LOANS AND LEASES

First Financial offers clients a variety of commercial and consumer loan and lease products with various interest rates and payment terms. Lending activities are primarily concentrated in states where the Bank currently operates banking centers (Ohio, Indiana and Kentucky). Additionally, First Financial has two national lending platforms, one that provides equipment and leasehold improvement financing for franchisees in the quick service and casual dining restaurant sector and another that provides loans secured by commissions and cash collateral accounts primarily to insurance agents and brokers. Commercial loan categories include commercial and industrial, commercial real estate, construction real estate and lease financing. Consumer loan categories include residential real estate, home equity, installment and credit card.

Purchased impaired loans. Loans accounted for under FASB ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, are referred to as purchased impaired loans. First Financial accounts for the majority of loans acquired in FDIC transactions as purchased impaired loans, except for loans with revolving privileges, which are outside the scope of FASB ASC Topic 310-30, and loans for which cash flows could not be estimated, which are accounted for under the cost recovery method. Purchased impaired loans include loans previously covered under loss sharing agreements as well as loans that remain subject to FDIC loss sharing coverage.

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 purchased impaired loans. First Financial had purchased impaired loans totaling $177.0 million and $191.6 million, at March 31, 2016 and December 31, 2015, respectively. The outstanding balance of all purchased impaired loans, including all contractual principal, interest, fees and penalties, was $196.2 million and $213.3 million as of March 31, 2016 and December 31, 2015, respectively. These balances exclude contractual interest not yet accrued.

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



	Three months ended
	March 31,
(Dollars in thousands)	2016			2015
Balance at beginning of period	$	64,857		$	106,622
Reclassification from/(to) nonaccretable difference	318			(1,576		)
Accretion	(4,210		)	(6,357		)
Other net activity ⁽¹⁾	(2,241		)	(6,701		)
Balance at end of period	$	58,724		$	91,988

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

First Financial regularly reviews its forecast of expected cash flows for purchased impaired loans. The Company recognized reclassifications from nonaccretable to accretable difference of $0.3 million for the first quarter of 2016, however, during the three months ended March 31, 2015, the Company recognized reclassifications from accretable to nonaccretable difference of $1.6 million due to changes in the cash flow expectations related to certain loan pools. These reclassifications can result in impairment and provision expense in the current period or yield adjustments on the related loan pools on a prospective basis.

Covered loans. Loans acquired in FDIC-assisted transactions 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 the loss sharing agreements, covered loans are subject to a stated loss threshold whereby the FDIC will reimburse First Financial for 80% of losses up to a stated loss threshold and 95% of losses in excess of the threshold. These loss sharing agreements provide for partial loss protection on single-family, residential loans for a period of ten years and First Financial is required to share any recoveries of previously charged-off amounts for the same time period, on the same pro-rata basis with the FDIC. All other loans subject to loss sharing agreements were provided loss protection for a period of five years and recoveries of previously charged-off amounts must be shared with the FDIC for an additional three year period, on the same pro-rata basis.

The Company's loss sharing agreements with the FDIC related to non-single family loans expired effective October 1, 2014, and the ten year period of loss protection on all other covered loans and covered OREO expires October 1, 2019. Covered loans totaled $109.2 million as of March 31, 2016 and $113.3 million as of December 31, 2015.

Credit Quality. To facilitate the monitoring of credit quality for commercial loans, and for purposes of determining an appropriate ALLL, First Financial utilizes the following categories of credit grades:

Pass - Higher quality loans that do not fit any of the other categories described below.

Special Mention - First Financial assigns a special mention rating to loans and leases with potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or lease or in First Financial's credit position at some future date.

Substandard - First Financial assigns a substandard rating to loans or leases that are inadequately protected by the current sound financial worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard loans and leases have well-defined weaknesses that jeopardize repayment of the debt. Substandard loans and leases are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not addressed.

Doubtful - First Financial assigns a doubtful rating to loans and leases with all the attributes of a substandard rating with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors that may work to the advantage and strengthening of the credit quality of the loan or lease, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.

The credit grades described above, which are derived from standard regulatory rating definitions, are assigned upon initial approval of credit to borrowers and updated periodically thereafter.

First Financial considers repayment performance to be the best indicator of credit quality for consumer loans. Consumer loans that have principal and interest payments that are past due by 90 days or more are generally classified as nonperforming. Additionally, consumer loans that have been modified in a TDR are classified as nonperforming.

Commercial and consumer credit exposure by risk attribute was as follows:



	As of March 31, 2016
			Real Estate
(Dollars in thousands)	Commercial		Construction		Commercial		Leasing		Total
Pass	$	1,680,764	$	337,472	$	2,182,683	$	99,583	$	4,300,502
Special Mention	22,155		3,417		19,754		0		45,326
Substandard	41,813		564		59,420		1,552		103,349
Doubtful	0		0		0		0		0
Total	$	1,744,732	$	341,453	$	2,261,857	$	101,135	$	4,449,177



(Dollars in thousands)	Real Estate Residential		Home Equity		Installment		Other		Total
Performing	$	499,849	$	460,341	$	41,408	$	39,283	$	1,040,881
Nonperforming	8,663		5,669		219		0		14,551
Total	$	508,512	$	466,010	$	41,627	$	39,283	$	1,055,432



	As of December 31, 2015
			Real Estate
(Dollars in thousands)	Commercial		Construction		Commercial		Leasing		Total
Pass	$	1,596,415	$	310,806	$	2,179,701	$	93,236	$	4,180,158
Special Mention	27,498		128		19,903		0		47,529
Substandard	39,189		778		58,693		750		99,410
Doubtful	0		0		0		0		0
Total	$	1,663,102	$	311,712	$	2,258,297	$	93,986	$	4,327,097



(Dollars in thousands)	Real Estate Residential		Home Equity		Installment		Other		Total
Performing	$	503,317	$	461,188	$	41,253	$	41,217	$	1,046,975
Nonperforming	8,994		5,441		253		0		14,688
Total	$	512,311	$	466,629	$	41,506	$	41,217	$	1,061,663

Delinquency. 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 date of the scheduled payment.

Loan delinquency, including loans classified as nonaccrual, was as follows:



	As of March 31, 2016
(Dollars in thousands)	30 – 59 days past due		60 – 89 days past due		> 90 days past due		Total past due		Current		Subtotal		Purchased impaired		Total		> 90 days past due and still accruing
Loans
Commercial	$	4,354	$	310	$	3,034	$	7,698	$	1,729,886	$	1,737,584	$	7,148	$	1,744,732	$	0
Real estate - construction	5,002		0		0		5,002		335,689		340,691		762		341,453		0
Real estate - commercial	2,718		0		6,631		9,349		2,141,626		2,150,975		110,882		2,261,857		0
Real estate - residential	858		0		2,020		2,878		450,582		453,460		55,052		508,512		0
Home equity	505		81		3,025		3,611		460,929		464,540		1,470		466,010		0
Installment	133		13		67		213		39,713		39,926		1,701		41,627		0
Other	435		328		59		822		139,596		140,418		0		140,418		59
Total	$	14,005	$	732	$	14,836	$	29,573	$	5,298,021	$	5,327,594	$	177,015	$	5,504,609	$	59



	As of December 31, 2015
(Dollars in thousands)	30 – 59 days past due		60 – 89 days past due		> 90 days past due		Total past due		Current		Subtotal		Purchased impaired		Total		> 90 days past due and still accruing
Loans
Commercial	$	2,255	$	2,232	$	1,937	$	6,424	$	1,648,902	$	1,655,326	$	7,776	$	1,663,102	$	0
Real estate - construction	0		17		0		17		310,872		310,889		823		311,712		0
Real estate - commercial	2,501		913		7,421		10,835		2,124,290		2,135,125		123,172		2,258,297		0
Real estate - residential	1,220		239		2,242		3,701		451,907		455,608		56,703		512,311		0
Home equity	696		248		2,830		3,774		461,647		465,421		1,208		466,629		0
Installment	197		111		48		356		39,206		39,562		1,944		41,506		0
Other	920		302		230		1,452		133,751		135,203		0		135,203		108
Total	$	7,789	$	4,062	$	14,708	$	26,559	$	5,170,575	$	5,197,134	$	191,626	$	5,388,760	$	108

Nonaccrual. Loans 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, 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 on nonaccrual status are applied as a reduction to the carrying value of the loan. A loan may return to accrual status if collection of future principal and interest payments is no longer doubtful.

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 provision for loan and lease losses or prospective yield adjustments.

Troubled Debt Restructurings. A loan modification is considered a TDR when the borrower is experiencing financial difficulty and concessions are made by the Company that would not otherwise be considered for a borrower with similar credit characteristics. The most common types of modifications include interest rate reductions, maturity extensions and modifications to principal amortization, including interest-only structures. Modified terms are dependent upon the financial position and needs of the individual borrower. If the modification agreement is violated, the loan is managed by the Company’s credit administration group for resolution, which may result in foreclosure in the case of real estate.

TDRs are generally classified as nonaccrual for a minimum period of six months and may qualify for return to accrual status once they have demonstrated performance with the restructured terms of the loan agreement.

First Financial had 271 TDRs totaling $37.7 million at March 31, 2016, including $30.1 million on accrual status and $7.5 million classified as nonaccrual. First Financial had $0.4 million of commitments outstanding to lend additional funds to borrowers whose loan terms have been modified through TDRs at March 31, 2016. At March 31, 2016, the ALLL included reserves of $2.4 million related to TDRs. For the three months ended March 31, 2016 and 2015, First Financial charged off $0.2 million and $6 thousand respectively, for the portion of TDRs determined to be uncollectible. Additionally, as of March 31, 2016, approximately $10.2 million of accruing TDRs have been performing in accordance with the restructured terms for more than one year.

First Financial had 271 TDRs totaling $38.2 million at December 31, 2015, including $28.9 million of loans on accrual status and $9.3 million classified as nonaccrual. First Financial had $1.8 million of commitments outstanding to lend additional funds to borrowers whose loan terms had been modified through TDRs. At December 31, 2015, the ALLL included reserves of $6.3 million related to TDRs. For the year ended December 31, 2015, First Financial charged off $2.7 million for the portion of TDRs determined to be uncollectible. As of December 31, 2015, approximately $10.3 million of the accruing TDRs had been performing in accordance with the restructured terms for more than one year.

The following tables provide information on loan modifications classified as TDRs during the three months ended March 31, 2016 and 2015:



	Three months ended
	March 31, 2016					March 31, 2015
(Dollars in thousands)	Number of loans	Pre-modification loan balance		Period end balance		Number of loans	Pre-modification loan balance		Period end balance
Commercial	8	$	2,083	$	2,095	8	$	360	$	359
Real estate - construction	0	0		0		0	0		0
Real estate - commercial	1	42		42		6	12,914		9,343
Real estate - residential	2	281		247		0	0		0
Home equity	4	149		140		0	0		0
Installment	2	7		7		0	0		0
Total	17	$	2,562	$	2,531	14	$	13,274	$	9,702

The following table provides information on how TDRs were modified during the three months ended March 31, 2016 and 2015.



	Three months ended
	March 31,
(Dollars in thousands)	2016		2015
Extended maturities	$	486	$	9,481
Adjusted interest rates	0		0
Combination of rate and maturity changes	162		62
Forbearance	0		0
Other ⁽¹⁾	1,883		159
Total	$	2,531	$	9,702

(1) Includes covenant modifications and other concessions, or combination of concessions, that do not consist of interest rate adjustments, forbearance and maturity extensions

First Financial considers repayment performance as an indication of the effectiveness of the Company's loan modifications. Borrowers that are 90 days or more past due on any principal or interest payments, or who prematurely terminate a restructured loan agreement without paying off the contractual principal balance (for example, in a deed-in-lieu arrangement), are considered to be in payment default of the terms of the TDR agreement.

The following table provides information on TDRs for which there was a payment default during the period that occurred within twelve months of the loan modification:



	Three months ended
	March 31, 2016			March 31, 2015
(Dollars in thousands)	Number of loans	Period end balance		Number of loans	Period end balance
Commercial	1	$	55	0	$	0
Real estate - construction	0	0		0	0
Real estate - commercial	0	0		3	967
Real estate - residential	1	214		1	73
Home equity	1	28		0	0
Installment	1	4		0	0
Total	4	$	301	4	$	1,040

Impaired Loans. Loans classified as nonaccrual and loans modified as TDRs are considered impaired. The following table provides information on impaired loans, excluding purchased impaired loans.



(Dollars in thousands)	March 31, 2016		December 31, 2015
Impaired loans
Nonaccrual loans⁽¹⁾
Commercial	$	3,917	$	8,405
Real estate-construction	0		0
Real estate-commercial	8,577		9,418
Real estate-residential	4,243		5,027
Home equity	5,036		4,898
Installment	113		127
Other	121		122
Nonaccrual loans ⁽¹⁾	22,007		27,997
Accruing troubled debt restructurings	30,127		28,876
Total impaired loans	$	52,134	$	56,873

(1) Nonaccrual loans include nonaccrual TDRs of $7.5 million and $9.3 million as of March 31, 2016 and December 31, 2015, respectively.



	Three months ended
	March 31,
(Dollars in thousands)	2016		2015
Interest income effect on impaired loans
Gross amount of interest that would have been recorded under original terms	$	754	$	967
Interest included in income
Nonaccrual loans	76		171
Troubled debt restructurings	232		132
Total interest included in income	308		303
Net impact on interest income	$	446	$	664

First Financial individually reviews all impaired commercial loan relationships greater than $250,000, as well as consumer loan TDRs greater than $100,000, to determine if a specific allowance is necessary based on the borrower’s overall financial condition, resources and payment record, support from guarantors and the realizable value of any collateral. Specific allowances are based on discounted cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans.

First Financial's investment in impaired loans was as follows:



	As of March 31, 2016
(Dollars in thousands)	Current balance		Contractual principal balance		Related allowance		Average current balance		YTD interest income recognized
Loans with no related allowance recorded
Commercial	$	13,512	$	14,442	$	0	$	14,965	$	74
Real estate - construction	0		0		0		0		0
Real estate - commercial	14,003		18,707		0		15,152		70
Real estate - residential	7,126		8,383		0		7,287		46
Home equity	5,569		7,673		0		5,455		21
Installment	219		236		0		236		1
Other	121		121		0		122		0
Total	40,550		49,562		0		43,217		212

Loans with an allowance recorded
Commercial	973		1,163		400		983		9
Real estate - construction	0		0		0		0		0
Real estate - commercial	8,974		8,974		763		8,663		77
Real estate - residential	1,537		1,551		236		1,542		9
Home equity	100		100		2		101		1
Installment	0		0		0		0		0
Other	0		0		0		0		0
Total	11,584		11,788		1,401		11,289		96

Total
Commercial	14,485		15,605		400		15,948		83
Real estate - construction	0		0		0		0		0
Real estate - commercial	22,977		27,681		763		23,815		147
Real estate - residential	8,663		9,934		236		8,829		55
Home equity	5,669		7,773		2		5,556		22
Installment	219		236		0		236		1
Other	121		121		0		122		0
Total	$	52,134	$	61,350	$	1,401	$	54,506	$	308



	As of and for the year December 31, 2015
(Dollars in thousands)	Current balance		Contractual principal balance		Related allowance		Average current balance		Interest income recognized
Loans with no related allowance recorded
Commercial	$	16,418	$	17,398	$	0	$	10,468	$	258
Real estate - construction	0		0		0		150		0
Real estate - commercial	16,301		20,479		0		19,363		344
Real estate - residential	7,447		8,807		0		8,143		184
Home equity	5,340		7,439		0		5,648		82
Installment	253		276		0		380		7
Other	122		122		0		24		0
Total	45,881		54,521		0		44,176		875

Loans with an allowance recorded
Commercial	993		1,178		357		1,409		26
Real estate - construction	0		0		0		0		0
Real estate - commercial	8,351		8,706		979		12,928		213
Real estate - residential	1,547		1,560		235		1,696		40
Home equity	101		101		2		101		3
Installment	0		0		0		0		0
Other	0		0		0		0		0
Total	10,992		11,545		1,573		16,134		282

Total
Commercial	17,411		18,576		357		11,877		284
Real estate - construction	0		0		0		150		0
Real estate - commercial	24,652		29,185		979		32,291		557
Real estate - residential	8,994		10,367		235		9,839		224
Home equity	5,441		7,540		2		5,749		85
Installment	253		276		0		380		7
Other	122		122		0		24		0
Total	$	56,873	$	66,066	$	1,573	$	60,310	$	1,157

OREO. OREO is comprised of properties acquired by the Company primarily through the loan foreclosure or repossession process, or other resolution activity that results in partial or total satisfaction of problem loans.

Changes in OREO were as follows:



	Three months ended
	March 31,
(Dollars in thousands)	2016 ⁽¹⁾			2015 ⁽¹⁾
Balance at beginning of period	$	13,254		$	22,674
Additions
Commercial	786			2,173
Residential	122			1,058
Total additions	908			3,231
Disposals
Commercial	(200		)	(4,145		)
Residential	(1,835		)	(412		)
Total disposals	(2,035		)	(4,557		)
Valuation adjustment
Commercial	(117		)	(418		)
Residential	(71		)	(24		)
Total valuation adjustment	(188		)	(442		)
Balance at end of period	$	11,939		$	20,906

The preceding table includes OREO subject to loss sharing agreements of $38 thousand and $0.3 million at March 31, 2016 and 2015, respectively.

FDIC indemnification asset. Changes in the balance of the FDIC indemnification asset and the related impact to the Consolidated Statements of Income are presented in the table that follows:



	Three months ended
	March 31,
(Dollars in thousands)	2016			2015			Affected Line Item in the Consolidated Statements of Income
Balance at beginning of period	$	17,630		$	22,666
Adjustments not reflected in income
Net FDIC claims (received) / paid	362			204
Adjustments reflected in income
Amortization	(1,171		)	(1,195		)	Interest income, other earning assets
FDIC loss sharing income	(565		)	(1,046		)	Noninterest income, FDIC loss sharing income
Offset to accelerated discount	0			(232		)	Noninterest income, accelerated discount on covered loans
Balance at end of period	$	16,256		$	20,397

The accounting for FDIC indemnification assets is closely related to the accounting for the underlying, indemnified assets as well as on-going assessment of the collectibility of the indemnification assets. The primary activities impacting the FDIC indemnification asset are FDIC claims, amortization, FDIC loss sharing income and accelerated discount. For a detailed discussion on the indemnification asset, please refer to the Loans and Leases note in the Company's 2015 Annual Report on Form 10-K.