DERIVATIVES

First Financial uses derivative instruments, including interest rate caps, floors and swaps, to meet the needs of its clients while managing the interest rate risk associated with certain transactions. First Financial does not use derivatives for speculative purposes.

While authorized to use a variety of derivative products, First Financial primarily utilizes interest rate swaps as a means to offer borrowers credit-based products that meet their needs and may from time to time utilize interest rate swaps to manage the interest rate risk profile of the Company. The interest rate swap agreements establish the basis on which interest rate payments are exchanged with counterparties referred to as the notional amount.

The following table summarizes the notional values of derivative financial instruments utilized by First Financial by the nature of the underlying asset or liability:



(Dollars in thousands)	June 30, 2013		December 31, 2012
Fair value hedges
Instruments associated with loans	$	910,175	$	935,493

As only interest rate payments are exchanged, the cash requirements and credit risk associated with interest rate swaps are significantly less than the notional amount and the Company’s credit risk exposure is limited to the market value of the instruments. First Financial manages the market value credit risk associated with counterparties through counterparty credit policies. These policies require the Company to maintain a total derivative notional position of less than 35% of assets, total credit exposure of less than 3% of capital and no single counterparty credit risk exposure greater than $20.0 million. The Company is currently well below all single counterparty and portfolio limits. At June 30, 2013, the Company had a total counterparty notional amount outstanding of approximately $495.4 million, spread among eight counterparties, with an outstanding liability from these contracts of $12.6 million. At December 31, 2012, the Company had a total counterparty notional amount outstanding of approximately $509.1 million, spread among eight counterparties, with an outstanding liability from these contracts of $26.0 million.

First Financial’s exposure to credit loss, in the event of nonperformance by a borrower, is limited to the market value of the derivative instrument associated with that borrower. First Financial monitors its derivative credit exposure to borrowers through the normal credit review processes the Company performs on all borrowers. Additionally, the Company monitors derivative credit risk exposure related to problem loans through the Company's allowance for loan and lease losses committee. First Financial considers the market value of a derivative instrument to be part of the carrying value of the related loan for these purposes as the borrower is contractually obligated to pay First Financial this amount in the event the derivative contract is terminated.

The following table summarizes the derivative financial instruments utilized by First Financial and their balances:



		June 30, 2013							December 31, 2012
				Estimated fair value							Estimated fair value
(Dollars in thousands)	Balance Sheet Classification	Notional amount		Gain		Loss			Notional amount		Gain		Loss
Fair value hedges
Pay fixed interest rate swaps with counterparty	Accrued interest and other liabilities	$	10,675	$	0	$	(1,082	)	$	12,739	$	0	$	(1,445	)
Matched interest rate swaps with borrower	Accrued interest and other assets	449,750		14,328		(1,169		)	461,377		24,135		0
Matched interest rate swaps with counterparty	Accrued interest and other liabilities	449,750		1,169		(14,418		)	461,377		0		(24,978		)
Total		$	910,175	$	15,497	$	(16,669	)	$	935,493	$	24,135	$	(26,423	)

In connection with its use of derivative instruments, from time to time First Financial and its counterparties are required to post cash collateral to offset the market position of the derivative instruments. First Financial maintains the right to offset these derivative positions with the collateral posted against them by or with the relevant counterparties. First Financial classifies the derivative cash collateral outstanding with its counterparties as an adjustment to the fair value of the derivative contracts within Accrued interest and other assets or Accrued interest and other liabilities in the Consolidated Balance Sheets.

The following table discloses the gross and net amounts of liabilities recognized in the Consolidated Balance Sheets:



	June 30, 2013							December 31, 2012
(Dollars in thousands)	Gross amounts of recognized liabilities		Gross amounts offset in the Consolidated Balance Sheets			Net amounts of liabilities presented in the Consolidated Balance Sheets		Gross amounts of recognized liabilities		Gross amounts offset in the Consolidated Balance Sheets			Net amounts of liabilities presented in the Consolidated Balance Sheets
Fair value hedges
Pay fixed interest rate swaps with counterparty	$	1,082	$	(444	)	$	638	$	1,445	$	(669	)	$	776
Matched interest rate swaps with counterparty	15,587		(13,552		)	2,035		24,978		(23,057		)	1,921
Total	$	16,669	$	(13,996	)	$	2,673	$	26,423	$	(23,726	)	$	2,697

The following table details the derivative financial instruments, the average remaining maturities and the weighted-average interest rates being paid and received by First Financial at June 30, 2013:



							Weighted-average rate
(Dollars in thousands)	Notional amount		Average maturity (years)	Fair value			Receive		Pay
Asset conversion swaps
Pay fixed interest rate swaps with counterparty	$	10,675	3.3	$	(1,082	)	2.21	%	6.85	%
Receive fixed, matched interest rate swaps with borrower	449,750		4.2	13,159			4.94	%	2.93	%
Pay fixed, matched interest rate swaps with counterparty	449,750		4.2	(13,249		)	2.93	%	4.94	%
Total asset conversion swaps	$	910,175	4.2	$	(1,172	)	3.91	%	3.97	%

The accounting for changes in the fair value of derivatives depends on the intended use of the derivative instrument and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.

Fair Value Hedges. First Financial utilizes interest rate swaps designated as fair value hedges as a means to offer commercial borrowers products that meet their needs, but are also designed to achieve First Financial’s desired interest rate risk profile. First Financial accomplishes this by entering into swap agreements with commercial borrowers and simultaneously entering into offsetting swap agreements, with substantially matching terms, with institutional counterparties. These interest rate swap agreements generally involve the receipt by First Financial of floating rate amounts from counterparties in exchange for payments to these counterparties by First Financial of fixed rate amounts received from commercial borrowers over the life of the agreements. These interest rate swap agreements do not involve an exchange of the underlying principal or notional amount. This results in First Financial’s loan customers receiving fixed rate funding, while providing First Financial with a floating rate asset. First Financial's matched interest rate swaps economically hedge offsetting "receive fixed" and "pay fixed" exposures, but do not qualify for hedge accounting.

The net interest receivable or payable on matched interest rate swaps is accrued and recognized as an adjustment to the interest income of the hedged item. The fair value of matched interest rate swaps is included within Accrued interest and other assets and Accrued interest and other liabilities on the Consolidated Balance Sheets.

For the unmatched, pay fixed interest rate swaps, which qualify for hedge accounting, the corresponding fair-value adjustment is included on the Consolidated Balance Sheets in the carrying value of the hedged item. The net interest receivable or payable on unmatched interest rate swaps is accrued and recognized as an adjustment to the interest income of the hedged item. Gains and losses from derivatives not considered effective in hedging the change in fair value of the hedged item, if any, are recognized in income immediately.

The following table details the location and amounts recognized for fair value hedges:



		Decrease to Interest income
(Dollars in thousands)		Three months ended						Six months ended
Derivatives in fair value hedging relationships	Location of change in fair value	June 30,						June 30,
		2013			2012			2013			2012
Interest rate contracts
Loans	Interest income - loans	$	(129	)	$	(192	)	$	(271	)	$	(388	)
Total		$	(129	)	$	(192	)	$	(271	)	$	(388	)

Cash Flow Hedges. First Financial utilizes interest rate swaps designated as cash flow hedges to manage the variability of cash flows, primarily net interest income, attributable to changes in interest rates. The net interest receivable or payable on an interest rate swap designated as a cash flow hedge is accrued and recognized as an adjustment to interest income or interest expense. The fair value of interest rate swaps is included within accrued interest and other liabilities on the Consolidated Balance Sheets. Changes in the fair value of interest rate swaps are included in accumulated other comprehensive income (loss). Gains and losses from derivatives not considered effective in hedging the cash flows related to the hedged items, if any, are recognized in income immediately.

In 2012, First Financial executed a cash flow hedge utilizing an interest rate swap to hedge against interest rate volatility on $35.0 million of floating rate interest-bearing deposits indexed to the U.S. Federal Funds Target Rate. This interest rate swap involves the receipt by First Financial of variable-rate interest amounts in exchange for fixed-rate interest payments by First Financial for a period of 7 years and does qualify for hedge accounting. Accrued interest and other assets included $1.1 million at June 30, 2013 and accrued interest and other liabilities included $0.2 million at December 31, 2012 reflecting the fair value of this cash flow hedge.