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. 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 are 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, again on the same pro-rata basis.

The five year period of loss protection will expire for the majority of First Financial's covered commercial loans and covered OREO during the third quarter of 2014. The ten year period of loss protection on all other covered loans and covered OREO will expire during the third quarter of 2019. The expiration of loss sharing protection will result in a reclassification of loan balances in the Consolidated Balance Sheets from covered loans to uncovered loans, but will not have an effect on the accounting for these loans.

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 loans:



	March 31, 2014						December 31, 2013
(Dollars in thousands)	Loans accounted for under FASB ASC Topic 310-30		Loans excluded from FASB ASC Topic 310-30		Total covered loans		Loans accounted for under FASB ASC Topic 310-30		Loans excluded from FASB ASC Topic 310-30		Total covered loans
Commercial	$	32,836	$	1,549	$	34,385	$	41,172	$	1,144	$	42,316
Real estate - construction	8,480		0		8,480		8,556		0		8,556
Real estate - commercial	228,666		6,131		234,797		263,146		5,487		268,633
Real estate - residential	77,768		0		77,768		80,733		0		80,733
Installment	4,534		572		5,106		5,073		568		5,641
Home equity	1,018		45,301		46,319		975		48,649		49,624
Other covered loans	0		2,550		2,550		0		2,370		2,370
Total covered loans	$	353,302	$	56,103	$	409,405	$	399,655	$	58,218	$	457,873

The outstanding balance of all purchased impaired loans, including all contractual principal, interest, fees and penalties, was $452.7 million and $493.6 million as of March 31, 2014 and December 31, 2013, 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
	March 31,
(Dollars in thousands)	2014			2013
Balance at beginning of period	$	133,671		$	224,694
Reclassification (to)/from nonaccretable difference	13,216			7,751
Accretion	(9,717		)	(17,947		)
Other net activity ⁽¹⁾	(5,772		)	(5,828		)
Balance at end of period	$	131,398		$	208,670

(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 of $13.2 million and $7.8 million during the first quarters of 2014 and 2013, respectively. These reclassifications resulted in yield adjustments on the related loan pools on a prospective basis. For further detail on impairment and provision expense related to covered purchased impaired loans, see "Covered Loans" in Note 6 - 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 4 - Loans, excluding covered loans.

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



	As of March 31, 2014
			Real Estate
(Dollars in thousands)	Commercial		Construction		Commercial		Total
Pass	$	21,891	$	5,228	$	170,119	$	197,238
Special Mention	1,055		0		5,564		6,619
Substandard	11,410		3,252		59,114		73,776
Doubtful	29		0		0		29
Total	$	34,385	$	8,480	$	234,797	$	277,662



(Dollars in thousands)	Real estate residential		Installment		Home equity		Other		Total
Performing	$	77,768	$	5,106	$	43,893	$	2,549	$	129,316
Nonperforming	0		0		2,426		1		2,427
Total	$	77,768	$	5,106	$	46,319	$	2,550	$	131,743



	As of December 31, 2013
			Real Estate
(Dollars in thousands)	Commercial		Construction		Commercial		Total
Pass	$	25,196	$	1,714	$	182,621	$	209,531
Special Mention	2,011		0		12,904		14,915
Substandard	14,693		6,842		73,108		94,643
Doubtful	416		0		0		416
Total	$	42,316	$	8,556	$	268,633	$	319,505



(Dollars in thousands)	Real estate residential		Installment		Home equity		Other		Total
Performing	$	80,733	$	5,636	$	47,731	$	2,370	$	136,470
Nonperforming	0		5		1,893		0		1,898
Total	$	80,733	$	5,641	$	49,624	$	2,370	$	138,368

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, 2014
(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	$	56	$	0	$	495	$	551	$	998	$	1,549	$	0
Real estate - commercial	0		76		1,221		1,297		4,834		6,131		0
Installment	20		0		0		20		552		572		0
Home equity	0		73		2,294		2,367		42,934		45,301		0
All other	20		22		9		51		2,499		2,550		8
Total	$	96	$	171	$	4,019	$	4,286	$	51,817	$	56,103	$	8



	As of December 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	$	60	$	335	$	483	$	878	$	266	$	1,144	$	0
Real estate - commercial	184		0		1,263		1,447		4,040		5,487		0
Installment	0		0		5		5		563		568		0
Home equity	239		36		1,727		2,002		46,647		48,649		0
All other	9		4		0		13		2,357		2,370		0
Total	$	492	$	375	$	3,478	$	4,345	$	53,873	$	58,218	$	0

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, 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 returned to accrual status if collection of future principal and interest payments is no longer doubtful.

Information as to covered nonaccrual loans, excluding loans accounted for under FASB ASC Topic 310-30, was as follows:



(Dollars in thousands)	March 31, 2014		December 31, 2013
Impaired loans
Nonaccrual loans ⁽¹⁾
Commercial	$	968	$	540
Real estate-commercial	1,315		1,349
Installment	0		5
Home equity	2,426		1,893
All other	1		0
Nonaccrual loans	4,710		3,787
Accruing troubled debt restructurings	15		335
Total impaired loans	$	4,725	$	4,122

(1) Nonaccrual loans include nonaccrual TDRs of $1.0 million and $0.9 million as of March 31, 2014 and December 31, 2013, respectively.



	Three months ended
	March 31,
(Dollars in thousands)	2014		2013
Interest income effect on impaired loans
Gross amount of interest that would have been recorded under original terms	$	70	$	138
Interest included in income
Nonaccrual loans	9		7
Troubled debt restructurings	0		0
Total interest included in income	9		7
Net impact on interest income	$	61	$	131

Impaired Loans. Covered loans classified as nonaccrual, 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, 2014
(Dollars in thousands)	Current Balance		Unpaid Principal Balance		Related Allowance		Average Balance		YTD Interest Income Recognized
Loans with no related allowance recorded
Commercial	$	968	$	1,266	$	0	$	922	$	6
Real estate - commercial	1,315		1,536		0		1,332		1
Installment	0		0		0		3		0
Home equity	2,441		3,914		0		2,167		2
All other	1		1		0		1		0
Total	$	4,725	$	6,717	$	0	$	4,425	$	9



	As of December 31, 2013
(Dollars in thousands)	Current Balance		Unpaid Principal Balance		Related Allowance		Average Balance		Interest Income Recognized
Loans with no related allowance recorded
Commercial	$	875	$	1,131	$	0	$	1,832	$	11
Real estate - commercial	1,349		2,648		0		1,786		4
Installment	5		5		0		2		0
Home equity	1,893		2,899		0		2,611		15
All other	0		0		0		8		0
Total	$	4,122	$	6,683	$	0	$	6,239	$	30

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.

Changes in covered OREO were as follows:



	Three months ended
	March 31,
(Dollars in thousands)	2014		2013
Balance at beginning of period	$	27,120	$	28,862
Additions
Commercial	730		6,462
Residential	28		216
Total additions	758		6,678
Disposals
Commercial	3,981		4,621
Residential	130		344
Total disposals	4,111		4,965
Valuation adjustment
Commercial	707		1,125
Residential	12		105
Total valuation adjustment	719		1,230
Balance at end of period	$	23,048	$	29,345