 2022, which included the provision for unfunded loan commitments in noninterest expense. Management believes that removing the provision for unfunded loan commitments from this metric enhances comparability for peer comparison purposes.

(6)Includes the allowance for credit losses on loans and unfunded loan commitments.

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NON-GAAP FINANCIAL MEASURES

The Company’s accounting and reporting policies conform to GAAP and general practices within the banking industry. As a supplement to GAAP, the Company provides non-GAAP performance results, which the Company believes are useful because they assist investors in assessing the Company’s operating performance. Where non-GAAP financial measures are used, the comparable GAAP financial measure, as well as the reconciliation to the comparable GAAP financial measure, can be found in the following table.

The taxable equivalent adjustment to net interest income and net interest margin recognizes the income tax savings when comparing taxable and tax-exempt assets. Interest income and yields on tax-exempt securities and loans are presented using the current federal income tax rate of 21%. Management believes that it is standard practice in the banking industry to present net interest income and net interest margin on a fully tax-equivalent basis and that it may enhance comparability for peer comparison purposes.

In management’s view, tangible common equity measures are capital adequacy metrics that may be meaningful to the Company, as well as analysts and investors, in assessing the Company’s use of equity and in facilitating comparisons with peers. These non-GAAP measures are valuable indicators of a financial institution’s capital strength since they eliminate intangible assets from shareholders’ equity and retain the effect of AOCI in shareholders’ equity.

Although intended to enhance investors’ understanding of the Company’s business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. In addition, these non-GAAP financial measures may differ from those used by other financial institutions to assess their business and performance. See the previously provided tables and the following reconciliations in the “Non-GAAP Reconciliations” section for details on the calculation of these measures to the extent presented herein.

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The following table presents GAAP to non-GAAP reconciliations for the previous five quarters:

(1)Represents a non-GAAP financial measure.

(2)Calculated using management’s estimate of the annual fully taxable equivalent rates (federal and state).

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The following table presents GAAP to non-GAAP reconciliations for the year-to-date periods:

(1)Represents a non-GAAP financial measure.

(2)Calculated using management’s estimate of the annual fully taxable equivalent rates (federal and state).

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RESULTS OF OPERATIONS

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

(1)    Represents a non-GAAP financial measure.  Refer to “Non-GAAP Financial Measures” section for reconciliations to GAAP financial measures.

(2)    Presented as calculated prior to December 31, 2022, which included the provision for unfunded loan commitments in noninterest expense. Management believes that removing the provision for unfunded loan commitments from this metric enhances comparability for peer comparison purposes.

Comparison of Fiscal Years 2022 and 2021

Net Interest Income

Net interest income is the most significant component of our earnings, comprising 77% of 2022 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.

Interest rates increased significantly during 2022. The Federal Reserve’s Federal Funds range is currently in a target range of 4.25% to 4.50%, with the Effective Federal Funds Rate at 4.33% at December 31, 2022. The Federal Reserve is expected to continue to increase the Federal Funds Rate into 2023. Management actively takes balance sheet restructuring, derivative, and deposit pricing actions to help mitigate interest rate risk. See the section of this Item 7 titled “Market Risk” for additional information regarding 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.

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.

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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.

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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 $11.5 million and $6.9 million, respectively, in 2022; $9.9 million and $4.0 million, respectively, in 2021; and $8.9 million and $4.7 million, respectively, in 2020; using the federal statutory tax rate in effect of 21%.

The increase in net interest income in 2022 when compared to 2021 was primarily due to higher average earning assets as a result of the merger, loan growth, higher rates, and higher accretion income. Partially offsetting these increases were higher average interest-bearing liabilities as a result of the merger, lower interest and fees related to PPP loans, and higher costs of average interest-bearing liabilities.  Accretion income associated with acquired loans and borrowings totaled $86.4 million in 2022, compared to $16.7 million in 2021.  Net interest income in 2022 included $6.9 million of interest and net fees on PPP loans, compared to $44.4 million in 2021. There were no unamortized fees on remaining PPP loans at December 31, 2022.

The increase in the net interest margin on a fully taxable equivalent basis in 2022 when compared to 2021 was primarily due to higher yields on interest earning assets, partially offset by higher costs of interest-bearing liabilities. The yield on average earning assets increased 71 basis points from 3.09% in 2021 to 3.80% in 2022 and the cost of interest-bearing liabilities increased 19 basis points from 0.30% in 2021 to 0.49% in 2022.  Average earning assets increased by $17.6 billion, or 83%.  The increase in average earning assets consisted of a $3.4 billion increase in investment securities, a $13.8 billion increase in loans, and a $362.1 million increase in money market and other interest-earning investments.  Average interest-bearing liabilities increased $11.7 billion, or 82%.  The increase in average interest-bearing liabilities consisted of an $10.0 billion increase in interest-bearing deposits, a $150.1 million increase in federal funds purchased and interbank borrowings, a $47.8 million increase in securities sold under agreements to repurchase, a $1.1 billion increase in FHLB advances, and a $350.2 million increase in other borrowings.  Average noninterest-bearing deposits increased by $5.6 billion.

The increase in average earning assets in 2022 compared to 2021 was primarily due to the merger with First Midwest and strong loan growth.  The loan portfolio, including loans held for sale, which generally has an average yield higher than the investment portfolio, was 71% of average interest earning assets in 2022, compared to 65% in 2021.

Average loans including loans held for sale increased $13.8 billion in 2022 compared to 2021 primarily due to the First Midwest merger and strong organic loan growth.

Average investments increased $3.4 billion in 2022 compared to 2021 reflecting the First Midwest merger.

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Average non-interest-bearing deposits increased $5.6 billion in 2022 compared to 2021 primarily due to the First Midwest merger.  Average interest-bearing deposits increased $10.0 billion in 2022 compared to 2021 driven by the First Midwest merger.

Average borrowed funds increased $1.6 billion in 2022 compared to 2021 primarily due to the First Midwest merger.

Provision for Credit Losses

Old National recorded a provision for credit losses of $144.8 million in 2022, compared to a recapture of $29.6 million in 2021.  Net charge-offs totaled $16.1 million in 2022, which included $11.2 million of net charge-offs on PCD loans, compared to net recoveries of $4.8 million in 2021.  The provision for credit losses on loans in 2022 included $96.3 million to establish an allowance for credit losses on non-PCD loans acquired in the First Midwest merger. Provision for credit losses on unfunded loan commitments totaled $21.3 million in 2022, including $11.0 million for unfunded loan commitments acquired in the First Midwest merger. Recapture of credit losses on unfunded loan commitments totaled $0.8 million in 2021. 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, provision expense may be 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 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 23% in 2022 compared to 26% in 2021.

The following table details the components of noninterest income:

(1)Total revenue includes the effect of a taxable equivalent adjustment of $18.4 million in 2022, $13.9 million in 2021, and $13.6 million in 2020.

The increase in noninterest income in 2022 compared to 2021 was primarily due to the First Midwest merger in February of 2022 and a $90.7 million gain on the sale of health savings accounts in the fourth quarter of 2022. The increase in noninterest income was partially offset by lower mortgage banking revenue, which was impacted by the higher rate environment, and, accordingly, lower production and gain on sale margins. In addition, wealth management fees were negatively impacted by current market conditions.

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On November 18, 2022, Old National completed its previously announced transaction with UMB, pursuant to which UMB acquired Old National’s business of acting as a qualified custodian for, and administering, health savings accounts. Old National served as custodian for health savings accounts comprised of both investment accounts and deposit accounts. At closing, the health savings accounts held in deposit accounts that were transferred totaled approximately $382 million and the transaction resulted in a $90.7 million pre-tax gain.

Noninterest Expense

The following table details the components of noninterest expense:

Noninterest expense increased $536.8 million in 2022 compared to 2021 reflective of the additional operating costs associated with the First Midwest merger, as well as $120.9 million of merger-related expenses and $26.8 million for property optimization. In addition, higher incentive accruals resulting from strong performance contributed to the increase. Noninterest expense for 2021 included $14.6 million of merger-related expenses.

During the fourth quarter of 2022, Old National initiated certain property optimization actions that included the closure and consolidation of certain branches as well as other real estate repositioning across our footprint. These actions resulted in expenses totaling $26.8 million that are associated with valuation adjustments related to these locations.

Amortization of tax credit investments increased $4.2 million in 2022 compared to 2021.  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 9 to the consolidated financial statements for additional information on our tax credit investments.

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 21.4% in 2022 compared to 18.1% in 2021.  The higher effective tax rate in 2022 compared to 2021 reflected the increase in pre-tax book income and higher post-merger estimated state effective tax rates.  An increase in non-deductible officer compensation also contributed to the higher tax rate, the majority of which was merger related. See Note 15 to the consolidated financial statements for additional details on Old National’s income tax provision.

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Comparison of Fiscal Years 2021 and 2020

In 2021, we generated net income applicable to common shareholders of $277.5 million and diluted net income per common share of $1.67 compared to $226.4 million and diluted net income per common share of $1.36, respectively, in 2020. The 2021 earnings included a $0.3 million increase in net interest income, a $35.6 million decrease in noninterest expense, and a $72.5 million decrease in provision for credit losses.  These favorable variances in net income applicable to common shareholders were partially offset by $25.1 million decrease in noninterest income and a $32.2 million increase in income tax expense.  High commercial loan production and mortgage production, consistently strong credit quality metrics, and low cost of total deposits all contributed to favorable 2021 performance when compared to 2020.

Net interest income increased slightly to $596.4 million in 2021, compared to $596.1 million in 2020.  Taxable equivalent net interest income was $610.3 million in 2021, compared to $609.7 million in 2020.  Average earning assets increased by $2.0 billion in 2021 and the yield on average earning assets decreased 44 basis points from 3.53% in 2020 to 3.09% in 2021.

The provision for credit losses was a recapture of $29.6 million in 2021, compared to an expense of $42.9 million in 2020. Charge-offs remained low during 2021 and we continued to see positive trends in credit quality.

Noninterest income decreased $25.1 million in 2021 compared to 2020 reflecting lower mortgage banking revenue and lower debt securities gains.

Noninterest expense decreased $35.6 million in 2021 compared to 2020 reflecting higher charges related to the ONB Way strategic initiative in 2020 and lower amortization of tax credit investments in 2021.

The provision for income taxes was $61.3 million in 2021 compared to $29.1 million in 2020.  Old National’s 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.

FINANCIAL CONDITION

Overview

At December 31, 2022, our assets were $46.8 billion, a $22.3 billion increase compared to $24.5 billion at December 31, 2021.  The increase was driven primarily by the merger with First Midwest in February of 2022, as well as organic loan growth.

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 $41.6 billion at December 31, 2022, an increase of $19.8 billion compared to earning assets of $21.9 billion at December 31, 2021.

Investment Securities

We classify the majority 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. During 2022, we transferred $3.0 billion of securities available-for-sale to held-to-maturity due to rising interest rates and related effects on the value of our investment securities.

Equity securities are recorded at fair value and totaled $52.5 million at December 31, 2022 compared to $13.2 million at December 31, 2021. The increase in equity securities was driven by the merger with First Midwest.

At December 31, 2022, the investment securities portfolio, including equity securities, was $10.2 billion compared to $7.6 billion at December 31, 2021, an increase of $2.7 billion driven primarily by the merger with First Midwest.  Investment securities represented 25% of earning assets at December 31, 2022, compared to 35% at December 31, 2021.  This decrease was driven by the First Midwest merger and stronger loan demand in 2022.  As of December 31, 2022, 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.

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The investment securities available-for-sale portfolio had net unrealized losses of $844.4 million at December 31, 2022, compared to net unrealized losses of $6.0 million at December 31, 2021.  The investment securities held-to-maturity portfolio had net unrealized losses of $445.5 million at December 31, 2022. Net unrealized losses increased from December 31, 2021 to December 31, 2022 primarily due to an increase in rates impacting market values for mortgage-backed, U.S. government-sponsored entities and agencies, and tax exempt municipal securities.

The investment securities available-for-sale portfolio including securities hedges had an effective duration of 4.57 at December 31, 2022, compared to 4.26 at December 31, 2021.  The total investment securities portfolio had an effective duration of 6.45 at December 31, 2022. Effective duration represents the percentage change in the fair value of the portfolio in response to a change in interest rates and is used to evaluate the portfolio’s price volatility at a single point in time.  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 2.50% in 2022 and 2.10% in 2021.

Loan Portfolio

We lend primarily to consumers and small to medium-sized commercial and commercial real estate clients in many diverse industries including, among others, real estate rental and leasing, manufacturing, healthcare, wholesale trade, construction, and agriculture.  Our policy is to concentrate our lending activity in the geographic market areas we serve, primarily in the Midwest region.

The following table presents the composition of the loan portfolio at December 31.

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The following table presents the maturity distribution and rate sensitivity of loans at December 31, 2022 and an analysis of these loans that have fixed and floating interest rates.

Commercial and Commercial Real Estate Loans

Commercial and commercial real estate loans are the largest classifications within earning assets, representing 53% at December 31, 2022, compared to 45% at December 31, 2021. At December 31, 2022, commercial and commercial real estate loans were $22.0 billion, an increase of $12.2 billion compared to December 31, 2021 driven by the merger with First Midwest and strong loan production in 2022.

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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.

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

(1)    Other includes agriculture real estate, hotels, self-storage, senior housing, land development, religion, and mixed-use properties.

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Residential Real Estate Loans

Residential real estate loans held in our portfolio increased $4.2 billion to $6.5 billion at December 31, 2022, compared to December 31, 2021, driven by the merger with First Midwest and organic loan growth.  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, personal, and home equity loans and lines of credit, increased $1.1 billion to $2.7 billion at December 31, 2022 compared to December 31, 2021, driven by the merger with First Midwest and loan growth.

Allowance for Credit Losses on Loans and Unfunded Loan Commitments

At December 31, 2022, the allowance for credit losses on loans was $303.7 million, compared to $107.3 million at December 31, 2021.  The increase in the allowance for credit losses on loans reflected $89.1 million of allowance for credit losses on acquired PCD loans established through acquisition accounting adjustments on or after the First Midwest merger date. In addition, the provision for credit losses expense in 2022 included $96.3 million to establish an allowance for credit losses on non-PCD loans acquired in the First Midwest merger. 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, provision expense may be 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 loan commitments 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 on 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 unfunded loan commitments is included in the provision for credit losses. The allowance for credit losses on unfunded loan commitments totaled $32.2 million at December 31, 2022, compared to $10.9 million at December 31, 2021. The increase in the allowance for credit losses on unfunded loan commitments was driven by the merger with First Midwest as well as organic loan growth.

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.

Goodwill and Other Intangible Assets

Goodwill and other intangible assets at December 31, 2022 totaled $2.1 billion, an increase of $1.1 billion compared to December 31, 2021 as a result of goodwill and other intangible assets recorded with the First Midwest merger.

Other Assets

Other assets increased $770.2 million since December 31, 2021 primarily due to higher net deferred tax assets related to the market value adjustments of certain investment securities, higher derivative assets, and deferred tax and other assets related to the First Midwest merger.

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Funding

The following table summarizes Old National’s total funding, comprised of deposits and wholesale borrowings at December 31:

The increase in total funding was driven by the merger with First Midwest as well as loan growth.  We use wholesale funding to augment deposit funding and to help maintain our desired interest rate risk position.  Wholesale funding as a percentage of total funding was 14% at December 31, 2022, compared to 12% at December 31, 2021.  See Notes 11, 12, and 13 to the consolidated financial statements for additional details on our financing activities.

At December 31, 2022, 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 $614.8 million from December 31, 2021 primarily due to higher derivative liabilities and accrued expenses and other liabilities associated with the First Midwest merger.

Capital

Shareholders’ equity totaled $5.1 billion, or 11% of total assets, at December 31, 2022 and $3.0 billion, or 12% of total assets, at December 31, 2021.  In relation to the merger of equals transaction with First Midwest, Old National issued 108,000 shares of Old National Series A Preferred Stock and 122,500 shares of Old National Series C Preferred Stock. Old National entered into two deposit agreements, each dated as of February 15, 2022, by and among Old National, Continental Stock Transfer & Trust Company, as depository, and the holders from time to time of the depositary receipts in connection with the issuance of the Old National Preferred Stock. Pursuant to the deposit agreements, Old National issued 4,320,000 depositary shares, each representing a 1/40th interest in a share of Old National Series A Preferred Stock, and 4,900,000 depositary shares, each representing a 1/40th interest in a

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share of Old National Series C Preferred Stock. The change in unrealized gains (losses) on available-for-sale investment securities decreased equity by $639.4 million during 2022.  In addition, available-for-sale investment securities with a fair value of $3.0 billion were transferred from the available-for-sale portfolio to the held-to-maturity portfolio during 2022. The resulting unrealized holding loss, net of tax, is included in shareholders’ equity and totaled $112.7 million at December 31, 2022. Old National repurchased 3.5 million shares of Common Stock in 2022 under a stock repurchase plan that was approved by the Company’s Board of Directors, which reduced equity by $63.8 million. Old National paid cash dividends of $0.56 per common share in 2022, which reduced equity by $163.5 million. Old National’s Common Stock is traded on the NASDAQ under the symbol “ONB” with 57,134 shareholders of record at December 31, 2022.

Capital Adequacy

Old National and the banking industry 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 21 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 our Board of Directors, Executive Leadership Team, and Senior Management to better assess, understand, monitor, and mitigate Old National’s risks.  The Risk Appetite Statement addresses the following major risks:  strategic, market, liquidity, credit, operational, talent management, compliance and regulatory, legal, and reputational.  Our Chief Risk Officer is independent of all other management and provides quarterly reports to the Board’s Enterprise Risk Committee.  The following discussion addresses certain of these major risks including credit, market, liquidity, operational, compliance and regulatory, and legal. Discussion of strategic, talent management, and reputational risks is provided in the section entitled “Risk Factors” in Item 1A of this Form 10-K.

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, 2022, we had pooled trust preferred securities with a fair value of $10.8 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 $3.0 million at December 31, 2022.  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.

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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 $108.9 million at December 31, 2022.

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 Midwest market areas we serve.  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 multi-family and non-residential properties such as retail centers, industrial properties as well as, 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 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 90% 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.

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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 management and overseen 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 provides oversight of loan policy changes as recommended by management 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, among others, real estate rental and leasing, manufacturing, healthcare, wholesale trade, construction, and agriculture.  Old National manages concentrations of credit exposure by industry, product, geography, client relationship, and loan size.  At December 31, 2022, our average commercial loan size was approximately $560,000 and our average commercial real estate loan size was approximately $1,200,000. 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, 2022, 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 in the Midwest region.

On February 15, 2022, Old National closed on its merger of equals transaction with First Midwest. As of the closing date of the transaction, First Midwest loans totaled $14.3 billion. Old National reviewed the acquired loans and determined that as of December 31, 2022, $275.6 million met the definition of criticized and $429.1 million were considered classified (of which $132.8 million are reported with nonaccrual loans). These loans are included in our summary of under-performing, criticized, and classified assets table below.

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The following table presents a summary of under-performing, criticized, and classified assets at December 31:

(1)Includes investment securities that fell below investment grade rating.

(2)Loans exclude loans held for sale.

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

Under-performing assets increased to $267.0 million at December 31, 2022, compared to $127.1 million at December 31, 2021 primarily due to the First Midwest merger.  Under-performing assets as a percentage of total loans at December 31, 2022 were 0.86%, a 7 basis point improvement from 0.93% at December 31, 2021.

Nonaccrual loans increased $131.5 million from December 31, 2021 to December 31, 2022 primarily due to the First Midwest merger. As a percentage of nonaccrual loans, the allowance for credit losses on loans was 127.50% at December 31, 2022, compared to 100.61% at December 31, 2021.

If nonaccrual and renegotiated loans outstanding at December 31, 2022 and 2021, respectively, had been accruing interest throughout the year in accordance with their original terms, interest income of approximately $7.9 million in 2022 and $5.1 million in 2021 would have been recorded on these loans. The amount of interest income actually recorded on nonaccrual and renegotiated loans was $5.1 million in 2022 and $1.3 million in 2021.

Total criticized and classified assets were $1.4 billion at December 31, 2022, an increase of $896.8 million from December 31, 2021.  Criticized and classified assets related to the First Midwest merger totaled $704.8 million at December 31, 2022. Other classified assets include investment securities that fell below investment grade rating totaling $24.7 million at December 31, 2022, compared to $4.3 million at December 31, 2021.

Old National may choose to restructure the contractual terms of certain loans.  At December 31, 2022, TDRs totaled $39.3 million, $24.0 million of which were included within nonaccrual loans.  At December 31, 2021, TDRs totaled $30.0 million, $11.7 million of which were included within nonaccrual loans.

Old National has established specific allowances for credit losses for clients whose loan terms have been modified as TDRs totaling $4.5 million at December 31, 2022 and $0.7 million at December 31, 2021.  Old National had not committed to lend any additional funds to clients with outstanding loans that are classified as TDRs at December 31, 2022 or December 31, 2021.

See Note 4 to the consolidated financial statements for additional information on TDRs.

Allowance for Credit Losses on Loans and Unfunded Loan Commitments

Credit quality within the loans held for investment portfolio is continuously monitored by management and is reflected within the allowance for credit losses on loans. The allowance for credit losses is an estimate of expected

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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 on loans held for investment and unfunded loan commitments 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 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 allowance for credit losses on loans 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.

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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 on loans. The allowance for credit losses on loans was calculated by pooling loans of similar credit risk characteristics and credit monitoring procedures. The four loan portfolios used to monitor and analyze interest income and yields – commercial, commercial real estate, residential real estate, and consumer – are reclassified into seven segments of loans – commercial, commercial real estate, BBCC, residential real estate, indirect, direct, and home equity for purposes of determining the allowance for credit losses on loans. 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 on 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 on loans was $303.7 million at December 31, 2022, compared to $107.3 million at December 31, 2021.  The increase reflects $89.1 million of allowance for credit losses on acquired PCD loans established through acquisition accounting adjustments as a result of the First Midwest merger. In addition, the provision for credit losses expense in 2022 included $96.3 million to establish an allowance for credit losses on non-PCD loans acquired in the First Midwest merger. 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, provision expense may be 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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The following table details the allowance for credit losses on 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 loan commitments 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 on 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 unfunded loan commitments is included in the provision for credit losses. The allowance for credit losses on unfunded loan commitments totaled $32.2 million at December 31, 2022, compared to $10.9 million at December 31, 2021. The increase in the allowance for credit losses on unfunded loan commitments was driven by the merger with First Midwest as well as organic loan growth.

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.

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 establish guidelines for asset and liability management, including measurement of short and long-term sensitivities to changes in interest rates, which are reviewed with the Enterprise Risk Committee of our Board of Directors. 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. 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, 2022 and 2021: