NOTE 12: ALLOWANCE FOR LOAN AND LEASE LOSSES

Uncovered Loans

For each reporting period, management maintains the allowance at a level that it considers sufficient to absorb inherent risks in the loan portfolio. Management’s evaluation in establishing the adequacy of the allowance includes evaluation of the loan and lease portfolios, actual past loan and lease loss experience, known and inherent risks in the portfolio, adverse situations that may affect a specific borrower’s ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, and other pertinent factors, such as periodic internal and external evaluations of delinquent, nonaccrual, and classified loans. The evaluation is inherently subjective as it requires utilizing material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans. The evaluation of these factors is the responsibility of the Allowance for Loan and Lease Losses Committee, which is comprised of senior officers from the risk management, credit administration, finance, and lending areas.

The allowance for commercial loans, including time and demand notes, tax-exempt loans, and commercial real estate loans begins with a process of estimating the probable losses inherent in the portfolio. The loss estimates for these commercial loans are established by category and based on First Financial’s internal system of credit risk ratings and historical loss data.

The estimate of losses inherent in the commercial portfolio may be adjusted for management’s estimate of probable losses on specific exposures dependent upon the values of the underlying collateral and/or the present value of expected future cash flows, as well as trends in delinquent and nonaccrual loans, prevailing economic conditions, changes in lending strategies, and other influencing factors.

In the commercial portfolio, certain loans, typically larger-balance non-homogeneous exposures, may have a specific allowance established based on the borrower’s overall financial condition, resources and payment record, support from guarantors, and the realizable value of any collateral.

The allowance for consumer loans which includes residential real estate, installment, home equity, credit card loans, and overdrafts, is established for each of the categories by estimating losses inherent in that particular category of consumer loans. The estimate of losses is primarily based on historical loss rates for the category, as well as trends in delinquent and nonaccrual loans, prevailing economic conditions, and other influencing factors. Consumer loans are evaluated as an asset type within a category (i.e., residential real estate, installment, etc.), as these loans are smaller with more homogeneous characteristics.

There were no material changes to First Financial’s accounting policies or methodology related to the allowance for loan and lease losses during the second quarter of 2011.

First Financial’s policy is to charge-off loans when, in management’s opinion, full collectibility of principal and interest based upon the contractual terms of the loan is unlikely.

Changes in the allowance for loan and lease losses for the previous five quarters are presented in the table that follows:

	Three Months Ended															Six Months Ended
	2011						2010									June 30,
(Dollars in thousands)	June 30,			Mar. 31,			Dec. 31,			Sep. 30,			June 30,			2011			2010
Balance at beginning of period	$	53,645		$	57,235		$	57,249		$	57,811		$	56,642		$	57,235		$	59,311
Provision for loan losses		5,756			647			9,741			6,287			6,158			6,403			17,536
Loans charged off		(6,232	)		(4,601	)		(10,285	)		(8,124	)		(5,457	)		(10,833	)		(19,942	)
Recoveries		502			364			530			1,275			468			866			906
Balance at end of period	$	53,671		$	53,645		$	57,235		$	57,249		$	57,811		$	53,671		$	57,811
Allowance for loan and lease losses to total ending loans		1.92	%		1.93	%		2.03	%		2.07	%		2.07	%		1.92	%		2.07	%

Year-to-date changes in the allowance for loan and lease losses by loan category were as follows:

	Six Months Ended June 30, 2011
			Real Estate
(Dollars in thousands)	Commercial		Construction		Commercial		Residential			Installment			Home Equity		Other		Total
Allowance for loan and lease losses:
Balance at beginning of period	$	10,138	$	8,326	$	14,917	$	8,907		$	1,981		$	10,939	$	2,027	$	57,235
Provision for loan and lease losses		1,930		1,841		6,205		(4,356	)		(119	)		242		660		6,403
Gross charge-offs		815		2,403		4,880		514			249			1,185		787		10,833
Recoveries		322		27		73		38			180			37		189		866
Total net charge-offs		493		2,376		4,807		476			69			1,148		598		9,967
Ending allowance for loan and lease losses	$	11,575	$	7,791	$	16,315	$	4,075		$	1,793		$	10,033	$	2,089	$	53,671
Ending allowance on loans individually evaluated for impairment	$	1,528	$	4,387	$	4,021	$	93		$	0		$	2	$	0	$	10,031
Ending allowance on loans collectively evaluated for impairment		679		41		351		69			9			69		0		1,218
	$	2,207	$	4,428	$	4,372	$	162		$	9		$	71	$	0	$	11,249
Loans and Leases:
Ending balance of loans individually evaluated for impairment	$	7,423	$	19,377	$	28,537	$	2,088		$	113		$	101	$	0	$	57,639
Ending balance of loans collectively evaluated for impairment		2,395		169		3,502		4,564			335			2,375		0		13,340
	$	9,818	$	19,546	$	32,039	$	6,652		$	448		$	2,476	$	0	$	70,979

	Twelve Months Ended December 31, 2010
			Real Estate
(Dollars in thousands)	Commercial		Construction		Commercial		Residential		Installment		Home Equity		Other		Total
Allowance for loan and lease losses:
Balance at beginning of period	$	18,590	$	8,143	$	15,190	$	5,308	$	2,159	$	8,063	$	1,858	$	59,311
Provision for loan and lease losses		4,252		8,778		6,836		5,268		457		6,183		1,790		33,564
Gross charge-offs		13,324		8,619		8,191		1,693		1,154		3,499		1,871		38,351
Recoveries		620		24		1,082		24		519		192		250		2,711
Total net charge-offs		12,704		8,595		7,109		1,669		635		3,307		1,621		35,640
Ending allowance for loan and lease losses	$	10,138	$	8,326	$	14,917	$	8,907	$	1,981	$	10,939	$	2,027	$	57,235
Ending allowance on loans individually evaluated for impairment	$	2,017	$	3,716	$	4,347	$	122	$	0	$	0	$	0	$	10,202
Ending allowance on loans collectively evaluated for impairment		279		7		196		149		4		82		0		717
	$	2,296	$	3,723	$	4,543	$	271	$	4	$	82	$	0	$	10,919
Loans and Leases:
Ending balance of loans individually evaluated for impairment	$	12,175	$	19,294	$	31,260	$	1,912	$	0	$	0	$	0	$	64,641
Ending balance of loans collectively evaluated for impairment		1,554		38		2,864		4,607		150		2,553		0		11,766
	$	13,729	$	19,332	$	34,124	$	6,519	$	150	$	2,553	$	0	$	76,407

Covered Loans

In accordance with the accounting guidance for business combinations, there was no allowance brought forward on any of the acquired loans as any credit deterioration evident in the loans was included in the determination of the fair value of the loans at the acquisition date.

First Financial established an allowance for loan losses associated with covered loans during 2010 based on its valuation procedures performed during the period. The Company continued to update its valuations related to loans covered under loss share agreements during the second quarter of 2011 and, as a result of impairment in certain loan pools, recognized total provision expense of $23.9 million and realized net charge-offs of $4.4 million during the quarter, resulting in an allowance for covered loan losses of $51.0 million as of June 30, 2011. For the first six months of 2011, the Company recognized total provision expense of $49.9 million and realized net charge-offs of $15.4 million. Additionally, the Company recognized loss share expenses of $6.5 million for the first six months of 2011 and $3.4 million for the second quarter of 2011 primarily related to losses on covered OREO during the period. The receivable due from the FDIC under loss share agreements related to the covered provision expense and losses on covered OREO of $45.1 million for the first six months of 2011 and $21.6 million for the second quarter of 2011 was recognized as FDIC loss share income and a corresponding increase to the FDIC indemnification asset.

For the second quarter of 2010, First Financial recognized provision expense on covered loans of $19.0 million related to net charge-offs of $17.7 million during the period. For the first six months of 2010, the Company recognized provision expense of $28.4 million related to net charge-offs of $27.1 million. The related receivable due from the FDIC under loss share agreements related to these loans of $15.2 million and $22.7 million for the second quarter and first six months, respectively, was recognized as FDIC loss share income and a corresponding increase to the FDIC indemnification asset.

Under the applicable accounting guidance, the allowance for loan losses related to covered loans as a result of impairment to loan pools arising from on-going valuation procedures is generally recognized in the current period as provision expense. Improvement in the credit outlook, however, is not recognized immediately but instead is reflected as an adjustment to the yield earned on the related loan pools on a prospective basis once any previously recorded impairment has been recaptured. The timing inherent in this accounting treatment may result in earnings volatility in future periods.

The allowance for loan and lease losses on covered loans is presented in the table below:

	June 30, 2011
			Real Estate
(Dollars in thousands)	Commercial		Commercial		Residential		Installment		Total
Ending allowance on loans acquired with deteriorated credit quality (ASC 310-30)	$	24,548	$	24,773	$	1,547	$	176	$	51,044
Ending allowance on acquired loans outside the scope of ASC 310-30		0		0		0		0		0
Ending allowance on covered loans	$	24,548	$	24,773	$	1,547	$	176	$	51,044

	December 31, 2010
			Real Estate
(Dollars in thousands)	Commercial		Commercial		Residential		Installment		Total
Ending allowance on loans acquired with deteriorated credit quality (ASC 310-30)	$	8,787	$	7,213	$	232	$	261	$	16,493
Ending allowance on acquired loans outside the scope of ASC 310-30		0		0		0		0		0
Ending allowance on covered loans	$	8,787	$	7,213	$	232	$	261	$	16,493

Changes in the allowance for loan and lease losses on covered loans for the previous five quarters were as follows:

	Three Months Ended															Six Months Ended
	2011						2010									June 30,
(Dollars in thousands)	Jun. 30			Mar. 31			Dec. 31			Sep. 30			Jun. 30			2011			2010
Balance at beginning of period	$	31,555		$	16,493		$	11,583		$	1,273		$	0		$	16,493		$	0
Provision for loan and lease losses		23,895			26,016			13,997			20,725			18,962			49,911			28,422
Loans charged-off		(7,456	)		(14,026	)		(9,351	)		(10,492	)		(17,689	)		(21,482	)		(27,149	)
Recoveries		3,050			3,072			264			77			0			6,122			0
Balance at end of period	$	51,044		$	31,555		$	16,493		$	11,583		$	1,273		$	51,044		$	1,273