COVERED LOANS

Loans acquired in Federal Deposit Insurance Corporation (FDIC)-assisted transactions initially covered under loss sharing agreements whereby the FDIC will reimburse First Financial for the majority of any losses incurred are referred to as covered loans. Pursuant to the terms of each loss sharing agreement, covered loans are subject to a stated loss threshold whereby the FDIC will reimburse First Financial for 80% of losses up to the stated loss threshold and 95% of losses in excess of the threshold. First Financial will reimburse the FDIC for its pro rata share of recoveries with respect to losses for which the FDIC paid First Financial a reimbursement under the loss sharing agreement. The FDIC’s obligation to reimburse First Financial for losses with respect to covered loans began with the first dollar of loss incurred.

First Financial accounts for the majority of covered loans under FASB ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, except 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. Loans accounted for under FASB ASC Topic 310-30 are referred to as purchased impaired loans.

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 (accretable difference) is recognized on all covered purchased impaired loans.

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



	September 30, 2013						December 31, 2012
(Dollars in thousands)	Loans accounted for under FASB ASC Topic 310-30		Loans excluded from FASB ASC Topic 310-30		Total purchased loans		Loans accounted for under FASB ASC Topic 310-30		Loans excluded from FASB ASC Topic 310-30		Total purchased loans
Commercial	$	51,077	$	1,199	$	52,276	$	94,775	$	7,351	$	102,126
Real estate - construction	8,692		0		8,692		10,631		0		10,631
Real estate - commercial	306,345		6,453		312,798		458,066		7,489		465,555
Real estate - residential	84,418		0		84,418		100,694		0		100,694
Installment	5,552		583		6,135		7,911		763		8,674
Home equity	1,009		50,683		51,692		2,080		55,378		57,458
Other covered loans	0		2,513		2,513		0		2,978		2,978
Total covered loans	$	457,093	$	61,431	$	518,524	$	674,157	$	73,959	$	748,116

The outstanding balance of all purchased impaired and nonimpaired loans accounted for under FASB ASC Topic 310-30, including all contractual principal, interest, fees and penalties, was $569.9 million and $852.9 million as of September 30, 2013 and December 31, 2012, respectively. These balances exclude contractual interest not yet accrued.

Changes in the carrying amount of accretable difference for covered purchased impaired loans were as follows:



	Three Months Ended						Nine months ended
	September 30,						September 30,
(Dollars in thousands)	2013			2012			2013			2012
Balance at beginning of period	$	173,920		$	283,296		$	224,694		$	344,410
Reclassification (to)/from nonaccretable difference	(4,979		)	2,338			(5,687		)	25,780
Accretion	(13,772		)	(21,730		)	(46,971		)	(71,674		)
Other net activity ⁽¹⁾	(8,347		)	(11,749		)	(25,214		)	(46,361		)
Balance at end of period	$	146,822		$	252,155		$	146,822		$	252,155

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

First Financial regularly reviews its forecast of expected cash flows for covered purchased impaired loans. During the second quarter 2013 the Company implemented certain enhancements to its valuation methodology and the estimation of impairment to place greater emphasis on changes in total expected cash flows and less emphasis on changes in the net present value of expected cash flows. These enhancements contributed to a net reclassification from accretable difference to nonaccretable difference of $5.0 million and resulted in lower yields on certain loan pools during the third quarter 2013. Conversely, First Financial recognized a $2.3 million reclassification from nonaccretable difference to accretable difference and higher yields on certain loan pools during the third quarter of 2012 related to improvement in the cash flow expectations for certain loan pools. For the nine months ended September 30, 2013, the Company recognized a net reclassification of $5.7 million from accretable difference to nonaccretable difference as a result of the enhancements to the valuation methodology. For the nine months ended September 30, 2012, the Company recognized a net reclassification of $25.8 million from nonaccretable difference to accretable difference. For further detail on impairment and provision expense related to covered purchased impaired loans, see "Covered Loans" in Note 10 - Allowance for Loan and Lease Losses.

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 8 - Loans, excluding covered loans.

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



	As of September 30, 2013
			Real Estate
(Dollars in thousands)	Commercial		Construction		Commercial		Total
Pass	$	27,580	$	1,714	$	175,085	$	204,379
Special Mention	7,933		0		41,478		49,411
Substandard	15,973		6,978		96,235		119,186
Doubtful	790		0		0		790
Total	$	52,276	$	8,692	$	312,798	$	373,766



(Dollars in thousands)	Real estate residential		Installment		Home equity		Other		Total
Performing	$	84,418	$	6,135	$	49,680	$	2,507	$	142,740
Nonperforming	0		0		2,012		6		2,018
Total	$	84,418	$	6,135	$	51,692	$	2,513	$	144,758



	As of December 31, 2012
			Real Estate
(Dollars in thousands)	Commercial		Construction		Commercial		Total
Pass	$	48,213	$	2,304	$	213,143	$	263,660
Special Mention	16,293		7		70,894		87,194
Substandard	35,596		8,320		181,345		225,261
Doubtful	2,024		0		173		2,197
Total	$	102,126	$	10,631	$	465,555	$	578,312



(Dollars in thousands)	Real estate residential		Installment		Home equity		Other		Total
Performing	$	100,694	$	8,674	$	53,231	$	2,967	$	165,566
Nonperforming	0		0		4,227		11		4,238
Total	$	100,694	$	8,674	$	57,458	$	2,978	$	169,804

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, 2013
(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	$	59	$	136	$	379	$	574	$	625	$	1,199	$	0
Real estate - commercial	59		5		1,809		1,873		4,580		6,453		0
Installment	6		0		0		6		577		583		0
Home equity	722		459		1,052		2,233		48,450		50,683		0
All other	3		0		49		52		2,461		2,513		43
Total	$	849	$	600	$	3,289	$	4,738	$	56,693	$	61,431	$	43



	As of December 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	$	351	$	148	$	3,781	$	4,280	$	3,071	$	7,351	$	0
Real estate - commercial	138		1,149		2,201		3,488		4,001		7,489		0
Installment	0		0		0		0		763		763		0
Home equity	286		296		3,697		4,279		51,099		55,378		0
All other	19		26		42		87		2,891		2,978		31
Total	$	794	$	1,619	$	9,721	$	12,134	$	61,825	$	73,959	$	31

Nonaccrual. Covered purchased impaired loans 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.

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 classified as nonaccrual 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 classified as nonaccrual. Any payments received while a loan is classified as nonaccrual are applied as a reduction to the carrying value of the loan. A loan may be reclassified as accrual if all contractual payments have been received and collection of future principal and interest payments is no longer doubtful.

Impaired Loans. Covered loans placed on nonaccrual status and covered loans modified as TDRs, excluding loans accounted for under FASB ASC Topic 310-30, are considered impaired. Information on covered nonaccrual loans, TDRs and impaired loans was as follows:



(Dollars in thousands)	September 30, 2013		December 31, 2012
Impaired loans
Nonaccrual loans
Commercial	$	438	$	4,498
Real estate-commercial	1,899		2,986
Installment	0		0
Home equity	2,012		4,227
All other	6		11
Nonaccrual loans	4,355		11,722
Accruing troubled debt restructurings	351		0
Total impaired loans	$	4,706	$	11,722



	Three months ended				Nine months ended
	September 30,				September 30,
(Dollars in thousands)	2013		2012		2013		2012
Interest income effect on impaired loans
Gross amount of interest that would have been recorded under original terms	$	81	$	146	$	334	$	504
Interest included in income
Nonaccrual loans	6		9		20		70
Troubled debt restructurings	3		0		6		0
Total interest included in income	9		9		26		70
Net impact on interest income	$	72	$	137	$	308	$	434

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, 2013
(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	$	789	$	1,045	$	0	$	2,072	$	11	$	3
Real estate - commercial	1,899		3,342		0		1,895		3		1
Installment	0		0		0		2		0		0
Home equity	2,012		2,739		0		2,790		12		5
All other	6		6		0		10		0		0
Total	$	4,706	$	7,132	$	0	$	6,769	$	26	$	9



	As of December 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	$	4,498	$	4,660	$	0	$	4,526	$	62
Real estate - commercial	2,986		3,216		0		2,153		18
Home equity	4,227		5,260		0		2,006		5
All other	11		11		0		13		0
Total	$	11,722	$	13,147	$	0	$	8,698	$	85

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 sharing 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. Estimated reimbursements due from the FDIC under loss sharing agreements related to any losses upon acquisition or subsequent write-downs in the carrying value of covered OREO are recorded as noninterest income and an increase to the FDIC indemnification asset in the same period. 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)	2013		2012		2013		2012
Balance at beginning of period	$	22,475	$	25,408	$	28,862	$	44,818
Additions
Commercial	8,572		8,578		21,063		13,677
Residential	95		737		472		3,423
Total additions	8,667		9,315		21,535		17,100
Disposals
Commercial	2,865		5,858		19,513		24,417
Residential	76		0		890		2,354
Total disposals	2,941		5,858		20,403		26,771
Write-downs
Commercial	451		249		2,133		5,665
Residential	0		0		111		866
Total write-downs	451		249		2,244		6,531
Balance at end of period	$	27,750	$	28,616	$	27,750	$	28,616