EX-13 2 q4201610-kexhibit13.htm EXHIBIT 13 Exhibit
EXHIBIT 13CELEBRATING 25 YEARS OF PROFITABILITY First Financial Bancorp 2015 Annual Report
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2016 ANNUAL REPORT Sustainable Growth: 153 Years of Strength and Stability




glossyfrombwfinal002.jpgTo commemorate our latest milestone, we decided to give back to the communities where we live and work. After a successful campaign in which our clients nominated their favorite charities via social media and within our banking centers, 25 of those organizations received a $1,000 donation. All recipients are 501(c)(3) charitable organizations and fall within one of our three areas of giving: economic development, financial literacy and neighborhood development. WITH MORE THAN 150 YEARS OF SERVICE, WE ARE PROUD OF OUR RICH HISTORY. 2015 CELEBRATES A MAJOR MILESTONE FStable Foundation for Growth Proven ability to navigate a dynamic environment through multiple business cycles Delivering Exceptional Client Services A sincere desire to understand client needs and provide value-added solutions is our way of business Strong Balance Sheet and Sound Credit Quality Prudent management and forward thinking keep us on the right path Our Core Growth Strategies The results from our 2016 efforts demonstrate our continued focus on organic growth and execution of our Premier Business Bank strategy. Focus on Organic Growth Leveraging the platform we have built and executing our Premier Business Bank strategy to drive disciplined, intentional growth 153 105 YEARS OF STRENGTH AND STABILITY QUARTERS OF CONSECUTIVE PROFITABILITY Total Shareholder Return Total Deposits 2016 $6.5 B 2015 $6.2 B 6% Net Income 2016 $88.5 M 2015 $75.1 M Net Income per Share-Diluted 2016 $1.43 2015 $1.21 18% Total Loans 2016 $5.8 B 2015 $5.4 B 7% First Financial KBW NASDAQ 1 year 3 year 5 year 7 year 10 year First Financial Bancorp 62% 81% 117% 166% 172% KBW Regional Bank Index 39% 51% 151% 187% 42% NASDAQ Composite 9% 34% 121% 159% 150% 100% 80 % 60 % 40 % 20 % 0 1 Year 3 Year 10 Year 0 50% 100% 150% 200% 1 YEAR 0 50 100 150% 200 6 2 % 8 1% 17 2 % 3 9 % 5 1% 4 2 % 9 % 3 4 % 1 5 0 % 3 YEAR 10 YEAR

OR FIRST



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Dear Fellow Shareholders, Our Company celebrated its 153rd anniversary and recorded its 105th consecutive quarter of profitability in 2016. Successfully operating as an independent community bank for over a century and a half, with 26 years of consecutive quarterly profits demonstrates the stability, sustainability and adaptability of our Company through multiple economic cycles. In a world too often focused on short-term results, this legacy and heritage is a source of immense pride. In 2016, we focused our efforts on furthering our Premier Business Bank strategy as well as leveraging the platform that we have built to drive solid, organic growth and enhance our performance. These efforts are reflected in our 2016 results: Total loans increased 7% to $5.8 billion1, Total deposits increased 6% to $6.5 billion1, Net income increased 18% to $89 million or $1.43 per diluted share, Disciplined expense management efforts allowed us to continue making targeted investments in our Company while our efficiency ratio improved to 59%2, Continued, solid credit performance with nonperforming loans declining to 0.83% of total loans1, Our capital ratios remain strong, with our Tier 1 and total capital ratios increasing to 10.46%1 and 13.10%1, The continued strength of our capital position allowed us to announce an increase in our quarterly shareholder dividend to $0.17 per share in January 2017. I am extremely proud of our associates’ efforts and what we accomplished together as a Company in 2016. As we look forward to 2017 and beyond, I find our Company navigating through a number of cross currents that will impact us in the years ahead. On one hand, there has been a renewed sense of economic optimism stemming from the perception of a more pro-business climate in Washington. On the other, we continue to operate in one of the most challenging and dynamic banking environments in history-from prolonged low interest rates, to ever- changing regulatory and compliance requirements, increasing competition from financial technology companies and evolving customer preferences due to changing technology. The market for our products and services continues to change at a rapid pace and we must adapt and evolve our business in order to remain relevant to our customers. Against this backdrop, our Company remains well positioned for sustained success and I am confident we will continue to meet the challenge. We remain focused on improving execution, finding new and innovative ways to help our clients and delivering exceptional client service. We will continue to differentiate First Financial by sharpening our execution of the Premier Business Bank strategy- delivering an exceptional client experience to businesses, their owners and their employees. In closing, I’d like to thank you for your continued support of our Company and I look forward to seeing what we will achieve together in 2017. Claude E. Davis Chief Executive Officer (1) As of December 31, 2016. (2) Efficiency ratio reflects total noninterest expense as a percentage of total revenue for the year ended December 31, 2016.



First Financial Bancorp 2016 Annual Report 1


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Murph Knapke Chairman of the Board, First Financial Bancorp; Partner, Knapke Law Office J. Wickliffe Ach Chief Executive Officer, Hixson, Inc. David S. Barker President and Chief Executive Officer, SIHO Insurance Services Cynthia O. Booth President and Chief Executive Officer, COBCO Enterprises Claude E. Davis Chief Executive Officer, First Financial Bancorp. Corinne R. Finnerty Principal, McConnell Finnerty PC Peter E. Geier Principal, PGeier Consulting, LLC Susan L. Knust Owner and President, Omega Warehouse Services William J. Kramer Vice President of Operations, Valco Companies, Inc. Jeffrey D. Meyer President, Clean Title Agency, Inc. John T. Neighbours Partner, Faegre Baker Daniels Richard E. Olszewski Owner/Operator, 7 Eleven Food Stores Maribeth S. Rahe President and Chief Executive Officer, Fort Washington Investment Advisors, Inc. Claude E. Davis Chief Executive Officer Matthew B. Burgess Chief Internal Auditor Scott T. Crawley Corporate Controller and Principal Accounting Officer Richard S. Dennen President, Commercial Finance John M. Gavigan Chief Financial Officer Shannon M. Kuhl Chief Legal Officer, Chief Compliance Officer and Corporate Secretary C. Douglas Lefferson Chief Credit Officer Bradley J. Ringwald President, Community Banking William J. Sorg Chief Risk Officer Paul C. Silva President, Investment Commercial Real Estate Anthony M. Stollings President, Consumer Banking and Chief Operating Officer Board of Directors Senior Management


2 First Financial Bancorp 2016 Annual Report



FINANCIAL HIGHLIGHTS
 
 
 
 
 
 
 
(Dollars in thousands, except per share data)
 
2016
 
2015
 
% Change
Earnings
 
 
 
 
 
 
Net interest income
 
$
272,671

 
$
246,502

 
10.6
 %
Net income
 
88,526

 
75,063

 
17.9
 %
 
 
 
 
 
 
 
Per Share
 
 
 
 
 
 
Net income per common share-basic
 
$
1.45

 
$
1.23

 
17.9
 %
Net income per common share-diluted
 
1.43

 
1.21

 
18.2
 %
Cash dividends declared per common share
 
0.64

 
0.64

 
0.0
 %
Tangible book value per common share (end of year)
 
10.56

 
9.69

 
9.0
 %
Market price (end of year)
 
28.45

 
18.07

 
57.4
 %
 
 
 
 
 
 
 
Balance Sheet - End of Year
 
 
 
 
 
 
Total assets
 
$
8,437,967

 
$
8,147,411

 
3.6
 %
Loans
 
5,757,482

 
5,388,760

 
6.8
 %
Investment securities
 
1,854,201

 
1,970,626

 
(5.9
)%
Deposits
 
6,525,788

 
6,179,624

 
5.6
 %
Shareholders' equity
 
865,224

 
809,376

 
6.9
 %
 
 
 
 
 
 
 
Ratios
 
 
 
 
 
 
Return on average assets
 
1.07
%
 
1.00
%
 
 
Return on average shareholders' equity
 
10.48
%
 
9.33
%
 
 
Return on average tangible shareholders' equity
 
13.96
%
 
12.66
%
 
 
Net interest margin
 
3.62
%
 
3.60
%
 
 
Net interest margin (fully tax equivalent)
 
3.68
%
 
3.66
%
 
 



First Financial Bancorp 2016 Annual Report 3









 
2016 Financial Highlights






4 First Financial Bancorp 2016 Annual Report


Glossary of Abbreviations and Acronyms

First Financial Bancorp has identified the following list of abbreviations and acronyms that are used in the Notes to Consolidated Financial Statements and the Management's Discussion and Analysis of Financial Condition and Results of Operations.

ABL
Asset based lending
 
FDIC
Federal Deposit Insurance Corporation
the Act
Private Securities Litigation Reform Act
 
FHLB
Federal Home Loan Bank
ALLL
Allowance for loan and lease losses
 
FHLMC
Federal Home Loan Mortgage Corporation
ASC
Accounting standards codification
 
First Financial
First Financial Bancorp.
ASU
Accounting standards update
 
FNMA
Federal National Mortgage Association
ATM
Automated teller machine
 
Form 10-K
First Financial Bancorp. Annual Report on Form 10-K
Bank
First Financial Bank
 
FRB
Federal Reserve Bank
Basel III
Basel Committee regulatory capital reforms, Third Basel Accord
 
GAAP
U.S. Generally Accepted Accounting Principles
Bp/bps
Basis point(s)
 
GNMA
Government National Mortgage Association
CDs
Certificates of deposits
 
IRLC
Interest Rate Lock Commitment
C&I
Commercial and industrial
 
MBSs
Mortgage-backed securities
CLOs
Collateralized loan obligations
 
N/A
Not applicable
CMOs
Collateralized mortgage obligations
 
NII
Net interest income
Company
First Financial Bancorp.
 
Oak Street
Oak Street Holdings Corporation
ERM
Enterprise Risk Management
 
OREO
Other real estate owned
EVE
Economic value of equity
 
SEC
United States Securities and Exchange Commission
Fair Value Topic
FASB ASC Topic 825, Financial Instruments
 
Special Assets
Special Assets Division
FASB
Financial Accounting Standards Board
 
TDR
Troubled debt restructuring
 
 
 
 
 


First Financial Bancorp 2016 Annual Report 5


Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

Table 1 • Financial Summary
 
 
 
 
 
 
 
 
 
 
December 31,
(Dollars in thousands, except per share data)
2016
 
2015
 
2014
 
2013
 
2012
Summary of operations
 
 
 
 
 
 
 
 
 
Interest income
$
305,950

 
$
269,759

 
$
247,859

 
$
245,208

 
$
280,930

Tax equivalent adjustment (1)
4,215

 
4,017

 
3,224

 
2,142

 
1,055

Interest income tax – equivalent (1)
310,165

 
273,776

 
251,083

 
247,350

 
281,985

Interest expense
33,279

 
23,257

 
19,234

 
16,888

 
27,589

  Net interest income tax – equivalent (1)
$
276,886

 
$
250,519

 
$
231,849

 
$
230,462

 
$
254,396

Interest income
$
305,950

 
$
269,759

 
$
247,859

 
$
245,208

 
$
280,930

Interest expense
33,279

 
23,257

 
19,234

 
16,888

 
27,589

  Net interest income
272,671

 
246,502

 
228,625

 
228,320

 
253,341

Provision for loan and lease losses
10,140

 
9,641

 
1,528

 
8,909

 
50,020

Noninterest income
69,601

 
75,202

 
63,965

 
73,647

 
122,421

Noninterest expenses
201,401

 
201,130

 
196,034

 
225,475

 
221,997

Income before income taxes
130,731

 
110,933

 
95,028

 
67,583

 
103,745

Income tax expense
42,205

 
35,870

 
30,028

 
19,234

 
36,442

   Net income
$
88,526

 
$
75,063

 
$
65,000

 
$
48,349

 
$
67,303

 
 
 
 
 
 
 
 
 
 
Per share data
 
 
 
 
 
 
 
 
 
Earnings per common share
 
 
 
 
 
 
 
 
 
Basic
$
1.45

 
$
1.23

 
$
1.11

 
$
0.84

 
$
1.16

Diluted
$
1.43

 
$
1.21

 
$
1.09

 
$
0.83

 
$
1.14

Cash dividends declared per common share
$
0.64

 
$
0.64

 
$
0.61

 
$
0.94

 
$
1.18

Average common shares outstanding–basic (in thousands)
61,206

 
61,063

 
58,663

 
57,270

 
57,877

Average common shares outstanding–diluted (in thousands)
61,985

 
61,848

 
59,393

 
58,073

 
58,869

 
 
 
 
 
 
 
 
 
 
Selected year-end balances
 
 
 
 
 
 
 
 
 
Total assets
$
8,437,967

 
$
8,147,411

 
$
7,217,821

 
$
6,417,213

 
$
6,497,048

Earning assets
7,719,285

 
7,431,707

 
6,594,626

 
5,840,849

 
5,961,727

Investment securities (2)
1,854,201

 
1,970,626

 
1,761,090

 
1,798,300

 
1,874,343

Total loans and leases
5,757,482

 
5,388,760

 
4,777,235

 
3,963,514

 
3,927,180

Interest-bearing demand deposits
1,513,771

 
1,414,291

 
1,225,378

 
1,125,723

 
1,160,815

Savings deposits
2,142,189

 
1,945,805

 
1,889,473

 
1,612,005

 
1,623,614

Time deposits
1,321,843

 
1,406,124

 
1,255,364

 
952,327

 
1,068,637

Noninterest-bearing demand deposits
1,547,985

 
1,413,404

 
1,285,527

 
1,147,452

 
1,102,774

Total deposits
6,525,788

 
6,179,624

 
5,655,742

 
4,837,507

 
4,955,840

Short-term borrowings
807,912

 
938,425

 
661,392

 
748,749

 
624,570

Long-term debt
119,589

 
119,540

 
48,241

 
60,780

 
75,202

Shareholders’ equity
865,224

 
809,376

 
784,077

 
682,161

 
710,425

 
 
 
 
 
 
 
 
 
 
Select Financial Ratios
 
 
 
 
 
 
 
 
 
Average loans to average deposits (3)
89.33
%
 
84.00
%
 
83.20
%
 
82.12
%
 
75.66
%
Net charge-offs to average loans and leases
0.10
%
 
0.18
%
 
0.27
%
 
0.99
%
 
1.34
%
Average shareholders’ equity to average total assets
10.24
%
 
10.73
%
 
10.75
%
 
11.17
%
 
11.30
%
Average common shareholders’ equity to average total assets
10.24
%
 
10.73
%
 
10.75
%
 
11.17
%
 
11.30
%
Return on average assets
1.07
%
 
1.00
%
 
0.96
%
 
0.77
%
 
1.07
%
Return on average common equity
10.48
%
 
9.33
%
 
8.94
%
 
6.89
%
 
9.43
%
Return on average equity
10.48
%
 
9.33
%
 
8.94
%
 
6.89
%
 
9.43
%
Net interest margin
3.62
%
 
3.60
%
 
3.71
%
 
3.97
%
 
4.37
%
Net interest margin (tax equivalent basis) (1)
3.68
%
 
3.66
%
 
3.76
%
 
4.01
%
 
4.39
%
Dividend payout
44.14
%
 
52.03
%
 
54.95
%
 
111.90
%
 
101.72
%
(1) Tax equivalent basis was calculated using a 35.00% tax rate in all years presented.
(2) Includes investment securities held-to-maturity, investment securities available-for-sale, investment securities trading, and other investments.
(3) Includes covered loans and loans held for sale.


6 First Financial Bancorp 2016 Annual Report


This annual report contains forward-looking statements. See the Forward-Looking Statements section that follows for further information on the risks and uncertainties associated with forward-looking statements. The following discussion and analysis is presented to facilitate the understanding of the financial position and results of operations of First Financial Bancorp. The discussion and analysis identifies trends and material changes that occurred during the reporting periods presented and should be read in conjunction with the Statistical Data, Consolidated Financial Statements and accompanying Notes.

Certain reclassifications of prior years' amounts have been made to conform to current year presentation. Such reclassifications had no effect on net earnings, total assets, liabilities and shareholders' equity.

EXECUTIVE SUMMARY

First Financial is an $8.4 billion bank holding company headquartered in Cincinnati, Ohio and, through its subsidiaries, operates primarily in Ohio, Indiana and Kentucky.  These subsidiaries include a commercial bank, First Financial Bank, with 102 banking centers and 124 ATMs. First Financial provides banking and financial services products through its four lines of business: commercial and private banking, retail banking, investment commercial real estate and commercial finance. These business units provide traditional banking services to business and retail clients. Commercial finance primarily provides financing solutions for franchisees in the quick service and casual dining restaurant sector, as well as insurance agents and brokers throughout the United States. Commercial and private banking includes First Financial Wealth Management, which had approximately $2.4 billion in assets under management as of December 31, 2016 and provides wealth planning, portfolio management, trust and estate, brokerage and retirement plan services. 

First Financial acquired the banking operations of Peoples Community Bank, and Irwin Union Bank and Trust Company and Irwin Union Bank, F.S.B., through FDIC-assisted transactions in 2009. In connection with these FDIC-assisted transactions, First Financial entered into loss sharing agreements with the FDIC. Under the terms of these agreements the FDIC reimburses First Financial for a percentage of losses with respect to certain loans (covered loans) and OREO (covered OREO) (collectively, covered assets). These agreements provide for loss protection on covered 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 covered loans were 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 five year loss sharing indemnification period related to non-single-family loans expired effective October 1, 2014. The three year period for sharing recoveries on non-single-family loans expires on October 1, 2017. The loss sharing protection related to all other covered loans of approximately $93.1 million will expire in the third quarter 2019. Covered assets represented 1.1% of First Financial's total assets at December 31, 2016.

The major components of First Financial’s operating results for the previous five years are summarized in Table 1 – Financial Summary and are discussed in greater detail in the sections that follow.

MARKET STRATEGY AND BUSINESS COMBINATIONS

First Financial’s goal is to develop a competitive advantage by utilizing a local market focus to provide a superior level of service and build long-term relationships with clients in order to help them reach greater levels of financial success. First Financial serves a combination of metropolitan and non-metropolitan markets in Ohio, Indiana and Kentucky through its full-service banking centers, and provides financing throughout the United States to franchise owners and clients within the financial services industry. First Financial’s market selection process includes a number of factors, but markets are primarily chosen for their potential for growth and long-term profitability.  First Financial intends to continue focusing plans for future growth and capital investments within its current metropolitan markets and evaluate other growth opportunities in metropolitan markets located within, or in close proximity to, the Company's current geographic footprint as well as other strategic acquisitions that provide product line extensions or industry verticals that compliment our existing business.  First Financial's investment in non-metropolitan markets has historically provided stable, low-cost funding sources and remains an important part of the Bank's core funding base.  

Oak Street. During 2015, First Financial completed its acquisition of Oak Street for cash consideration, and concurrent with the close of the transaction, First Financial paid off all of Oak Street's existing long-term debt. Oak Street is a nationwide lender based in Indianapolis, Indiana that provides loans, secured by commissions and cash collateral accounts, primarily to insurance agents and brokers to grow their agency business and maximize their book-of-business value. Oak Street's lending activities are driven by agency acquisitions, agency ownership transitions, the purchase by agencies of books of business, as well as financing general working capital needs.  The underwriting of these loans involves analyses of collateral (through use of Oak Street's proprietary software system) that consists of insurance commissions revenue, which is then monitored throughout the life of the loans.

First Financial Bancorp 2016 Annual Report 7


The Oak Street transaction was accounted for using the acquisition method of accounting and accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at estimated fair value on the acquisition date, in accordance with FASB ASC Topic 805, Business Combinations. The fair value measurements of assets acquired and liabilities assumed are subject to refinement for up to one year after the closing date of the acquisition as additional information relative to closing date fair values become available.  No adjustments were made to the estimated fair value of the assets or liabilities acquired from Oak Street.

The goodwill arising from the Oak Street acquisition reflects the business's high growth potential and scalable platform. The acquisition leveraged First Financial’s excess capital and is expected to provide additional revenue growth and diversification. The goodwill is not deductible for income tax purposes as the merger was accounted for as a tax-free exchange. The tax-free exchange resulted in a carryover of tax attributes and tax basis to the Company's subsequent income tax filings and was adjusted for any fair value adjustments required in accounting for the acquisitions. For further detail, see Note 8 – Goodwill and Other Intangible Assets.

OVERVIEW OF OPERATIONS
 
Net income for the year ended December 31, 2016 was $88.5 million, resulting in earnings per diluted common share of $1.43. This compares to net income of $75.1 million and earnings per diluted common share of $1.21 in 2015. First Financial’s return on average shareholders’ equity for 2016 was 10.48%, compared to 9.33% for 2015, and First Financial’s return on average assets was 1.07% and 1.00% for 2016 and 2015, respectively.
  
Net interest income in 2016 increased $26.2 million, or 10.6%, from 2015, to $272.7 million, primarily driven by higher earning asset balances as well as higher yields earned on the investment and loan portfolios. The net interest margin on a fully tax equivalent basis was 3.68% for 2016 compared with 3.66% in 2015.
 
Noninterest income declined $5.6 million, or 7.4%, during the year, from $75.2 million in 2015 to $69.6 million in 2016. The decrease in noninterest income was primarily due to lower income from the accelerated discount on covered loans that prepay during the year as well as lower gains from sales of investment securities, which were partially offset by higher FDIC loss sharing, other noninterest and bankcard income.

Noninterest expense increased $0.3 million, or 0.1%, from $201.1 million in 2015 to $201.4 million in 2016, as higher salaries and benefits and data processing expenses were partially offset by declines in professional services, loss sharing and other noninterest expenses as well as a decline in losses on OREO properties.
 
Total loans increased $368.7 million, or 6.8%, from $5.4 billion at December 31, 2015 to $5.8 billion at December 31, 2016, as a result of strong organic growth during the year. Total deposits increased $346.2 million, or 5.6%, from $6.2 billion at December 31, 2015 to $6.5 billion as of December 31, 2016, as a result of strong deposit generation efforts during the year.
 
The ALLL was $58.0 million, or 1.01% of total loans at December 31, 2016, compared to $53.4 million, or 0.99% of total loans at December 31, 2015. The Company's credit quality performance remained stable in 2016, reflecting disciplined underwriting and credit monitoring procedures. In addition to sound underwriting practices and robust monitoring procedures, improved economic conditions in First Financial's existing markets contributed to lower levels of net charge-offs, nonperforming and classified assets during the year.

First Financial’s operational results may be influenced by certain economic factors and conditions, such as market interest rates, competition within the industry, household and business spending levels, consumer confidence and the regulatory environment. For a more detailed discussion of the Company's operations, please refer to the sections that follow.


First Financial Bancorp 2016 Annual Report 8


NET INCOME
 
2016 vs. 2015. First Financial’s net income increased $13.5 million, or 17.9%, to $88.5 million in 2016, compared to net income of $75.1 million in 2015. The increase was primarily related to a $26.2 million, or 10.6%, increase in net interest income, partially offset by a decrease in noninterest income of $5.6 million, or 7.4% and an increase in income tax expense of $6.3 million, or 17.7%, during 2016.

2015 vs. 2014. First Financial’s net income increased $10.1 million, or 15.5%, to $75.1 million in 2015, compared to net income of $65.0 million in 2014. The increase was primarily related to a $21.9 million, or 8.8%, increase in interest income as well as an increase in noninterest income of $11.2 million, or 17.6%, partially offset by an increase in interest expense of $4.0 million, or 20.9% and an increase in income tax expense of $5.8 million, or 19.5%, during 2015.

For more detail, refer to the Net interest income, Noninterest income, Noninterest expenses and Income taxes sections that follow.

NET INTEREST INCOME
 
First Financial’s net interest income for the years 2012 through 2016 is shown in Table 1 – Financial Summary. Net interest income, First Financial’s principal source of income, is the excess of interest received from earning assets, including loan-related fees, less interest paid on interest-bearing liabilities. The amount of net interest income is determined by the volume and mix of earning assets, the rates earned on such earning assets and the volume, mix and rates paid for the deposits and borrowed money that support the earning assets.
 
For analytical purposes, net interest income is also presented in Table 1 – Financial Summary on a tax equivalent basis assuming a 35.00% marginal tax rate. Net interest income is presented on a tax equivalent basis to consistently reflect income from tax-exempt assets, such as municipal loans and investments, in order to facilitate a comparison between taxable and tax-exempt amounts.  Management believes that it is a standard practice in the banking industry to present net interest margin and net interest income on a fully tax equivalent basis as these measures provide useful information to make peer comparisons. First Financial's tax equivalent net interest margin was 3.68%, 3.66% and 3.76% for 2016, 2015 and 2014, respectively.

Table 3 – Volume/Rate Analysis - Tax Equivalent Basis describes the extent to which changes in interest rates as well as changes in the volume of earning assets and interest-bearing liabilities have affected First Financial’s net interest income on a tax equivalent basis during the years presented. Nonaccrual loans and loans held for sale were included in the average loan balances used to determine the yields in Table 3 – Volume/Rate Analysis - Tax Equivalent Basis. Table 3 – Volume/Rate Analysis - Tax Equivalent Basis should be read in conjunction with the Statistical Information table.
 
Loan fees included in the interest income computation for 2016, 2015 and 2014 were $9.9 million, $5.6 million and $4.3 million, respectively. The increase in loan fees in 2016 was primarily a result of strong organic loan growth as well as the full year impact from the Oak Street acquisition.

2016 vs. 2015. Net interest income increased $26.2 million, or 10.6%, from $246.5 million in 2015 to $272.7 million in 2016, primarily due to an increase in average earning assets and higher yields earned during 2016. Average earning assets increased from $6.8 billion in 2015 to $7.5 billion in 2016, while the yield on earning assets increased from 3.94% in 2015 to 4.07% in 2016.

Interest income was $306.0 million in 2016, a $36.2 million, or 13.4%, increase from 2015. The increase was primarily attributable to interest income from loans, which increased $32.5 million, or 14.1%, from $230.2 million in 2015 to $262.7 million in 2016 as well as a $3.5 million, or 8.9%, increase in taxable interest income earned on investment securities during the period. The increase in interest income on loans resulted from an increase in interest and fees earned on the Company's loan portfolio as average loan balances increased $666.0 million, or 13.5%, during 2016. Higher loan balances in 2016 resulted from strong organic loan growth during the period as well as the full year impact from loans acquired in the Oak Street transaction, which were partially offset by continued paydowns and resolutions in the Company's high-yielding covered/formerly covered loan portfolio. The increase in interest income on investment securities was driven by higher yields earned during the period.

Interest expense was $33.3 million in 2016, which was a $10.0 million, or 43.1%, increase from 2015. Interest expense increased as the average balance of interest-bearing deposits increased $275.6 million, or 6.0%, due to the Company's strong deposit generation efforts during the period. Additionally, the cost of funds related to these deposits increased to 47 bps for 2016 from 43 bps in 2015, reflecting the full year impact of an increase in interest rates in December 2015. Interest expense

First Financial Bancorp 2016 Annual Report 9

Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

was also impacted in 2016 by a $254.8 million, or 40.7%, increase in average short-term borrowings which were utilized to help fund for the Company's asset growth during the period.

2015 vs. 2014. Net interest income increased $17.9 million, or 7.8%, from $228.6 million in 2014 to $246.5 million in 2015, primarily due to an increase in average earning assets, partially offset by lower yields during 2015. Average earning assets increased from $6.2 billion in 2014 to $6.8 billion in 2015, while the yield on earning assets declined 8 bps from 4.02% in 2014 to 3.94% in 2015.

Interest income was $269.8 million in 2015, a $21.9 million, or 8.8%, increase from 2014. The increase was primarily attributable to interest income from loans, which increased $21.4 million, or 10.3%, from $208.8 million in 2014 to $230.2 million in 2015, partially offset by a $1.3 million, or 3.3%, decrease in interest income earned on taxable investment securities during the period as yields declined slightly. The increase in interest income resulted from an increase in interest and fee income earned on the Company's loan portfolio. This was primarily a result of strong organic loan growth during the period as well as the impact from the Oak Street transaction, partially offset by continued paydowns and resolutions in the Company's high-yielding covered loan portfolio and lower origination yields. Average loan balances increased $669.1 million, or 15.6%, during 2015, however, new loan originations were recorded at yields lower than the yields on loans that paid off or matured during the period, muting the impact of higher loan balances on interest income and net interest margin.

Interest expense was $23.3 million in 2015, a $4.0 million, or 20.9%, increase from 2014. Interest expense increased as the average balance of interest-bearing deposits increased $581.3 million, or 14.6%, primarily due to the Company's strong deposit generation efforts during the period as well as the full year impact of the Columbus, Ohio bank acquisitions completed in 2014. Additionally, the cost of funds related to these deposits increased 2 bps to 43 bps for 2015 from 41 bps in 2014, negatively impacting net interest margin. Interest expense was also impacted by an increase in average long-term borrowings of $14.1 million, or 24.5%, primarily resulting from the issuance of $120.0 million of subordinated notes during 2015.

Table 3 • Volume/Rate Analysis - Tax Equivalent Basis (1) 
 
 
 
 
 
 
2016 change from 2015 due to
 
2015 change from 2014 due to
(Dollars in thousands)
 
Volume
Rate
 
Total
 
Volume
Rate
 
Total
Interest income
 
 
 
 
 
 
 
 
 
 
 
 
Loans (2)
 
$
31,284

 
$
1,412

 
$
32,696

 
$
31,379

 
$
(9,742
)
 
$
21,637

Indemnification asset
 
1,655

 
(1,424
)
 
231

 
2,843

 
(2,052
)
 
791

Investment securities (3)
 
 
 
 
 
 
 
 
 
 
 
 
Taxable
 
641

 
2,885

 
3,526

 
(573
)
 
(774
)
 
(1,347
)
Tax-exempt
 
54

 
(171
)
 
(117
)
 
1,400

 
217

 
1,617

Total investment securities interest (3)
 
695

 
2,714

 
3,409

 
827

 
(557
)
 
270

Interest-bearing deposits with other banks
 
(14
)
 
67

 
53

 
21

 
(26
)
 
(5
)
Total
 
33,620

 
2,769

 
36,389

 
35,070

 
(12,377
)
 
22,693

 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand deposits
 
293

 
619

 
912

 
101

 
(171
)
 
(70
)
Savings deposits
 
140

 
1,248

 
1,388

 
455

 
(660
)
 
(205
)
Time deposits
 
246

 
593

 
839

 
2,756

 
840

 
3,596

Short-term borrowings
 
1,304

 
1,838

 
3,142

 
(264
)
 
360

 
96

Long-term debt
 
2,465

 
1,276

 
3,741

 
477

 
129

 
606

Total
 
4,448

 
5,574

 
10,022

 
3,525

 
498

 
4,023

Net interest income
 
$
29,172

 
$
(2,805
)
 
$
26,367

 
$
31,545

 
$
(12,875
)
 
$
18,670


(1) Tax equivalent basis was calculated using a 35.00% tax rate.
(2) Includes nonaccrual loans and loans held-for-sale.
(3) Includes investment securities held-to-maturity, investment securities available-for-sale and other investments.


10 First Financial Bancorp 2016 Annual Report


NONINTEREST INCOME AND NONINTEREST EXPENSES
 
Noninterest income and noninterest expenses for 2016, 2015 and 2014 are shown in Table 4 – Noninterest income and Noninterest expenses.
 
NONINTEREST INCOME
 
2016 vs. 2015. Noninterest income declined $5.6 million, or 7.4%, from $75.2 million in 2015 to $69.6 million in 2016. The decline was primarily related to a $6.9 million, or 64.3%, decline in accelerated discount on covered/formerly covered loans and a $1.3 million, or 84.5%, decline in net gains on sales of investment securities, partially offset by a $0.9 million, or 37.2%, increase in FDIC loss sharing income, a $0.6 million, or 5.8%, increase in other noninterest income and a $0.6 million, or 4.8%, increase in bankcard income.

Income from the accelerated discount on covered/formerly covered loans declined from $10.8 million in 2015 to $3.9 million in 2016. Accelerated discounts on covered/formerly covered loans result from prepayment activity and the accelerated recognition of the remaining discount that would have been recognized over the life of the loan had it not prepaid. Lower income from the accelerated discount on covered/formerly covered loans during 2016 was related to lower levels of prepayment activity during the year.

Noninterest income from gains on sales of investment securities decreased $1.3 million, or 84.5%, in 2016 as $207.0 million of sales of primarily mortgage backed and other investment securities resulted in net gains of $0.2 million during the period compared to sales of $70.2 million of investment securities that resulted in net gains of $1.5 million during 2015.

Partially offsetting the declines in accelerated discount and gains on sales of investment securities was an increase in FDIC loss sharing income of $0.9 million, or 37.2%, from negative $2.5 million during 2015 to negative $1.6 million in 2016. FDIC loss sharing income represents the proportionate share of credit losses, recoveries and resolution expenses on covered assets that First Financial expects to receive from or pay to the FDIC. Negative FDIC loss sharing income during 2016 and 2015 reflects a net payable due to the FDIC. Other noninterest income increased primarily due to $2.4 million of previously unrealized income from the redemption of a limited partnership investment during the period, partially offset by lower limited partnership distributions in 2016. Bankcard income increased as a result of elevated card volume and customer activity during 2016.

2015 vs. 2014. Noninterest income increased $11.2 million, or 17.6%, from $64.0 million in 2014 to $75.2 million in 2015 primarily related to a $6.6 million, or 157.9%, increase in accelerated discount on covered loans, a $2.9 million or 188.9%, increase in client derivative fees, a $2.1 million, or 48.3%, increase in gains on sales of loans, a $2.0 million, or 22.7%, increase in other noninterest income and a $1.4 million net gain on sales of investment securities, partially offset by a $2.9 million, or 781.4%, decrease in FDIC loss sharing income.

Income from the accelerated discount on covered/formerly covered loans increased from $4.2 million in 2014 to $10.8 million in 2015, primarily related to the expiration of loss sharing coverage on non-single-family assets on October 1, 2014 as well as elevated levels of prepayment activity on non-single family assets during 2015. The increase in noninterest income related to accelerated discount was partially offset by a related $2.6 million increase in provision expense on covered/formerly covered loans.

Client derivative fees increased as increases in variable rate lending led to strong customer demand for interest rate swaps. Gains on sales of loans increased from $4.4 million in 2014 to $6.5 million in 2015 due to strong mortgage origination activity during the period. Other noninterest income increased, primarily due to $1.2 million of distributions received from limited partnership investments during the period. The increase in net gains on sales of investment securities was primarily related to sales of agency mortgage-backed securities during 2015 in an effort to re-balance the mix and duration of certain investments in the portfolio.

FDIC loss sharing income decreased $2.9 million or 781.4% from loss sharing income of $0.4 million during 2014 to $2.5 million of negative loss sharing income in 2015, reflecting a net payable due to the FDIC.


First Financial Bancorp 2016 Annual Report 11

Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

Table 4 • Noninterest Income and Noninterest Expenses
 
2016
 
2015
 
2014
(Dollars in thousands)
Total
% Change
 
Total
% Change
 
Total
% Change
Noninterest income
 
 
 
 
 
 
 
 
Service charges on deposit accounts
$
18,933

(0.4
)%
 
$
19,015

(6.2
)%
 
$
20,274

(1.6
)%
Trust and wealth management fees
13,200

0.5
 %
 
13,128

(3.7
)%
 
13,634

(4.8
)%
Bankcard income
12,132

4.8
 %
 
11,578

7.8
 %
 
10,740

(1.6
)%
Client derivative fees
4,570

4.1
 %
 
4,389

188.9
 %
 
1,519

(25.4
)%
Net gains from sales of loans
6,804

5.1
 %
 
6,471

48.3
 %
 
4,364

38.5
 %
FDIC loss sharing income
(1,563
)
(37.2
)%
 
(2,487
)
(781.4
)%
 
365

(90.2
)%
Accelerated discount on covered/formerly covered loans
3,850

(64.3
)%
 
10,791

157.9
 %
 
4,184

(41.5
)%
Other
11,441

5.8
 %
 
10,812

22.7
 %
 
8,815

(12.2
)%
Subtotal
69,367

(5.9
)%
 
73,697

15.3
 %
 
63,895

(11.2
)%
Gains on sales of investment securities
234

(84.5
)%
 
1,505

N/M

 
70

(95.9
)%
Total
$
69,601

(7.4
)%
 
$
75,202

17.6
 %
 
$
63,965

(13.1
)%
 
 
 
 
 
 
 
 
 
Noninterest expenses
 
 
 
 
 
 
 
 
Salaries and employee benefits
$
122,361

9.5
 %
 
$
111,792

3.8
 %
 
$
107,702

6.2
 %
Net occupancy
18,329

0.5
 %
 
18,232

(5.0
)%
 
19,187

(9.5
)%
Furniture and equipment
8,663

(0.7
)%
 
8,722

2.0
 %
 
8,554

(4.6
)%
Data processing
11,406

5.0
 %
 
10,863

(16.2
)%
 
12,963

26.7
 %
Marketing
3,965

6.5
 %
 
3,723

3.3
 %
 
3,603

(15.6
)%
Communication
1,889

(12.6
)%
 
2,161

(5.1
)%
 
2,277

(29.0
)%
Professional services
6,303

(34.5
)%
 
9,622

55.9
 %
 
6,170

(10.3
)%
State intangible tax
2,034

(12.7
)%
 
2,331

10.4
 %
 
2,111

(46.3
)%
FDIC assessments
4,293

(3.4
)%
 
4,446

(0.4
)%
 
4,462

(0.9
)%
Loss (gain)-other real estate owned
(1,212
)
(165.1
)%
 
1,861

115.9
 %
 
862

N/M

Loss sharing expense
696

(62.7
)%
 
1,865

(60.2
)%
 
4,686

(33.8
)%
Other
22,674

(11.1
)%
 
25,512

8.8
 %
 
23,457

(6.8
)%
Total
$
201,401

0.1
 %
 
$
201,130

2.6
 %
 
$
196,034

(13.1
)%

N/M = Not meaningful
 

NONINTEREST EXPENSES

2016 vs. 2015. Noninterest expenses increased $0.3 million, or 0.1%, in 2016 compared to 2015, primarily due to a $10.6 million, or 9.5%, increase in salaries and employee benefits and a $0.5 million increase in data processing expenses during the period. These increases were partially offset by a $3.3 million, or 34.5%, decrease in professional services, a $3.1 million, or 165.1%, decline in OREO losses, a $2.8 million, or 11.1%, decrease in other noninterest expenses and a $1.2 million, or 62.7%, decline in loss sharing expenses.
  
The increase in salaries and employee benefits resulted from the full year impact of staff additions from the Oak Street acquisition and higher performance-based compensation, as well as annual compensation adjustments. The increase in data processing expenses was primarily related to investments in data management and system upgrades, in addition to various other software license expenses. The decline in professional services was primarily related to $2.2 million of acquisition-related costs associated with the Oak Street transaction in 2015. OREO losses decreased as the Company recorded $1.2 million of gains on sales of OREO properties in 2016, compared to losses of $1.9 million in 2015. The decline in other noninterest expense from $25.5 million in 2015 to $22.7 million in 2016 was primarily the result of a legal settlement accrual and debt extinguishment costs in 2015, and the decline in loss sharing expenses in 2016 was due to lower collection costs resulting from the continued decline in covered asset balances.


12 First Financial Bancorp 2016 Annual Report


2015 vs. 2014. Noninterest expenses increased $5.1 million, or 2.6%, in 2015 compared to 2014, primarily due to a $4.1 million, or 3.8%, increase in salaries and employee benefits, a $3.5 million, or 55.9%, increase in professional services expenses and a $2.1 million, or 8.8%, increase in other noninterest expenses during the period. These increases were partially offset by a $2.8 million, or 60.2%, decrease in loss sharing expense and a $2.1 million, or 16.2%, decline in data processing expenses.
  
The increase in salaries and benefits was related to staff additions from the Oak Street and Columbus acquisitions and annual salary adjustments, partially offset by lower health care costs during 2015. The increase in professional services was primarily related to $2.2 million of acquisition-related costs associated with the Oak Street transaction. Higher other noninterest expense was driven by a $0.9 million prepayment fee related to the extinguishment of FHLB debt and $0.7 million of reserve adjustments for litigation related items which were resolved in 2015.

The decline in loss sharing expenses in 2015 was due to lower collection costs resulting from lower covered asset balances. Data processing expenses declined $2.1 million in 2015 primarily due to acquisition-related expenses from the Columbus transactions in 2014.

INCOME TAXES
 
First Financial’s income tax expense in 2016 totaled $42.2 million compared to $35.9 million in 2015 and $30.0 million in 2014, resulting in effective tax rates of 32.3%, 32.3% and 31.6% in 2016, 2015 and 2014, respectively. The effective tax rate in 2016 was unchanged from 2015, but was impacted by favorable provision to return adjustments related to affordable housing and historic tax credit investments as well as a decline in tax exempt interest income during 2016, in addition to non-deductible acquisition related expenses in 2015. The increase in the effective tax rate in 2015 compared to 2014 was primarily the result of non-deductible acquisition related expenses, partially offset by an increase in tax-exempt income in 2015.

Further information on income taxes is presented in Note 14 – Income Taxes in the Notes to Consolidated Financial Statements.

LENDING PRACTICES
 
First Financial remains dedicated to meeting the financial needs of individuals and businesses through its client-focused business model. The loan portfolio is comprised of a broad range of borrowers primarily located in the Ohio, Indiana and Kentucky markets; however, the commercial finance line of business serves a national client base.

First Financial’s loan portfolio consists of commercial loan types, including C&I, construction real estate, commercial real estate and lease financing (equipment leasing), as well as consumer loan types, such as residential real estate, home equity, installment and credit card loans.

Commercial and Industrial C&I loans include revolving lines of credit and term loans to commercial customers for use in normal business operations to finance working capital needs, equipment purchases, leasehold improvements or other projects.  C&I loans are generally underwritten individually and secured with the assets of the Company and/or the personal guarantee of the business owners.  C&I loans also include ABL, equipment and leasehold improvement financing for select concepts and franchisees in the quick service and casual dining restaurant sector and commission-based loans to insurance agents and brokers.  ABL transactions typically involve larger commercial clients and are secured by specific assets, such as inventory, accounts receivable, machinery and equipment.  In the franchise lending space, First Financial focuses on a limited number of restaurant concepts that have sound economics, low closure rates and strong brand awareness within specified local, regional or national markets.  Under the nationwide insurance lending platform, First Financial serves insurance agents and brokers that are looking to maximize their book-of-business value and grow their agency business.  First Financial's lending portfolios are managed to a risk-appropriate level so as not to create industry, geographic, franchise concept or borrower concentrations.

While economic trends, including positive GDP momentum, wage gains and unemployment rates showed further improvement during 2016, the pace of growth remains gradual and business spending levels have not materially increased. First Financial is optimistic that moderate economic improvements realized in 2016 will lead to further economic expansion in the coming periods, which would stimulate business growth and economic investment among current and prospective customers, resulting in additional lending opportunities for the Bank.

First Financial maintains vigorous underwriting processes to assess prospective C&I borrowers' credit worthiness prior to origination, and actively monitors C&I relationships subsequent to funding in order to ensure adequate oversight of the portfolio.


First Financial Bancorp 2016 Annual Report 13

Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

Construction Real Estate Real estate construction loans are term loans to individuals, companies or developers used for the construction of a commercial or residential property for which repayment will be generated by the sale or permanent financing of the property. Generally, these loans are for construction projects that have been pre-sold, pre-leased or have secured permanent financing, as well as loans to real estate companies with significant equity invested in the project. An independent credit team underwrites construction real estate loans, which are managed by experienced lending officers and monitored through the construction phase by a centralized funding desk that manages loan disbursements.

As economic conditions, including rising property values, have improved, First Financial continues to pursue select real estate construction lending opportunities while actively monitoring industry and portfolio-specific credit trends and concentrations, however in the second half of 2016, First Financial moderated the pace of new construction originations in an effort to improve profitability and limit certain sector concentrations.

Commercial Real Estate Commercial real estate loans consist of term loans secured by a mortgage lien on real estate properties such as apartment buildings, office and industrial buildings and retail shopping centers. Additionally, the Company's franchise lending activities discussed in the "Commercial and Industrial" section often include the financing of real estate as well as equipment. The credit underwriting for both owner-occupied and investor income producing real estate loans includes detailed market analysis, historical and projected cash flow analysis, appropriate equity margins, assessment of lessees and lessors and type of real estate, among other factors.

The type, age, condition, location and any potential environmental risks associated with commercial real estate properties are considered in the underwriting process for both owner-occupied and investment properties. Credit risk is mitigated by limiting total credit exposure to individual borrowers and by requiring borrowers to have adequate down payments or cash equity, thereby limiting the loan balance in relation to the market value of the property. First Financial also regularly reviews borrower financial performance, makes periodic site visits to financed properties and monitors rental rates, occupancy trends, capitalization rates and other factors that could potentially influence real estate collateral values in the Company's markets.

First Financial believes the sector has demonstrated gradual, but continuous improvement and that the Company's current underwriting criteria, coupled with active credit monitoring of loan relationships, provides adequate oversight of the commercial real estate loan portfolio.

Lease Financing Lease financing consists of lease transactions for the purchase of both new and used business equipment for commercial clients. Lease products may include tax leases, finance leases, lease lines of credit and interim funding. The credit underwriting for lease transactions includes detailed analysis of the lessee's industry and business model, nature of the equipment, equipment resale values, historical and projected cash flow analysis, secondary sources of repayment and guarantor analysis as well as other considerations.

Residential Real Estate Residential real estate loans represent loans to consumers for the financing of a residence.
These loans generally have a 15 to 30 year term and a fixed interest rate, but may have a shorter term to maturity with an adjustable interest rate, and in most cases, are extended to borrowers to finance their primary residence. First Financial sells residential real estate loan originations into the secondary market on both servicing retained and servicing released bases. Residential real estate loans are generally underwritten to secondary market lending standards, utilizing underwriting processes that rely on empirical data to assess credit risk as well as analysis of the borrower's ability to repay their obligations, credit history, the amount of any down payment and the market value or other characteristics of the property. First Financial also offers a residential mortgage product that features similar borrower credit characteristics but a more streamlined underwriting process than typically required to sell to government-sponsored enterprises and thus is retained on the Consolidated Balance Sheets.

While First Financial continues to sell the majority of residential real estate originations into the secondary market, the Company believes its current underwriting criteria coupled with the monitoring of a number of portfolio metrics, including credit scores and loan-to-value ratios, provides adequate oversight of this portfolio.

Home Equity Home equity lending includes both home equity loans and revolving lines of credit secured by a first or second lien on the borrower’s residence. First Financial's origination practices for home equity lending keep both the credit decision and the documentation within First Financial's control. Home equity lending underwriting considerations include the borrower's credit history as well as to debt-to-income and loan-to-value policy limits.

First Financial believes its current underwriting criteria coupled with the monitoring of a number of portfolio metrics including credit scores, loan-to-value ratios, line size and utilization rates provide adequate oversight of the home equity portfolio.

14 First Financial Bancorp 2016 Annual Report



Installment – Installment lending consists of consumer loans not secured by real estate, including loans secured by automobiles and unsecured personal loans.

Credit Card – Credit card lending consists of secured and unsecured revolving lines of credit to consumer and business customers. Credit card lines are generally available for an indefinite period of time as long as the borrower's credit characteristics do not materially or adversely change, but may be canceled by the Company under certain circumstances.

Underwriting for installment and credit card lending focuses on a borrower's ability to repay their obligations, including debt-to-income analysis and credit history among other considerations.

Credit Management. Subject to First Financial’s credit policy and guidelines, credit underwriting and approval occur within the market and/or the centralized line of business originating the loan. First Financial has delegated to each market president and line of business manager a lending limit sufficient to address the majority of client requests in a timely manner. Loan requests for amounts greater than those limits require the approval of a designated credit officer or senior credit committee and may require additional approvals from the chief credit officer, the chief executive officer and the board of directors. This allows First Financial to manage the initial credit risk exposure through a standardized, strategic and disciplined loan approval process, but with an increasingly higher level of authority. Plans to purchase or sell a participation in a loan, or a group of loans, requires the approval of certain senior lending and administrative officers, and in some cases could include the board of directors.

Credit management practices are dependent on the type and nature of the loan. First Financial monitors all significant
exposures on an on going basis. Commercial loans are assigned internal risk ratings reflecting the risk of loss inherent in the loan. These internal risk ratings are assigned upon initial approval of credit and are updated periodically thereafter. First Financial reviews and adjusts its risk ratings based on actual experience, which is the basis for determining an appropriate ALLL, and provides the Company with an assessment of the current risk level in the portfolio. First Financial's commercial risk ratings of pass, special mention, substandard and doubtful are derived from standard regulatory rating definitions and facilitate the monitoring of credit quality across the commercial loan portfolio. For further information regarding these risk ratings, see Note 5 – Loans and Leases in the Notes to the Consolidated Financial Statements.

Commercial loans rated as special mention, substandard or doubtful are considered criticized, while loans rated as substandard or doubtful are considered classified. Commercial loans may be designated as criticized/classified based on individual borrower performance or industry and environmental factors. Criticized/classified loans are subject to additional reviews to assess the borrower’s credit status and develop appropriate action plans.

Classified loans are managed by the Special Assets department. Special Assets is a credit group whose primary focus is to handle the day-to-day management of workouts, commercial recoveries and problem loan resolutions. Special Assets ensures that First Financial has appropriate oversight, improved communication and timely resolution of issues throughout the loan portfolio. Additionally, the Credit Risk Management group within First Financial's Risk Management function provides objective oversight and assessment of commercial credit quality and processes using an independent credit risk review approach.

Consumer lending credit approvals are based on, among other factors, the financial strength and payment history of the borrower, type of exposure and the transaction structure. Consumer loans are generally smaller dollar amounts than other types of lending and are made to a large number of customers, providing diversification within the portfolio. Credit risk in the consumer loan portfolio is managed by loan type, and consumer loan asset quality indicators, including delinquency, are continuously monitored. The Credit Risk Management group performs product-level performance reviews and assesses credit quality and compliance with underwriting and loan administration guidelines across the consumer loan portfolio.

First Financial Bancorp 2016 Annual Report 15

Management’s Discussion And Analysis Of Financial Condition And Results Of Operations


LOANS AND LEASES
 
2016 vs. 2015. First Financial continued to experience strong loan demand in 2016 as a result of focused sales efforts, our diversified product suite and expanded presence in key metropolitan markets. Loans, excluding loans held for sale, totaled $5.8 billion at December 31, 2016, increasing $368.7 million, or 6.8%, compared to December 31, 2015. The increase in loan balances from December 31, 2015 was primarily related to strong organic growth. C&I loans increased $118.8 million, or 7.1%, and commercial real estate loans increased $169.3 million, or 7.5%, during 2016. Average loan balances, excluding loans held for sale increased $666.0 million, or 13.5%, from $4.9 billion at December 31, 2015 to $5.6 billion at December 31, 2016.

Covered loans declined to $93.1 million at December 31, 2016 from $113.3 million as of December 31, 2015.  Declines in covered loan balances were expected as there were no acquisitions of loans subject to loss sharing agreements during the period. The ten year period of loss protection on all remaining covered loans and covered OREO will expire during the third quarter of 2019.  The covered loan portfolio will continue to decline through payoffs, loan sales, charge-offs and termination or expiration of loss sharing coverage unless First Financial acquires additional loans subject to loss sharing agreements.

At December 31, 2016, C&I loans represented 31.0% of loans while commercial real estate, construction real estate and lease financing balances represented 42.2%, 6.9% and 1.6%, respectively. Residential real estate loans represented 8.7% of loan balances while home equity, installment and credit card loans represented 8.0%, 0.9% and 0.8%, respectively.
 
Comparatively, at December 31, 2015, C&I loans represented 30.9% of loans while commercial real estate, construction real estate and lease financing balances represented 41.9%, 5.8% and 1.7%, respectively. Residential real estate loans represented 9.5% of loan balances while home equity, installment and credit card loans represented 8.7%, 0.8% and 0.8%, respectively.

Table 5 • Loan and Lease Portfolio
 
 
 
 
 
 
 
 
 
 
December 31,
(Dollars in thousands)
2016
 
2015
 
2014
 
2013
 
2012
Commercial and industrial
$
1,781,948

 
$
1,663,102

 
$
1,315,114

 
$
1,077,984

 
$
963,159

Lease financing
93,108

 
93,986

 
77,567

 
80,135

 
50,788

Real estate – construction
399,434

 
311,712

 
197,571

 
89,297

 
84,148

Real estate – commercial
2,427,577

 
2,258,297

 
2,140,667

 
1,765,620

 
1,882,563

Real estate – residential
500,980

 
512,311

 
501,894

 
433,664

 
418,904

Home equity
460,388

 
466,629

 
458,627

 
426,078

 
424,958

Installment
50,639

 
41,506

 
47,320

 
52,774

 
65,484

Credit card
43,408

 
41,217

 
38,475

 
37,962

 
37,176

Total loans and leases
$
5,757,482

 
$
5,388,760

 
$
4,777,235

 
$
3,963,514

 
$
3,927,180


Table 6 – Loan Maturity/Rate Sensitivity indicates the contractual maturity of C&I loans and construction real estate loans outstanding at December 31, 2016 as well as their sensitivity to changes in interest rates.

For discussion of risks associated with the loan portfolio and First Financial's ALLL, see the Credit Risk section included in Management’s Discussion and Analysis.

16 First Financial Bancorp 2016 Annual Report



Table 6 • Loan Maturity/Rate Sensitivity
 
 
December 31, 2016
 
 
Maturity
 
 
 
 
After one
 
 
 
 
 
 
Within
 
but within
 
After
 
 
(Dollars in thousands)
 
one year
 
five years
 
five years
 
Total
Commercial and industrial
 
$
552,158

 
$
918,026

 
$
311,764

 
$
1,781,948

Construction real estate
 
175,052

 
223,768

 
614

 
399,434

   Total
 
$
727,210

 
$
1,141,794

 
$
312,378

 
$
2,181,382

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
After one
 
 
 
 
 
 
Within
 
but within
 
After
 
 
(Dollars in thousands)
 
one year
 
five years
 
five years
 
Total
Fixed rate
 
$
101,936

 
$
223,009

 
$
87,023

 
$
411,968

Variable rate
 
625,274

 
918,785

 
225,355

 
1,769,414

   Total
 
$
727,210

 
$
1,141,794

 
$
312,378

 
$
2,181,382


ASSET QUALITY

Nonperforming assets consist of nonaccrual loans, accruing TDRs and OREO. 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. Classified assets include nonperforming assets plus performing loans internally rated substandard or worse.

Purchased impaired loans were grouped into pools for purposes of periodically re-estimating expected cash flows and recognizing impairment or improvement in the loan pools. Accordingly, 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 provision for loan and lease losses or prospective yield adjustments.

Loans are classified as TDRs when borrowers are experiencing financial difficulties and concessions are made by the Company that would not otherwise be considered for a borrower with similar credit characteristics. 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. OREO consists of properties acquired by First Financial primarily through loan defaults by borrowers.

See Table 7 – Nonperforming Assets for a summary of First Financial’s nonaccrual loans, TDRs and OREO.

2016 vs. 2015. Total nonperforming assets declined $15.9 million, or 22.6%, to $54.3 million at December 31, 2016 from $70.1 million at December 31, 2015, due to a $10.3 million decline in nonaccrual loans and a $7.0 million decline in OREO, which were partially offset by a $1.4 million increase in accruing TDRs.

The decline in nonaccrual loans during 2016 was the result of strong problem loan resolution efforts and solid credit performance within the Company's loan portfolio, particularly in C&I loans. The decrease in OREO was the result of the resolution and sale of $9.4 million of commercial and residential real estate property as well as $0.5 million of valuation adjustments, partially offset by $2.9 million of additions during the year.

First Financial's nonperforming loans as a percentage of total loans and leases declined to 0.83% at December 31, 2016 from 1.06% at December 31, 2015 as a result of declining nonperforming loan balances and growth in the loan portfolio during the period. Additionally, classified asset balances declined $7.3 million, or 5.5%, to $125.2 million at December 31, 2016 from $132.4 million at December 31, 2015.

First Financial Bancorp 2016 Annual Report 17

Management’s Discussion And Analysis Of Financial Condition And Results Of Operations


The declines in nonperforming and classified assets during 2016 reflect successful resolution efforts as well as gradual improvement in economic conditions in the markets in which First Financial operates. The U.S. economy has maintained consistent growth levels in recent periods and management remains optimistic that sustained improvements in the employment outlook and real estate markets, as well as stable levels of business and consumer confidence, will contribute to the Company's credit quality trends in future periods.

Table 7 • Nonperforming Assets
 
December 31,
(Dollars in thousands)
2016
 
2015
 
2014
 
2013
 
2012
Nonaccrual loans (1)
$
17,730

 
$
27,997

 
$
48,469

 
$
41,392

 
$
76,763

Accruing troubled debt restructurings (2)
30,240

 
28,876

 
15,928

 
15,429

 
10,856

Other real estate owned (OREO)
6,284

 
13,254

 
22,674

 
46,926

 
41,388

Total nonperforming assets
$
54,254

 
$
70,127

 
$
87,071

 
$
103,747

 
$
129,007

 
 
 
 
 
 
 
 
 
 
Nonperforming assets as a percent of total loans plus OREO
0.94
%
 
1.30
%
 
1.81
%
 
2.59
%
 
3.25
%
 
 
 
 
 
 
 
 
 
 
Accruing loans past due 90 days or more
$
142

 
$
108

 
$
216

 
$
218

 
$
243

 
 
 
 
 
 
 
 
 
 
Classified assets
$
125,155

 
$
132,431

 
$
154,804

 
$
234,251

 
$
392,245


(1) Nonaccrual loans include nonaccrual TDRs of $5.1 million, $9.3 million, $12.3 million, $13.8 million and $14.1 million as of December 31, 2016, 2015, 2014, 2013, and 2012, respectively.
(2) Accruing troubled debt restructurings include TDRs past due 90 days or more and still accruing of $2.7 million as of December 31, 2016 There were no 90 days past due and still accruing TDRs as of December 31, 2015, 2014, 2013, and 2012.

INVESTMENTS
 
First Financial utilizes its investment portfolio as a source of liquidity and interest income, as well as a tool for managing the Company's interest rate risk profile. As such, the Company's primary investment strategy is to invest in debt securities with low credit risk, such as treasury, government agency and agency residential MBSs. The investment portfolio is also managed with consideration to prepayment and extension/maturity risk. First Financial invests primarily in MBSs issued by U.S. government agencies and corporations, such as the GNMA, the FHLMC and the FNMA. Such securities, are considered to have a low credit risk and high liquidity profile due to government agency guarantees. Government and agency backed securities comprised 67.3% and 76.1% of First Financial's investment securities portfolio as of December 31, 2016 and 2015, respectively.

The Company also invests in certain securities that are not supported by government or agency guarantees, whose realization is dependent on future principal and interest repayments and thus carry greater credit risk. First Financial performs a detailed pre-purchase collateral and structural analysis on these securities and strategically invests in asset classes in which First Financial has expertise and experience, as well as a senior position in the capital structure. First Financial continuously monitors credit risk and geographic concentration risk in its evaluation of market opportunities that would enhance the overall performance of the portfolio. Securities not supported by government or agency guarantees represented 32.7% and 23.9% of First Financial's investment securities portfolio as of December 31, 2016 and 2015, respectively.

The other investments category in the Consolidated Balance Sheets consists primarily of First Financial’s investments in FRB and FHLB stock.

Gains and losses on debt securities are generally due to fluctuations in current market yields relative to the yields of the debt securities at their amortized cost.  All securities with unrealized losses are reviewed quarterly to determine if any impairment is considered other than temporary, requiring a write-down to fair value. First Financial considers the percentage loss on a security, duration of the loss, average life or duration of the security, credit rating of the security as well as payment performance and the Company’s intent and ability to hold the security when determining whether any impairment is other than temporary. First Financial had no other than temporary impairment expense for the years ended December 31, 2016 and 2015.


18 First Financial Bancorp 2016 Annual Report


2016 vs. 2015. First Financial’s investment portfolio at December 31, 2016 totaled $1.9 billion, a $116.4 million, or 5.9%, decrease from December 31, 2015, and represented 22.0% and 24.2% of total assets at December 31, 2016 and December 31, 2015, respectively. The decrease in the investment portfolio during 2016 was primarily related to the Company's redeployment of cash flows from investments to support strong loan growth.
 
First Financial classified $1.0 billion, or 56.1%, and $1.2 billion, or 60.4%, of investment securities as available-for-sale at December 31, 2016 and 2015, respectively. First Financial classified $763.3 million, or 41.2%, and $726.3 million, or 36.9%, of investment securities as held-to-maturity at December 31, 2016 and 2015, respectively.

First Financial recorded a $4.5 million unrealized after-tax loss on the investment portfolio as a component of equity in accumulated other comprehensive income resulting from changes in the fair value of available for sale securities at December 31, 2016, which declined $0.4 million from a $4.9 million unrealized after-tax loss at December 31, 2015.

Security debentures issued by the U.S. government and U.S. government agencies and corporations, including the FHLB, FHLMC, FNMA and the U.S. Export/Import Bank represented 1.1% and 1.2% of the investment portfolio at December 31, 2016 and 2015, respectively.

Investments in MBSs, including CMOs, represented 69.2% and 75.3% of the investment securities at December 31, 2016 and 2015, respectively. MBSs are participations in pools of residential real estate loans, the principal and interest payments of which are passed through to the security investors. MBSs are subject to prepayment risk, particularly during periods of falling interest rates, and extension risk during periods of rising interest rates. Prepayments of the underlying residential real estate loans may shorten the lives of the securities, thereby affecting yields to maturity and market values. First Financial does not own any interest-only securities, principal-only securities or other securities considered high risk. 

Tax-exempt securities of states, municipalities and other political subdivisions increased to $167.5 million as of December 31, 2016 from $103.3 million as of December 31, 2015 and comprised 9.3% and 5.4% of the investment portfolio at December 31, 2016 and 2015, respectively. The securities are diversified to include states as well as issuing authorities within states, thereby decreasing geographic portfolio risk. First Financial continuously monitors the risk associated with this investment type and reviews underlying ratings for possible downgrades. First Financial does not own any state or other political subdivision securities that are currently impaired.

Asset-backed securities were $321.2 million, or 17.8% of the investment portfolio at December 31, 2016 and $233.0 million, or 12.2% of the investment portfolio at December 31, 2015. First Financial considers these investment securities to have lower credit risk and a high liquidity profile as a result of explicit guarantees on the collateral.

Other securities, consisting primarily of taxable securities of states, municipalities and other political subdivisions and debt securities issued by corporations, decreased to $46.7 million, or 2.6% of the investment portfolio at December 31, 2016 from $113.3 million and 5.9% at December 31, 2015.

The overall duration of the investment portfolio decreased to 3.2 years as of December 31, 2016 from 3.4 years as of December 31, 2015. First Financial has avoided adding to its portfolio any particular securities that would materially increase credit risk or geographic concentration risk and First Financial continuously monitors and considers these risks in its evaluation of current market opportunities that would enhance the overall performance of the portfolio.

Table 8 • Investment Securities as of December 31
 
 
 
 
 
 
 
 
2016
 
2015
 
 
 
Percent of
 
 
 
Percent of
(Dollars in thousands)
Amount
 
Portfolio
 
Amount
 
Portfolio
U.S. treasuries
$
97

 
0.0
%
 
$
97

 
0.0
%
Securities of U.S. government agencies and corporations
20,027

 
1.1
%
 
23,826

 
1.2
%
Mortgage-backed securities
1,247,668

 
69.2
%
 
1,443,385

 
75.3
%
Obligations of state and other political subdivisions
167,466

 
9.3
%
 
103,281

 
5.4
%
Asset-backed securities
321,212

 
17.8
%
 
233,001

 
12.2
%
Other securities
46,654

 
2.6
%
 
113,311

 
5.9
%
Total
$
1,803,124

 
100.0
%
 
$
1,916,901

 
100.0
%
 

First Financial Bancorp 2016 Annual Report 19

Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

The estimated maturities and weighted-average yields of held-to-maturity and available-for-sale investment securities are shown in Table 9 – Investment Securities as of December 31, 2016. Tax-equivalent adjustments, using a 35.00% rate, were included in calculating yields on tax-exempt obligations of state and other political subdivisions.

First Financial held cash on deposit with the Federal Reserve of $82.5 million and $33.7 million at December 31, 2016 and 2015, respectively. First Financial continually monitors its liquidity position as part of its enterprise risk management framework, specifically through its asset/liability management process.
 
First Financial will continue to monitor loan and deposit demand, as well as balance sheet composition, capital sensitivity and the interest rate environment as it manages investment strategies in future periods. See Note 4 – Investment Securities in the Notes to Consolidated Financial Statements for additional information on First Financial's investment portfolio and Note 20 – Fair Value Disclosures for additional information on how First Financial determines the fair value of investment securities.

Table 9 • Investment Securities as of December 31, 2016
 
Maturity (2)
 
Within one year
 
After one but within five years
 
After five but within ten years
 
After ten years
(Dollars in thousands)
Amount
 
Yield(1)
 
Amount
 
Yield(1)
 
Amount
 
Yield(1)
 
Amount
 
Yield(1)
Held-to-Maturity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities of other U.S. government agencies and corporations
$
0

 
0.00
%
 
$
0

 
0.00
%
 
$
13,011

 
2.60
%
 
$
0

 
0.00
%
Mortgage-backed securities
754

 
1.80
%
 
615,309

 
2.40
%
 
63,595

 
3.10
%
 
0

 
0.00
%
Obligations of state and other political subdivisions
207

 
3.30
%
 
10,016

 
2.80
%
 
51,782

 
3.50
%
 
8,580

 
2.30
%
   Total
$
961

 
2.12
%
 
$
625,325

 
2.41
%
 
$
128,388

 
3.21
%
 
$
8,580

 
2.30
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-Sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. treasuries
$
0

 
0.00
%
 
$
0

 
0.00
%
 
$
97

 
2.00
%
 
$
0

 
0.00
%
Securities of other U.S. government agencies and corporations
0

 
0.00
%
 
0

 
0.00
%
 
7,016

 
2.60
%
 
0

 
0.00
%
Mortgage-backed securities
11,807

 
2.70
%
 
396,303

 
2.60
%
 
149,799

 
2.60
%
 
10,101

 
3.00
%
Obligations of state and other political subdivisions
1,915

 
2.60
%
 
46,758

 
2.80
%
 
44,197

 
3.20
%
 
4,011

 
4.10
%
Asset-backed securities
68,479

 
2.70
%
 
180,222

 
2.80
%
 
65,750

 
3.00
%
 
6,761

 
1.50
%
Other securities
0

 
0.00
%
 
15,684

 
2.70
%
 
2,121

 
6.90
%
 
28,849

 
2.30
%
   Total
$
82,201

 
2.70
%
 
$
638,967

 
2.67
%
 
$
268,980

 
2.83
%
 
$
49,722

 
2.47
%

(1) Tax equivalent basis was calculated using a 35.00% tax rate and yields were based on amortized cost.
(2) Maturity represents estimated life of investment securities.


DERIVATIVES
 
First Financial is authorized to use certain 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.

First Financial primarily utilizes interest rate swaps as a means to offer borrowers credit-based products that meet their needs and achieve the Company's desired interest rate risk profile. These interest rate swaps generally involve the receipt by First Financial of floating rate amounts from swap counterparties in exchange for payments to these counterparties by First Financial of fixed rate amounts received from borrowers. This results in First Financial's loan customers receiving fixed rate funding while providing First Financial with a floating rate asset.
 
In conjunction with participating interests in commercial loans, First Financial periodically enters into risk participation agreements with counterparties whereby First Financial assumes a portion of the credit exposure associated with an interest rate swap on the participated loan in exchange for a fee. Under these agreements, First Financial will make payments to the counterparty if the loan customer defaults on its obligation to perform under the interest rate swap contract with the counterparty.

20 First Financial Bancorp 2016 Annual Report



First Financial enters into IRLCs and forward commitments for the future delivery of mortgage loans to third party investors, which are considered derivatives. When borrowers secure an IRLC with First Financial and the loan is intended to be sold, First Financial will enter into forward commitments for the future delivery of the loans to third party investors in order to hedge against the effect of changes in interest rates impacting IRLCs and loans held for sale.

See Note 11 – Derivatives in the Notes to Consolidated Financial Statements for additional information regarding First Financial's use of derivative instruments.
 
DEPOSITS
 
First Financial solicits deposits by offering commercial and consumer clients a wide variety of savings and transaction accounts, including checking, savings, money-market and time deposits of various maturities and rates.
 
2016 vs. 2015. First Financial's total deposits increased $346.2 million, or 5.6%, from $6.2 billion at December 31, 2015 to $6.5 billion as of December 31, 2016. Noninterest bearing deposits increased $134.6 million, or 9.5%, while interest-bearing checking deposits increased $99.5 million, or 7.0%, savings deposits increased $196.4 million, or 10.1%, and time deposits decreased $84.3 million, or 6.0%, during the period.

Non-time deposit balances totaled $5.2 billion as of December 31, 2016, increasing $430.4 million, or 9.0%, compared to December 31, 2015 while time deposit balances decreased $84.3 million, or 6.0%.

Total average deposits for 2016 increased $392.6 million, or 6.6%, from 2015 primarily due to increases in average interest-bearing demand deposits of $202.4 million, or 16.0%, average savings deposits of $50.9 million, or 2.6%, average time deposits of $22.3 million, or 1.7%, and average noninterest bearing deposits of $117.0 million, or 8.7%. The year-over-year growth in average deposits was due to strong organic deposit generation efforts.
 
Table 10 – Maturities of Time Deposits Greater Than or Equal to $100,000 shows the contractual maturity of these deposits that were outstanding at December 31, 2016, which represent 11.3% of total deposits.
  
Table 10 • Maturities Of Time Deposits Greater Than Or Equal To $100,000
 
December 31, 2016
(Dollars in thousands)
CDs
 
IRAs
 
Brokered CDs
 
Total
Maturing in
 
 
 
 
 
 
 
   3 months or less
$
50,782

 
$
3,159

 
$
118,079

 
$
172,020

   3 months to 6 months
44,513

 
2,147

 
69,116

 
115,776

   6 months to 12 months
89,988

 
4,215

 
38,261

 
132,464

   over 12 months
256,243

 
56,340

 
6,775

 
319,358

     Total
$
441,526

 
$
65,861

 
$
232,231

 
$
739,618


BORROWINGS
 
First Financial's short-term borrowings include repurchase agreements utilized for corporate sweep accounts with cash management account agreements in place as well as overnight advances from the FHLB. The Company's long-term borrowings consist of subordinated debt, FHLB long-term advances and repurchase agreements utilizing investment securities pledged as collateral.

2016 vs. 2015. Short-term borrowings are utilized to manage normal liquidity needs and decreased to $807.9 million at December 31, 2016, from $938.4 million at December 31, 2015.

First Financial utilizes short-term borrowings and longer-term advances from the FHLB as wholesale funding sources. First Financial had $687.7 million of short-term borrowings from the FHLB at December 31, 2016 compared to $849.1 million at December 31, 2015.


First Financial Bancorp 2016 Annual Report 21

Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

Total long-term debt increased to $119.6 million at December 31, 2016, from $119.5 million at December 31, 2015. During 2015, First Financial issued $120.0 million of subordinated notes, which have a fixed interest rate of 5.125% payable semiannually, and mature on August 25, 2025. These notes are not redeemable by the Company or callable by the holders of the notes prior to maturity and are treated as Tier 2 capital for regulatory capital purposes. Long-term borrowings from the FHLB were $0.4 million and $0.5 million at December 31, 2016 and 2015, respectively.
 
Both short-term and long-term FHLB advances must be collateralized with qualifying assets, which are typically commercial and residential real estate loans, as well as government and agency securities. For ease of borrowing execution First Financial utilizes a blanket collateral agreement with the FHLB and had $3.5 billion of assets pledged as collateral at December 31, 2016.

See Note 10 – Borrowings in the Notes to Consolidated Financial Statements for additional information on First Financial's borrowings.

LIQUIDITY

Liquidity management is the process by which First Financial manages the continuing flow of funds necessary to meet its financial commitments on a timely basis and at a reasonable cost. These funding commitments include withdrawals by depositors, credit commitments to borrowers, shareholder dividends, share repurchases, operating expenses and capital expenditures. Liquidity is derived primarily from deposit growth, principal and interest payments on loans and investment securities, maturing loans and investment securities, access to wholesale funding sources and collateralized borrowings.

First Financial’s most stable source of liability-funded liquidity for both long and short-term needs is deposit growth and retention of the core deposit base. In addition to core deposit funding, First Financial also utilizes a variety of short and long-term funding sources, which include subordinated notes, longer-term advances from the FHLB and a short-term line of credit.

Outstanding subordinated debt totaled $118.5 million and $118.4 million, and included prepaid debt issuance costs of $1.5 million and $1.7 million as of December 31, 2016 and December 31, 2015, respectively. Long-term debt also included FHLB long-term advances of $0.4 million and $0.5 million as of December 31, 2016 and December 31, 2015, respectively as well as an interest-free $0.8 million capital loan outstanding with a municipality at December 31, 2016 and 2015. First Financial's total remaining borrowing capacity from the FHLB was $722.1 million at December 31, 2016.

Both First Financial and the Bank received investment grade credit ratings from Kroll Bond Rating Agency, Inc, an independent rating agency. These credit ratings impact the cost and availability of financing to First Financial, and a downgrade to these credit ratings could affect First Financial's or the Bank’s abilities to access the credit markets and potentially increase borrowing costs, which would negatively impact financial condition and liquidity. Key factors in maintaining high credit ratings include consistent and diverse earnings, strong credit quality and capital ratios, diverse funding sources and disciplined liquidity monitoring procedures. The ratings of First Financial and the Bank at December 31, 2016 were as follows:
 
First Financial Bancorp
First Financial Bank
Senior Unsecured Debt
BBB+
A-
Subordinated Debt
BBB
A-
Short-Term Debt
K2
BBB+
Deposit
N/A
K2
Short-Term Deposit
N/A
K2

First Financial maintains a short-term credit facility with an unaffiliated bank for $15.0 million that matures on May 29, 2017. This facility can have a variable or fixed interest rate and provides First Financial additional liquidity, if needed, for various corporate activities, including the repurchase of First Financial shares and the payment of dividends to shareholders. As of December 31, 2016 and December 31, 2015, there was no outstanding balance. The credit agreement requires First Financial to maintain certain covenants related to asset quality and capital levels, and First Financial was in compliance with all covenants associated with this line of credit as of December 31, 2016 and December 31, 2015.

First Financial's principal source of asset-funded liquidity is marketable investment securities, particularly those of shorter maturities. The market value of investment securities classified as available-for-sale totaled $1.0 billion at December 31, 2016. Securities classified as held-to-maturity that are maturing within one year are an additional source of liquidity and totaled $1.0

22 First Financial Bancorp 2016 Annual Report


million at December 31, 2016. Other types of assets such as cash and due from banks, interest-bearing deposits with other banks, as well as loans maturing within one year, are also sources of liquidity.

At December 31, 2016, in addition to liquidity on hand of $204.0 million, First Financial had unused and available overnight wholesale funding sources of approximately $2.4 billion, or approximately 28.3% of total assets, to fund loan and deposit activities, as well as general corporate requirements.

Certain restrictions exist regarding the ability of First Financial’s subsidiary, First Financial Bank, to transfer funds to First Financial in the form of cash dividends, loans, other assets or advances. The approval of the Bank's primary federal regulator is required to pay dividends in excess of regulatory limitations. Dividends paid to First Financial from its subsidiaries totaled $52.7 million, $17.3 million and $31.7 million for 2016, 2015 and 2014, respectively. As of December 31, 2016, First Financial’s subsidiaries had retained earnings of $494.0 million of which $150.1 million was available for distribution to First Financial without prior regulatory approval. Additionally, First Financial had $59.3 million in cash at the parent company as of December 31, 2016, which approximates the Company’s annual shareholder dividend and operating expenses. Share repurchases, if any, also impact First Financial's liquidity. For further information regarding share repurchases, see the Capital section that follows.

Capital expenditures, such as banking center expansion, remodeling and technology investments, were $9.7 million for 2016, $7.5 million for 2015 and $10.6 million for 2014. Material commitments for capital expenditures as of December 31, 2016, were $12.0 million. Management believes that sufficient liquidity exists to fund its future capital expenditure commitments.

Management is not aware of any other events or regulatory requirements that, if implemented, are likely to have a material effect on First Financial’s liquidity.
Table 11 • Contractual Obligations as of December 31, 2016
 
(Dollars in thousands)
 
Less than one year
 
One to three years
 
Three to five years
 
More than five years
 
Total
Contractual Obligations
 
 
 
 
 
 
 
 
 
 
Long-term debt obligations (including interest)
 
 
 
 
 
 
 
 
 

Federal Home Loan Bank borrowings
 
$
112

 
$
234

 
$
0

 
$
0

 
$
346

Subordinated debt
 
5,637

 
12,813

 
12,300

 
144,497

 
175,247

Capital loan with municipality
 
0

 
0

 
0

 
775

 
775

Operating lease obligations
 
7,082

 
11,854

 
10,305

 
15,286

 
44,527

Pension obligations
 
4,081

 
8,564

 
10,787

 
27,515

 
50,947

Time deposits
 
635,294

 
516,940

 
165,986

 
3,623

 
1,321,843

Total
 
$
652,206

 
$
550,405

 
$
199,378

 
$
191,696

 
$
1,593,685

 
CAPITAL

Risk-Based Capital. First Financial and its subsidiary, First Financial Bank, are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory guidelines. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet minimum capital requirements can initiate regulatory action.

The Board of Governors of the Federal Reserve System approved a final rule implementing changes intended to strengthen the regulatory capital framework for all banking organizations (Basel III) which became effective January 1, 2015, subject to a phase-in period for certain provisions.  Basel III established and defined quantitative measures to ensure capital adequacy which require First Financial to maintain minimum amounts and ratios of Common Equity tier 1 capital, total and tier 1 capital to risk-weighted assets and tier 1 capital to average assets (leverage ratio).  

The rule includes a minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets which began on January 1, 2016 at 0.625% and will be phased-in over a four-year period, increasing by the same amount on each subsequent January 1, until fully phased-in on January 1, 2019.  Further, Basel III increased the minimum ratio of tier 1 capital to risk-weighted assets from 4.0% to 6.0% and all banks are now subject to a 4.0% minimum leverage ratio.  The required total risk-based capital ratio was unchanged. Failure to maintain the required

First Financial Bancorp 2016 Annual Report 23

Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

common equity Tier 1 capital conservation buffer will result in potential restrictions on a bank’s ability to pay dividends, repurchase stock and/or pay discretionary compensation to its employees.  The revised capital requirements also provide strict eligibility criteria for regulatory capital instruments and change the method for calculating risk-weighted assets in an effort to better identify riskier assets, such as highly volatile commercial real estate and nonaccrual loans, which requires higher capital allocations.

First Financial's tier 1 capital is comprised of total shareholders' equity less unrealized gains and losses on investment securities available-for-sale, any amounts resulting from retirement plan valuation adjustments that are recorded within accumulated other comprehensive income (loss), intangible assets and any valuation related to mortgage servicing rights. Total risk-based capital consists of Tier 1 capital plus the qualifying ALLL and gross unrealized gains on investment securities.

For purposes of calculating the leverage ratio, average assets represents quarterly average assets less assets not qualifying for Total risk-based capital, including intangible assets, non-qualifying mortgage servicing rights and the ALLL.

First Financial's tier 1 and total capital ratios increased from 10.29% and 13.04%, respectively, as of December 31, 2015 to 10.46% and 13.10% as of December 31, 2016. The increases in the Company's capital ratios were primarily due to an increase in capital from increased earnings, partially offset by an increase in risk-weighted assets resulting from organic loan growth during the period. The leverage ratio increased to 8.60% at December 31, 2016 compared to 8.33% as of December 31, 2015 and the Company’s tangible common equity ratio increased from 7.53% at December 31, 2015 to 7.96% at December 31, 2016 primarily due to a $48.9 million, or 12.6%, increase in retained earnings.

Management believes that, as of December 31, 2016, First Financial met all capital adequacy requirements to which it was subject. At December 31, 2016 and 2015, regulatory notifications categorized First Financial Bank as well-capitalized under the regulatory framework for prompt corrective action. There have been no conditions or events that management believes has changed the Company’s capital categorization.

For further detail on First Financial's capital ratios at December 31, 2016, see Note 17 – Capital in the Notes to Consolidated Financial Statements.


24 First Financial Bancorp 2016 Annual Report


Table 12 • Capital Adequacy
 
 
 
 
December 31,
(Dollars in thousands)
2016
 
2015
Consolidated capital calculations
 
 
 
Common stock
$
570,382

 
$
571,155

 
Retained earnings
437,188

 
388,240

 
Accumulated other comprehensive loss
(28,443
)
 
(30,580
)
 
Treasury stock, at cost
(113,903
)
 
(119,439
)
Total shareholders' equity
865,224

 
809,376

 
Common equity tier I capital adjustments
 
 
 
 
Goodwill and other intangibles
(210,625
)
 
(211,865
)
Total tangible equity
$
654,599

 
$
597,511

 
Total assets
$
8,437,967

 
$
8,147,411

 
Goodwill and other intangibles
(210,625
)
 
(211,865
)
Total tangible assets
$
8,227,342

 
$
7,935,546

Common tier 1 capital
$
703,891

 
$
648,748

Tier 1 capital
703,995

 
648,852

Total capital
881,158

 
822,431

Total risk-weighted assets
6,728,737

 
6,308,139

Average assets (1)
8,190,130

 
7,787,019

 
 
 
 
 
Regulatory capital
 
 
 
 
Common tier 1 ratio
10.46
%
 
10.28
%
 
Tier 1 ratio
10.46
%
 
10.29
%
 
Total capital ratio
13.10
%
 
13.04
%
 
Leverage ratio
8.60
%
 
8.33
%
 
 
 
 
 
Other capital ratios
 
 
 
 
Total shareholders' equity to ending assets
10.25
%
 
9.93
%
 
Total tangible shareholders' equity to ending tangible assets
7.96
%
 
7.53
%
 
 
 
 
 
(1) For purposes of calculating the Leverage ratio, certain intangible assets are excluded from average assets.

First Financial generally seeks to balance the return of earnings to shareholders, through shareholder dividends and share repurchases, with capital retention to maintain adequate levels of capital and support the Company's growth plans, as well as share price considerations.

Shelf Registrations. In July 2014, First Financial filed a shelf registration on Form S-3 with the SEC. This shelf registration allows First Financial to raise capital from time to time through the sale of various types of securities, subject to approval by the Company's board of directors, and expires on July 31, 2017. Under this shelf registration, First Financial issued $120.0 million of subordinated notes in 2015.

Shareholder Dividends. First Financial’s dividend payout ratio, or total dividends paid divided by net income available to common shareholders, was 44.1%, 52.0% and 55.0% for the years 2016, 2015 and 2014, respectively. The dividend payout ratio is continually reviewed by management and the board of directors for consistency with First Financial’s overall capital planning activities and compliance with applicable regulatory limitations. In January 2017, the board of directors authorized an increase to the Company's quarterly dividend from $0.16 to $0.17 per common share, payable on April 3, 2017 to all shareholders of record as of March 2, 2017.

Share Repurchases. In October 2012, First Financial's board of directors approved a share repurchase plan under which the Company has the ability to repurchase up to 5,000,000 common shares. The Company did not repurchase any shares under this

First Financial Bancorp 2016 Annual Report 25

Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

plan during 2016. The Company repurchased 239,967 shares for $4.5 million under the 2012 share repurchase plan during 2015 at an average price of $18.75 per share and 40,255 shares for $0.7 million during 2014 at an average price of $17.32 per share. At December 31, 2016, 3,509,133 shares remained available for purchase under the 2012 share repurchase plan.

Shareholders' Equity. Total shareholders’ equity at December 31, 2016 was $865.2 million, compared to total shareholders’ equity at December 31, 2015 of $809.4 million.

For further detail, see the Consolidated Statements of Changes in Shareholders’ Equity.

PENSION PLAN
 
First Financial sponsors a non-contributory defined-benefit pension plan covering substantially all employees. The significant assumptions used in the valuation and accounting for the pension plan include the discount rate, expected return on plan assets and the rate of employee compensation increase. The discount rate assumption was determined using published December 31, 2016 corporate bond indices and projected plan cash flows and comparisons to external industry surveys. The expected return on plan assets was 7.5% for 2016 and 2015, and was based on the composition of plan assets as well as economic forecasts and trends in addition to actual returns. First Financial will continue to monitor the return on plan assets and the investment vehicle used to fund the plan. The assumed rate of compensation increase was 3.5% and was compared to historical increases for plan participants for reasonableness.

Presented below is the estimated impact on First Financial’s projected benefit obligation and pension expense as of December 31, 2016, assuming shifts in the significant assumptions: 
 
Discount rate
 
Expected return on
plan assets
 
Rate of compensation increase
 (Dollars in thousands)
 
-100 BP
 
+100 BP
 
-100 BP
 
+100 BP
 
-100 BP
 
+100 BP
Change in Projected Benefit Obligation
 
$
6,190

 
$
(4,761
)
 
N/A

 
N/A

 
$
(274
)
 
$
604

Change in Pension Expense
 
719

 
(594
)
 
$
1,286

 
$
(1,286
)
 
(67
)
 
123

 
As a result of the plan’s current funding status and updated actuarial projections for 2016, First Financial recorded income related to its pension plan of $1.2 million for 2016, $1.0 million for 2015 and $1.1 million for 2014 in the Consolidated Statements of Income. Contributions, if necessary, are required to meet ERISA’s minimum funding standards and the estimated quarterly contribution requirements during this period.  First Financial made no cash contributions to fund the pension plan in 2016, 2015 or 2014 and does not expect to make a cash contribution to its pension plan in 2017 given the plan's over-funded status.

See Note 15 – Employee Benefit Plans in the Notes to Consolidated Financial Statements for additional information on First Financial's pension plan.

ENTERPRISE RISK MANAGEMENT
 
First Financial considers risk to be any issue that could impact the Company’s ability to meet its objectives or have an adverse impact on its capital or earnings. First Financial manages risks through a structured ERM approach that routinely assesses the overall level of risk, identifies specific risks and evaluates the steps being taken to mitigate those risks. First Financial continues to enhance its risk management capabilities and has, over time, embedded risk awareness as part of the culture of the Company. ERM allows First Financial to align a variety of risk management activities within the Company into a cohesive, enterprise-wide approach and focus on process-level risk management activities and strategic objectives within the risk management culture. Additionally, ERM allows the Company to deliberately develop risk responses and the effectiveness of mitigation compared to established thresholds for risk appetite and tolerance, consider significant organizational changes and consolidate information through a common process for management and the board of directors.

First Financial has identified ten types of risk that it monitors in its ERM framework.  These risks include credit, market, operational, compliance, strategic, reputation, information technology, cyber, legal and environmental/external risk.
 
First Financial uses a robust regulatory risk framework as one of the foundational components of its ERM framework.  This allows for a common categorization across the Company, and provides a consistent and complete risk framework that can be summarized and assessed enterprise-wide. Additionally, the risk framework utilized is consistent with that used by the Company’s regulators, which results in additional feedback on First Financial’s ability to assess and measure risk across the

26 First Financial Bancorp 2016 Annual Report


organization as well as the ability for management and the board of directors to identify and understand differences in assessed risk profiles.
 
ERM helps ensure that First Financial continues to identify and adequately address risks that emerge from a combination of new customers, products and associates, changing markets, new lines of business and processes and new or evolving systems.
 
The goals of First Financial’s ERM framework are to:

focus on the Company at both the enterprise and line of business levels;
align the Company's risk appetite with its strategic, operational, compliance and reporting objectives;
enhance risk response decisions;
reduce operational deficiencies and possible losses;
identify and manage interrelated risks;
provide integrated responses to multiple risks;
improve the deployment and allocation of capital; and
improve overall business performance.
 
Specific enterprise-level objectives include:

creating a holistic view of risk in which risk is comprehensively considered, consistently communicated and documented in decision making;
centralizing the oversight of risk management activities;
defining the risks that will be addressed by the enterprise and each functional area or business unit to create an awareness of risks affecting the Company;
establishing and maintaining systems and mechanisms to identify, assess, monitor and measure risks that may impact First Financial’s ability to achieve its business objectives;
creating a process which ensures that, for all new lines of business and new product decisions, management evaluates the expertise needed and assesses the risks involved;
establishing and maintaining systems and mechanisms to monitor risk responses;
developing risk occurrence information systems to provide early warning of events or situations that create risk for the Company;
steadfastly maintaining a compliance culture and framework that ensures adherence to laws, rules and regulations, fair treatment and privacy of customers and prevention of money laundering and terrorist financing;
implementing and reviewing risk measurement techniques that management may use to establish the Company’s risk tolerance, assess risk likelihood and impact and analyze risk monitoring processes; and
establishing appropriate management reporting systems regarding the enterprise-wide risk exposures and allocation of capital.

Line of business-level objectives focus on why the particular business or business unit risk exists; how the business affects the Company’s strategy, earnings, reputation and other key success factors; and whether the line of business objectives are aligned with enterprise objectives.
 
Board of Directors and Board Risk & Compliance Committee. First Financial’s board of directors is responsible for understanding the Company’s compliance and risk management objectives and risk tolerance, and as such, board oversight of the Company’s compliance and risk management activities is a key component to an effective risk management process. Responsibilities of the board of directors include:

establishing and guiding the Company’s strategic direction and tolerance for risk, including the determination of the aggregate risk appetite and identifying the senior managers who have the responsibility for managing risk;
monitoring the Company’s performance and overall risk profile, ensuring that the level of risk is maintained at prudent levels and is supported by adequate capital;
ensuring that the Company implements sound fundamental principles that facilitate the identification, measurement, monitoring and control of risk;
ensuring that adequate resources are dedicated to compliance and risk management; and
ensuring that awareness of risk management activities is evident throughout the organization.

The board of directors has defined broad risk tolerance levels, or limits, to guide management in the decision-making process, and is responsible for establishing information and communication requirements to ensure that risk management activities remain within these tolerance limits. The board risk and compliance committee, a standing committee of the board of directors,

First Financial Bancorp 2016 Annual Report 27

Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

is responsible for carrying out the board’s responsibilities in this regard. Other standing committees of the board (audit, compensation, corporate governance and nominating, and capital markets) oversee particular areas of risk assigned specifically to them.

Executive and Senior Management. Members of executive and senior management are responsible for managing risk activities and delegating risk authority and tolerance to the responsible risk owners.

Management must identify which processes and activities are critical to achieving the Company’s business objectives within the designated tolerance levels.  Management must then delegate responsibility, authority and accountability to the appropriate risk owners who are responsible for ensuring that the respective processes and activities are designed and implemented to manage the related risks within those delegated tolerance levels.

Chief Risk Officer. The chief risk officer is responsible for the oversight of the Company’s ERM processes.  The chief risk officer may appoint other officers or establish other management committees as required for effective risk management and governance, including risk identification, risk measurement, risk monitoring, risk control or mitigation and risk reporting.  The chief risk officer is also responsible for the maintenance of procedures, methodologies and guidelines considered necessary to administer the ERM program.

Chief Compliance Officer. The chief compliance officer is responsible for the oversight of the Company’s compliance management function, which includes Bank Secrecy Act/Anti-Money Laundering and all other regulatory compliance.  The chief compliance officer is authorized to implement all necessary actions to ensure achievement of the objectives of an effective compliance program and may appoint other officers or establish other management committees as required for effective compliance management. The chief compliance officer reviews and evaluates compliance issues and concerns and is responsible for monitoring and reporting results of the compliance efforts as well as providing guidance to the board of directors and senior management team on matters relating to compliance.

Committee Chairs. The ERM program utilizes fourteen management committees as its primary assessment and communication mechanism for identified risks.  Committee chairs play key roles in the execution of risk management activities throughout the enterprise and are responsible for continuous updates and communication among committee members in conjunction with the risk management department regarding changes to risk profiles, changes to risk assessments and the emergence of new risks that could impact the Company.

Internal Audit. Internal audit is responsible for planning audit activities to periodically reassess the design and operation of key risk management processes and to make periodic evaluations of the ongoing accuracy and effectiveness of the communications from risk owners to senior management and from senior management to the board of directors.

Risk Assessment Process. The periodic assessment of risks is a key component of a sound ERM program.  Managers, business line leaders and executives are responsible for developing the risk assessment for their individual departments, business lines and subsidiaries.  The chief risk officer, management and the board risk committee are responsible for ensuring that risk is viewed and analyzed from a global perspective. Furthermore, interrelated risks should be considered, describing how a single risk or event may create multiple risks and the need for management to develop an entity-level view of risk.

Risk management programs, in each functional component and in aggregate, accomplish the following:

identify risks and their respective owners;
link identified risks and their mitigation to the Company's strategic objectives;
evaluate the risks and their associated likelihood of occurrence and consequences;
develop strategies to manage risk, such as avoiding the risk; reducing the negative effect of the risk; transferring the risk to another party; and/or accepting some or all of the consequences of a particular risk;
prioritize the risk issues in regards to the current risk status and trend;
provide reports to management and risk owners that will assist them in implementing appropriate risk management processes;
assist management in assessing the alternatives for managing risks;
assist management in the development of risk management plans; and
track risk management efforts.

Monitoring and Reporting. The board of directors oversees risk reporting and monitoring through the board risk committee, which meets at least quarterly. 


28 First Financial Bancorp 2016 Annual Report


Management continually reviews any risk identified as key, as well as the appropriateness of established tolerance limits and the actions considered as necessary to mitigate key risks.  As circumstances warrant, management provides recommendations to the board risk and compliance committee related to changes or adjustments to key risks or tolerance limits.
 
First Financial believes that communication is fundamental to successful risk management and is based on a strong partnership between the risk management department, management and the board of directors.  Productive reporting and communication with management is required for collaborative and effective risk management.

CREDIT RISK
  
Credit risk represents the risk of loss due to failure of a customer or counterparty to meet its financial obligations in accordance with contractual terms. First Financial manages credit risk through its underwriting practices, periodically reviewing and approving its credit exposures using credit policies and guidelines approved by the board of directors.

Allowance for loan and lease losses. First Financial records a provision for loan and lease losses (provision) in the Consolidated Statements of Income to maintain the ALLL at a level considered sufficient to absorb probable incurred loan and lease losses inherent in the portfolio. Actual losses on loans and leases are charged against the ALLL, which is a reserve accumulated on the Consolidated Balance Sheets through the recognition of the provision. The recorded values of the loans and leases actually removed from the Consolidated Balance Sheets due to credit deterioration are referred to as charge-offs. First Financial's policy is to charge-off all or a portion of a loan when, in management's opinion, it is unlikely to collect the principal amount owed in full either through payments from the borrower or from the liquidation of collateral. All loans charged-off are subject to continuous review and concerted efforts are made to maximize any recovery. In most cases, the borrower’s debt obligation is not canceled even though the balance may have been charged-off. Any subsequent recovery of a previously charged-off loan is credited back to the ALLL.

Purchased impaired loans are accounted for under FASB ASC Topic 310-30, whereby First Financial is required to periodically re-estimate the expected cash flows on the loans. For purposes of applying the guidance under FASB ASC Topic 310-30, First Financial grouped acquired loans into pools based on common risk characteristics. Generally, a decline in expected cash flows for a pool of loans is considered impairment and recorded as provision expense. Estimated reimbursements due from the FDIC under loss sharing agreements related to any declines in expected cash flows for a pool of loans are recorded as noninterest income. Improvement in expected cash flows, once any previously recorded impairment is recaptured, is recognized prospectively as an adjustment to the yield on the loans.

Management determines the adequacy of the ALLL based on historical loss experience as well as other significant factors such as composition of the portfolio; economic conditions; geographic footprint; the results of periodic internal and external evaluations of delinquent, nonaccrual and classified loans; and any other situations that may affect a specific borrower's ability to repay. This evaluation is inherently subjective as it requires utilizing material estimates that may be susceptible to significant change. The evaluation of these factors is the responsibility of the ALLL committee, which is comprised of senior officers from the risk management, credit administration, finance and lending areas.

See Table 13 – Summary of Allowance for Loan and Lease Losses and Selected Statistics for a summary of activity impacting the allowance and Table 14 – Allocation of the Allowance for Loan and Lease Losses for detail on the composition of the allowance.

2016 vs. 2015. The ALLL at December 31, 2016 was $58.0 million, or 1.01% of loans which was a $4.6 million, or 8.5%, increase from a balance of $53.4 million or 0.99% of loans at December 31, 2015. Provision expense increased $0.5 million, or 5.2%, to $10.1 million in 2016 from $9.6 million in 2015.

Net charge-offs decreased $3.5 million, or 38.7%, to $5.6 million for 2016 compared to $9.1 million for 2015, while the ratio of net charge-offs as a percentage of average loans outstanding declined to 0.10% in 2016 from 0.18% in 2015. The decline in net charge-offs during 2016 was primarily the result of lower net losses in the C&I, commercial real estate and residential real estate portfolios.

The increase in the ALLL during 2016 was primarily a result of strong loan growth during the period. Overall credit metrics continued to improve with declines in net charge-offs, nonperforming assets and classified assets when compared to December 31, 2015. The ALLL as a percentage of loans reflects continued stability in property values and overall economic conditions across the Company's footprint. The ALLL as a percentage of nonperforming loans, including accruing TDRs was 120.8% at December 31, 2016 compared with 93.9% at December 31, 2015.

First Financial Bancorp 2016 Annual Report 29

Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

For further discussion of First Financial's ALLL, see Note 6 – Allowance for Loan and Lease Losses in the Notes to Consolidated Financial Statements.
Table 13 • Summary Of Allowance For Loan And Lease Losses And Selected Statistics
(Dollars in thousands)
2016
 
2015
 
2014
 
2013
 
2012
Transactions in the allowance for loan and lease losses:
 
 
 
 
 
 
 
 
 
Balance at January 1
$
53,398

 
$
52,858

 
$
62,730

 
$
92,967

 
$
95,411

Loans charged-off:
 
 
 
 
 
 
 
 
 
   Commercial and industrial
2,630

 
5,408

 
9,156

 
11,695

 
17,188

   Real estate – construction
93

 
85

 
1,348

 
611

 
5,555

   Real estate – commercial
4,983

 
10,083

 
9,478

 
36,622

 
23,986

   Real estate – residential
387

 
1,531

 
1,454

 
1,729

 
3,110

Home equity
1,445

 
1,891

 
2,774

 
3,533

 
5,751

Installment
386

 
509

 
605

 
536

 
2,377

Credit card
1,190

 
1,049

 
1,158

 
1,285

 
1,252

   Lease financing
0

 
0

 
0

 
496

 
0

      Total loans charged-off
11,114

 
20,556

 
25,973

 
56,507

 
59,219