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.

Covered loans totaled $332.3 million as of September 30, 2014 and $457.9 million as of December 31, 2013. The Company's loss sharing agreements with the FDIC related to non-single family loans expired effective October 1, 2014, and as a result, approximately $190.3 million, or 57.3%, of the Company's covered loan portfolio will no longer be covered by FDIC loss sharing effective that date. 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 and the related allowance for loan and lease losses in the Consolidated Balance Sheets from covered loans to uncovered loans as of October 1, 2014, but will not have an effect on the accounting for these loans.

The following table reflects the carrying value of all covered loans:



	September 30, 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	$	22,403	$	1,341	$	23,744	$	41,172	$	1,144	$	42,316
Real estate - construction	1,748		0		1,748		8,556		0		8,556
Real estate - commercial	178,618		5,295		183,913		263,146		5,487		268,633
Real estate - residential	72,315		0		72,315		80,733		0		80,733
Installment	3,073		497		3,570		5,073		568		5,641
Home equity	1,128		43,730		44,858		975		48,649		49,624
Other covered loans	0		2,117		2,117		0		2,370		2,370
Total covered loans	$	279,285	$	52,980	$	332,265	$	399,655	$	58,218	$	457,873

Purchased Impaired Loans. First Financial accounts for the majority of loans acquired in FDIC transactions 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. These loans include loans previously covered under loss sharing agreements as well as loans that remain subject to FDIC loss sharing coverage. 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 outstanding balance of all purchased impaired loans, including all contractual principal, interest, fees and penalties, was $337.5 million and $493.6 million as of September 30, 2014 and December 31, 2013, 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						Nine months ended
	September 30,						September 30,
(Dollars in thousands)	2014			2013			2014			2013
Balance at beginning of period	$	127,764		$	173,920		$	133,671		$	224,694
Reclassification from/(to) nonaccretable difference	(2,295		)	(4,979		)	19,864			(5,687		)
Accretion	(8,158		)	(13,772		)	(26,808		)	(46,971		)
Other net activity ⁽¹⁾	(4,250		)	(8,347		)	(13,666		)	(25,214		)
Balance at end of period	$	113,061		$	146,822		$	113,061		$	146,822

(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 a reclassification from accretable to nonaccretable difference of $2.3 million during the third quarter of 2014 due to changes in the cash flow expectations related to certain loan pools. However, First Financial recognized a $19.9 million reclassification from nonaccretable difference to accretable difference during the first nine months of 2014. During the third quarter of 2013, First Financial recognized a $5.0 million reclassification from accretable to nonaccretable difference and $5.7 million for the first nine months of 2013. 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. 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 September 30, 2014
			Real Estate
(Dollars in thousands)	Commercial		Construction		Commercial		Total
Pass	$	14,790	$	1,605	$	150,628	$	167,023
Special Mention	418		0		4,924		5,342
Substandard	8,536		143		28,361		37,040
Doubtful	0		0		0		0
Total	$	23,744	$	1,748	$	183,913	$	209,405



(Dollars in thousands)	Real estate residential		Installment		Home equity		Other		Total
Performing	$	72,315	$	3,570	$	41,416	$	2,117	$	119,418
Nonperforming	0		0		3,442		0		3,442
Total	$	72,315	$	3,570	$	44,858	$	2,117	$	122,860



	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 September 30, 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	$	0	$	49	$	656	$	705	$	636	$	1,341	$	0
Real estate - commercial	0		144		251		395		4,900		5,295		0
Installment	0		0		0		0		497		497		0
Home equity	361		0		3,086		3,447		40,283		43,730		0
All other	23		3		3		29		2,088		2,117		3
Total	$	384	$	196	$	3,996	$	4,576	$	48,404	$	52,980	$	3



	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. 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)	September 30, 2014		December 31, 2013
Impaired loans
Nonaccrual loans ⁽¹⁾
Commercial	$	906	$	540
Real estate-commercial	256		1,349
Installment	0		5
Home equity	3,442		1,893
All other	0		0
Nonaccrual loans	4,604		3,787
Accruing troubled debt restructurings	70		335
Total impaired loans	$	4,674	$	4,122

(1) Nonaccrual loans include nonaccrual TDRs of $0.9 million and $0.9 million as of September 30, 2014 and December 31, 2013, respectively.



	Three months ended				Nine months ended
	September 30,				September 30,
(Dollars in thousands)	2014		2013		2014		2013
Interest income effect on impaired loans
Gross amount of interest that would have been recorded under original terms	$	72	$	81	$	201	$	334
Interest included in income
Nonaccrual loans	18		6		34		20
Troubled debt restructurings	0		3		1		6
Total interest included in income	18		9		35		26
Net impact on interest income	$	54	$	72	$	166	$	308

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 September 30, 2014
(Dollars in thousands)	Current balance		Unpaid principal balance		Related allowance		Average balance		YTD interest income recognized		Quarterly interest income recognized
Loans with no related allowance recorded
Commercial	$	960	$	1,302	$	0	$	936	$	16	$	6
Real estate - commercial	256		395		0		819		2		1
Installment	0		0		0		1		0		0
Home equity	0		4,908		0		2,493		17		11
All other	3,458		0		0		0		0		0
Total	$	4,674	$	6,605	$	0	$	4,249	$	35	$	18



	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				Nine months ended
	September 30,				September 30,
(Dollars in thousands)	2014		2013		2014		2013
Balance at beginning of period	$	19,439	$	22,475	$	27,120	$	28,862
Additions
Commercial	0		8,572		3,937		21,063
Residential	118		95		409		472
Total additions	118		8,667		4,346		21,535
Disposals
Commercial	7,498		2,865		17,429		19,513
Residential	38		76		536		890
Total disposals	7,536		2,941		17,965		20,403
Valuation adjustment
Commercial	718		451		2,186		2,133
Residential	123		0		135		111
Total valuation adjustment	841		451		2,321		2,244
Balance at end of period	$	11,180	$	27,750	$	11,180	$	27,750