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 the loss sharing agreements, covered loans are subject to a stated loss threshold, as outlined in each loss sharing agreement, 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. First Financial will reimburse the FDIC for its 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:



	March 31, 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	$	83,262	$	7,162	$	90,424	$	94,775	$	7,351	$	102,126
Real estate - construction	9,866		0		9,866		10,631		0		10,631
Real estate - commercial	419,177		6,773		425,950		458,066		7,489		465,555
Real estate - residential	95,991		0		95,991		100,694		0		100,694
Installment	6,938		702		7,640		7,911		763		8,674
Home equity	1,706		53,315		55,021		2,080		55,378		57,458
Other covered loans	0		2,906		2,906		0		2,978		2,978
Total covered loans	$	616,940	$	70,858	$	687,798	$	674,157	$	73,959	$	748,116

The balance of all loans accounted for under FASB ASC Topic 310-30, including all contractual principal, interest, fees and penalties, was $1.0 billion and $1.1 billion as of March 31, 2013 and December 31, 2012, respectively. These balances include $237.0 million and $220.4 million of contractual interest not yet accrued as of March 31, 2013 and December 31, 2012, respectively.

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



	Three months ended
	March 31,
(Dollars in thousands)	2013			2012
Balance at beginning of period	$	224,694		$	344,410
Reclassification from nonaccretable difference	7,751			14,384
Accretion	(17,947		)	(25,919		)
Other net activity ⁽¹⁾	(5,828		)	(19,206		)
Balance at end of period	$	208,670		$	313,669

(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. 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 2013 of $7.8 million. Similarly, the Company reclassified $14.4 million from nonaccretable to accretable difference during the first quarter of 2012. These reclassifications resulted in yield adjustments on the related 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 first recorded 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 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 March 31, 2013
			Real Estate
(Dollars in thousands)	Commercial		Construction		Commercial		Total
Pass	$	43,544	$	1,608	$	209,130	$	254,282
Special Mention	10,071		1		49,927		59,999
Substandard	34,823		8,257		166,893		209,973
Doubtful	1,986		0		0		1,986
Total	$	90,424	$	9,866	$	425,950	$	526,240



(Dollars in thousands)	Real estate residential		Installment		Home equity		Other		Total
Performing	$	95,991	$	7,640	$	52,906	$	2,893	$	159,430
Nonperforming	0		0		2,115		13		2,128
Total	$	95,991	$	7,640	$	55,021	$	2,906	$	161,558



	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 March 31, 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	$	0	$	33	$	2,022	$	2,055	$	5,107	$	7,162	$	0
Real estate - commercial	0		81		1,274		1,355		5,418		6,773		0
Installment	0		0		0		0		702		702		0
Home equity	99		343		1,614		2,056		51,259		53,315		0
All other	11		11		41		63		2,843		2,906		28
Total	$	110	$	468	$	4,951	$	5,529	$	65,329	$	70,858	$	28



	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 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 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 was as follows:



(Dollars in thousands)	March 31, 2013		December 31, 2012
Nonaccrual loans
Commercial	$	2,097	$	4,498
Real estate-commercial	1,282		2,986
Home equity	2,115		4,227
All other	13		11
Total	$	5,507	$	11,722



	Three months ended
	March 31,
(Dollars in thousands)	2013		2012
Interest income effect on impaired loans
Gross amount of interest that would have been recorded under original terms	$	138	$	208
Interest included in income	7		48
Net impact on interest income	$	131	$	160

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, 2013
(Dollars in thousands)	Current Balance		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		YTD Interest Income Recognized
Loans with no related allowance recorded:
Commercial	$	2,097	$	4,345	$	0	$	3,298	$	3
Real estate - commercial	1,282		2,673		0		2,134		1
Home equity	2,115		3,342		0		3,171		3
All other	13		13		0		12		0
Total	$	5,507	$	10,373	$	0	$	8,615	$	7



	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
	March 31,
(Dollars in thousands)	2013		2012
Balance at beginning of period	$	28,862	$	44,818
Additions
Commercial	6,462		2,750
Residential	216		2,624
Total additions	6,678		5,374
Disposals
Commercial	4,621		5,005
Residential	344		543
Total disposals	4,965		5,548
Write-downs
Commercial	1,125		3,084
Residential	105		71
Total write-downs	1,230		3,155
Balance at end of period	$	29,345	$	41,489