LOANS AND LEASES

First Financial offers clients a variety of commercial and consumer loan and lease products with various interest rates and payment terms. Lending activities are primarily concentrated in states where the Bank currently operates banking centers (Ohio, Indiana and Kentucky). Additionally, First Financial has two national lending platforms, one that provides equipment and leasehold improvement financing for franchisees in the quick service and casual dining restaurant sector and another that provides loans secured by commissions and cash collateral accounts exclusively to insurance agents and brokers. Commercial loan categories include commercial and industrial (commercial), commercial real estate, construction real estate and lease financing. Consumer loan categories include residential real estate, home equity, installment and credit card.

Purchased impaired loans. Loans accounted for under FASB ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, are referred to as purchased impaired loans. First Financial accounts for the majority of loans acquired in FDIC transactions as purchased impaired loans, except for loans with revolving privileges, which are outside the scope of FASB ASC Topic 310-30, and loans for which cash flows could not be estimated, which are accounted for under the cost recovery method. Purchased impaired loans include loans previously covered under loss sharing agreements as well as loans that remain subject to FDIC loss sharing coverage.

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 purchased impaired loans. First Financial had purchased impaired loans totaling $207.8 million and $264.9 million, at September 30, 2015 and December 31, 2014, respectively. The outstanding balance of all purchased impaired loans, including all contractual principal, interest, fees and penalties, was $236.5 million and $314.5 million as of September 30, 2015 and December 31, 2014, 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)	2015			2014			2015			2014
Balance at beginning of period	$	78,945		$	127,764		$	106,622		$	133,671
Reclassification from/(to) nonaccretable difference	76			(2,295		)	(2,048		)	19,864
Accretion	(4,945		)	(8,158		)	(17,046		)	(26,808		)
Other net activity ⁽¹⁾	(4,746		)	(4,250		)	(18,198		)	(13,666		)
Balance at end of period	$	69,330		$	113,061		$	69,330		$	113,061

(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 reclassifications from nonaccretable to accretable difference of $0.1 million for the third quarter of 2015, however, during the nine months ended September 30, 2015, the Company recognized reclassifications from accretable to nonaccretable difference of $2.0 million. During the third quarter of 2014, First Financial recognized $2.3 million of reclassifications from accretable to nonaccretable difference, while in the nine months ended September 30, 2014, the Company recognized reclassifications from nonaccretable to accretable difference of $19.9 million due to changes in the cash flow expectations related to certain loan pools. Reclassifications from nonaccretable to accretable difference can result in impairment and provision expense in the current period and reclassifications from accretable to nonaccretable difference can result in yield adjustments on the related loan pools on a prospective basis.

Covered loans. Loans acquired in FDIC-assisted transactions 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 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. 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, on the same pro-rata basis.

The Company's loss sharing agreements with the FDIC related to non-single family loans expired effective October 1, 2014, and the ten year period of loss protection on all other covered loans and covered OREO expires October 1, 2019. Covered loans totaled $117.6 million as of September 30, 2015 and $135.7 million as of December 31, 2014.

Credit Quality. To facilitate the monitoring of credit quality for commercial loans, and for purposes of determining an appropriate allowance for loan and lease losses, First Financial utilizes the following categories of credit grades:

Pass - Higher quality loans that do not fit any of the other categories described below.

Special Mention - First Financial assigns a special mention rating to loans and leases with potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or lease or in First Financial's credit position at some future date.

Substandard - First Financial assigns a substandard rating to loans or leases that are inadequately protected by the current sound financial worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard loans and leases have well-defined weaknesses that jeopardize repayment of the debt. Substandard loans and leases are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not addressed.

Doubtful - First Financial assigns a doubtful rating to loans and leases with all the attributes of a substandard rating with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors that may work to the advantage and strengthening of the credit quality of the loan or lease, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.

The credit grades described above, which are derived from standard regulatory rating definitions, are assigned upon initial approval of credit to borrowers and updated periodically thereafter.

First Financial considers repayment performance to be the best indicator of credit quality for consumer loans. Consumer loans that have principal and interest payments that are past due by 90 days or more are generally classified as nonperforming. Additionally, consumer loans that have been modified in a TDR are classified as nonperforming.

Commercial and consumer credit exposure by risk attribute was as follows:



	As of September 30, 2015
			Real Estate
(Dollars in thousands)	Commercial		Construction		Commercial		Leasing		Total
Pass	$	1,571,656	$	275,197	$	2,081,930	$	81,053	$	4,009,836
Special Mention	40,433		130		20,414		1,626		62,603
Substandard	25,378		913		67,318		0		93,609
Doubtful	0		0		0		0		0
Total	$	1,637,467	$	276,240	$	2,169,662	$	82,679	$	4,166,048



(Dollars in thousands)	Real Estate Residential		Installment		Home Equity		Other		Total
Performing	$	497,643	$	39,547	$	457,893	$	39,759	$	1,034,842
Nonperforming	9,010		427		5,736		0		15,173
Total	$	506,653	$	39,974	$	463,629	$	39,759	$	1,050,015



	As of December 31, 2014
			Real Estate
(Dollars in thousands)	Commercial		Construction		Commercial		Leasing		Total
Pass	$	1,265,116	$	195,787	$	2,027,897	$	75,839	$	3,564,639
Special Mention	30,903		0		25,928		1,728		58,559
Substandard	19,095		1,784		86,842		0		107,721
Doubtful	0		0		0		0		0
Total	$	1,315,114	$	197,571	$	2,140,667	$	77,567	$	3,730,919



(Dollars in thousands)	Real Estate Residential		Installment		Home Equity		Other		Total
Performing	$	490,314	$	46,806	$	452,281	$	38,475	$	1,027,876
Nonperforming	11,580		514		6,346		0		18,440
Total	$	501,894	$	47,320	$	458,627	$	38,475	$	1,046,316

Delinquency. 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 date of the scheduled payment.

Loan delinquency, including loans classified as nonaccrual, was as follows:



	As of September 30, 2015
(Dollars in thousands)	30 – 59 days past due		60 – 89 days past due		> 90 days past due		Total past due		Current		Subtotal		Purchased impaired		Total		> 90 days past due and still accruing
Loans
Commercial	$	949	$	887	$	4,125	$	5,961	$	1,622,274	$	1,628,235	$	9,232	$	1,637,467	$	0
Real estate - construction	0		0		79		79		275,351		275,430		810		276,240		0
Real estate - commercial	1,094		1,120		14,510		16,724		2,018,164		2,034,888		134,774		2,169,662		0
Real estate - residential	1,964		391		2,365		4,720		442,154		446,874		59,779		506,653		0
Installment	20		50		257		327		37,531		37,858		2,116		39,974		0
Home equity	512		150		3,309		3,971		458,574		462,545		1,084		463,629		0
Other	684		131		58		873		121,565		122,438		0		122,438		58
Total	$	5,223	$	2,729	$	24,703	$	32,655	$	4,975,613	$	5,008,268	$	207,795	$	5,216,063	$	58



	As of December 31, 2014
(Dollars in thousands)	30 – 59 days past due		60 – 89 days past due		> 90 days past due		Total past due		Current		Subtotal		Purchased impaired		Total		> 90 days past due and still accruing
Loans
Commercial	$	1,002	$	3,647	$	2,110	$	6,759	$	1,290,975	$	1,297,734	$	17,380	$	1,315,114	$	0
Real estate - construction	276		0		223		499		195,773		196,272		1,299		197,571		0
Real estate - commercial	8,356		838		13,952		23,146		1,944,207		1,967,353		173,314		2,140,667		0
Real estate - residential	1,198		344		4,224		5,766		426,908		432,674		69,220		501,894		0
Installment	133		17		272		422		44,235		44,657		2,663		47,320		0
Home equity	697		466		4,079		5,242		452,357		457,599		1,028		458,627		0
Other	1,133		128		216		1,477		114,565		116,042		0		116,042		216
Total	$	12,795	$	5,440	$	25,076	$	43,311	$	4,469,020	$	4,512,331	$	264,904	$	4,777,235	$	216

Nonaccrual. Loans 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 on nonaccrual status are applied as a reduction to the carrying value of the loan. A loan may return to accrual status if collection of future principal and interest payments is no longer doubtful.

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 loan loss provision or prospective yield adjustments.

Troubled Debt Restructurings. A loan modification is considered a TDR when the borrower is experiencing financial difficulty and concessions are made by the Company that would not otherwise be considered for a borrower with similar credit characteristics. The most common types of modifications include interest rate reductions, maturity extensions and modifications to principal amortization, including interest only structures. Modified terms are dependent upon the financial position and needs of the individual borrower. If the modification agreement is violated, the loan is managed by the Company’s credit administration group for resolution, which may result in foreclosure in the case of real estate.

TDRs are generally classified as nonaccrual for a minimum period of six months and may qualify for return to accrual status once they have demonstrated performance with the restructured terms of the loan agreement.

First Financial had 271 TDRs totaling $33.8 million at September 30, 2015, including $20.2 million on accrual status and $13.6 million classified as nonaccrual. First Financial had an insignificant amount of commitments outstanding to lend additional funds to borrowers whose loan terms have been modified through TDRs at September 30, 2015. At September 30, 2015, the allowance for loan and lease losses included reserves of $2.4 million related to TDRs. For the three and nine months ended September 30, 2015, First Financial charged off $0.7 million and $2.5 million, respectively, for the portion of TDRs determined to be uncollectible. Additionally, at September 30, 2015, approximately $8.8 million of accruing TDRs have been performing in accordance with the restructured terms for more than one year.

First Financial had 262 TDRs totaling $28.2 million at December 31, 2014, including $15.9 million of loans on accrual status and $12.3 million classified as nonaccrual. First Financial had an insignificant amount of commitments outstanding to lend additional funds to borrowers whose loan terms had been modified through TDRs. At December 31, 2014, the allowance for loan and lease losses included reserves of $3.7 million related to TDRs. For the year ended December 31, 2014, First Financial charged off $1.0 million for the portion of TDRs determined to be uncollectible. At December 31, 2014, approximately $10.5 million of the accruing TDRs had been performing in accordance with the restructured terms for more than one year.

The following tables provide information on loan modifications classified as TDRs during the three and nine months ended September 30, 2015 and 2014:



	Three months ended
	September 30, 2015					September 30, 2014
(Dollars in thousands)	Number of loans	Pre-modification loan balance		Period end balance		Number of loans	Pre-modification loan balance		Period end balance
Commercial	5	$	171	$	166	6	$	3,712	$	3,384
Real estate - construction	0	0		0		0	0		0
Real estate - commercial	2	2,159		2,000		2	375		373
Real estate - residential	6	920		901		7	322		264
Installment	2	50		50		3	6		6
Home equity	6	231		229		6	126		125
Total	21	$	3,531	$	3,346	24	$	4,541	$	4,152

	Nine months ended
	September 30, 2015					September 30, 2014
(Dollars in thousands)	Number of loans	Pre-modification loan balance		Period end balance		Number of loans	Pre-modification loan balance		Period end balance
Commercial	27	$	1,686	$	1,676	11	$	3,938	$	3,594
Real estate - construction	0	0		0		0	0		0
Real estate - commercial	14	17,499		13,734		11	2,583		2,453
Real estate - residential	9	1,282		1,228		30	1,712		1,527
Installment	9	96		96		6	21		19
Home equity	16	2,281		1,768		26	791		758
Total	75	$	22,844	$	18,502	84	$	9,045	$	8,351

The following table provides information on how TDRs were modified during the three and nine months ended September 30, 2015 and 2014.



	Three months ended				Nine months ended
	September 30,				September 30,
(Dollars in thousands)	2015		2014		2015		2014
Extended maturities	$	2,166	$	3,505	$	12,827	$	4,402
Adjusted interest rates	0		0		0		301
Combination of rate and maturity changes	0		402		1,219		1,643
Forbearance	0		0		260		320
Other ⁽¹⁾	1,180		245		4,196		1,685
Total	$	3,346	$	4,152	$	18,502	$	8,351

(1) Includes covenant modifications and other concessions, or combination of concessions, that do not consist of interest rate adjustments, forbearance and maturity extensions

First Financial considers repayment performance as an indication of the effectiveness of the Company's loan modifications. Borrowers classified as a TDR that are 90 days or more past due on any principal or interest payments, or who prematurely terminate a restructured loan agreement without paying off the contractual principal balance (for example, in a deed-in-lieu arrangement), are considered to be in payment default of the terms of the TDR agreement.

The following table provides information on TDRs for which there was a payment default during the period that occurred within twelve months of the loan modification:



	Three months ended
	September 30, 2015			September 30, 2014
(Dollars in thousands)	Number of loans	Period end balance		Number of loans	Period end balance
Commercial	2	$	344	0	$	0
Real estate - construction	0	0		0	0
Real estate - commercial	0	0		0	0
Real estate - residential	0	0		1	1
Installment	0	0		0	0
Home equity	1	14		0	0
Total	3	$	358	1	$	1

	Nine months ended
	September 30, 2015			September 30, 2014
(Dollars in thousands)	Number of loans	Period end balance		Number of loans	Period end balance
Commercial	2	$	344	1	$	143
Real estate - construction	0	0		0	0
Real estate - commercial	4	1,146		0	0
Real estate - residential	1	73		3	28
Installment	0	0		1	0
Home equity	1	14		3	92
Total	8	$	1,577	8	$	263

Impaired Loans. Loans classified as nonaccrual, excluding purchased impaired loans, and loans modified as TDRs are considered impaired. The following table provides information on nonaccrual loans, TDRs and total impaired loans.



(Dollars in thousands)	September 30, 2015		December 31, 2014
Impaired loans
Nonaccrual loans⁽¹⁾
Commercial	$	7,438	$	6,627
Real estate-construction	79		223
Real estate-commercial	17,732		27,969
Real estate-residential	4,940		7,241
Installment	321		451
Home equity	5,203		5,958
Nonaccrual loans ⁽¹⁾	35,713		48,469
Accruing troubled debt restructurings	20,226		15,928
Total impaired loans	$	55,939	$	64,397

(1) Nonaccrual loans include nonaccrual TDRs of $13.6 million and $12.3 million as of September 30, 2015 and December 31, 2014, respectively.



	Three months ended				Nine months ended
	September 30,				September 30,
(Dollars in thousands)	2015		2014		2015		2014
Interest income effect on impaired loans
Gross amount of interest that would have been recorded under original terms	$	852	$	910	$	2,750	$	2,543
Interest included in income
Nonaccrual loans	91		186		370		363
Troubled debt restructurings	168		110		436		321
Total interest included in income	259		296		806		684
Net impact on interest income	$	593	$	614	$	1,944	$	1,859

First Financial individually reviews all impaired commercial loan relationships greater than $250,000, as well as consumer loan TDRs greater than $100,000, to determine if a specific allowance is necessary based on the borrower’s overall financial condition, resources and payment record, support from guarantors and the realizable value of any collateral. Specific allowances are based on discounted cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans.

First Financial's investment in impaired loans was as follows:



	As of September 30, 2015
(Dollars in thousands)	Current balance		Contractual principal balance		Related allowance		Average current balance		YTD interest income recognized		Quarterly interest income recognized
Loans with no related allowance recorded
Commercial	$	9,981	$	11,848	$	0	$	8,981	$	153	$	47
Real estate - construction	79		383		0		187		0		0
Real estate - commercial	20,834		26,044		0		20,129		263		77
Real estate - residential	7,452		8,787		0		8,317		136		44
Installment	427		460		0		412		6		2
Home equity	5,635		7,503		0		5,725		58		19
Other	0		0		0		0		0		0
Total	44,408		55,025		0		43,751		616		189

Loans with an allowance recorded
Commercial	868		868		478		1,513		16		6
Real estate - construction	0		0		0		0		0		0
Real estate - commercial	9,004		9,633		938		14,072		145		54
Real estate - residential	1,558		1,570		235		1,734		27		9
Installment	0		0		0		0		0		0
Home equity	101		101		2		101		2		1
Other	0		0		0		0		0		0
Total	11,531		12,172		1,653		17,420		190		70

Total
Commercial	10,849		12,716		478		10,494		169		53
Real estate - construction	79		383		0		187		0		0
Real estate - commercial	29,838		35,677		938		34,201		408		131
Real estate - residential	9,010		10,357		235		10,051		163		53
Installment	427		460		0		412		6		2
Home equity	5,736		7,604		2		5,826		60		20
Other	0		0		0		0		0		0
Total	$	55,939	$	67,197	$	1,653	$	61,171	$	806	$	259



	As of and for the year December 31, 2014
(Dollars in thousands)	Current balance		Contractual principal balance		Related allowance		Average current balance		Interest income recognized
Loans with no related allowance recorded
Commercial	$	7,611	$	9,284	$	0	$	7,146	$	146
Real estate - construction	223		443		0		223		0
Real estate - commercial	19,285		23,631		0		15,653		285
Real estate - residential	9,561		10,867		0		9,485		182
Installment	514		577		0		513		8
Home equity	6,246		9,041		0		5,658		85
Other	0		0		0		0		0
Total	43,440		53,843		0		38,678		706

Loans with an allowance recorded
Commercial	2,398		2,605		739		4,234		57
Real estate - construction	0		0		0		0		0
Real estate - commercial	16,439		17,662		4,002		11,471		187
Real estate - residential	2,019		2,080		310		2,088		40
Installment	0		0		0		0		0
Home equity	101		101		2		101		3
Other	0		0		0		0		0
Total	20,957		22,448		5,053		17,894		287

Total
Commercial	10,009		11,889		739		11,380		203
Real estate - construction	223		443		0		223		0
Real estate - commercial	35,724		41,293		4,002		27,124		472
Real estate - residential	11,580		12,947		310		11,573		222
Installment	514		577		0		513		8
Home equity	6,347		9,142		2		5,759		88
Other	0		0		0		0		0
Total	$	64,397	$	76,291	$	5,053	$	56,572	$	993

OREO. OREO is comprised of properties acquired by the Company primarily through the loan foreclosure or repossession process, or other resolution activity that results in partial or total satisfaction of problem loans.

Changes in OREO were as follows:



	Three months ended						Nine months ended
	September 30,						September 30,
(Dollars in thousands)	2015 ⁽¹⁾			2014 ⁽¹⁾			2015 ⁽¹⁾			2014 ⁽¹⁾
Balance at beginning of period	$	16,401		$	32,809		$	22,674		$	46,926
Additions
Commercial	178			883			2,745			6,211
Residential	1,405			292			3,210			1,926
Total additions	1,583			1,175			5,955			8,137
Disposals
Commercial	(852		)	(9,695		)	(9,394		)	(27,672		)
Residential	(1,708		)	(115		)	(2,844		)	(1,041		)
Total disposals	(2,560		)	(9,810		)	(12,238		)	(28,713		)
Valuation adjustment
Commercial	(183		)	(1,490		)	(963		)	(3,496		)
Residential	(54		)	(188		)	(241		)	(358		)
Total valuation adjustment	(237		)	(1,678		)	(1,204		)	(3,854		)
Balance at end of period	$	15,187		$	22,496		$	15,187		$	22,496

(1) Includes OREO subject to loss sharing agreements of $1.4 million and $11.2 million at September 30, 2015 and 2014, respectively.

FDIC indemnification asset. Changes in the balance of the FDIC indemnification asset and the related impact to the Consolidated Statements of Income are presented in the table that follows:



	Three months ended						Nine months ended
	September 30,						September 30,
(Dollars in thousands)	2015			2014			2015			2014			Affected Line Item in the Consolidated Statements of Income
Balance at beginning of period	$	20,338		$	30,420		$	22,666		$	45,091
Adjustments not reflected in income
Net FDIC claims (received) / paid	758			(1,423		)	2,382			(7,422		)
Adjustments reflected in income
Amortization	(1,192		)	(1,486		)	(3,562		)	(4,215		)	Interest income, other earning assets
FDIC loss sharing income	(973		)	(192		)	(2,323		)	408			Noninterest income, FDIC loss sharing income
Offset to accelerated discount	0			(3,159		)	(232		)	(9,702		)	Noninterest income, accelerated discount on covered loans
Balance at end of period	$	18,931		$	24,160		$	18,931		$	24,160

The accounting for FDIC indemnification assets is closely related to the accounting for the underlying, indemnified assets as well as on-going assessment of the collectibility of the indemnification assets. The primary activities impacting the FDIC indemnification asset are FDIC claims, amortization, FDIC loss sharing income and accelerated discount.

FDIC claims - First Financial files quarterly certifications with the FDIC and submits claims for losses, valuation adjustments and collection expenses incurred, less recoveries of any previous amounts claimed that are reimbursable back to the FDIC, as allowed under the loss sharing agreements. Cash reimbursements are generally received within 30 days of filing and are recorded as a credit to the indemnification asset balance, thus reducing its carrying value.

Amortization - As the yield on covered loans increased over time as a result of improvement in the expected cash flows on covered loans, the yield on the indemnification asset declined. The yield on the indemnification asset became negative in the first quarter of 2011 at which time the indemnification asset began to decline through monthly amortization at the negative yield.

FDIC loss sharing income - FDIC loss sharing income represents the proportionate share of credit costs on covered assets that First Financial expects to receive from the FDIC. Credit costs on covered assets include provision expense on covered loans, losses on covered OREO and other covered collection and asset resolution costs recorded as loss sharing expense under noninterest expenses in the Consolidated Statements of Income.

Offset to accelerated discount - Accelerated discounts on covered loans occur when covered loans prepay and represent the accelerated recognition of the remaining discount that would have been recognized over the life of the loan had the loan not prepaid. In conjunction with the recognition of accelerated discount, First Financial also recognizes a related offset through noninterest income and reduction to the indemnification asset for a portion of the discount representing expected credit loss included in the discount recorded at acquisition.