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. 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 accounted for under FASB ASC Topic 310-30.

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



	September 30, 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	$	114,574	$	7,171	$	121,745	$	182,625	$	13,267	$	195,892
Real estate - construction	12,898		0		12,898		17,120		0		17,120
Real estate - commercial	504,453		7,867		512,320		627,257		9,787		637,044
Real estate - residential	105,113		0		105,113		121,117		0		121,117
Installment	9,108		784		9,892		12,123		1,053		13,176
Home equity	2,679		57,823		60,502		4,146		60,832		64,978
Other covered loans	0		3,045		3,045		0		3,917		3,917
Total covered loans	$	748,825	$	76,690	$	825,515	$	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 $1.2 billion and $1.6 billion as of September 30, 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						Nine months ended
	September 30,						September 30,
(Dollars in thousands)	2012			2011			2012			2011
Balance at beginning of period ⁽¹⁾	$	283,296		$	421,781		$	344,410		$	509,945
Reclassification from nonaccretable difference	2,338			17,311			25,780			50,517
Accretion	(21,730		)	(31,168		)	(71,674		)	(97,447		)
Other net activity ⁽²⁾	(11,749		)	(4,878		)	(46,361		)	(59,969		)
Balance at end of period	$	252,155		$	403,046		$	252,155		$	403,046

(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 of accounting

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

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 September 30, 2012
			Real Estate
(Dollars in thousands)	Commercial		Construction		Commercial		Total
Pass	$	60,033	$	2,309	$	249,139	$	311,481
Special Mention	15,289		3,290		65,766		84,345
Substandard	43,628		7,299		197,234		248,161
Doubtful	2,795		0		181		2,976
Total	$	121,745	$	12,898	$	512,320	$	646,963



(Dollars in thousands)	Real estate residential		Installment		Home equity		Other		Total
Performing	$	105,113	$	9,892	$	58,639	$	3,039	$	176,683
Nonperforming	0		0		1,863		6		1,869
Total	$	105,113	$	9,892	$	60,502	$	3,045	$	178,552



	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

First Financial reviews its forecast of expected cash flows for loans accounted for under FASB ASC Topic 310-30 on a quarterly basis. The Company experienced changes in both the timing and amount of expected cash flows on certain loan pools related to payment activities and loan resolution strategies resulting in a $2.3 million reclassification from nonaccretable to accretable difference during the third quarter of 2012. Similarly, the Company reclassified $17.3 million from nonaccretable to accretable difference during the third quarter of 2011, and $25.8 million and $50.5 million for the nine months ended September 30, 2012, and 2011, respectively.

Generally, net increases in expected cash flows for a pool of loans results in a yield adjustments on the loan pool on a prospective basis. Net declines in expected cash flows for a pool of loans are 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 September 30, 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	$	10	$	316	$	1,960	$	2,286	$	4,885	$	7,171	$	0
Real estate - commercial	0		0		941		941		6,926		7,867		0
Installment	0		0		0		0		784		784		0
Home equity	332		1,135		1,855		3,322		54,501		57,823		0
All other	139		7		13		159		2,886		3,045		7
Total	$	481	$	1,458	$	4,769	$	6,708	$	69,982	$	76,690	$	7



	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 ninety 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 returned to accrual status if all contractual payments have been received and collection of future principal and interest payments is no longer doubtful.

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



(Dollars in thousands)	September 30, 2012		December 31, 2011
Nonaccrual loans
Commercial	$	2,448	$	7,203
Real estate-commercial	1,589		2,192
Home equity	1,863		1,747
All other	6		18
Total	$	5,906	$	11,160



	Three months ended				Nine months ended
	September 30,				September 30,
(Dollars in thousands)	2012		2011		2012		2011
Interest income effect on impaired loans
Gross amount of interest that would have been recorded under original terms	$	146	$	268	$	504	$	769
Interest included in income	9		8		70		49
Net impact on interest income	$	137	$	260	$	434	$	720

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 September 30, 2012
(Dollars in thousands)	Current Balance		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		YTD Interest Income Recognized		Quarterly Interest Income Recognized
Loans with no related allowance recorded:
Commercial	$	2,448	$	4,731	$	0	$	4,533	$	55	$	4
Real estate - commercial	1,589		3,188		0		1,945		14		5
Home equity	1,863		2,885		0		1,451		1		0
All other	6		6		0		14		0		0
Total	$	5,906	$	10,810	$	0	$	7,943	$	70	$	9



	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

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				Nine months ended
	September 30,				September 30,
(Dollars in thousands)	2012		2011		2012		2011
Balance at beginning of period	$	25,408	$	36,687	$	44,818	$	35,257
Additions
Commercial	8,578		16,699		13,677		38,431
Residential	737		490		3,423		2,315
Total additions	9,315		17,189		17,100		40,746
Disposals
Commercial	5,858		9,440		24,417		20,940
Residential	0		901		2,354		6,992
Total disposals	5,858		10,341		26,771		27,932
Write-downs
Commercial	249		614		5,665		4,138
Residential	0		83		866		1,095
Total write-downs	249		697		6,531		5,233
Balance at end of period	$	28,616	$	42,838	$	28,616	$	42,838