NOTE 10: COVERED LOANS

Loans acquired in Federal Deposit Insurance Corporation (FDIC)-assisted transactions are initially covered under loss sharing agreements whereby the FDIC will reimburse First Financial for the majority of any losses incurred and are referred to as covered loans.

First Financial evaluates purchased loans for impairment in accordance with the provisions of FASB ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. The cash flows expected to be collected on purchased loans are estimated based upon the expected remaining life of the underlying loans, which includes the effects of estimated prepayments. Purchased loans are considered impaired if there is evidence of credit deterioration since origination and if it is probable that not all contractually required payments will be collected. First Financial is accounting for the majority of its covered loans under FASB ASC Topic 310-30 except for loans with revolving privileges, which are outside the scope of this guidance, and loans for which cash flows could not be estimated, which are accounted for under the cost recovery method. For purposes of applying the guidance under FASB ASC Topic 310-30, First Financial grouped acquired loans into pools based on common risk characteristics.

Purchased impaired loans are not classified as nonperforming assets as the loans are considered to be performing under FASB ASC Topic 310-30. Therefore, interest income, through accretion of the difference between the carrying value of the loans and the expected cash flows is being recognized on all purchased loans being accounted for under FASB ASC Topic 310-30.

The following table reflects the carrying value of all purchased impaired and nonimpaired covered loans:



	March 31, 2012						December 31, 2011
(Dollars in thousands)	Loans Accounted For Under FASB ASC Topic 310-30		Loans excluded from FASB ASC Topic 310-30 ⁽¹⁾		Total Purchased Loans		Loans Accounted For Under FASB ASC Topic 310-30		Loans Excluded From FASB ASC Topic 310-30 ⁽¹⁾		Total Purchased Loans
Commercial	$	153,771	$	11,162	$	164,933	$	182,625	$	13,267	$	195,892
Real estate - construction	16,727		0		16,727		17,120		0		17,120
Real estate - commercial	599,897		9,244		609,141		627,257		9,787		637,044
Real estate - residential	115,428		0		115,428		121,117		0		121,117
Installment	11,255		824		12,079		12,123		1,053		13,176
Home equity	3,731		61,093		64,824		4,146		60,832		64,978
Other covered loans	0		3,487		3,487		0		3,917		3,917
Total covered loans	$	900,809	$	85,810	$	986,619	$	964,388	$	88,856	$	1,053,244

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

The outstanding balance of all loans accounted for under FASB ASC Topic 310-30, including contractual principal, interest, fees and penalties, was $1.5 billion and $1.6 billion as of March 31, 2012 and December 31, 2011, respectively.

Changes in the carrying amount of accretable yield for loans accounted for under FASB ASC Topic 310-30 were as follows:



	Three Months Ended
	March 31,
(Dollars in thousands)	2012			2011
Balance at beginning of period ⁽¹⁾	$	344,410		$	509,945
Reclassification from non-accretable difference	14,384			21,977
Accretion	(25,919		)	(34,461		)
Other net activity ⁽²⁾	(19,206		)	(36,171		)
Balance at end of period	$	313,669		$	461,290

(1) Excludes loans with revolving privileges which are scoped out of FASB Topic 310-30 and certain loans which First Financial elected to treat under the cost recovery method.

(2) Includes the impact of loan repayments and charge-offs.

First Financial reviewed its forecast of expected cash flows for loans accounted for under FASB ASC Topic 310-30 during the first quarter of 2012. The Company recognized improvement in the cash flow expectations related to certain loan pools resulting in the reclassification from nonaccretable to accretable difference during the first quarter of 2012 and 2011 of $14.4 million and $22.0 million, respectively. These reclassifications resulted in yield adjustments on these loan pools on a prospective basis. The Company also recognized declines in the cash flow expectations of certain loan pools. Any decline in expected cash flows for a pool of loans is considered impairment and recorded as provision expense, and a related allowance for loan and lease losses on covered loans, on a discounted basis during the period. Improved cash flow expectations for loan pools that were impaired during prior periods is recorded first as a reversal of previously recorded impairment and then as an increase in prospective yield when all previously recorded impairment has been recaptured. For further detail on impairment and provision expense related to loans accounted for under FASB ASC Topic 310-30, see "Covered Loans" under Note 11 - Allowance for Loan and Lease Losses.

Covered loans accounted for under FASB ASC Topic 310-30 are classified as performing, even though they may be contractually past due, as any nonpayment of contractual principal or interest is considered in the periodic re-estimation of expected cash flows and is included in the resulting recognition of current period covered loan loss provision or prospective yield adjustments.

Delinquency. Covered loans are considered past due or delinquent when the contractual principal or interest due in accordance with the terms of the loan agreement or any portion thereof remains unpaid after the due date of the scheduled payment.

Covered loan delinquency, excluding loans accounted for under FASB ASC Topic 310-30, was as follows:



	As of March 31, 2012
(Dollars in thousands)	30 - 59 days past due		60 - 89 days past due		> 90 days past due		Total past due		Current		Total		> 90 days past due and accruing
Loans
Commercial	$	411	$	23	$	2,935	$	3,369	$	7,793	$	11,162	$	0
Real estate - commercial	207		144		1,801		2,152		7,092		9,244		0
Installment	0		0		0		0		824		824		0
Home equity	827		400		546		1,773		59,320		61,093		0
All other	45		51		16		112		3,375		3,487		1
Total	$	1,490	$	618	$	5,298	$	7,406	$	78,404	$	85,810	$	1



	As of December 31, 2011
(Dollars in thousands)	30 - 59 days past due		60 - 89 days past due		> 90 days past due		Total past due		Current		Total		> 90 days past due and accruing
Loans
Commercial	$	73	$	294	$	6,490	$	6,857	$	6,410	$	13,267	$	0
Real estate - commercial	184		0		1,870		2,054		7,733		9,787		0
Installment	0		0		0		0		1,053		1,053		0
Home equity	1,344		11		1,679		3,034		57,798		60,832		0
All other	10		6		125		141		3,776		3,917		107
Total	$	1,611	$	311	$	10,164	$	12,086	$	76,770	$	88,856	$	107

Nonaccrual. Similar to uncovered loans, covered loans accounted for outside FASB ASC Topic 310-30 are classified as nonaccrual when, in the opinion of management, collection of principal or interest is doubtful or when principal or interest payments are 90 days or more past due. Generally, these loans are placed on nonaccrual status due to the continued failure to adhere to contractual payment terms by the borrower coupled with other pertinent factors, such as, insufficient collateral value. The accrual of interest income is discontinued and previously accrued, but unpaid interest is reversed when a loan is placed in nonaccrual status. Any payments received while a loan is in nonaccrual status are applied as a reduction to the carrying value of the loan. A loan may be placed back on accrual status if all contractual payments have been received and collection of future principal and interest payments is no longer doubtful.

Information as to covered nonaccrual loans, excluding loans accounted for under FASB ASC Topic 310-30 was as follows:



(Dollars in thousands)	March 31, 2012		December 31, 2011
Impaired loans
Nonaccrual loans
Commercial	$	5,283	$	7,203
Real estate-commercial	2,476		2,192
Home equity	646		1,747
All other	15		18
Total	$	8,420	$	11,160



	Three Months Ended March 31,
(Dollars in thousands)	2012		2011
Interest income effect on impaired loans
Gross amount of interest that would have been recorded under original terms	$	208	$	261
Interest included in income	48		27
Net impact on interest income	$	160	$	234

Impaired Loans. Covered loans placed in nonaccrual status, excluding loans accounted for under FASB ASC Topic 310-30, are considered impaired. First Financial’s investment in covered impaired loans, excluding loans accounted for under FASB ASC Topic 310-30, was as follows:



	As of March 31, 2012
(Dollars in thousands)	Current Balance		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Loans with no related allowance recorded:
Commercial	$	5,283	$	8,143	$	0	$	6,243	$	43
Real estate - commercial	2,476		4,403		0		2,334		4
Home equity	646		1,122		0		1,197		1
All other	15		15		0		17		0
Total	$	8,420	$	13,683	$	0	$	9,791	$	48



	As of December 31, 2011
(Dollars in thousands)	Current Balance		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Loans with no related allowance recorded:
Commercial	$	7,203	$	10,152	$	0	$	9,873	$	47
Real estate - commercial	2,192		4,002		0		2,504		5
Installment	1,747		2,878		0		1,559		6
Home equity	18		18		0		9		0
Total	$	11,160	$	17,050	$	0	$	13,945	$	58

Credit Quality. For further discussion of First Financial's monitoring of credit quality for commercial and consumer loans, including discussion of the risk attributes noted below, please see Note 9 - Loans.

Covered commercial and consumer credit exposure by risk attribute was as follows:



	As of March 31, 2012
			Real Estate
(Dollars in thousands)	Commercial		Construction		Commercial		Total
Pass	$	98,021	$	2,469	$	311,978	$	412,468
Special Mention	16,137		3,524		71,937		91,598
Substandard	46,711		10,734		224,954		282,399
Doubtful	4,064		0		272		4,336
Total	$	164,933	$	16,727	$	609,141	$	790,801



(Dollars in thousands)	Real Estate Residential		Installment		Home Equity		Other		Total
Performing	$	115,428	$	12,079	$	64,178	$	3,472	$	195,157
Nonperforming	0		0		646		15		661
Total	$	115,428	$	12,079	$	64,824	$	3,487	$	195,818



	December 31, 2011
			Real Estate
(Dollars in thousands)	Commercial		Construction		Commercial		Total
Pass	$	113,201	$	2,506	$	340,889	$	456,596
Special Mention	22,468		3,597		63,880		89,945
Substandard	52,103		11,017		230,870		293,990
Doubtful	8,120		0		1,405		9,525
Total	$	195,892	$	17,120	$	637,044	$	850,056



(Dollars in thousands)	Real Estate Residential		Installment		Home Equity		Other		Total
Performing	$	121,117	$	13,176	$	63,231	$	3,899	$	201,423
Nonperforming	0		0		1,747		18		1,765
Total	$	121,117	$	13,176	$	64,978	$	3,917	$	203,188

Covered OREO. Covered OREO is comprised of properties acquired by the Company through the loan foreclosure or repossession process, or other resolution activities that result in partial or total satisfaction of problem covered loans. These properties remain subject to loss share agreements whereby the FDIC reimburses First Financial for the majority of any losses incurred. The acquired properties are recorded at the lower of cost or fair value upon acquisition. Losses arising at the time of acquisition of such properties are charged against the allowance for loan and lease losses. Subsequent write-downs in the carrying value of covered OREO properties are expensed as incurred. Improvements to the properties may be capitalized if the improvements contribute to the overall value of the property, but may not be capitalized in excess of the net realizable value of the property.

Changes in covered OREO were as follows:



	Three months ended March 31,
(Dollars in thousands)	2012		2011
Balance at beginning of period	$	44,818	$	35,257
Additions
Commercial	2,750		11,197
Residential	2,624		881
Total additions	5,374		12,078
Disposals
Commercial	5,005		9,266
Residential	543		2,336
Total disposals	5,548		11,602
Write-downs
Commercial	3,084		2,085
Residential	71		0
Total write-downs	3,155		2,085
Balance at end of period	$	41,489	$	33,648