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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C.  20549

FORM 10-Q


☒ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended                                           September 30, 2020                                                   

OR

☐ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________________ to ____________________

Commission file number 001-34762
FIRST FINANCIAL BANCORP /OH/
(Exact name of registrant as specified in its charter)
Ohio 31-1042001
(State or other jurisdiction of
incorporation or organization) 		(I.R.S. Employer
Identification No.)
255 East Fifth Street, Suite 800 Cincinnati, Ohio 45202
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code:  (877) 322-9530

Securities registered pursuant to Section 12(b) of the Act:
Title of each class Trading symbol   Name of each exchange on which registered
Common stock, No par value FFBC   The NASDAQ Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   ☒    No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of large accelerated filer, accelerated filer, smaller reporting company, and emerging growth company in Rule 12b-2 of the Exchange Act.
Large accelerated filer  ☒ Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
☐
Emerging growth company
☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of Exchange Act).
Yes  ☐ No   ☒

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. The registrant has one class of common stock (no par value) with 98,018,237 shares outstanding at November 5, 2020.

FIRST FINANCIAL BANCORP.

INDEX

  Page No.
   
 
   
 
   
1
   
2
3
5
6
   
7
   
42
   
59
   
59
   
 
   
60
   
60
   
60
   
61
   
62


Glossary of Abbreviations and Acronyms

First Financial has identified the following list of abbreviations and acronyms that are used in the Notes to Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations.
AFS Available-for-sale Form 10-K First Financial Bancorp. Annual Report on Form 10-K
ACL Allowance for credit losses FRB Federal Reserve Bank
ALLL Allowance for loan and lease losses GAAP U.S. Generally Accepted Accounting Principles
Allowance Collectively or individually, Allowance for credit losses and Allowance for loan and lease losses HTM Held-to-maturity
AOCI Accumulated other comprehensive income Insignificant Less than $0.1 million
ASC Accounting standards codification IRLC Interest rate lock commitment
ASU Accounting standards update LGD Loss Given Default
Bank First Financial Bank MD&A
Management's Discussion and Analysis of Financial Condition and Results of Operations
Basel III Basel Committee regulatory capital reforms, Third Basel Accord MSFG MainSource Financial Group, Inc.
BGF or Bannockburn Bannockburn Global Forex, LLC N/A Not applicable
Bp/bps Basis point(s) NII Net interest income
BOLI Bank owned life insurance OBS Off-balance sheet
CDs Certificates of deposit OREO Other real estate owned
C&I Commercial & industrial PCA Prompt corrective action
CRE Commercial real estate PCD Purchased credit deteriorated
Company First Financial Bancorp. PCI Purchase credit impaired
DDA Demand deposit account PD Probability of default
Dodd-Frank Dodd–Frank Wall Street Reform and Consumer Protection Act PPP Paycheck Protection Program
EAD Exposure at Default PPPLF Paycheck Protection Program Liquidity Facility
ERM Enterprise risk management R&S Reasonable and supportable
EVE Economic value of equity ROU Right-of-use
Fair Value Topic FASB ASC Topic 820, Fair Value Measurement SEC U.S. Securities and Exchange Commission
FASB Financial Accounting Standards Board SOFR Secured Overnight Financing Rate
FDIC Federal Deposit Insurance Corporation Topic 842 FASB ASC Topic 842, Leasing
FHLB Federal Home Loan Bank TDR Troubled debt restructuring
FRB Federal Reserve Bank TTC Through the cycle
First Financial First Financial Bancorp. USD United States dollars



PART I - FINANCIAL INFORMATION
ITEM I - FINANCIAL STATEMENTS
FIRST FINANCIAL BANCORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
September 30,
2020 		December 31,
2019
  (Unaudited)  
Assets    
Cash and due from banks $ 207,128  $ 200,691 
Interest-bearing deposits with other banks 38,806  56,948 
Investment securities available-for-sale, at fair value (amortized cost $2,915,937 at September 30, 2020 and $2,798,298 at December 31, 2019)
3,004,963  2,852,084 
Investment securities held-to-maturity (fair value $123,441 at September 30, 2020 and $142,821 at December 31, 2019)
118,072  142,862 
Other investments 118,292  125,020 
Loans held for sale 69,008  13,680 
Loans and leases
Commercial & industrial 3,292,313  2,465,877 
Lease financing 74,742  88,364 
Construction real estate 575,648  493,182 
Commercial real estate 4,347,125  4,194,651 
Residential real estate 1,027,702  1,055,949 
Home equity 754,743  771,869 
Installment 84,629  82,589 
Credit card 43,907  49,184 
Total loans and leases 10,200,809  9,201,665 
Less: Allowance for credit losses (1)
168,544  57,650 
Net loans and leases 10,032,265  9,144,015 
Premises and equipment 209,474  214,506 
Goodwill 937,771  937,771 
Other intangibles 67,419  76,201 
Accrued interest and other assets 1,122,449  747,847 
Total assets $ 15,925,647  $ 14,511,625 
Liabilities    
Deposits    
Interest-bearing demand $ 2,632,467  $ 2,364,881 
Savings 3,446,678  2,960,979 
Time 1,935,392  2,240,441 
Total interest-bearing deposits 8,014,537  7,566,301 
Noninterest-bearing 3,552,893  2,643,928 
Total deposits 11,567,430  10,210,229 
Federal funds purchased and securities sold under agreements to repurchase 247,658  165,181 
FHLB short-term borrowings 0  1,151,000 
Total short-term borrowings 247,658  1,316,181 
Long-term debt 1,341,164  414,376 
Total borrowed funds 1,588,822  1,730,557 
Accrued interest and other liabilities 521,580  323,134 
Total liabilities 13,677,832  12,263,920 
Shareholders' equity    
Common stock - no par value
   
Authorized - 160,000,000 shares; Issued - 104,281,794 shares in 2020 and 2019
1,637,489  1,640,771 
Retained earnings 694,484  711,249 
Accumulated other comprehensive income (loss) 42,266  13,323 
Treasury stock, at cost, 6,282,031 shares in 2020 and 5,790,796 shares in 2019
(126,424) (117,638)
Total shareholders' equity 2,247,815  2,247,705 
Total liabilities and shareholders' equity $ 15,925,647  $ 14,511,625 
(1) Beginning January 1, 2020, calculation is based on current expected loss methodology. Prior to January 1, 2020, calculation was based on incurred loss methodology.

See Notes to Consolidated Financial Statements.
1
FIRST FINANCIAL BANCORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
  2020 2019 2020 2019
Interest income    
Loans and leases, including fees $ 103,249  $ 126,786  $ 324,924  $ 376,207 
Investment securities
Taxable 17,906  22,180  55,387  70,031 
Tax-exempt 4,884  4,457  14,403  13,051 
Total interest on investment securities 22,790  26,637  69,790  83,082 
Other earning assets 31  222  220  638 
Total interest income 126,070  153,645  394,934  459,927 
Interest expense    
Deposits 7,886  20,151  36,002  60,006 
Short-term borrowings 51  7,199  6,412  19,805 
Long-term borrowings 5,953  4,760  14,482  14,764 
Total interest expense 13,890  32,110  56,896  94,575 
Net interest income 112,180  121,535  338,038  365,352 
Provision for credit losses - loans and leases (1)
15,299  5,228  57,038  25,969 
Provision for credit losses - unfunded commitments (1)
(1,925) (216) 2,013  (342)
Net interest income after provision for credit losses 98,806  116,523  278,987  339,725 
Noninterest income    
Service charges on deposit accounts 7,356  9,874  21,792  28,596 
Trust and wealth management fees 3,855  3,718  12,438  11,731 
Bankcard income 3,124  3,316  8,666  15,399 
Client derivative fees 2,203  4,859  8,292  11,468 
Foreign exchange income 10,530  1,708  27,072  1,725 
Net gain from sales of loans 18,594  4,806  38,087  10,128 
Net gain (loss) on sales/transfers of investment securities 2  105  (55) (110)
Other 3,835  4,754  11,316  15,668 
Total noninterest income 49,499  33,140  127,608  94,605 
Noninterest expenses    
Salaries and employee benefits 63,769  53,212  174,516  155,109 
Net occupancy 5,625  5,509  17,107  17,735 
Furniture and equipment 3,638  4,120  11,372  11,758 
Data processing 6,837  5,774  20,245  15,885 
Marketing 1,856  1,346  4,415  4,928 
Communication 855  910  2,652  2,385 
Professional services 2,443  4,771  6,923  9,062 
State intangible tax 1,514  1,445  4,544  4,062 
FDIC assessments 1,350  (1,097) 4,045  918 
Intangible assets amortization 2,779  2,432  8,362  6,521 
Other 6,845  8,020  21,685  21,082 
Total noninterest expenses 97,511  86,442  275,866  249,445 
Income before income taxes 50,794  63,221  130,729  184,885 
Income tax expense 9,317  12,365  23,231  35,487 
Net income $ 41,477  $ 50,856  $ 107,498  $ 149,398 
Net earnings per common share - basic $ 0.43  $ 0.52  $ 1.10  $ 1.52 
Net earnings per common share - diluted $ 0.42  $ 0.51  $ 1.10  $ 1.51 
Cash dividends declared per share $ 0.23  $ 0.23  $ 0.69  $ 0.67 
Average common shares outstanding - basic 97,247,080  98,517,025  97,400,942  98,177,802 
Average common shares outstanding - diluted 98,008,733  99,077,723  98,117,463  98,723,173 
(1) Beginning January 1, 2020, calculation is based on current expected loss methodology. Prior to January 1, 2020, calculation was based on incurred loss methodology.
See Notes to Consolidated Financial Statements.
2
FIRST FINANCIAL BANCORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
2020 2019 2020 2019
Net income $ 41,477  $ 50,856  $ 107,498  $ 149,398 
Other comprehensive income (loss), net of tax:
Unrealized gain (loss) on debt securities arising during the period 5,434  9,915  27,861  57,930 
Change in retirement obligation 401  269  1,082  805 
Unrealized gain (loss) on derivatives 0  73  0  217 
Other comprehensive income (loss) 5,835  10,257  28,943  58,952 
Comprehensive income $ 47,312  $ 61,113  $ 136,441  $ 208,350 
                   See Notes to Consolidated Financial Statements.

3
FIRST FINANCIAL BANCORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in thousands except per share data)
(Unaudited)
  Common Stock Retained Accumulated other comprehensive Treasury stock  
  Shares Amount Earnings income (loss) Shares Amount Total
Balance at July 1, 2019 104,281,794  $ 1,623,699  $ 657,730  $ 5,193  (5,634,104) $ (98,433) $ 2,188,189 
Net income   50,856  50,856 
Other comprehensive income (loss) 10,257  10,257 
Cash dividends declared:
Common stock at $0.23 per share (23,218) (23,218)
Purchase of common stock (1,143,494) (27,372) (27,372)
Common stock issued in connection with business combinations 13,658  2,601,823  47,276  60,934 
Restricted stock awards, net of forfeitures 271  (11,200) (309) (38)
Share-based compensation expense 1,705  1,705 
Balance at September 30, 2019 104,281,794  $ 1,639,333  $ 685,368  $ 15,450  (4,186,975) $ (78,838) $ 2,261,313 
Balance at July 1, 2020 104,281,794  $ 1,635,070  $ 675,532  $ 36,431  (6,262,936) $ (126,014) $ 2,221,019 
Net income 41,477  41,477 
Other comprehensive income (loss) 5,835  5,835 
Cash dividends declared:
Common stock at $0.23 per share (22,525) (22,525)
Restricted stock awards, net of forfeitures 403  (19,095) (410) (7)
Share-based compensation expense 2,016  2,016 
Balance at September 30, 2020 104,281,794  $ 1,637,489  $ 694,484  $ 42,266  (6,282,031) $ (126,424) $ 2,247,815 

See Notes to Consolidated Financial Statements.

4
FIRST FINANCIAL BANCORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in thousands except per share data)
(Unaudited)
  Common Stock Retained Accumulated other comprehensive Treasury stock  
  Shares Amount Earnings income (loss) Shares Amount Total
Balance at January 1, 2019 104,281,794  $ 1,633,256  $ 600,014  $ (44,408) (6,387,508) $ (110,613) $ 2,078,249 
Impact of cumulative effect of adoption of new accounting principles 2,636  906  3,542 
Net income   149,398  149,398 
Other comprehensive income (loss) 58,952  58,952 
Cash dividends declared:
Common stock at $0.67 per share (66,680) (66,680)
Purchase of common stock (1,143,494) (27,372) (27,372)
Common stock issued in connection with business combinations 13,658  2,601,823  47,276  60,934 
Warrant exercises (7,830) 452,134  7,830  0 
Exercise of stock options, net of shares purchased (264) 20,424  354  90 
Restricted stock awards, net of forfeitures (5,954) 269,646  3,687  (2,267)
Share-based compensation expense 6,467  6,467 
Balance at September 30, 2019 104,281,794  $ 1,639,333  $ 685,368  $ 15,450  (4,186,975) $ (78,838) $ 2,261,313 
Balance at January 1, 2020 104,281,794  $ 1,640,771  $ 711,249  $ 13,323  (5,790,796) $ (117,638) $ 2,247,705 
Impact of cumulative effect of adoption of new accounting principles (56,882) (56,882)
Net income 107,498  107,498 
Other comprehensive income (loss) 28,943  28,943 
Cash dividends declared:
Common stock at $0.69 per share (67,381) (67,381)
Purchase of common stock (880,000) (16,686) (16,686)
Exercise of stock options, net of shares purchased (140) 10,405  212  72 
Restricted stock awards, net of forfeitures (8,891) 378,360  7,688  (1,203)
Share-based compensation expense 5,749  5,749 
Balance at September 30, 2020 104,281,794  $ 1,637,489  $ 694,484  $ 42,266  (6,282,031) $ (126,424) $ 2,247,815 

See Notes to Consolidated Financial Statements.
5
FIRST FINANCIAL BANCORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
Nine months ended
September 30,
  2020 2019
Operating activities    
Net income $ 107,498  $ 149,398 
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses 59,051  25,969 
Depreciation and amortization 24,955  20,136 
Stock-based compensation expense 5,749  6,467 
Pension expense (income) 1,705  781 
Net amortization (accretion) on investment securities 13,570  8,663 
Net (gain) loss on sales of investment securities 55  110 
Originations of loans held for sale (691,716) (269,271)
Net gains from sales of loans held for sale (38,087) (10,128)
Proceeds from sales of loans held for sale 674,475  260,243 
Deferred income taxes (9,744) 12,626 
Amortization of operating leases 5,973  5,494 
Payments for operating leases (5,801) (5,652)
Decrease (increase) cash surrender value of life insurance (985) (3,017)
Decrease (increase) in interest receivable (13,262) 201 
(Decrease) increase in interest payable (4,559) 1,160 
Decrease (increase) in other assets (350,021) (232,483)
(Decrease) increase in other liabilities 177,275  137,405 
Net cash provided by (used in) operating activities (43,869) 108,102 
Investing activities    
Proceeds from sales of securities available-for-sale 42,628  400,533 
Proceeds from calls, paydowns and maturities of securities available-for-sale 658,521  401,586 
Purchases of securities available-for-sale (787,048) (518,455)
Proceeds from calls, paydowns and maturities of securities held-to-maturity 25,005  12,073 
Purchases of other investment securities (18,659) (11,620)
Net decrease (increase) in interest-bearing deposits with other banks 18,142  (1,931)
Net decrease (increase) in loans and leases (1,007,585) (267,320)
Proceeds from disposal of other real estate owned 1,487  1,207 
Purchases of premises and equipment (13,404) (15,227)
Net cash acquired (paid) from business combinations 0  (51,663)
Net cash (paid) received for branch divestitures 0  118 
Net cash provided by (used in) investing activities (1,080,913) (50,699)
Financing activities    
Net (decrease) increase in total deposits 1,357,201  (56,419)
Net (decrease) increase in short-term borrowings (1,068,523) 173,495 
Payments on long-term debt (105,201) (74,454)
Proceeds from long-term borrowings 881,673  0 
Proceeds from issuance of long-term borrowings 150,000  0 
Cash dividends paid on common stock (67,317) (66,482)
Treasury stock purchase (16,686) (27,372)
Proceeds from exercise of stock options 72  90 
Net cash provided by (used in) financing activities 1,131,219  (51,142)
Cash and due from banks    
Change in cash and due from banks 6,437  6,261 
Cash and due from banks at beginning of period 200,691  236,221 
Cash and due from banks at end of period $ 207,128  $ 242,482 
Supplemental schedule for investing activities
Business combinations
Assets acquired, net of purchase consideration $ 0  $ (39,140)
Liabilities assumed 0  18,298 
Goodwill $ 0  $ 57,438 
See Notes to Consolidated Financial Statements.
6
FIRST FINANCIAL BANCORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2020
(Unaudited)

NOTE 1:  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation. The Consolidated Financial Statements of First Financial Bancorp., a financial holding company principally serving Ohio, Indiana, Kentucky and Illinois, include the accounts and operations of First Financial and its wholly-owned subsidiary, First Financial Bank. All significant intercompany transactions and accounts have been eliminated in consolidation.  Certain reclassifications of prior periods' amounts have been made to conform to current year presentation. Such reclassifications had no effect on net earnings.

These interim financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they may not include all of the information and accompanying notes necessary to constitute a complete set of financial statements required by GAAP and should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.  Management believes these unaudited consolidated financial statements reflect all adjustments of a normal recurring nature which are necessary for a fair presentation of the results for the interim periods presented.  The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year or any other interim period.  The Consolidated Balance Sheet as of December 31, 2019 has been derived from the audited financial statements in the Company’s 2019 Form 10-K.

Use of estimates. The preparation of financial statements in conformity with GAAP requires management to make estimates, assumptions and judgments that affect the amounts reported in the Consolidated Financial Statements and accompanying Notes.  These estimates, assumptions and judgments are inherently subjective and may be susceptible to significant change. Actual realized amounts could differ materially from these estimates.

COVID-19. In the first nine months of 2020, First Financial's operations and financial results were significantly impacted by the COVID-19 pandemic. The spread of COVID-19 has caused significant economic disruption throughout the United States as state and local governments issued stay at home orders and temporarily closed non-essential businesses. The potential financial impact from the pandemic is unknown at this time, however prolonged disruption may adversely impact several industries within the Company's geographic footprint and impair the ability of First Financial's customers to fulfill their contractual obligations to the Company. This could cause First Financial to experience a material adverse effect on business operations, asset valuations, financial condition and results of operations. Material adverse impacts may include all or a combination of valuation impairments on First Financial's intangible assets, investments, loans, mortgage servicing rights or counter-party risk derivatives.

Investment securities. First Financial classifies debt securities into three categories: HTM, trading and AFS. Management classifies investment securities into the appropriate category at the time of purchase and re-evaluates that classification as deemed appropriate.

Investment securities are classified as HTM when First Financial has the positive intent and ability to hold the securities to maturity. HTM securities are recorded at amortized cost.
 
Investment securities classified as trading are held principally for resale in the near-term and are recorded at fair value. Fair value is determined using quoted market prices. Gains or losses on trading securities, both realized and unrealized, are reported in noninterest income.
 
Investment securities not classified as either HTM or trading are classified as AFS. AFS securities are recorded at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of accumulated other comprehensive income (loss) in shareholders' equity.
 
The amortized cost of investment securities classified as either HTM or AFS is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-backed securities, over the estimated life of the security. Such amortization and accretion are considered an adjustment to the yield on the security and included in interest income from investments. Interest and dividends are also included in interest income from investment securities in the Consolidated Statements of Income. Realized gains and losses are based on the amortized cost of the security sold using the specific identification method.
7
Allowance for credit losses - held-to-maturity securities. Management measures expected credit losses on held-to-maturity debt securities on a collective basis by security type. The estimate of expected credit losses considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. Management classifies the held-to-maturity portfolio into the following major security types: Mortgage-backed, CMOs and Obligations of state and other political subdivisions.

Nearly all of the HTM securities held by the Company are issued by U.S. government entities and agencies. These securities are either explicitly or implicitly guaranteed by the U.S. government, are highly rated by major rating agencies and have a long history of no credit losses. The remainder of the Company's HTM securities are non-agency collateralized mortgage obligations and obligations of state and other political subdivisions which currently carry ratings no lower than A+. Accrued interest receivable on held-to maturity debt securities, which totaled $0.2 million as of September 30, 2020, is excluded by policy election from the estimate of credit losses.

Allowance for credit losses - available-for-sale securities. For available-for-sale debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For debt securities available-for-sale that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security.

If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit loss is recognized in other comprehensive income. Changes in the allowance for credit losses are recorded as provision for credit loss expense. Losses are charged against the allowance when management believes the uncollectibility of an available-for-sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Accrued interest receivable on available-for-sale debt securities, which totaled $11.7 million as of September 30, 2020, is excluded from the estimate of credit losses.

Allowance for credit losses - loans and leases. The allowance for credit losses is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Management's determination of the adequacy of the ACL is based on an assessment of the expected credit losses on loan and leases over the expected life of the loan. The ACL is increased by provision expense and decreased by charge-offs, net of recoveries of amounts previously charged-off. Loans are charged off when management believes that the collection of the principal amount owed in full, either through payments from the borrower or a guarantor or from the liquidation of collateral, is unlikely. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. Any interest that is accrued but not collected is reversed against interest income when a loan is placed on nonaccrual status, which typically occurs prior to charging off all, or a portion, of a loan. The Company made the policy election to exclude accrued interest receivable on loans and leases from the estimate of credit losses. 

Management estimates the allowance balance using relevant available information from both internal and external sources, relating to past events, current conditions and reasonable and supportable forecasts. Historical credit loss experience paired with economic forecasts provide the basis for the quantitatively modeled estimation of expected credit losses. First Financial adjusts its quantitative model, as necessary, to reflect conditions not already considered by the quantitative model. These adjustments are commonly known as the Qualitative Framework.

First Financial quantitatively models expected credit loss using PD, LGD and EAD over the R&S forecast period, reversion and post-reversion periods.
Utilizing third-party software, the Bank forecasts PD by using a parameterized transition matrix approach. Average transition matrices are calculated over the TTC period, which was defined as the period from December 2007 to December 2016. TTC transition matrices are adjusted under forward-looking macroeconomic expectations to obtain R&S forecasts.
First Financial is not required to develop forecasts over full the contractual term of the financial asset or group of financial assets. Rather, for periods beyond which the entity is able to make or obtain R&S forecasts of expected credit losses, the Company reverts in a straight line manner over a one year period to an average TTC loss level that is reflective of the
8
prepayment adjusted contractual term of the financial asset or group of financial assets. The R&S period, elected by the bank to be two years, is forecasted using econometric data sourced from Moody's, an industry-leading independent third party.

FFB utilizes a non-parametric loss curve approach embedded within a third-party software for estimating LGD. The PD multiplied by LGD produces an expected loss rate that, when calculating the ACL, is applied to contractual loan cash flows, adjusted for expected future rates of principal prepayments.
The Company adjusts its quantitative model for certain qualitative factors to reflect the extent to which management expects current conditions and R&S forecasts to differ from the conditions that existed for the period over which historical information was evaluated. The Qualitative Framework reflects changes related to relevant data, such as changes in asset quality trends, portfolio growth and composition, national and local economic factors, credit policy and administration and other factors not considered in the base quantitative model.

Loans that do not share risk characteristics are evaluated on an individual basis. First Financial will typically evaluate on an individual basis any loans that are on nonaccrual, designated as a TDR, or reasonably expected to be designated as a TDR. When management determines that foreclosure is probable or when repayment is expected to be provided substantially through the operation or sale of underlying collateral, expected credit losses are based on the fair value of the collateral at the reporting date, adjusted for selling costs. For loans evaluated on an individual basis that are not determined to be collateral dependent, a discounted cash flow analysis is performed to determine expected credit losses.

Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals and modifications unless either of the following applies: management has a reasonable expectation at the reporting date that a troubled debt restructuring will be executed with an individual borrower or the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Company. Credit card receivables do not have stated maturities. In determining the estimated life of a credit card receivable, management first estimates the future cash flows expected to be received and then applies those expected future cash flows to the credit card balance.

Allowance for credit losses - unfunded commitments. Effective January 1, 2020, First Financial adopted ASC 326, at which time First Financial estimated expected credit losses over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life consistent with the Company's ACL methodology for loans and leases. Adjustments to the reserve for unfunded commitments are recorded in Provision for credit losses - unfunded commitments in the Consolidated Statements of Income.

Prior to the adoption of ASC 326, First Financial maintained its reserve to absorb probable losses incurred in standby letters of credit and outstanding loan commitments. First Financial determined the adequacy of this reserve based upon an evaluation of the unfunded credit facilities, which included consideration of historical commitment utilization experience, credit risk ratings and historical loss rates, consistent with the Company's ALLL methodology at the time.

NOTE 2:  ACCOUNTING STANDARDS RECENTLY ADOPTED OR ISSUED

Standards Adopted in 2020

On January 1, 2020, the Company adopted ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which replaced the previously required incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities. It also applies to off-balance sheet credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments) and net investments in leases recognized by a lessor in accordance with Topic 842 on leases. In addition, ASC 326 made changes to the accounting for available-for-sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available-for-sale debt securities that management does not intend to sell or believes that it is more likely than not they will be required to sell. The Company adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost and OBS credit exposures. Results for reporting periods beginning after January 1, 2020 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. The Company recorded a net decrease to retained earnings of $56.9 million as of January 1, 2020 for the cumulative effect of
9
adopting ASC 326. As detailed in the following table, the transition adjustment included a $61.5 million increase to ACL, a $12.2 million increase in the ACL for unfunded commitments and a $16.8 million decrease in deferred tax liabilities.

The Company adopted CECL using the prospective transition approach for financial assets purchased with credit deterioration that were previously classified as purchased credit impaired and accounted for under ASC 310-30. In accordance with the standard, First Financial did not reassess whether PCI assets met the definition of PCD assets as of the date of adoption.

The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard.  In March 2020, the OCC, the Board of Governors of the Federal Reserve System, and the FDIC announced an interim final rule to delay the estimated impact on regulatory capital stemming from the implementation of CECL. The interim final rule maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period. First Financial is adopting the capital transition relief over the five year permissible period.

The impact of adopting ASC 326 was as follows:
January 1, 2020
(dollars in thousands) As Reported under ASC 326 Pre-ASC 326 Impact of ASC 326 Adoption
Assets
Loans
Commercial and industrial $ 28,485  $ 18,584  $ 9,901 
Lease financing 1,089 971 118
Construction real estate 13,960 2,381 11,579
Commercial real estate 47,697 23,579 24,118
Residential real estate 10,789 5,299 5,490
Home equity 13,217 4,787 8,430
Installment 1,193 392 801
Credit card 2,725 1,657 1,068
Allowance for credit losses on loans $ 119,155  $ 57,650  $ 61,505 
Liabilities
Deferred tax liability $ 16,252  $ 33,030  $ (16,778)
Allowance for credit losses on OBS credit exposures 12,740 585 12,155

For more information on the calculation of the ACL, please refer to Note 1 - Summary of Significant Accounting Policies and Note 5 - Allowance for Credit Losses.

During the first quarter of 2020, the Company adopted ASU No. 2018-13, Disclosure Framework: Changes to the Disclosure Requirements for Fair Value Measurement, which eliminates, adds and modifies certain disclosure requirements for fair value measurements.  Under the changes, entities are no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, but must disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements.  This update did not have a material impact on the Company’s Consolidated Financial Statements.


NOTE 3:  INVESTMENTS

For the three months ended September 30, 2020, there were sales of $1.3 million of AFS securities with insignificant gross realized gains and gross realized losses. For the three months ended September 30, 2019, proceeds on the sale of $284.9 million of AFS securities resulted in $1.2 million in gross realized gains and $1.1 million in gross realized losses. For the nine months ended September 30, 2020, there were sales of $42.6 million of AFS securities with $0.1 million in gross realized gains and $0.2 million in gross realized losses. For the nine months ended September 30, 2019, there were $400.5 million sales of AFS securities with $1.9 million in gross realized gains and $1.8 million in gross realized losses. In conjunction with the
10
adoption of ASU 2017-12 in the first quarter of 2019, First Financial reclassified $268.7 million of HTM securities to AFS resulting in a $0.2 million realized loss recorded in the Consolidated Statement of Income.

The following is a summary of HTM and AFS investment securities as of September 30, 2020:
  
Held-to-maturity Available-for-sale
(Dollars in thousands) Amortized
cost 		Unrecognized gain Unrecognized loss Fair
value 		Amortized
cost 		Unrealized
gain 		Unrealized
loss 		Fair
value
U.S. Treasuries $ 0  $ 0  $ 0  $ 0  $ 99  $ 4  $ 0  $ 103 
Securities of U.S. government agencies and corporations 0  0  0  0  59  1  0  60 
Mortgage-backed securities - residential 16,069  250  0  16,319  393,395  16,084  (59) 409,420 
Mortgage-backed securities - commercial 84,701  3,834  0  88,535  550,408  10,943  (4,791) 556,560 
Collateralized mortgage obligations 6,987  93  0  7,080  680,581  25,891  (339) 706,133 
Obligations of state and other political subdivisions 10,315  1,192  0  11,507  761,589  41,007  (599) 801,997 
Asset-backed securities 0  0  0  0  433,811  2,963  (2,978) 433,796 
Other securities 0  0  0  0  95,995  1,496  (597) 96,894 
Total $ 118,072  $ 5,369  $ 0  $ 123,441  $ 2,915,937  $ 98,389  $ (9,363) $ 3,004,963 

The following is a summary of HTM and AFS investment securities as of December 31, 2019:
  
Held-to-maturity Available-for-sale
(Dollars in thousands) Amortized
cost 		Unrecognized gain Unrecognized
loss 		Fair
value 		Amortized
cost 		Unrealized
gain 		Unrealized
loss 		Fair
value
U.S. Treasuries $ 0  $ 0  $ 0  $ 0  $ 99  $ 1  $ 0  $ 100 
Securities of U.S. government agencies and corporations 0  0  0  0  156  2  0  158 
Mortgage-backed securities - residential 20,818  122  (174) 20,766  421,945  9,709  (99) 431,555 
Mortgage-backed securities - commercial 101,267  571  (1,225) 100,613  474,174  4,988  (2,644) 476,518 
Collateralized mortgage obligations 9,763  0  (108) 9,655  769,076  16,753  (385) 785,444 
Obligations of state and other political subdivisions 11,014  804  (31) 11,787  652,986  23,729  (462) 676,253 
Asset-backed securities 0  0  0  0  400,081  1,414  (1,064) 400,431 
Other securities 0  0  0  0  79,781  1,959  (115) 81,625 
Total $ 142,862  $ 1,497  $ (1,538) $ 142,821  $ 2,798,298  $ 58,555  $ (4,769) $ 2,852,084 

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The following table provides a summary of investment securities by contractual maturity as of September 30, 2020, except for residential and commercial mortgage-backed securities, collateralized mortgage obligations and asset-backed securities, which are shown as single totals due to the unpredictability of the timing in principal repayments.
  Held-to-maturity Available-for-sale
(Dollars in thousands) Amortized
cost 		Fair
value 		Amortized
cost 		Fair
value
By Contractual Maturity:
Due in one year or less $ 0  $ 0  $ 4,098  $ 4,133 
Due after one year through five years 0  0  53,902  55,486 
Due after five years through ten years 5,784  6,864  183,872  190,863 
Due after ten years 4,531  4,643  615,870  648,572 
Mortgage-backed securities - residential 16,069  16,319  393,395  409,420 
Mortgage-backed securities - commercial 84,701  88,535  550,408  556,560 
Collateralized mortgage obligations 6,987  7,080  680,581  706,133 
Asset-backed securities 0  0  433,811  433,796 
Total $ 118,072  $ 123,441  $ 2,915,937  $ 3,004,963 

Unrealized 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. For securities in an unrealized loss position, the Company first assesses whether it intends to sell or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For debt securities available-for-sale that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security.

At this time, First Financial does not intend to sell, and it is not more likely than not that the Company will be required to sell, debt securities temporarily impaired prior to maturity or recovery of the recorded value. First Financial had no other than temporary impairment related to its investment securities portfolio as of September 30, 2020 or December 31, 2019.

As of September 30, 2020, the Company's investment securities portfolio consisted of 1,291 securities, of which 119 were in an unrealized loss position. As of December 31, 2019, the Company's investment securities portfolio consisted of 1,273 securities, of which 140 were in an unrealized loss position.

Primarily all of First Financial’s HTM debt securities are issued by U.S. government-sponsored enterprises. These securities carry the explicit and/or implicit guarantee of the U.S. government, are widely recognized as “risk free,” and have a long history of zero credit loss. The remainder of the Company's HTM securities are non-agency collateralized mortgage obligations and obligations of state and other political subdivisions which currently carry ratings no lower than A+. There were no HTM securities on nonaccrual status, past due or in a loss position as of September 30, 2020. Therefore, the Company did not record an allowance for credit losses for these securities as of September 30, 2020.

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The following tables provide the fair value and gross unrealized losses on investment securities in an unrealized loss position for which an allowance for credit losses has not been recorded, aggregated by investment category and the length of time the individual securities have been in a continuous loss position:
  September 30, 2020
  Less than 12 months 12 months or more Total
(Dollars in thousands) Fair
value 		Unrealized
loss 		Fair
value 		Unrealized
loss 		Fair
value 		Unrealized
loss
U.S. Treasuries $ 0  $ 0  $ 0  $ 0  $ 0  $ 0 
Securities of U.S. Government agencies and corporations 0  0  0  0  0  0 
Mortgage-backed securities - residential 20,145  (59) 0  0  20,145  (59)
Mortgage-backed securities - commercial 145,885  (1,568) 44,164  (3,223) 190,049  (4,791)
Collateralized mortgage obligations 42,042  (339) 1  0  42,043  (339)
Obligations of state and other political subdivisions 81,678  (599) 0  0  81,678  (599)
Asset-backed securities 138,610  (1,307) 97,031  (1,671) 235,641  (2,978)
Other securities 19,033  (349) 4,577  (248) 23,610  (597)
Total $ 447,393  $ (4,221) $ 145,773  $ (5,142) $ 593,166  $ (9,363)
  December 31, 2019
  Less than 12 months 12 months or more Total
  Fair Unrealized Fair Unrealized Fair Unrealized
(Dollars in thousands) value loss value loss value loss
U.S. Treasuries $ 0  $ 0  $ 0  $ 0  $ 0  $ 0 
Securities of U.S. Government agencies and corporations 0  0  0  0  0  0 
Mortgage-backed securities - residential 40,190  (209) 11,063  (64) 51,253  (273)
Mortgage-backed securities - commercial 111,658  (298) 104,069  (3,571) 215,727  (3,869)
Collateralized mortgage obligations 85,248  (297) 30,628  (196) 115,876  (493)
Obligations of state and other political subdivisions 118,623  (457) 7,950  (36) 126,573  (493)
Asset-backed securities 125,889  (553) 54,963  (511) 180,852  (1,064)
Other securities 0  0  5,649  (115) 5,649  (115)
Total $ 481,608  $ (1,814) $ 214,322  $ (4,493) $ 695,930  $ (6,307)

For further detail on the fair value of investment securities, see Note 16 – Fair Value Disclosures.

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NOTE 4:  LOANS AND LEASES

First Financial offers clients a variety of commercial and consumer loan and lease products with diverse interest rates and payment terms. Commercial loan categories include C&I, CRE, construction real estate and lease financing. Consumer loan categories include residential real estate, home equity, installment and credit card.

Lending activities are primarily concentrated in states where the Bank operates banking centers (Ohio, Indiana, Kentucky and Illinois). First Financial also offers two nationwide lending platforms, one that provides equipment and leasehold improvement financing for franchisees in the quick service and casual dining restaurant sector and another that primarily provides loans that are secured by commissions and cash collateral to insurance agents and brokers.

In accordance with the CARES Act, First Financial participated in offering PPP loans to its customers. These loans provide a direct incentive for small businesses to keep their workers on the payroll and to maintain their operations. PPP loans are eligible to be forgiven provided certain conditions are met. As of September 30, 2020, First Financial had $886.1 million in PPP loans, net of unearned fees of $24.2 million.

Credit Quality. To facilitate the monitoring of credit quality for commercial loans, First Financial utilizes the following categories of credit grades:

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

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

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

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

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

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

The following table sets forth the Company's loan portfolio at September 30, 2020 by risk attribute and origination date:
(Dollars in thousands) 2020 2019 2018 2017 2016 Prior Term Total Revolving Total
Commercial & industrial
Pass $ 1,254,361  $ 502,248  $ 384,079  $ 242,588  $ 153,411  $ 152,890  $ 2,689,577  $ 468,883  $ 3,158,460 
Special mention 21,981  6,871  16,363  13,925  2,366  8,325  69,831  10,570  80,401 
Substandard 4,513  1,086  7,802  25,010  6,804  1,626  46,841  6,611  53,452 
Doubtful 0  0  0  0  0  0  0  0  0 
Total $ 1,280,855  $ 510,205  $ 408,244  $ 281,523  $ 162,581  $ 162,841  $ 2,806,249  $ 486,064  $ 3,292,313 
Lease financing
Pass $ 11,084  $ 30,564  $ 13,872  $ 7,983  $ 5,971  $ 3,367  $ 72,841  $ 0  $ 72,841 
Special mention 317 0 0 0 0 0 317 0 317 
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(Dollars in thousands) 2020 2019 2018 2017 2016 Prior Term Total Revolving Total
Substandard 9 0 476 822 277 0 1,584 0 1,584 
Doubtful 0 0 0 0 0 0 0 0 0 
Total $ 11,410  $ 30,564  $ 14,348  $ 8,805  $ 6,248  $ 3,367  $ 74,742  $ 0  $ 74,742 
Construction real estate
Pass $ 53,598  $ 211,962  $ 223,732  $ 34,952  $ 23,987  $ 990  $ 549,221  $ 15,822  $ 565,043 
Special mention 0  621  0  9,984  0  0  10,605  0  10,605 
Substandard 0  0  0  0  0  0  0  0  0 
Doubtful 0  0  0  0  0  0  0  0  0 
Total $ 53,598  $ 212,583  $ 223,732  $ 44,936  $ 23,987  $ 990  $ 559,826  $ 15,822  $ 575,648 
Commercial real estate - investor
Pass $ 379,720  $ 1,096,225  $ 445,501  $ 451,095  $ 327,564  $ 431,524  $ 3,131,629  $ 39,470  $ 3,171,099 
Special mention 952  56  0  15,178  16,873  8,697  41,756  559  42,315 
Substandard 6,198  2,562  17,861  7,241  94  15,843  49,799  0  49,799 
Doubtful 0  0  0  0  0  0  0  0  0 
Total $ 386,870  $ 1,098,843  $ 463,362  $ 473,514  $ 344,531  $ 456,064  $ 3,223,184  $ 40,029  $ 3,263,213 
Commercial real estate - owner
Pass $ 155,486  $ 180,808  $ 153,043  $ 144,601  $ 140,566  $ 219,723  $ 994,227  $ 40,541  $ 1,034,768 
Special mention 2,048  1,946  13,043  4,903  4,540  11,873  38,353  59  38,412 
Substandard 647  520  851  4,907  446  3,361  10,732  0  10,732 
Doubtful 0  0  0  0  0  0  0  0  0 
Total $ 158,181  $ 183,274  $ 166,937  $ 154,411  $ 145,552  $ 234,957  $ 1,043,312  $ 40,600  $ 1,083,912 
Residential real estate
Performing $ 228,049  $ 265,023  $ 133,562  $ 74,811  $ 68,109  $ 250,625  $ 1,020,179  $ 0  $ 1,020,179 
Nonperforming 242  526  642  509  88  5,516  7,523  0  7,523 
Total $ 228,291  $ 265,549  $ 134,204  $ 75,320  $ 68,197  $ 256,141  $ 1,027,702  $ 0  $ 1,027,702 
Home equity
Performing $ 45,297  $ 22,107  $ 19,391  $ 12,418  $ 10,704  $ 46,839  $ 156,756  $ 594,615  $ 751,371 
Nonperforming 0  0  75  39  29  204  347  3,025  3,372 
Total $ 45,297  $ 22,107  $ 19,466  $ 12,457  $ 10,733  $ 47,043  $ 157,103  $ 597,640  $ 754,743 
Installment
Performing $ 18,610  $ 17,887  $ 12,809  $ 10,367  $ 2,582  $ 3,708  $ 65,963  $ 18,557  $ 84,520 
Nonperforming 9  29  25  21  21  4  109  0  109 
Total $ 18,619  $ 17,916  $ 12,834  $ 10,388  $ 2,603  $ 3,712  $ 66,072  $ 18,557  $ 84,629 
Credit cards
Performing $ 0  $ 0  $ 0  $ 0  $ 0  $ 0  $ 0  $ 43,426  $ 43,426 
Nonperforming 0  0  0  0  0  0  0  481  481 
Total $ 0  $ 0  $ 0  $ 0  $ 0  $ 0  $ 0  $ 43,907  $ 43,907 
Grand Total $ 2,183,121  $ 2,341,041  $ 1,443,127  $ 1,061,354  $ 764,432  $ 1,165,115  $ 8,958,190  $ 1,242,619  $ 10,200,809 
15

Commercial and consumer credit exposure by risk attribute as of December 31, 2019 was as follows:
  As of December 31, 2019
  Commercial Real Estate Lease
(Dollars in thousands) & industrial Construction Commercial financing Total
Pass $ 2,324,021  $ 493,182  $ 4,108,752  $ 85,262  $ 7,011,217 
Special Mention 100,954  0  59,383  488  160,825 
Substandard 40,902  0  26,516  2,614  70,032 
Doubtful 0  0  0  0  0 
Total $ 2,465,877  $ 493,182  $ 4,194,651  $ 88,364  $ 7,242,074 
(Dollars in thousands) Residential
real estate 		Home equity Installment Credit card Total
Performing $ 1,040,787  $ 766,169  $ 82,385  $ 48,983  $ 1,938,324 
Nonperforming 15,162  5,700  204  201  21,267 
Total $ 1,055,949  $ 771,869  $ 82,589  $ 49,184  $ 1,959,591 

Delinquency. Loans are considered past due or delinquent when the contractual principal or interest due in accordance with the terms of the loan agreement remains unpaid after the date of the scheduled payment.

Loan delinquency, including loans classified as nonaccrual, was as follows:
  As of September 30, 2020
(Dollars in thousands) 30 – 59
days
past due 		60 – 89
days
past due 		> 90 days
past due 		Total
past
due 		Current Total > 90 days
past due
and still
accruing
Loans              
Commercial & industrial $ 54  $ 133  $ 2,181  $ 2,368  $ 3,289,945  $ 3,292,313  $ 0 
Lease financing 0  0  0  0  74,742  74,742  0 
Construction real estate 0  0  0  0  575,648  575,648  0 
Commercial real estate-investor 84  7,895  1,286  9,265  3,253,948  3,263,213  0 
Commercial real estate-owner 755  0  1,051  1,806  1,082,106  1,083,912  0 
Residential real estate 2,816  340  4,368  7,524  1,020,178  1,027,702  0 
Home equity 1,468  319  1,585  3,372  751,371  754,743  0 
Installment 50  20  38  108  84,521  84,629  0 
Credit card 215  183  83  481  43,426  43,907  79 
Total $ 5,442  $ 8,890  $ 10,592  $ 24,924  $ 10,175,885  $ 10,200,809  $ 79 

  As of December 31, 2019
(Dollars in thousands) 30 – 59
days
past due 		60 – 89
days
past due 		> 90 days
past due 		Total
past
due 		Current Subtotal Purchased
impaired 		Total > 90 days
past due
and still
accruing
Loans              
Commercial & industrial $ 1,266  $ 3,332  $ 14,518  $ 19,116  $ 2,443,680  $ 2,462,796  $ 3,081  $ 2,465,877  $ 0 
Lease financing 0  0  0  0  88,364  88,364  0  88,364  0 
Construction real estate 0  0  0  0  493,167  493,167  15  493,182  0 
Commercial real estate 776  857  5,613  7,246  4,151,513  4,158,759  35,892  4,194,651  0 
Residential real estate 8,032  1,928  5,031  14,991  1,014,138  1,029,129  26,820  1,055,949  0 
Home equity 2,530  1,083  2,795  6,408  762,863  769,271  2,598  771,869  0 
Installment 111  50  148  309  82,022  82,331  258  82,589  0 
Credit card 208  75  201  484  48,700  49,184  0  49,184  201 
Total $ 12,923  $ 7,325  $ 28,306  $ 48,554  $ 9,084,447  $ 9,133,001  $ 68,664  $ 9,201,665  $ 201 
16

For PCD assets, the delinquency status was determined individually for each loan in accordance with the individual loan's contractual repayment terms. Prior to the adoption of CECL in the first quarter of 2020, PCI loans were classified as performing, even though they may have been contractually past due, as any nonpayment of contractual principal or interest was considered in the periodic re-estimation of expected cash flows and was included in the resulting recognition of current period provision for credit losses or prospective yield adjustments.

Nonaccrual. Loans are classified as nonaccrual when, in the opinion of management, collection of principal or interest is doubtful or when principal or interest payments are 90 days or more past due. Generally, loans are classified as nonaccrual due to the continued failure to adhere to contractual payment terms by the borrower, coupled with other pertinent factors. When a loan is classified as nonaccrual, the accrual of interest income is discontinued and previously accrued but unpaid interest is reversed. Any payments received while a loan is on nonaccrual status are applied as a reduction to the carrying value of the loan. A loan classified as nonaccrual may return to accrual status if none of the principal and interest is due and unpaid, and the Bank expects repayment of the remaining contractual principal and interest.

Troubled Debt Restructurings. A loan modification is considered a TDR when the borrower is experiencing financial difficulty and a concession is made by the Company that would not otherwise be considered for a borrower with similar credit characteristics. The most common types of modifications include interest rate reductions, maturity extensions and modifications to principal amortization, including interest-only structures. Modified terms are dependent upon the financial position and needs of the individual borrower. If the modification agreement is violated, the loan is managed by the Company’s credit administration group for resolution, which may result in foreclosure in the case of real estate. In accordance with the Coronavirus Aid, Relief, and Economic Security (CARES) Act, performing loans that demonstrated limited signs of credit deterioration, but were modified to provide borrowers relief during the COVID-19 pandemic were not considered to be TDR as of September 30, 2020.

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

First Financial had 169 TDRs totaling $37.1 million at September 30, 2020, including $7.8 million on accrual status and $29.3 million classified as nonaccrual. First Financial had $0.2 million of commitments outstanding to lend additional funds to borrowers whose loan terms have been modified through TDRs, and the ACL included reserves of $5.7 million related to TDRs at September 30, 2020. Additionally, as of September 30, 2020, $5.4 million of accruing TDRs have been performing in accordance with the restructured terms for more than one year.

First Financial had 157 TDRs totaling $30.0 million at December 31, 2019, including $11.4 million of loans on accrual status and $18.5 million classified as nonaccrual. First Financial had $2.5 million commitments outstanding to lend additional funds to borrowers whose loan terms had been modified through TDRs. At December 31, 2019, the ALLL included reserves of $2.5 million related to TDRs, and $4.7 million of the accruing TDRs had been performing in accordance with the restructured terms for more than one year.

17
The following tables provide information on loan modifications classified as TDRs during the three and nine months ended September 30, 2020 and 2019:
Three months ended
September 30, 2020 September 30, 2019
(Dollars in thousands) Number of loans Pre-modification loan balance Period end balance Number of loans Pre-modification loan balance Period end balance
Commercial & industrial 1  $ 1,480  $ 1,480  2  $ 2,482  $ 2,521 
Construction real estate 0  0  0  0  0  0 
Commercial real estate 0  0  0  2  1,659  1,658 
Residential real estate 2  109  92  5  478  455 
Home equity 4  120  118  1  35  36 
Installment 0  0  0  1  30  29 
Total 7  $ 1,709  $ 1,690  11  $ 4,684  $ 4,699 
Nine months ended
September 30, 2020 September 30, 2019
(Dollars in thousands) Number of loans Pre-modification loan balance Period end balance Number of loans Pre-modification loan balance Period end balance
Commercial & industrial 8  $ 14,984  $ 14,984  8  $ 25,009  $ 25,071 
Construction real estate 0  0  0  0  0  0 
Commercial real estate 0  0  0  9  3,024  2,932 
Residential real estate 20  1,677  1,581  22  2,944  2,626 
Home equity 10  346  344  13  358  330 
Installment 1  26  15  1  30  29 
Total 39  $ 17,033  $ 16,924  53  $ 31,365  $ 30,988 

For TDRs identified during the three and nine months ended September 30, 2020, there were $0.6 million and $1.7 million, respectively, of chargeoffs for the portion of TDRs determined to be uncollectible. For TDRs identified during the three and nine months ended September 30, 2019, there were $2.3 million chargeoffs for the portion of TDRs determined to be uncollectible.

The following table provides information on how TDRs were modified during the nine months ended September 30, 2020 and 2019:
Three months ended Nine months ended
September 30, September 30,
(Dollars in thousands) 2020 2019 2020 2019
Extended maturities $ 0  $ 0  $ 0  $ 2,877 
Adjusted interest rates 0 0 0  5,284 
Combination of rate and maturity changes 0 0 0  508 
Forbearance 1,480 4,349 4,663  19,984 
Other (1)
210 350 12,261  2,335 
Total $ 1,690  $ 4,699  $ 16,924  $ 30,988 
(1) Includes covenant modifications and other concessions, or combination of concessions, that do not consist of interest rate adjustments, forbearance and maturity extensions

First Financial considers repayment performance as an indication of the effectiveness of the Company's loan modifications. Borrowers that are 90 days or more past due on any principal or interest payments, or who prematurely terminate a restructured loan agreement without paying off the contractual principal balance, are considered to be in default of the terms of the TDR agreement.
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For each of the three and nine month periods ended September 30, 2020, there was one TDR relationship with an insignificant balance for which there was a payment default during the period that occurred within twelve months of the loan modifications. For the three month period ended September 30, 2019, there was one TDR relationship for $0.1 million for which there was a payment default during the period that occurred within twelve months of the loan modifications. For the nine months ended September 30, 2019, there were three TDR relationships for $7.0 million for which there was a payment default during the period that occurred within twelve months of the loan modification.

As stated in the CARES Act, loan modifications in response to COVID-19 executed on a loan that was not more than 30 days past due as of December 31, 2019 and executed between March 1, 2020, and the earlier of 60 days after the date of termination of the National Emergency or December 31, 2020 are not required to be reported as TDR. As of September 30, 2020, the Company's loan portfolio included 1,902 commercial loans with balances of $2.1 billion and 1,830 consumer loans with balances of $131.4 million that were modified in response to COVID-19 that are not considered TDRs. Of the loan balances initially modified, $1.5 billion have returned to a normal payment schedule, with $631.2 million receiving a second deferral. The second round of deferrals consist primarily of hotel and franchise loans, which comprise $438.2 million or 69% of the total balances deferred for a second time.
Nonperforming Loans. Loans classified as nonaccrual and loans modified as TDRs are considered nonperforming for September 30, 2020 and impaired as of December 31, 2019. The following table provides information on nonperforming loans:
September 30, 2020 December 31, 2019
(Dollars in thousands) Nonaccrual loans with a related ACL Nonaccrual loans with no related ACL Total nonaccrual Total nonaccrual
Nonaccrual loans (1)
   
Commercial & industrial $ 20,558  $ 14,128  $ 34,686  $ 24,346 
Lease financing 0  1,092  1,092  223 
Construction real estate 0  0  0  0 
Commercial real estate 1,310  23,211  24,521  7,295 
Residential real estate 252  11,852  12,104  10,892 
Home equity 0  5,374  5,374  5,242 
Installment 0  153  153  167 
Total nonaccrual loans $ 22,120  $ 55,810  $ 77,930  $ 48,165 
(1) Nonaccrual loans include nonaccrual TDRs of $29.3 million and $18.5 million as of September 30, 2020 and December 31, 2019, respectively.

Three months ended Nine months ended
September 30, September 30,
(Dollars in thousands) 2020 2019 2020 2019
Interest income effect on nonperforming loans  
Gross amount of interest that would have been recorded under original terms $ 1,552  $ 1,568  $ 4,185  $ 4,648 
Interest included in income
Nonaccrual loans 689  336  1,226  863 
Troubled debt restructurings 64  184  367  689 
Total interest included in income 753  520  1,593  1,552 
Net impact on interest income $ 799  $ 1,048  $ 2,592  $ 3,096 

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

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First Financial's investment in impaired loans as of December 31, 2019 was as follows:
  As of December 31, 2019
(Dollars in thousands) Current balance Contractual
principal
balance 		Related
allowance
Loans with no related allowance recorded
Commercial & industrial $ 16,726  $ 19,709  $ 0 
Lease financing 223  223  0 
Construction real estate 0  0  0 
Commercial real estate 10,160  17,897  0 
Residential real estate 14,868  17,368  0 
Home equity 5,700  6,462  0 
Installment 204  341  0 
Total 47,881  62,000  0 
Loans with an allowance recorded
Commercial & industrial 10,754  21,513  2,044 
Lease financing 0  0  0 
Construction real estate 0  0  0 
Commercial real estate 671  675  113 
Residential real estate 294  294  18 
Home equity 0  0  0 
Installment 0  0  0 
Total 11,719  22,482  2,175 
Total
Commercial & industrial 27,480  41,222  2,044 
Lease financing 223  223  0 
Construction real estate 0  0  0 
Commercial real estate 10,831  18,572  113 
Residential real estate 15,162  17,662  18 
Home equity 5,700  6,462  0 
Installment 204  341  0 
Total $ 59,600  $ 84,482  $ 2,175 

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First Financial's average impaired loans and interest income recognized by class for the three and nine months ended September 30, 2019 were as follows:
Three months ended Nine months ended
September 30, 2019 September 30, 2019
(Dollars in thousands) Average
Recorded
Investment 		Interest
Income
Recognized 		Average
Recorded
Investment 		Interest
Income
Recognized
Loans with no related allowance recorded
Commercial & industrial $ 37,835  $ 316  $ 35,626  $ 807 
Lease financing 148  0  155  0 
Construction real estate 6  0  7  0 
Commercial real estate 18,703  94  20,907  295 
Residential real estate 15,388  74  16,177  229 
Home equity 5,594  29  5,941  95 
Installment 150  0  162  2 
Total 77,824  513  78,975  1,428 
Loans with an allowance recorded
Commercial & industrial 4,316  1  3,213  87 
Lease financing 142  0  71  0 
Construction real estate 0  0  0  0 
Commercial real estate 1,010  4  1,507  27 
Residential real estate 668  2  484  10 
Home equity 0  0  0  0 
Installment 0  0  0  0 
Total 6,136  7  5,275  124 
Total
Commercial & industrial 42,151  317  38,839  894 
Lease financing 290  0  226  0 
Construction real estate 6  0  7  0 
Commercial real estate 19,713  98  22,414  322 
Residential real estate 16,056  76  16,661  239 
Home equity 5,594  29  5,941  95 
Installment 150  0  162  2 
Total $ 83,960  $ 520  $ 84,250  $ 1,552 

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The following table provides collateral information by class of loan for collateral-dependent loans with a specific reserve. A loan is considered to be collateral dependent when the borrower is experiencing financial difficulty and the repayment is expected to be provided substantially through the operation or sale of collateral.
September 30, 2020
Type of Collateral
(Dollar in thousands) Business
assets 		Commercial real estate Equipment Residential real estate Total
Class of loan
Commercial & industrial $ 10,091  $ 0  $ 11,541  $ 0  $ 21,632 
Commercial real estate-investor 0 0  0  649  649 
Commercial real estate-owner 0 0  0  662  662 
Residential real estate 0 0  0  1,235  1,235 
Total $ 10,091  $ 0  $ 11,541  $ 2,546  $ 24,178 

Lease financing. The Company prospectively applied FASB ASC Topic 842 in the first quarter of 2019. First Financial originates both sales-type and direct financing leases, and the Company manages and reviews lease residuals in accordance with its credit policies. Sales-type lease contracts contain the ability to purchase the underlying equipment at lease maturity and profit or loss is recognized at lease commencement.  Direct financing leases are generally three to five years in length and may be extended at maturity, however, early cancellation may result in a fee to the borrower.  For direct financing leases, the net unearned income is deferred and amortized over the life of the lease.  Income recognized in first nine months of 2020 and 2019 related to the implementation of FASB ASC Topic 842 was insignificant.

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

Changes in OREO were as follows:
Three months ended Nine months ended
  September 30, September 30,
(Dollars in thousands) 2020 2019 2020 2019
Balance at beginning of period $ 1,872  $ 1,421  $ 2,033  $ 1,401 
Additions
Commercial & industrial 187  217  510  353 
Residential real estate 136  104  282  1,376 
Total additions 323  321  792  1,729 
Disposals    
Commercial & industrial 0  (228) (217) (498)
Residential real estate (510) (325) (1,270) (709)
Total disposals (510) (553) (1,487) (1,207)
Valuation adjustment    
Commercial & industrial (22) (56) 448  (111)
Residential real estate (20) 480  (143) (199)
Total valuation adjustment (42) 424  305  (310)
Balance at end of period $ 1,643  $ 1,613  $ 1,643  $ 1,613 

NOTE 5:  ALLOWANCE FOR CREDIT LOSSES

Allowance for credit losses - loans and leases. The allowance for credit losses is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. The ACL is increased by provision expense and decreased by charge-offs, net of recoveries of amounts previously charged-off. 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
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either through payments from the borrower or a guarantor or from the liquidation of collateral. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. Accrued interest receivable on loans and leases, which totaled $41.2 million as of September 30, 2020, is excluded from the estimate of credit losses. 

Management estimates the allowance balance using relevant available information from both internal and external sources, relating to past events, current conditions and reasonable and supportable forecasts. Historical credit loss experience paired with economic forecasts provides the basis for the quantitatively modeled estimation of expected credit losses. First Financial adjusts its quantitative model, as necessary, to reflect conditions not already considered by the quantitative model. These adjustments are commonly known as the Qualitative Framework.

The allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. The Company has identified the following portfolio segments and measures the ACL using the following methods:

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 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. Within the 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.

Current period default rates are utilized in the modeling of the ACL for C&I loans, and are adjusted for forecasted changes in the treasury term spread and market volatility index. Changes in current period defaults or forecasted expectations for these economic variables could result in volatility in the Company's ACL in future periods.

Lease financing – Lease financing consists of lease transactions for the acquisition 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 in addition to other considerations.

The ACL model for leases sources expected default rates from the C&I portfolio model. Therefore, changes in forecasted expectations for the treasury term spread and market volatility index could result in volatility in the Company's ACL in future periods.

Construction real estate – Real estate construction loans are term loans to individuals, companies or developers used for the construction or development 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.

The construction ACL model is adjusted for forecasted changes in rental vacancy rates in the Bank's geographic footprint and the housing price index. Changes in forecasted expectations for these economic variables could result in volatility in the Company's ACL in future periods.

Commercial real estate - owner & investor – 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 in addition to 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, environmental risks and the type, age, condition and location of real estate, among other factors.

First Financial models owner-occupied and investor CRE separately when determining the ACL. For owner occupied CRE, current period default rates are utilized in the modeling, and are adjusted for forecasted changes in the BAA bond spread, national rental vacancy rates and the consumer confidence index. Current period default rates are also utilized in the modeling
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of investor CRE loans, and are adjusted for forecasted changes in the BAA bond spread, multifamily building permits within the Bank’s geographic footprint and national rental vacancy rates. Changes in current period defaults and forecasted expectations for these economic variables could result in volatility in the Company's ACL in future periods.

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. In most cases, these loans 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.

The residential real estate ACL model is adjusted for forecasted changes in the housing price index, housing starts within the Bank’s geographic footprint and national single-family existing home sales. Changes in forecasted expectations for these economic variables could result in volatility in the Company's ACL in future periods.

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. Home equity lending underwriting considerations include the borrower's credit history as well as to debt-to-income and loan-to-value policy limits.

The home equity ACL model is adjusted for forecasted changes in the consumer credit growth rate within the Bank’s geographic footprint and the working-age labor participation rate. Changes in forecasted expectations for these economic variables could result in volatility in the Company's ACL in future periods.

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

The ACL model for installment loans sources expected default rates from the residential real estate and home equity portfolio models and is paired with installment specific LGD rates. Changes in forecasted expectations for the consumer credit growth rate within the Bank’s geographic footprint, the working-age labor participation rate, the housing price index, housing starts within the Bank’s geographic footprint and national existing single-family existing home sales could result in volatility in the Company's ACL in future periods.

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 lines are unconditionally cancellable by the Company at any time.

The ACL model for credit card loans sources expected default rates from the residential real estate and home equity portfolio models and is paired with credit card specific LGD rates. Changes in forecasted expectations for the consumer credit growth rate within the Bank’s geographic footprint, the working-age labor participation rate, the housing price index, housing starts within the Bank’s geographic footprint and national existing single-family existing home sales could result in volatility in the Company's ACL in future periods.

First Financial's ACL is influenced by loan volumes, risk rating migration, delinquency status and other conditions influencing loss expectations, such as reasonable and supportable forecasts of economic conditions.  For the three and nine months ended September 30, 2020 the ACL increased primarily due to First Financial's expectation of higher credit losses resulting from the COVID-19 pandemic, however, this was somewhat offset by an increase in prepayment rates during the period.

The Company utilized the final Moody's September baseline forecast as its R&S forecast in the quantitative model, which included consideration of the impact from both the COVID-19 pandemic and the related government stimulus response, as well as the potential for further government stimulus actions. For reasonableness, the Company also considered the impact to the model from alternative, more adverse economic forecasts, slower prepayment speeds and increased default rates. These alternative analyses were utilized to inform the Company's qualitative adjustments. Additionally, First Financial considered its credit exposure to certain industries believed to be at risk for future credit stress related to the COVID-19 pandemic, such as franchise, hotel and investor commercial real estate lending when making qualitative adjustments to the ACL model.
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Changes in the allowance by loan category were as follows:
  Three months ended September 30, 2020
(Dollars in thousands) Commercial & industrial Lease financing Construction real estate Commercial real estate Residential real estate Home Equity Installment Credit card Total
Allowance for credit losses:                
Balance at beginning of period $ 50,421  $ 1,431  $ 15,357  $ 62,340  $ 10,581  $ 14,236  $ 1,226  $ 3,069  $ 158,661 
Provision for credit losses 1,297  702  3,613  12,896  (1,364) (1,455) 35  (425) 15,299 
Gross charge-offs (1,467) (852) 0  (3,789) (22) (460) (59) (171) (6,820)
Recoveries 265  6  0  760  91  209  35  38  1,404 
Total net charge-offs (1,202) (846) 0  (3,029) 69  (251) (24) (133) (5,416)
Ending allowance for credit losses $ 50,516  $ 1,287  $ 18,970  $ 72,207  $ 9,286  $ 12,530  $ 1,237  $ 2,511  $ 168,544 
  Three months ended September 30, 2019
(Dollars in thousands) Commercial & industrial Lease financing Construction real estate Commercial real estate Residential real estate Home Equity Installment Credit card Total
Allowance for credit losses:                
Balance at beginning of period $ 24,586  $ 1,393  $ 2,919  $ 20,357  $ 5,008  $ 5,307  $ 395  $ 1,584  $ 61,549 
Provision for credit losses 2,654  (388) (152) 1,684  702  68  (2) 662  5,228 
Loans charged off (9,556) 0  0  (535) (278) (627) (65) (598) (11,659)
Recoveries 556  0  0  347  64  335  93  39  1,434 
Total net charge-offs (9,000) 0  0  (188) (214) (292) 28  (559) (10,225)
Ending allowance for credit losses $ 18,240  $ 1,005  $ 2,767  $ 21,853  $ 5,496  $ 5,083  $ 421  $ 1,687  $ 56,552 
  
Nine months ended September 30, 2020
(Dollars in thousands) Commercial & industrial Lease financing Construction real estate Commercial real estate Residential real estate Home equity Installment Credit card Total
Allowance for credit losses:                
Beginning balance, prior to adoption of ASC 326 $ 18,584  $ 971  $ 2,381  $ 23,579  $ 5,299  $ 4,787  $ 392  $ 1,657  $ 57,650 
Impact of adopting ASC 326 9,901  118  11,579  24,118  5,490  8,430  801  1,068  61,505 
Provision for credit losses 23,331  1,044  4,996  28,922  (1,454) (236) 78  357  57,038 
Loans charged off (3,840) (852) 0  (5,830) (285) (1,155) (127) (716) (12,805)
Recoveries 2,540  6  14  1,418  236  704  93  145  5,156 
Total net charge-offs (1,300) (846) 14  (4,412) (49) (451) (34) (571) (7,649)
Ending allowance for credit losses $ 50,516  $ 1,287  $ 18,970  $ 72,207  $ 9,286  $ 12,530  $ 1,237  $ 2,511  $ 168,544 
  Nine months ended September 30, 2019
(Dollars in thousands) Commercial & industrial Lease financing Construction real estate Commercial real estate Residential real estate Home equity Installment Credit card Total
Allowance for credit losses:                
Balance at beginning of period $ 18,746  $ 1,130  $ 3,413  $ 21,048  $ 4,964  $ 5,348  $ 362  $ 1,531  $ 56,542 
Provision for credit losses 22,164  (25) (714) 1,966  841  427  49  1,261  25,969 
Loans charged off (23,757) (100) 0  (1,835) (510) (1,784) (192) (1,228) (29,406)
Recoveries 1,087  0  68  674  201  1,092  202  123  3,447 
Total net charge-offs (22,670) (100) 68  (1,161) (309) (692) 10  (1,105) (25,959)
Ending allowance for credit losses $ 18,240  $ 1,005  $ 2,767  $ 21,853  $ 5,496  $ 5,083  $ 421  $ 1,687  $ 56,552 

The ACL balance and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2019 was as follows:
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As of December 31, 2019
(Dollars in thousands) Commercial & industrial Lease financing Construction real estate Commercial real estate Residential real estate Home equity Installment Credit card Total
Ending allowance balance attributable to loans
Individually evaluated for impairment $ 2,044  $ 0  $ 0  $ 113  $ 18  $ 0  $ 0  $ 0  $ 2,175 
Collectively evaluated for impairment 16,540  971  2,381  23,466  5,281  4,787  392  1,657  55,475 
Ending allowance for credit losses $ 18,584  $ 971  $ 2,381  $ 23,579  $ 5,299  $ 4,787  $ 392  $ 1,657  $ 57,650 
Loans                
Individually evaluated for impairment $ 27,480  $ 223  $ 0  $ 10,831  $ 15,162  $ 5,700  $ 204  $ 0  $ 59,600 
Collectively evaluated for impairment 2,438,397  88,141  493,182  4,183,820  1,040,787  766,169  82,385  49,184  9,142,065 
Total loans $ 2,465,877  $ 88,364  $ 493,182  $ 4,194,651  $ 1,055,949  $ 771,869  $ 82,589  $ 49,184  $ 9,201,665 

Allowance for credit losses - unfunded commitments. First Financial estimates expected credit losses over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life consistent with the Company's ACL methodology for loans and leases.

Prior to the adoption of ASC 326, First Financial maintained its reserve to absorb probable losses incurred in standby letters of credit and outstanding loan commitments. First Financial determined the adequacy of this reserve based upon an evaluation of the unfunded credit facilities, which included consideration of historical commitment utilization experience, credit risk ratings and historical loss rates, consistent with the Company's ALLL methodology at the time.

The ACL on unfunded commitments was $14.8 million as of September 30, 2020 and $0.6 million as of December 31, 2019. Additionally, First Financial recorded $1.9 million of provision recapture related to the allowance for credit losses on unfunded commitments for the three months ended September 30, 2020. However, First Financial recorded a provision for credit losses on unfunded commitments of $2.0 million for the nine months ended September 30, 2020. First Financial recorded $0.2 million and $0.3 million of provision recapture for unfunded commitments in three and nine month periods ended September 30, 2019, respectively.

NOTE 6:  GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill. Assets and liabilities acquired in a business combination are recorded at their estimated fair values as of the acquisition date. The excess of the purchase price of the acquisition over the fair value of net assets acquired is recorded as goodwill.

Changes in the carrying amount of goodwill for the three and nine months ended September 30, 2020 and September 30, 2019 were as follows:
Three months ended Nine months ended
September 30, September 30,
(Dollars in thousands) 2020 2019 2020 2019
Balance at beginning of period $ 937,771  $ 879,727  $ 937,771  $ 880,251 
Goodwill resulting from business combinations 0  57,962  0  57,438 
Balance at end of period $ 937,771  $ 937,689  $ 937,771  $ 937,689 

During the third quarter of 2019, First Financial recorded $58.0 million of additions to goodwill resulting from the Bannockburn acquisition. In the first quarter of 2019, First Financial recorded its final adjustments to goodwill related to the 2018 MSFG merger. For further detail on the acquisition of Bannockburn, see Note 17 - Business Combinations.

Goodwill is evaluated for impairment on an annual basis as of October 1 of each year, or whenever events or changes in circumstances indicate that the fair value of a reporting unit may be below its carrying value.  In response to the COVID-19 pandemic and the related deterioration in general economic conditions, First Financial performed an interim qualitative impairment test as of September 30, 2020. The results of this interim qualitative test did not indicate that the Company's goodwill was impaired as of September 30, 2020. First Financial will continue to monitor the status of its goodwill and
26
intangible assets for signs of further deterioration and potential impairment. First Financial performed its annual impairment test as of October 1, 2019 and no impairment was indicated at that time.

Other intangible assets. Other intangible assets consist primarily of core deposit, customer list and other miscellaneous intangibles.

Core deposit intangibles represent the estimated fair value of acquired customer deposit relationships on the date of acquisition and are amortized on an accelerated basis over their estimated useful lives. First Financial's core deposit intangibles have an estimated weighted average remaining life of 7.3 years.

First Financial recorded a $39.4 million customer list intangible asset in conjunction with the Bannockburn merger to account for the obligation or advantage on the part of either the Company or the customer to continue the pre-existing relationship subsequent to the merger. The customer list intangible asset is amortized on a straight-line basis over its estimated useful life of 11 years.

Other miscellaneous intangibles include purchase commissions, non-compete agreements and trade name intangibles. Other intangible assets are included in Other intangibles in the Consolidated Balance Sheets.  

Amortization expense recognized on intangible assets for the three months ended September 30, 2020 and 2019 were $2.8 million and $2.4 million, respectively. Amortization expense recognized on intangible assets for the nine months ended September 30, 2020 and 2019 was $8.4 million and $6.5 million, respectively.

The gross carrying amount and accumulated amortization of other intangible assets at September 30, 2020 and December 31, 2019 were as follows:
(Dollars in thousands) September 30, 2020 December 31, 2019
Gross
carrying
amount 		Accumulated
amortization 		Gross
carrying
amount 		Accumulated
amortization
Amortized intangible assets
Core deposit intangibles $ 51,031  $ (25,930) $ 51,031  $ (21,149)
Customer list 39,420  (3,883) 39,420  (1,195)
Other 10,093  (3,312) 10,093  (1,999)
Total $ 100,544  $ (33,125) $ 100,544  $ (24,343)

NOTE 7:  LEASES

A lease is defined as a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. First Financial is primarily the lessee in its leasing agreements, and substantially all of those agreements are for real estate property for branches, ATM locations or office space.

On January 1, 2019, the Company adopted Topic 842 and all subsequent modifications. For First Financial, this adoption primarily affected the accounting treatment for operating lease agreements in which the Company is the lessee. Substantially all of the Company's leases are classified as operating leases, and therefore, were previously not recognized on the Company’s Consolidated Balance Sheets.

With the adoption of Topic 842, operating lease agreements were required to be recognized on the Consolidated Balance Sheets as an ROU asset and a corresponding lease liability. The Company's right to use an asset over the life of a lease is recorded as a "right of use" asset in Accrued interest and other assets on the Consolidated Balance Sheets and was $67.2 million and $58.6 million at September 30, 2020 and December 31, 2019, respectively. Certain adjustments to the ROU asset may be required for items such as initial direct costs paid or incentives received. First Financial recorded a $74.9 million and $64.3 million lease liability in Accrued interest and other liabilities on the Consolidated Balance Sheet at September 30, 2020 and December 31, 2019, respectively.

The calculated amount of the ROU assets and lease liabilities are impacted by the length of the lease term and the discount rate used to calculate the present value of minimum lease payments. Regarding the discount rate, Topic 842 requires the use of the rate implicit in the lease whenever this rate is readily determinable. As this rate is rarely determinable, the Company utilizes its
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incremental borrowing rate at lease inception, on a collateralized basis, over a similar term. For operating leases existing prior to January 1, 2019, the rate was based upon the remaining lease term as of that date.

Leases with an initial term of 12 months or less are not recorded on the balance sheet, and First Financial recognizes lease expense for these leases on a straight-line basis over the term of the lease. Most leases include one or more options to renew, with renewal terms that can extend the lease term from one to 20 years or more. The exercise of renewal options on operating leases is at the Company's sole discretion, and certain leases may include options to purchase the leased property. If at lease inception, the Company considers the exercising of a renewal option to be reasonably certain, the Company will include the extended term in the calculation of the ROU asset and lease liability. First Financial does not enter into lease agreements which contain material residual value guarantees or material restrictive covenants.

Certain leases provide for increases in future minimum annual rental payments as defined in the lease agreements and leases generally also include real estate taxes and common area maintenance charges in the annual rental payments.

The components of lease expense were as follows:
Three months ended Nine months ended
September 30, September 30,
(Dollars in thousands) 2020 2019 2020 2019
Operating lease cost $ 1,972  $ 1,846  $ 5,973  $ 5,494 
Short-term lease cost 30  14  111  15 
Variable lease cost 632  688  1,899  1,918 
Total operating lease cost $ 2,634  $ 2,548  $ 7,983  $ 7,427 

Future minimum commitments due under these lease agreements as of September 30, 2020 are as follows:
(Dollars in thousands) Operating leases
2020 (remaining three months) $ 1,767 
2021 7,116 
2022 7,283 
2023 7,312 
2024 7,045 
Thereafter 64,700 
Total lease payments 95,223 
Less imputed interest 20,316 
Total $ 74,907 

The weighted average remaining lease term and discount rate for the Company's operating leases were as follows:
September 30, 2020 December 31, 2019
Operating leases
Weighted-average remaining lease term 15.1 years 15.6 years
Weighted-average discount rate 3.10  % 3.43  %

Supplemental cash information at September 30, 2020 and 2019 related to leases was as follows:
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Three months ended Nine months ended
September 30, September 30,
(Dollars in thousands) 2020 2019 2020 2019
Cash paid for amounts included in the measurement of lease liabilities  
Operating cash flows from operating leases $ 1,928  $ 1,893  $ 5,801  $ 5,652 
ROU assets obtained in exchange for lease obligations
Operating leases 29  582  9,688  65,520 

NOTE 8:  BORROWINGS

Short-term borrowings on the Consolidated Balance Sheets include repurchase agreements utilized for corporate sweep accounts with cash management account agreements in place, federal funds purchased and overnight advances from the FHLB. All repurchase agreements are subject to terms and conditions agreed to by the Bank and the client. To secure its liability to the client, the Bank is authorized to sell or repurchase U.S. Treasury, government agency and mortgage-backed securities.

The following shows the remaining contractual maturity of repurchase agreements by collateral pledged:
(Dollars in thousands) Overnight and continuous
Repurchase agreements
Mortgage-backed securities $ 29,096 
Collateralized mortgage obligations 85,562 
Total $ 114,658 

Securities sold under agreements to repurchase were secured by securities with a carrying amount of $114.7 million and $90.2 million as of September 30, 2020 and December 31, 2019, respectively.

First Financial had $133.0 million federal funds purchased at September 30, 2020 and $165.2 million as of December 31, 2019. The Company had no short-term borrowings with the FHLB at September 30, 2020 and had $1.2 billion at December 31, 2019. These short-term borrowings are used to manage normal liquidity needs and support the Company's asset and liability management strategies.

First Financial had $1.3 billion and $414.4 million of long-term debt as of September 30, 2020 and December 31, 2019, respectively, which included FRB borrowings, subordinated notes, FHLB long term advances and an interest free loan with a municipality.

During the third quarter of 2020 First Financial participated in the PPPLF, which is a program created by the FRB to extend credit to eligible financial institutions that originate PPP loans. The bank had outstanding PPPLF advances of $881.7 million as of September 30, 2020, with an average interest rate of 35 basis points. These borrowings are secured by pledged PPP loans and prepay in conjunction with reductions in the principal balances of those loans.

The following is a summary of First Financial's long-term debt:
  September 30, 2020 December 31, 2019
(Dollars in thousands) Amount Average rate Amount Average rate
FRB borrowings $ 881,672  0.35  % $ 0  N/A
FHLB borrowings 138,424  1.69  % 242,428  1.94  %
Subordinated notes 321,280  4.86  % 170,967  4.97  %
Unamortized debt issuance costs (2,866) N/A (1,007) N/A
Lease liability 1,879  3.81  % 1,213  4.48  %
Capital loan with municipality 775  0.00  % 775  0.00  %
Total long-term debt $ 1,341,164  1.57  % $ 414,376  3.20  %

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In April 2020, First Financial issued $150.0 million of fixed to floating rate subordinated notes. The subordinated notes have an initial fixed interest rate of 5.25% to, but excluding, May 15, 2025, payable semi-annually in arrears. From, and including, May 15, 2025, the interest rate on the subordinated notes will reset quarterly to a floating rate per annum equal to a benchmark rate, which is expected to be the then-current three-month term SOFR, plus 5 basis points, payable quarterly in arrears. The subordinated notes mature on May 15, 2030. These notes are redeemable by the Company in whole or in part beginning with the interest payment date of May 15, 2025.

In 2015, First Financial issued $120.0 million of subordinated notes, which have a fixed interest rate of 5.125% payable semiannually and mature in August 2025. These notes are not redeemable by the Company, or callable by the holders of the notes prior to maturity. In addition, First Financial acquired $49.5 million of variable rate subordinated notes in the MSFG merger that were issued to previously formed trusts in exchange for the trust proceeds. Interest on the acquired subordinated notes is payable quarterly, in arrears, and the Company has the option to defer interest payments for a period not to exceed 20 consecutive quarters. These acquired subordinated notes mature 30 years after the date of original issuance and may be called at par following the 5 year anniversary of issuance. First Financial also acquired $8.4 million of 6.00% fixed rate private placement subordinated debt in conjunction with the MSFG merger that was issued in 2015 and matures in 2025. These notes are redeemable by the Company at par following the 5 year anniversary of issuance. The subordinated notes are treated as Tier 2 capital for regulatory capital purposes and are included in Long-term debt on the Consolidated Balance Sheets.

In addition to subordinated notes, long-term debt included $138.4 million and $242.4 million of fixed rate FHLB long-term advances as of September 30, 2020 and December 31, 2019, respectively. As of September 30, 2020, long-term FHLB advances had a weighted average interest rate of 1.69%. These instruments are primarily utilized to reduce overnight liquidity risk and to mitigate interest rate sensitivity on the Consolidated Balance Sheets.

NOTE 9:  ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

Shareholders’ equity is affected by transactions and valuations of asset and liability positions that require adjustments to accumulated other comprehensive income (loss).  The related tax effects allocated to other comprehensive income and reclassifications out of accumulated other comprehensive income (loss) are as follows:
  Three months ended September 30, 2020
  Total other comprehensive income (loss) Total accumulated other
comprehensive income (loss)
(Dollars in thousands) Prior to
reclass 		Reclass
from 		Pre-tax Tax effect Net of tax Beginning balance Net activity Ending balance
Unrealized gain (loss) on debt securities $ 6,931  $ 2  $ 6,929  $ (1,495) $ 5,434  $ 63,691  $ 5,434  $ 69,125 
Retirement obligation 0  (519) 519  (118) 401  (27,260) 401  (26,859)
Total $ 6,931  $ (517) $ 7,448  $ (1,613) $ 5,835  $ 36,431  $ 5,835  $ 42,266 
  Three months ended September 30, 2019
  Total other comprehensive income (loss) Total accumulated other
comprehensive income (loss)
(Dollars in thousands) Prior to
reclass 		Reclass
from 		Pre-tax Tax effect Net of tax Beginning balance Net activity Ending balance
Unrealized gain (loss) on debt securities $ 12,719  $ 105  $ 12,614  $ (2,699) $ 9,915  $ 37,320  $ 9,915  $ 47,235 
Unrealized gain (loss) on derivatives 94  0  94  (21) 73  (73) 73  0 
Retirement obligation 0  (347) 347  (78) 269  (32,054) 269  (31,785)
Total $ 12,813  $ (242) $ 13,055  $ (2,798) $ 10,257  $ 5,193  $ 10,257  $ 15,450 
  Nine months ended September 30, 2020
  Total other comprehensive income (loss) Total accumulated
other comprehensive income (loss)
(Dollars in thousands) Prior to
reclass 		Reclass
from 		Pre-tax Tax effect Net of tax Beginning balance Net activity Ending balance
Unrealized gain (loss) on debt securities $ 35,474  $ (55) $ 35,529  $ (7,668) $ 27,861  $ 41,264  $ 27,861  $ 69,125 
Retirement obligation 0  (1,401) 1,401  (319) 1,082  (27,941) 1,082  (26,859)
Total $ 35,474  $ (1,456) $ 36,930  $ (7,987) $ 28,943  $ 13,323  $ 28,943  $ 42,266 
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  Nine months ended September 30, 2019
  Total other comprehensive income (loss) Total accumulated
other comprehensive income (loss)
(Dollars in thousands) Prior to
reclass 		Reclass
from 		Pre-tax Tax effect Net of tax Beginning balance Net activity Cumulative effect of new standard Ending balance
Unrealized gain (loss) on debt securities $ 73,588  $ (110) $ 73,698  $ (15,768) $ 57,930  $ (11,601) $ 57,930  $ 906  $ 47,235 
Unrealized gain (loss) on derivatives 281  0  281  (64) 217  (217) 217  0  0 
Retirement obligation 0  (1,042) 1,042  (237) 805  (32,590) 805  0  (31,785)
Total $ 73,869  $ (1,152) $ 75,021  $ (16,069) $ 58,952  $ (44,408) $ 58,952  $ 906  $ 15,450 

The following table presents the activity reclassified from accumulated other comprehensive income into income during the three and nine month periods ended September 30, 2020 and 2019, respectively:
Amount reclassified from
accumulated other comprehensive income (loss)
Three months ended Nine months ended
September 30, September 30,
(Dollars in thousands) 2020 2019 2020 2019 Affected Line Item in the Consolidated Statements of Income
Realized gain (loss) on securities available-for-sale $ 2  $ 105  $ (55) $ (110) Net gain (loss) on sales of investments securities
Defined benefit pension plan
Amortization of prior service cost (1)
106  104  308  310  Other noninterest expense
Recognized net actuarial loss (1)
(625) (451) (1,709) (1,352) Other noninterest expense
Defined benefit pension plan total (519) (347) (1,401) (1,042)
Total reclassifications for the period, before tax $ (517) $ (242) $ (1,456) $ (1,152)
(1) Included in the computation of net periodic pension cost (see Note 13 - Employee Benefit Plans for additional details).

NOTE 10:  DERIVATIVES

First Financial uses certain derivative instruments, including interest rate caps, floors, swaps and foreign exchange contracts, to meet the needs of its clients while managing the interest and currency rate risk associated with certain transactions.  First Financial may also utilize interest rate swaps to manage the interest rate risk profile of the Company. Interest rate payments are exchanged with counterparties, based on the notional amount established in the interest rate agreement. As only interest rate payments are exchanged, the cash requirements and credit risk associated with interest rate swaps are significantly less than the notional amount and the Company’s credit risk exposure is limited to the market value of the instruments. First Financial does not use derivatives for speculative purposes.

First Financial manages market value credit risk through counterparty credit policies including a review of total derivative notional position to total assets, total credit exposure to total capital and counterparty credit exposure risk.

Client derivatives. First Financial utilizes interest rate swaps as a means to offer commercial borrowers fixed rate funding while providing the Company with floating rate assets.

At September 30, 2020, for the interest rate derivatives, the Company had a total counterparty notional amount outstanding of $2.2 billion, spread among nineteen counterparties, with an estimated fair value of $206.2 million. At December 31, 2019, the Company had interest rate derivatives with a total counterparty notional amount outstanding of $1.9 billion, spread among eighteen counterparties, with an estimated fair value of $67.5 million.

First Financial monitors its derivative credit exposure to borrowers by monitoring the creditworthiness of the related loan customers through the Company's normal credit review processes. Additionally, the Company's ACL Committee monitors derivative credit risk exposure related to problem loans through the Company's ACL committee. First Financial considers the market value of a derivative instrument to be part of the carrying value of the related loan for these purposes as the borrower is contractually obligated to pay First Financial this amount in the event the derivative contract is terminated.
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In connection with its use of derivative instruments, First Financial and its counterparties may be required to post cash collateral to offset the market position of the derivative instruments. First Financial maintains the right to offset these derivative positions with the collateral posted against them by or with the relevant counterparties.

Foreign exchange contracts. First Financial may enter into foreign exchange derivative contracts for the benefit of commercial customers to hedge their exposure to foreign currency fluctuations. Similar to the hedging of interest rate risk from interest rate derivative contracts, First Financial also enters into foreign exchange contracts with major financial institutions to economically hedge a substantial portion of the exposure from client driven foreign exchange activity. These derivatives are classified as free-standing instruments with the revaluation gain or loss recorded in Foreign exchange income in the Consolidated Statements of Income. The Company has risk limits and internal controls in place to help ensure excessive risk is not being taken in providing this service to customers. These controls include an independent determination of currency volatility and credit equivalent exposure on these contracts, counterparty credit approvals and country limits performed by independent risk management. At September 30, 2020, the Company had total counterparty notional amount outstanding of $3.1 billion spread among six counterparties, with an estimated fair value of $0.7 million. At December 31, 2019, the Company had total counterparty notional amounts outstanding of $1.9 billion spread among six counterparties, with an estimated fair value of $18.3 million.

In connection with its use of foreign exchange contracts, First Financial and its counterparties may be required to post cash collateral to offset the market position of the derivative instruments. First Financial maintains the right to offset these derivative positions with the collateral posted against them by or with the relevant counterparties.

The following table details the classification and amounts of client derivatives and foreign exchange contracts recognized in the Consolidated Balance Sheets:
  
  September 30, 2020 December 31, 2019
  Estimated fair value Estimated fair value
(Dollars in thousands) Balance sheet classification Notional
amount 		Gain Loss Notional
amount 		Gain Loss
Client derivatives - instruments associated with loans            
Matched interest rate swaps with borrower Accrued interest and other assets $ 2,246,698  $ 208,296  $ (1) $ 1,923,375  $ 70,799  $ (2,636)
Matched interest rate swaps with counterparty Accrued interest and other liabilities 2,246,698  1  (208,403) 1,923,375  2,636  (70,808)
Foreign exchange contracts
Matched foreign exchange contracts with customers
Accrued interest and other assets 3,085,637  35,888  (36,545) 1,869,934  28,739  (10,433)
Match foreign exchange contracts with counterparty
Accrued interest and other liabilities 3,085,637  36,545  (35,888) 1,869,934  10,433  (28,739)
Total   $ 10,664,670  $ 280,730  $ (280,837) $ 7,586,618  $ 112,607  $ (112,616)

The following table discloses the gross and net amounts of client derivatives and foreign exchange contacts recognized in the Consolidated Balance Sheets:
September 30, 2020 December 31, 2019
(Dollars in thousands) Gross amounts of recognized liabilities Gross amounts offset in the Consolidated Balance Sheets Net amounts of liabilities (assets) presented in the Consolidated Balance Sheets Gross amounts of recognized liabilities Gross amounts offset in the Consolidated Balance Sheets Net amounts of liabilities (assets) presented in the Consolidated Balance Sheets
Client derivatives
Matched interest rate swaps with counterparty $ 208,404  $ (425,946) $ (217,542) $ 73,444  $ (147,193) $ (73,749)
Foreign exchange contracts with counterparty 72,433  (38,686) 33,747  39,172  (41,202) (2,030)
Total $ 280,837  $ (464,632) $ (183,795) $ 112,616  $ (188,395) $ (75,779)

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The following table details the derivative financial instruments, the average remaining maturities and the weighted-average interest rates being paid and received by First Financial at September 30, 2020:
(Dollars in thousands) Notional
amount 		Average
maturity
(years) 		Fair
value
Client derivatives-interest rate contracts      
Receive fixed, matched interest rate swaps with borrower $ 2,246,698  5.2 $ 208,295 
Pay fixed, matched interest rate swaps with counterparty 2,246,698  5.2 (208,402)
Client derivatives-foreign exchange contracts
Foreign exchange contracts-pay USD
$ 3,085,637  0.5 (657)
Foreign exchange contracts-receive USD
$ 3,085,637  0.5 657 
Total client derivatives $ 10,664,670  2.5 $ (107)

Credit derivatives. 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. The total notional value of these agreements totaled $235.0 million as of September 30, 2020 and $216.2 million as of December 31, 2019. The fair value of these agreements is recorded in Accrued interest and other liabilities on the Consolidated Balance Sheets and was $0.4 million at September 30, 2020 and $0.2 million at December 31, 2019.

Mortgage derivatives. 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 IRLCs with First Financial and the loans are 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. At September 30, 2020, the notional amount of the IRLCs was $158.1 million and the notional amount of forward commitments was $153.0 million. As of December 31, 2019, the notional amount of IRLCs was $33.4 million and the notional amount of forward commitments was $37.8 million. The unrealized gain on these agreements was $1.1 million and $0.9 million at September 30, 2020 and December 31, 2019, respectively, and were recorded in accrued interest and other assets on the Consolidated Balance Sheets.

NOTE 11:  COMMITMENTS AND CONTINGENCIES

First Financial offers a variety of financial instruments including loan commitments and letters of credit to assist clients in meeting their requirement for liquidity and credit enhancement. GAAP does not require these financial instruments to be recorded in the Consolidated Financial Statements.

First Financial utilizes the same credit policies in issuing commitments and conditional obligations as it does for credit instruments recorded on the Consolidated Balance Sheets. First Financial’s exposure to credit loss in the event of non-performance by the counterparty was represented by the contractual amounts of those instruments. Effective January 1, 2020, First Financial adopted ASC 326, at which time First Financial estimated expected credit losses over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life consistent with the Company's ACL methodology for loans and leases. Adjustments to the reserve for unfunded commitments are recorded in Provision for credit losses - unfunded commitments in the Consolidated Statements of Income. First Financial had $14.8 million of ACL for unfunded commitments recorded in Accrued interest and other liabilities on the Consolidated Balance Sheets as of September 30, 2020.

Prior to the adoption of ASC 326, First Financial maintained its reserve to absorb probable losses incurred in standby letters of credit and outstanding loan commitments. First Financial determined the adequacy of this reserve based upon an evaluation of the unfunded credit facilities, which included consideration of historical commitment utilization experience, credit risk ratings and historical loss rates, consistent with the Company's ALLL methodology at the time. First Financial had $0.6 million of reserves for unfunded commitments recorded in Accrued interest and other liabilities on the Consolidated Balance Sheets at December 31, 2019.

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Loan commitments. Loan commitments are agreements to extend credit to a client, absent any violation of conditions established in the commitment agreement.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments will expire without being fully drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The amount of collateral obtained, if deemed necessary by First Financial upon extension of credit, is based on management’s credit evaluation of the client.  The collateral held varies, but may include securities, real estate, inventory, plant or equipment.  First Financial had commitments outstanding to extend credit totaling $3.5 billion at September 30, 2020 and $3.3 billion at December 31, 2019. As of September 30, 2020, loan commitments with a fixed interest rate totaled $128.8 million while commitments with variable interest rates totaled $3.4 billion. At December 31, 2019, loan commitments with a fixed interest rate totaled $123.7 million while commitments with variable interest rates totaled $3.2 billion. First Financial's fixed rate loan commitments have interest rates ranging from 0.00% to 21.00% for both September 30, 2020 and December 31, 2019 and have maturities ranging from less than one year to 30.0 years for September 30, 2020 and less than one year to 31.6 years for December 31, 2019.

The following table presents by type First Financial's active loan balances and related obligations to extend credit as of September 30, 2020.
(dollars in thousands) Unfunded commitment Loan balance
Commercial & industrial $ 1,287,307  $ 3,292,313 
Lease financing 0 74,742
Construction real estate 404,441 575,648
Commercial real estate-investor 142,502 3,263,213
Commercial real estate-owner 47,943 1,083,912
Residential real estate 31,513 1,027,702
Home equity 750,994 754,743
Installment 20,138 84,629
Credit card 204,527 43,907
Total $ 2,889,365  $ 10,200,809 

Letters of credit. Letters of credit are conditional commitments issued by First Financial to guarantee the performance of a client to a third party.  First Financial’s letters of credit consist of performance assurances made on behalf of clients who have a contractual commitment to produce or deliver goods or services.  The risk to First Financial arises from its obligation to make payment in the event of the client's contractual default to produce the contracted good or service to a third party.  First Financial issued letters of credit aggregating $37.6 million and $33.4 million at September 30, 2020 and December 31, 2019, respectively. Management conducts regular reviews of these instruments on an individual client basis.

Investments in affordable housing tax credits. First Financial has made investments in certain qualified affordable housing tax credits. These credits are indirect federal subsidies that provide tax incentives to encourage investment in the acquisition, development, and rehabilitation of affordable rental housing, and allow investors to claim tax credits and other tax benefits (such as deductions from taxable income for operating losses) on their federal income tax returns. The principal risk associated with qualified affordable housing investments is the potential for noncompliance with the tax code requirements, such as failure to rent property to qualified tenants, resulting in the unavailability or recapture of the tax credits and other tax benefits. Investments in affordable housing projects are accounted for under the proportional amortization method and are included in Accrued interest and other assets in the Consolidated Balance Sheets.

First Financial's affordable housing commitments totaled $43.5 million and $38.5 million as of September 30, 2020 and December 31, 2019, respectively. The Company recognized tax credits of $1.8 million and $1.6 million for the three months ended September 30, 2020 and 2019, respectively. First Financial recognized tax credits of $5.5 million and $4.8 million for the nine months ended September 30, 2020 and 2019, respectively. The Company recognized amortization expense, which was included in income tax expense, of $2.0 million and $1.6 million for the three months ended September 30, 2020 and 2019, respectively, and $6.1 million and $5.4 million for the nine months ended September 30, 2020 and 2019, respectively. First Financial had no affordable housing contingent commitments as of September 30, 2020 or December 31, 2019.

Investments in historic tax credits. First Financial has noncontrolling financial investments in private investment funds and partnerships which are not consolidated. These investments may generate a return through the realization of federal and state income tax credits, as well as other tax benefits, such as tax deductions from net operating losses of the investments over a period of time. Investments in historic tax credits are accounted for under the equity method of accounting and are carried in
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Accrued interest and other assets on the Consolidated Balance Sheets. The Company’s recorded investment in these entities was approximately $3.8 million at September 30, 2020 and $3.1 million at December 31, 2019. The maximum exposure to loss related to these investments was $4.1 million at September 30, 2020 and $5.1 million at December 31, 2019, representing the Company’s investment balance and its unfunded commitments to invest additional amounts. Investments in historic tax credits resulted in $0.1 million of tax credits for the three months ended September 30, 2020 and were insignificant for the three months ended September 30, 2019. Investments in historic tax credits resulted in $0.3 million of tax credits for the nine months ended September 30, 2020 and $0.1 million for the nine months ended September 30, 2019.

Contingencies/Litigation. First Financial and its subsidiaries are engaged in various matters of litigation from time to time, and have a number of unresolved claims pending. Additionally, as part of the ordinary course of business, First Financial and its subsidiaries are parties to litigation involving claims to the ownership of funds in particular accounts, the collection of delinquent accounts, challenges to security interests in collateral and foreclosure interests that are incidental to our regular business activities. While the ultimate liability with respect to these litigation matters and claims cannot be determined at this time, First Financial believes that damages, if any, and other amounts relating to pending matters are not probable or cannot be reasonably estimated as of September 30, 2020. Reserves are established for these various matters of litigation when appropriate under FASB ASC Topic 450, Contingencies, based in part upon the advice of legal counsel. First Financial had no reserves related to litigation matters as of September 30, 2020 or December 31, 2019.

NOTE 12:  INCOME TAXES

For the third quarter of 2020, income tax expense was $9.3 million, resulting in an effective tax rate of 18.3% compared with income tax expense of $12.4 million and an effective tax rate of 19.6% for the comparable period in 2019. The decrease in the effective tax rate in the third quarter of 2020 compared to the same period in 2019 is due to lower pre-tax income in the third quarter of 2020 as well as higher executive compensation in 2019. For the first nine months of 2020, income tax expense was $23.2 million, resulting in an effective tax rate of 17.8% compared with income tax expense of $35.5 million and an effective tax rate of 19.2% for the comparable period in 2019. The decrease in the year-to-date effective tax rate is primarily due to lower pre-tax income in the first nine months of 2020 and the carryback of certain net operating losses as allowed under the CARES Act. These adjustments were partially offset by an unfavorable impact related to stock compensation activity in 2020.

At September 30, 2020 and December 31, 2019, First Financial had $1.9 million and $2.4 million, respectively, of unrecognized tax benefits, as determined under FASB ASC Topic 740-10, Income Taxes, that if recognized would favorably impact the effective income tax rate in future periods. The unrecognized tax benefits relate to state income tax exposures from taking tax positions where the Company believes it is likely that, upon examination, a state may take a position contrary to the position taken by First Financial. The Company believes that resolution regarding our uncertain tax positions is reasonably possible within the next twelve months and could result in full, partial or no recognition of the benefit. First Financial recognizes interest accrued related to unrecognized tax benefits and penalties as income tax expense. At September 30, 2020 and December 31, 2019, the Company had no interest or penalties recorded.

First Financial and its subsidiaries are subject to U.S. federal income tax as well as state and local income tax in several jurisdictions.  Tax years prior to 2017 have been closed and are no longer subject to U.S. federal income tax examinations. Tax years 2017 through 2019 remain open to examination by the federal taxing authority.

First Financial is no longer subject to state and local income tax examinations for years prior to 2012.  Tax years 2012 through 2019 remain open to state and local examination in various jurisdictions.

NOTE 13:  EMPLOYEE BENEFIT PLANS

First Financial sponsors a non-contributory defined benefit pension plan which covers substantially all employees and uses a December 31 measurement date for the plan. Plan assets are primarily invested in fixed income and publicly traded equity mutual funds. The pension plan does not directly own any shares of First Financial common stock or any other First Financial security or product.

First Financial made no cash contributions to fund the pension plan during the nine months ended September 30, 2020, or the year ended December 31, 2019, and does not expect to make cash contributions to the plan through the remainder of 2020.

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As a result of the plan’s actuarial projections, First Financial recorded expense as set forth in the following table. The amounts are recognized in First Financial’s Consolidated Statements of Income related to the Company's pension plan.
Three months ended Nine months ended
September 30, September 30,
(Dollars in thousands) 2020 2019 2020 2019
Service cost $ 2,079  $ 1,649  $ 5,855  $ 4,944 
Interest cost 624  694  1,831  2,083 
Expected return on assets (2,443) (2,429) (7,382) (7,288)
Amortization of prior service cost (106) (104) (308) (310)
Net actuarial loss 625  451  1,709  1,352 
     Net periodic benefit cost (income) $ 779  $ 261  $ 1,705  $ 781 

NOTE 14:  REVENUE RECOGNITION

The majority of the Company’s revenues come from sources that are outside of the scope of ASU 2014-09, Revenue from Contracts with Customers. Income sources that are outside of this standard include income earned on loans, leases, securities, derivatives and foreign exchange. The Company's services that fall within the scope of ASU 2014-09 are presented within Noninterest income and are recognized as revenue when the Company satisfies its obligation to the customer. Services within the scope of this guidance include service charges on deposits, trust and wealth management fees, bankcard income, gain/loss on the sale of OREO and investment brokerage fees.

Service charges on deposit accounts. The Company earns revenues from its deposit customers for transaction-based fees, account maintenance fees and overdraft fees. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering and ACH fees, are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer's request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Similarly, overdraft fees are recognized at the point in time that the overdraft occurs as this corresponds with the Company's performance obligation. Service charges on deposit accounts are withdrawn from the customer's deposit account.

Trust and wealth management fees. Trust and wealth management fees are primarily asset-based, but can also include flat fees based upon a specific service rendered, such as tax preparation services. The Company’s performance obligation is generally satisfied over time and the resulting fees are recognized monthly, based upon the month-end market value of the assets under management and the applicable fees. The Company does not earn performance-based incentives. Optional services such as real estate sales and tax return preparation services are also available to existing trust and wealth management customers. The Company’s performance obligation for these transactional-based services is generally satisfied, and related revenue recognized, as incurred.

Bankcard income. The Company earns interchange fees from cardholder transactions conducted through the Visa payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized concurrent with the transaction processing services provided to the cardholder. Interchange income is presented on the Consolidated Statements of Income net of expenses. Gross interchange income for the third quarter of 2020 was $6.3 million, which was partially offset by $3.1 million of expenses within Noninterest income. Gross interchange income for the third quarter of 2019 was $6.3 million, which was partially offset by $3.0 million of expenses. Gross interchange income for the first nine months of 2020 was $17.6 million, which was partially offset by $8.9 million of expenses within Noninterest income. Gross interchange income for the first nine months of 2019 was $24.2 million, which was partially offset by $8.8 million of expenses.

Other. Other noninterest income consists of other recurring revenue streams such as transaction fees, safe deposit rental income, insurance commissions, merchant referral income, gain (loss) on sale of OREO and brokerage revenue. Transaction fees primarily include check printing sales commissions, collection fees and wire transfer fees which arise from in-branch transactions. Safe deposit rental income arises from fees charged to the customer on an annual basis and recognized upon receipt of payment. Insurance commissions are agent commissions earned by the Company and earned upon the effective date of the bound coverage. Merchant referral income is associated with a program whereby the Company receives a share of processing revenue that is generated from clients that were referred by First Financial to the service provider. Revenue is recognized at the point in time when the transaction occurs.

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The Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of the executed deed. When the Company finances the sale of OREO to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectibility of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer.

Brokerage revenue represents fees from investment brokerage services provided to customers by a third party provider. The Company receives commissions from the third-party service provider on a monthly basis based upon customer activity for the month. The fees are recognized monthly and a receivable is recorded until commissions are paid the following month. Because the Company (i) acts as an agent in arranging the relationship between the customer and the third-party service provider and (ii) does not control the services rendered to the customers, investment brokerage fees are presented net of related costs.
NOTE 15:  EARNINGS PER COMMON SHARE

The following table sets forth the computation of basic and diluted earnings per common share:
Three months ended Nine months ended
September 30, September 30,
(Dollars in thousands, except per share data) 2020 2019 2020 2019
Numerator    
Net income available to common shareholders $ 41,477  $ 50,856  $ 107,498  $ 149,398 
Denominator
Weighted average shares outstanding for basic earnings per common share 97,247,080  98,517,025  97,400,942  98,177,802 
Effect of dilutive securities
Employee stock awards 761,653  560,698  716,521  545,371 
Adjusted weighted average shares for diluted earnings per common share 98,008,733  99,077,723  98,117,463  98,723,173 
Earnings per share available to common shareholders    
Basic $ 0.43  $ 0.52  $ 1.10  $ 1.52 
Diluted $ 0.42  $ 0.51  $ 1.10  $ 1.51 

If applicable, stock options and warrants with exercise prices greater than the average market price of the common shares are excluded from the computation of net income per diluted share, as they would be antidilutive.  Using the end of period price of the Company's common shares, there were no antidilutive options at September 30, 2020 and September 30, 2019.  

NOTE 16:  FAIR VALUE DISCLOSURES

The fair value framework as disclosed in the Fair Value Topic includes a hierarchy which focuses on prioritizing the inputs used in valuation techniques.  The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1), a lower priority to observable inputs other than quoted prices in active markets for identical assets and liabilities (Level 2) and the lowest priority to unobservable inputs (Level 3).  When determining the fair value measurements for assets and liabilities, First Financial looks to active markets to price identical assets or liabilities whenever possible and classifies such items in Level 1.  When identical assets and liabilities are not traded in active markets, First Financial looks to observable market data for similar assets and liabilities and classifies such items as Level 2.  Certain assets and liabilities are not actively traded in observable markets and First Financial must use alternative techniques, based on unobservable inputs, to determine the fair value and classifies such items as Level 3. The level within the fair value hierarchy is based on the lowest level of input that is significant in the fair value measurement.

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The estimated fair values of First Financial’s financial instruments not measured at fair value on a recurring or nonrecurring basis in the consolidated financial statements were as follows:
Carrying Estimated fair value
(Dollars in thousands) value Total Level 1 Level 2 Level 3
September 30, 2020
Financial assets
Cash and short-term investments $ 245,934  $ 245,934  $ 245,934  $ 0  $ 0 
Investment securities held-to-maturity 118,072  123,441  0  123,441  0 
Other investments 118,292  N/A N/A N/A N/A
Loans held for sale 69,008  69,008  0  69,008  0 
Loans and leases 10,032,265  9,953,876  0  0  9,953,876 
Accrued interest receivable 53,127  53,127  0  11,902  41,225 
Financial liabilities
Deposits 11,567,430  11,576,499  0  11,576,499  0 
Short-term borrowings 247,658  247,658  247,658  0  0 
Long-term debt 1,341,164  1,337,424  0  1,337,424  0 
Accrued interest payable 9,112  9,112  104  9,008  0 
Carrying Estimated fair value
(Dollars in thousands) value Total Level 1 Level 2 Level 3
December 31, 2019
Financial assets
Cash and short-term investments $ 257,639  $ 257,639  $ 257,639  $ 0  $ 0 
Investment securities held-to-maturity 142,862  142,821  0  142,821  0 
Other investments 125,020  N/A N/A N/A N/A
Loans held for sale 13,680  13,680  0  13,680  0 
Loans and leases 9,144,015  9,134,215  0  0  9,134,215 
Accrued interest receivable 39,591  39,591  0  12,743  26,848 
Financial liabilities
Deposits 10,210,229  10,209,790  0  10,209,790  0 
Short-term borrowings 1,316,181  1,316,181  1,316,181  0  0 
Long-term debt 414,376  414,937  0  414,937  0 
Accrued interest payable 13,671  13,671  1,899  11,772  0 

The following methods, assumptions and valuation techniques were used by First Financial to measure different financial assets and liabilities at fair value on a recurring or nonrecurring basis.

Investment securities. Investment securities classified as available-for-sale are recorded at fair value on a recurring basis.  Fair value measurement is based upon quoted market prices, when available (Level 1).  If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar investment securities.  First Financial compiles prices from various sources who may apply such techniques as matrix pricing to determine the value of identical or similar investment securities (Level 2).  Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for the specific investment securities but rather relying on the investment securities’ relationship to other benchmark quoted investment securities.  Any investment securities not valued based upon the methods previously described are considered Level 3.

First Financial utilizes values provided by third-party pricing vendors to price the investment securities portfolio in accordance with the fair value hierarchy of the Fair Value Topic and reviews the pricing methodologies utilized by the pricing vendors to ensure that the fair value determination is consistent with the applicable accounting guidance.  First Financial’s pricing process
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includes a series of quality assurance activities where prices are compared to recent market conditions, historical prices and other independent pricing services.  Further, the Company periodically validates the fair value of a sample of securities in the portfolio by comparing the fair values to prices from other independent sources for the same or similar securities.  First Financial analyzes unusual or significant variances, conducts additional research with the pricing vendor, and if necessary, takes appropriate action based on its findings.  The results of the quality assurance process are incorporated into the selection of pricing providers by the portfolio manager.

Derivatives. The fair values of derivative instruments are based primarily on a net present value calculation of the cash flows related to the interest rate swaps and foreign exchange contracts at the reporting date, using primarily observable market inputs such as interest rate yield curves which represents the cost to terminate the swap if First Financial should choose to do so. Additionally, First Financial utilizes an internally-developed model to value the credit risk component of derivative assets and liabilities, which is recorded as an adjustment to the fair value of the derivative asset or liability on the reporting date. Derivative instruments are classified as Level 2 in the fair value hierarchy.

Nonperforming loans. The fair value of nonperforming loans are specifically reviewed for purposes of determining the appropriate amount of impairment to be allocated to the ACL.  Fair value is generally measured based on the value of the collateral securing the loans.  Collateral may be in the form of real estate or business assets including equipment, inventory and accounts receivable.  The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed third-party appraiser (Level 3). The value of business equipment is based on an outside appraisal, if deemed significant, or the net book value on the applicable borrower financial statements.  Likewise, values for inventory and accounts receivable collateral are based on borrower financial statement balances or aging reports on a discounted basis as appropriate (Level 3).  Nonperforming loans are measured at fair value on a nonrecurring basis.  Any fair value adjustments are recorded in the period expected to occur as provision for credit losses on the Consolidated Statements of Income.

OREO. Assets acquired through loan foreclosure are recorded at fair value less costs to sell, with any difference between the fair value of the property and the carrying value of the loan recorded as a charge-off. If the fair value is higher than the carrying amount of the loan, the excess is recognized first as a recovery and then as noninterest income. Subsequent changes in value are reported as adjustments to the carrying amount and are recorded in noninterest expense. The carrying value of OREO is not re-measured to fair value on a recurring basis, but is subject to fair value adjustments when the carrying value differs from the fair value, less estimated selling costs. Fair value is based on recent real estate appraisals and is updated at least annually. The Company classifies OREO in level 3 of the fair value hierarchy.
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The financial assets and liabilities measured at fair value on a recurring basis in the consolidated financial statements were as follows:
  Fair value measurements using
(Dollars in thousands) Level 1 Level 2 Level 3 Assets/liabilities
at fair value
September 30, 2020
Assets        
Investment securities available-for-sale $ 103  $ 2,964,105  $ 40,755  $ 3,004,963 
Interest rate derivative contracts 0  208,443  0  208,443 
Foreign exchange derivative contracts 0  72,433  0  72,433 
Total $ 103  $ 3,244,981  $ 40,755  $ 3,285,839 
Liabilities        
Interest rate derivative contracts $ 0  $ 209,401  $ 0  $ 209,401 
Foreign exchange derivative contracts 0  72,433  0  72,433 
Total $ 0  $ 281,834  $ 0  $ 281,834 

  Fair value measurements using
(Dollars in thousands) Level 1 Level 2 Level 3 Assets/liabilities
at fair value
December 31, 2019
Assets        
Investment securities available-for-sale $ 100  $ 2,842,794  $ 9,190  $ 2,852,084 
Interest rate derivative contracts 0  73,558  0  73,558 
Foreign exchange derivative contracts 0  39,172  0  39,172 
Total $ 100  $ 2,955,524  $ 9,190  $ 2,964,814 
Liabilities        
Interest rate derivative contracts $ 0  $ 73,750  $ 0  $ 73,750 
Foreign exchange derivative contracts $ 0  $ 39,172  $ 0  $ 39,172 
Total $ 0  $ 112,922  $ 0  $ 112,922 

The following table presents a reconciliation for certain AFS securities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine month periods ended September 30, 2020 and September 30, 2019.
Three months ended Nine months ended
September 30, September 30,
(dollars in thousands) 2020 2019 2020 2019
Beginning balance $ 41,577  $ 12,798  $ 9,190  $ 14,715 
Accretion (amortization) (9) 5  10  (557)
Increase (decrease) in fair value 12  0  (26) 33 
Settlements (825) (2,940) 31,581  (4,328)
Ending balance $ 40,755  $ 9,863  $ 40,755  $ 9,863 

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Certain financial assets and liabilities are measured at fair value on a nonrecurring basis.  Adjustments to the fair market value of these assets usually result from the application of fair value accounting or write-downs of individual assets.  The following table summarizes financial assets and liabilities measured at fair value on a nonrecurring basis.
  Fair value measurements using
(Dollars in thousands) Level 1 Level 2 Level 3
September 30, 2020
Assets      
Impaired loans $ 0  $ 0  $ 16,030 
OREO 0  0  484 
  Fair value measurements using
(Dollars in thousands) Level 1 Level 2 Level 3
December 31, 2019
Assets      
Impaired loans $ 0  $ 0  $ 9,268 
OREO 0  0  1,088 

NOTE 17:  BUSINESS COMBINATIONS

In August, 2019, the Company completed the acquisition of Bannockburn Global Forex, LLC. Pursuant to the acquisition agreement, First Financial agreed to acquire all of the issued and outstanding membership interests of BGF for aggregate consideration of approximately $114.6 million consisting of $53.7 million in cash and $60.9 million of First Financial common stock. BGF was a privately held capital markets trading firm specializing in foreign currency advisory, hedge analytics, and transaction processing for closely held enterprises.  Upon completion of the transaction, Bannockburn became a division of the Bank, but continues to operate as Bannockburn Global Forex, taking advantage of its existing brand recognition within the foreign exchange industry.

The Bannockburn 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 were $74.9 million and $18.4 million, respectively, and were subject to refinement for up to one year after the closing date of the acquisition as additional information relative to closing date fair values became available.  The fair values of assets acquired and liabilities assumed were considered final as of August 2020. Goodwill arising from the BGF acquisition was $58.0 million and reflects the business’s high growth potential and the expectation that the acquisition will provide additional revenue growth and diversification. The goodwill is deductible for income tax purposes as the transaction is considered a taxable exchange.  For further detail, see Note 6 – Goodwill and Other Intangible Assets.
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ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FIRST FINANCIAL BANCORP. AND SUBSIDIARIES
(Unaudited)

All reclassifications of prior period amounts, if applicable, have been made to conform to the current period’s presentation and had no effect on the Company's previously reported net income or financial condition.

EXECUTIVE SUMMARY

First Financial Bancorp. is a $15.9 billion financial holding company headquartered in Cincinnati, Ohio, which operates through its subsidiaries primarily in Ohio, Indiana, Kentucky and Illinois. These subsidiaries include First Financial Bank, an
Ohio-chartered commercial bank, which operated 143 full service banking centers as of September 30, 2020. First Financial
provides banking and financial services products to business and retail clients through its six lines of business: Commercial,
Retail Banking, Mortgage Banking, Wealth Management, Investment Commercial Real Estate and Commercial Finance.
Commercial Finance provides equipment and leasehold improvement financing for franchisees in the quick service and casual
dining restaurant sector and commission-based financing, primarily to insurance agents and brokers, throughout the United
States. Wealth Management had $2.8 billion in assets under management as of September 30, 2020 and provides the following
services: financial planning, investment management, trust administration, estate settlement, brokerage services and retirement planning.

MARKET STRATEGY

First Financial aims to develop a competitive advantage by utilizing a local market focus to provide superior service and build long-term relationships with clients while helping them achieve greater financial success. First Financial serves a combination of metropolitan and community markets in Ohio, Indiana, Kentucky and Illinois through its full-service banking centers, and provides financing to franchise owners and clients within the financial services industry throughout the United States. First Financial’s market selection process includes a number of factors, but markets are primarily chosen for their potential for long-term profitability and growth.  First Financial intends to concentrate plans for future growth and capital investment within its current metropolitan markets, and will continue to evaluate additional growth opportunities in metropolitan markets located within, or in close proximity to, the Company's current geographic footprint.  Additionally, First Financial may assess strategic acquisitions that provide product line extensions or additional industry verticals that compliment its existing business and diversify its product suite and revenue streams. First Financial's investment in community markets is an important part of the Bank's core funding base and has historically provided stable, low-cost funding sources. 

BUSINESS COMBINATIONS

In August 2019, the Company acquired Bannockburn Global Forex, LLC, an industry-leading capital markets firm. The Cincinnati-based company provides transactional currency payments, foreign exchange hedging and other advisory products to closely held enterprises, financial sponsors and financial institutions across the United States. Bannockburn became a division of the Bank and continues to operate as Bannockburn Global Forex, taking advantage of its existing brand recognition within the foreign exchange industry. The total purchase consideration was $114.6 million, consisting of $53.7 million in cash and $60.9 million in First Financial common stock. The transaction resulted in First Financial recording $58.0 million of goodwill on the Consolidated Balance Sheet, which reflects the business’ high growth potential, and the expectation that the acquisition will provide additional revenue growth and diversification. The goodwill is deductible for income tax purposes as the transaction is considered a taxable exchange.

The BGF transaction was accounted for using the acquisition method of accounting. 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.

See Note 17 – Business Combinations in the Notes to Consolidated Financial Statements for further discussion of these transactions.

COVID-19 CONSIDERATIONS

The Company's operations and financial results for the majority of 2020 were substantially influenced by the COVID-19 pandemic. The Company updated operating protocols to continuously provide virtually all banking services while prioritizing the health of both its clients and associates. Nearly all banking centers had returned to full service by the end of the third
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quarter after being limited to drive-through services for most of the second quarter. Sales associates, support teams and management largely continued working remotely; however, associates located in the Company's corporate offices and operations centers began to gradually return to those locations at reduced capacity levels in the third quarter. In addition, the Company has maintained its focus on enhancing remote, mobile and online processes to better support a bank anytime anywhere environment.

To assist clients during the pandemic, the Company quickly implemented distinct COVID-19 relief programs to provide comprehensive financial assistance to clients through payment deferrals, fee waivers, and suspension of vehicle repossessions and residential property foreclosures, among others. The Company also actively monitored the actions of federal and state governments to proactively assist clients and ensure awareness of each financial assistance program available.

The Bank underwent a significant level of cross training and redeployment of associate resources to rapidly meet the influx of client requests in response to the passage of the CARES Act and the establishment of the Paycheck Protection Program. The Company's response to the PPP resulted in early successes in providing customer relief and as of September 30, 2020, the Company had approximately 6,800 active PPP loans with $886.1 million in balances, net of unearned fees of $24.2 million.

Further, as of September 30, 2020, the Company had modified $2.1 billion in commercial loans and $131.4 million in consumer loans to provide relief to borrowers adversely impacted by the pandemic. As stated in the CARES Act, loan modifications in response to COVID-19 executed on a loan that was not more than 30 days past due as of December 31, 2019 and executed between March 1, 2020, and the earlier of 60 days after the date of termination of the National Emergency or December 31, 2020 are not required to be reported as TDR. As of the end of the third quarter, $2.1 billion, or 96%, of the loans originally modified had exited the initial 90 day deferral period, with $1.5 billion, or 70%, returning to a normal payment schedule and $631.2 million, or 30%, receiving a second deferral. While initial deferrals were universally granted upon request, additional deferrals are authorized on a case by case basis only after relationship managers perform enhanced due diligence of borrower operations, financial condition, liquidity and cash flow during the deferral period. The second round of deferrals consist primarily of hotel and franchise loans, which comprise $438.2 million or 69% of the total balances deferred for a second time.

Additionally, First Financial contributed $1.0 million in the first quarter of 2020 to help fund agencies providing COVID-19 relief efforts in the communities throughout its geographic footprint, and further contributed $0.5 million to the First Financial Foundation in the third quarter.

OVERVIEW OF OPERATIONS

Third quarter 2020 net income was $41.5 million and earnings per diluted common share were $0.42. This compares with third quarter 2019 net income of $50.9 million and earnings per diluted common share of $0.51. For the nine months ended September 30, 2020, net income was $107.5 million and earnings per diluted common share were $1.10. This compares with net income of $149.4 million and earnings per diluted common share of $1.51 for the first nine months of 2019.
Return on average assets for the third quarter 2020 was 1.04% compared to 1.41% for the same period in 2019, and return on average shareholders’ equity for the third quarter 2020 was 7.40% compared to 9.13% for the third quarter 2019. Return
on average assets for the nine months ended September 30, 2020 was 0.93% compared to 1.41% for the same period in 2019, and return on average shareholders' equity was 6.50% and 9.29% for the first nine months of 2020 and 2019, respectively.
A discussion of First Financial's operating results for the three and nine months ended September 30, 2020 follows.

NET INTEREST INCOME

First Financial’s principal source of income is net interest income, which is the excess of interest received from earning assets, including loan-related fees and purchase accounting accretion, 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 assets and the volume, mix and rates paid for the deposits and borrowed money that support the earning assets. Earning assets consist of interest-bearing loans to customers as well as marketable investment securities.

For analytical purposes, net interest income is also presented in the table that follows, adjusted to a tax equivalent basis assuming a 21% 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 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.
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Three months ended Nine months ended
September 30, September 30,
(Dollars in thousands) 2020 2019 2020 2019
Net interest income $ 112,180  $ 121,535  $ 338,038  $ 365,352 
Tax equivalent adjustment 1,628  1,759  4,916  4,698 
Net interest income - tax equivalent $ 113,808  $ 123,294  $ 342,954  $ 370,050 
Average earning assets $ 13,456,501  $ 12,343,327  $ 13,031,826  $ 12,267,988 
Net interest margin (1)
3.32  % 3.91  % 3.46  % 3.98  %
Net interest margin (fully tax equivalent) (1)
3.36  % 3.96  % 3.52  % 4.03  %
(1) Calculated using annualized net interest income divided by average earning assets.

Net interest income for the third quarter 2020 was $112.2 million, a decrease of $9.4 million, or 7.7%, from third quarter 2019 net interest income of $121.5 million.  This change was primarily driven by a $27.6 million, or 17.9%, decrease in interest income, partially offset by an $18.2 million, or 56.7%, decrease in interest expense.  Net interest income on a fully tax equivalent basis for the third quarter 2020 was $113.8 million compared to $123.3 million for the third quarter 2019. Net interest income on a fully tax equivalent basis was $343.0 million for the nine months ended September 30, 2020, which represented a $27.1 million, or 7.3%, decrease compared to $370.1 million for the same period of the prior year.

Net interest margin on a fully tax equivalent basis decreased 60 bps to 3.36% for the third quarter 2020 compared to 3.96% for the comparable quarter in 2019 as interest rates declined and accretion on acquired loans continued to moderate. Net interest margin on a fully tax equivalent basis for the nine months ended September 30, 2020 was 3.52%, which was a decrease of 51 bps compared to the same period in 2019.

Interest income decreased $27.6 million, or 17.9%, in the third quarter of 2020 when compared to the same quarter in 2019 as a decrease in the yield on earning assets to 3.72% from 4.94% more than offset the impact of higher earning asset balances. The declining yield on earning assets resulted from an approximately 180 bp reduction in the fed funds target rate from September 30, 2019. Average earning assets increased to $13.5 billion in the third quarter 2020 from $12.3 billion in the same quarter of 2019 as loan balances grew largely due to PPP activity. For the nine months ended September 30, 2020, interest income decreased $65.0 million, or 14.1%, compared to the same period in 2019.

Interest expense decreased $18.2 million, or 56.7%, in the third quarter of 2020 when compared to the comparable quarter in 2019 due to lower rates paid on deposits, the Company's aggressive and deliberate management of funding costs and lower borrowing balances. Lower interest rates led to a 68 bp decline in the cost of interest-bearing deposits, which was 0.39% in the third quarter of 2020 compared to 1.07% for the same period in the prior year. The cost of borrowed funds decreased to 1.57% for the third quarter 2020 from 2.61% during the third quarter 2019, reflecting the decline in interest rates and a shift to FRB long term borrowings, which were used to fund PPP activity and carry a relatively modest interest rate of 0.35%. For the nine months ended September 30, 2020, interest expense decreased $37.7 million, or 39.8%, compared to the same period of 2019.

In addition, the impact from PPP loans resulted in 6 basis points of net interest margin dilution in the third quarter of 2020 when compared to Q3 2019 as these loans have lower yields relative to the balance of the Company's loan portfolio.
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CONSOLIDATED AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS
Quarterly Averages Year-to-Date Averages
   September 30, 2020 September 30, 2019 September 30, 2020 September 30, 2019
(Dollars in thousands) Balance Yield Balance Yield Balance Yield Balance Yield
Earning assets        
Investments        
Investment securities $ 3,162,832  2.86  % $ 3,290,666  3.21  % $ 3,147,655  2.96  % $ 3,351,559  3.31  %
Interest-bearing deposits with other banks 40,277  0.31  % 38,569  2.28  % 57,138  0.51  % 35,525  2.40  %
Gross loans (1)
10,253,392  4.00  % 9,014,092  5.58  % 9,827,033  4.42  % 8,880,904  5.66  %
Total earning assets 13,456,501  3.72  % 12,343,327  4.94  % 13,031,826  4.05  % 12,267,988  5.01  %
Nonearning assets        
Allowance for loan and lease losses (165,270)   (61,911)   (147,349) (59,129)
Cash and due from banks 233,216    191,000    251,147  182,025 
Accrued interest and other assets 2,317,563    1,848,098    2,225,018  1,735,731 
Total assets $ 15,842,010    $ 14,320,514    $ 15,360,642  $ 14,126,615 
Interest-bearing liabilities        
Deposits        
Interest-bearing demand $ 2,668,635  0.08  % $ 2,325,405  0.56  % $ 2,563,633  0.21  % $ 2,310,095  0.55  %
Savings 3,342,514  0.14  % 2,945,076  0.69  % 3,164,753  0.25  % 3,038,620  0.74  %
Time 2,015,933  1.20  % 2,234,227  2.09  % 2,276,064  1.54  % 2,226,548  2.02  %
   Total interest-bearing deposits 8,027,082  0.39  % 7,504,708  1.07  % 8,004,450  0.60  % 7,575,263  1.06  %
Borrowed funds
Short-term borrowings 180,956  0.11  % 1,297,247  2.20  % 740,712  1.16  % 1,142,437  2.32  %
Long-term debt 1,338,792  1.76  % 519,736  3.63  % 768,770  2.52  % 545,279  3.62  %
   Total borrowed funds 1,519,748  1.57  % 1,816,983  2.61  % 1,509,482  1.85  % 1,687,716  2.74  %
Total interest-bearing liabilities 9,546,830  0.58  % 9,321,691  1.37  % 9,513,932  0.80  % 9,262,979  1.37  %
Noninterest-bearing liabilities        
Noninterest-bearing demand deposits 3,535,432    2,513,458    3,172,841  2,485,291 
Other liabilities 529,326    275,038    465,116  227,400 
Shareholders' equity 2,230,422    2,210,327    2,208,753  2,150,945 
Total liabilities and shareholders' equity $ 15,842,010    $ 14,320,514    $ 15,360,642  $ 14,126,615 
Net interest income $ 112,180    $ 121,535    $ 338,038  $ 365,352 
Net interest spread   3.14  %   3.57  % 3.25  % 3.64  %
Contribution of noninterest-bearing sources of funds   0.18  %   0.34  % 0.21  % 0.34  %
Net interest margin (2)
  3.32  %   3.91  % 3.46  % 3.98  %
Tax equivalent adjustment 0.04  % 0.05  % 0.06  % 0.05  %
 Net interest margin (fully tax equivalent) (2)
3.36  % 3.96  % 3.52  % 4.03  %
(1) Loans held for sale and nonaccrual loans are included in gross loans.
(2) The net interest margin exceeds the interest spread as noninterest-bearing funding sources, demand deposits, other liabilities and shareholders' equity also support earning assets.
45
RATE/VOLUME ANALYSIS

The impact on net interest income from changes in interest rates as well as the volume of interest-earning assets and interest-bearing liabilities is illustrated in the table below:
  
Changes for the three months ended September 30, 2020 Changes for the nine months ended September 30, 2020
  Comparable quarter income variance Comparable quarter income variance
(Dollars in thousands) Rate Volume Total Rate Volume Total
Earning assets      
Investment securities $ (2,926) $ (921) $ (3,847) $ (8,771) $ (4,521) $ (13,292)
Interest-bearing deposits with other banks (192) 1  (191) (501) 83  (418)
Gross loans (1)
(36,016) 12,479  (23,537) (82,566) 31,283  (51,283)
Total earning assets (39,134) 11,559  (27,575) (91,838) 26,845  (64,993)
Interest-bearing liabilities    
Total interest-bearing deposits (12,778) 513  (12,265) (25,934) 1,930  (24,004)
Borrowed funds    
Short-term borrowings (6,833) (315) (7,148) (9,915) (3,478) (13,393)
Long-term debt (2,449) 3,642  1,193  (4,492) 4,210  (282)
Total borrowed funds (9,282) 3,327  (5,955) (14,407) 732  (13,675)
Total interest-bearing liabilities (22,060) 3,840  (18,220) (40,341) 2,662  (37,679)
Net interest income
$ (17,074) $ 7,719  $ (9,355) $ (51,497) $ 24,183  $ (27,314)
(1) Loans held for sale and nonaccrual loans are included in gross loans.
NONINTEREST INCOME

Third quarter 2020 noninterest income was $49.5 million, increasing $16.4 million, or 49.4%, compared to $33.1 million for the comparable quarter of 2019. Net gains from sales of loans increased $13.8 million, or 286.9%, to $18.6 million due to record mortgage origination activity driven by historically low interest rates. Foreign exchange income was $8.8 million higher than the comparable period due to the full quarter impact of the BGF acquisition as well as the record high income generation by BGF in the third quarter of 2020. Service charges on deposit accounts decreased $2.5 million, or 25.5%, primarily attributed to a decline in transaction volumes resulting from the pandemic. Demand for back to back swaps slowed as loan growth moderated in the third quarter of 2020, resulting in a $2.7 million, or 54.7%, decrease in client derivative fees compared to the same quarter in 2019, while third quarter other noninterest income decreased $0.9 million, or 19.3%, from the same quarter of 2019, driven primarily by lower income on bank owned life insurance and accelerated amortization of mortgage servicing rights reslting from an increase in prepayments.

Noninterest income for the nine months ending September 30, 2020 was $127.6 million compared to $94.6 million for the comparable period of of 2019, increasing $33.0 million, or 34.9%. Net gain from sales of loans increased $28.0 million, or 276.1%, due to high origination volumes resulting from low interest rates. Foreign exchange income increased $25.3 million due to the full year impact and strong operating results subsequent to the BGF acquisition. Year to date bankcard income decreased $6.7 million, or 43.7%, in 2020 due to the impact of the Durbin amendment, which became effective in the third quarter of 2019, along with lower transaction volumes resulting from the pandemic. Service charges on deposit accounts decreased $6.8 million, or 23.8%, due to pandemic related fee waivers and lower transaction activity. Client derivative fees declined $3.2 million, or 27.7%, in the first nine months of 2020 as loan growth moderated, while other noninterest income decreased $4.4 million, or 27.8%, due to lower income on limited partnership investments and accelerated amortization of mortgage servicing rights due to an increase in prepayments in 2020.

NONINTEREST EXPENSE

Third quarter 2020 noninterest expense was $97.5 million, increasing $11.1 million, or 12.8%, compared to $86.4 million for the comparable quarter of 2019. Salaries and employee benefits of $63.8 million increased $10.6 million, or 19.8%, primarily driven by performance related incentives and commissions, as well as higher healthcare costs. Data processing expenses increased $1.1 million, or 18.4%, to $6.8 million in the third quarter of 2020 compared to $5.8 million in 2019 as the Company continued to make strategic investments to enhance its digital capabilities and establish required PPP lending processes. FDIC assessments increased $2.4 million, or 223.1%, due to a small bank assessment credit recognized in 2019, while professional services decreased $2.3 million, or 48.8%, to $2.4 million largely due to acquisition related expenses in the third quarter of 2019. Other noninterest expense decreased $1.2 million, or 14.7%, largely due to higher loan collection costs in the comparable quarter of 2019.
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Noninterest expense for the nine months ending September 30, 2020 was $275.9 million compared to $249.4 million for the
comparable period of of 2019. Salaries and benefits increased $19.4 million, or 12.5%, driven by annual salary adjustments, higher performance related incentives and commissions and increased healthcare costs. Year-to-date data processing expenses increased $4.4 million, or 27.4%, due to the Company's investment in digital enhancements, while FDIC assessments increased $3.1 million, or 340.6%, due to the prior year recognition of a small bank assessment credit. Intangible asset amortization increased $1.8 million, or 28.2%, subsequent to the BGF acquisition. Partially offsetting these increases, professional services declined $2.1 million, or 23.6%, primarily due to merger-related expenses incurred in 2019 related to the BGF acquisition that did not recur in 2020.

INCOME TAXES

For the third quarter of 2020, income tax expense was $9.3 million, resulting in an effective tax rate of 18.3% compared with income tax expense of $12.4 million and an effective tax rate of 19.6% for the comparable period in 2019. The decline in the effective tax rate in the third quarter of 2020 compared to the same period in 2019 was due to lower pre-tax income in the third quarter of 2020 in addition to higher executive compensation in 2019. For the first nine months of 2020, income tax expense was $23.2 million, resulting in an effective tax rate of 17.8% compared with income tax expense of $35.5 million and an effective tax rate of 19.2% for the comparable period in 2019. The decrease in the year-to-date effective tax rate was primarily due to lower pre-tax income in the first nine months of 2020 and the carryback of certain net operating losses as allowed under the CARES Act. These adjustments were partially offset by an unfavorable impact related to stock compensation activity in 2020.

The Company's effective tax rate may fluctuate from quarter to quarter due to changes in income, tax jurisdictions, tax-enhanced assets and tax credit investments.

LOANS

Loans, excluding Loans held for sale, totaled $10.2 billion as of September 30, 2020 and $9.2 billion as of December 31, 2019, representing a $999.1 million, or 10.9%, increase period over period. The majority of the increase was driven by $886.1 million in PPP loans, which are net of unearned fees of $24.2 million. C&I loans increased $826.4 million, or 33.5%, to $3.3 billion while Commercial real estate loans increased $152.5 million, or 3.6%, to $4.3 billion. Third quarter 2020 average loans, excluding loans held for sale, increased $1.2 billion, or 13.5%, from the third quarter of 2019. 

ASSET QUALITY

Nonperforming assets consist of nonaccrual loans, accruing TDRs (collectively, nonperforming loans) 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 a borrower's continued failure to adhere to contractual payment terms, coupled with other pertinent factors. When a loan is classified as nonaccrual, the accrual of interest income is discontinued and previously accrued but unpaid interest is reversed.

Nonperforming assets were $87.3 million, or 0.55% of total assets, at September 30, 2020 compared to $61.6 million, or 0.42% of total assets, at December 31, 2019. This $25.7 million, or 41.7%, increase was driven by three relationships that were downgraded to nonaccrual during the current year.

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. TDRs totaled $37.1 million at September 30, 2020, which represents an increase of $7.1 million, or 23.8%, from $30.0 million at December 31, 2019. This increase was attributed to one of the aforementioned relationships designated as a TDR during the year.

As of September 30, 2020, the Company had modified $2.1 billion in commercial loans and $131.4 million in consumer loans in response to COVID-19. As stated in the CARES Act, loan modifications in response to COVID-19 executed on a loan that was not more than 30 days past due as of December 31, 2019 and executed between March 1, 2020, and the earlier of 60 days after the date of termination of the National Emergency or December 31, 2020 are not required to be reported as TDR. Of the loan balances initially modified, $1.5 billion have returned to a normal payment schedule, with $631.2 million receiving a second deferral. The second round of deferrals consist primarily of hotel and franchise loans, which comprise $438.2 million or 69% of the total balances deferred for a second time. The Company is closely monitoring the pandemic recovery activities of its
47
clients, especially those who have received deferral modifications and those in industries most adversely impacted by the pandemic.

Classified assets, which are defined by the Company as nonperforming assets plus performing loans internally rated substandard or worse, totaled $134.0 million as of September 30, 2020 compared to $89.3 million at December 31, 2019. Classified assets increased $44.8 million, or 50.1%, as seven large relationships, including two previously mentioned, received risk rating downgrades during the period. These seven loans were not concentrated in a single industry, geographic location or loan type. Classified assets were 84 bps as a percentage of total assets at September 30, 2020, compared to 62 bps as of December 31, 2019.

The following table details nonperforming, underperforming and classified assets, in addition to related credit quality ratios as of September 30, 2020 and the four previous quarters.
  Three months ended
  2020 2019
(Dollars in thousands) Sep. 30, June 30, Mar. 31, Dec. 31, Sep. 30,
Nonperforming loans, nonperforming assets, and underperforming assets
Nonaccrual loans (1)
 
Commercial and industrial $ 34,686  $ 33,906  $ 21,126  $ 24,346  $ 28,358 
Lease financing 1,092  1,353  222  223  284 
Construction real estate 0  0  0  0  5 
Commercial real estate 24,521  14,002  10,050  7,295  14,889 
Residential real estate 12,104  12,813  11,163  10,892  11,655 
Home equity 5,374  5,604  5,821  5,242  5,427 
Installment 153  201  145  167  75 
Nonaccrual loans 77,930  67,879  48,527  48,165  60,693 
Accruing troubled debt restructurings 7,759  8,377  22,206  11,435  18,450 
Total nonperforming loans 85,689  76,256  70,733  59,600  79,143 
Other real estate owned 1,643  1,872  1,467  2,033  1,613 
Total nonperforming assets 87,332  78,128  72,200  61,633  80,756 
Accruing loans past due 90 days or more 79  124  120  201  287 
Total underperforming assets $ 87,411  $ 78,252  $ 72,320  $ 61,834  $ 81,043 
Total classified assets $ 134,002  $ 125,543  $ 124,510  $ 89,250  $ 132,500 
Credit quality ratios
Allowance for loan and lease losses to  
Nonaccrual loans 216.28% 233.74% 296.51% 119.69% 93.18  %
Nonperforming loans 196.69% 208.06% 203.42% 96.73% 71.46  %
Total ending loans 1.65% 1.56% 1.55% 0.63% 0.62  %
Nonperforming loans to total loans 0.84% 0.75% 0.76% 0.65% 0.87  %
Nonperforming assets to
Ending loans, plus OREO 0.86% 0.77% 0.78% 0.67% 0.89  %
Total assets 0.55% 0.49% 0.48% 0.42% 0.56  %
Nonperforming assets, excluding accruing TDRs to
Ending loans, plus OREO 0.78% 0.68% 0.54% 0.55% 0.69  %
Total assets 0.50% 0.44% 0.33% 0.35% 0.43  %
Classified assets to total assets 0.84% 0.79% 0.83% 0.62% 0.92  %
(1) Nonaccrual loans include nonaccrual TDRs of $29.3 million, $32.7 million, $18.4 million, $18.5 million and $21.5 million as of September 30, 2020, June 30, 2020, March 31, 2020, December 31,2019 and September 30, 2019, respectively.

INVESTMENTS

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First Financial's investment portfolio totaled $3.2 billion, or 20.4% of total assets, at September 30, 2020 and $3.1 billion, or 21.5% of total assets, at December 31, 2019.  AFS securities totaled $3.0 billion at September 30, 2020 and $2.9 billion at December 31, 2019, while HTM securities totaled $118.1 million at September 30, 2020 and $142.9 million at December 31, 2019. The effective duration of the investment portfolio declined to 3.0 years as of September 30, 2020, compared to 3.4 years as of December 31, 2019, as the Company has positioned the investment portfolio to optimize performance with a flattened yield curve.

The Company invests in certain securities which carry credit risk since their realization is dependent on future principal and interest repayments. Prior to purchase, First Financial performs a detailed 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 enhance the overall performance of the portfolio.

At September 30, 2020, the Company's Consolidated Financial Statements reflected a $69.1 million unrealized after-tax gain on debt securities as a component of equity in accumulated other comprehensive income and a $0.1 million unrealized gain on equity securities within other noninterest income.
First Financial will continue to monitor loan demand and deposit activity, as well as balance sheet composition, capital sensitivity and the interest rate environment when considering future investment strategies.

DEPOSITS AND FUNDING

Total deposits were $11.6 billion as of September 30, 2020 and $10.2 billion as of December 31, 2019. This increase was driven by a $909.0 million, or 34.4%, increase in noninterest bearing demand deposits; a $485.7 million, or 16.4%, increase in savings deposits; and a $267.6 million, or 11.3%, increase in interest bearing demand deposits compared to December 31, 2019. The increase in deposits was attributed to customers retaining CARES Act stimulus payments and PPP loan proceeds as well as strong origination efforts in the third quarter of 2020.

Average deposits for the third quarter 2020 increased $1.5 billion, or 15.4%, to $11.6 billion from $10.0 billion for the comparable quarter of 2019. This increase was driven by a $1.0 billion, or 40.7%, increase in average noninterest-bearing deposits; a $397.4 million, or 13.5%, increase in average savings deposits; and a $343.2 million, or 14.8%, increase in average interest-bearing demand deposits. These increases were partially offset by a $218.3 million, or 9.8%, decrease in average time deposit balances.

Borrowed funds were $1.6 billion as of September 30, 2020 compared to $1.7 billion as of December 31, 2019. First Financial utilizes short-term borrowings and long-term advances from the FHLB as wholesale funding sources. First Financial had no short-term borrowings with the FHLB at September 30, 2020, compared to $1.2 billion at December 31, 2019. Short-term borrowings also included fed funds purchased and repurchase agreements of $247.7 million and $165.2 million at September 30, 2020 and December 31, 2019, respectively.

Long-term debt, which included FRB and FHLB long-term advances, subordinated notes and an interest free loan with a municipality, was $1.3 billion and $414.4 million at September 30, 2020 and December 31, 2019, respectively. The Company had $881.7 million of FRB advances from the PPPLF included in long-term borrowings as of September 30, 2020. The PPPLF was established by the Federal Reserve to supply a source of liquidity and term financing to financial institutions participating in the PPP. These borrowings carry a 0.35% interest rate and are secured by the Company's PPP loans. FHLB long-term advances declined $104.0 million, or 42.9%, to $138.4 million at September 30, 2020 from $242.4 million as of December 31, 2019 as the Company shifted its funding to the PPPLF, and otherwise implemented funding strategies to manage liquidity and interest rate risk. First Financial's total remaining borrowing capacity from the FHLB was $1.8 billion as of September 30, 2020.

Outstanding subordinated debt totaled $318.4 million as of September 30, 2020 and $170.0 million as of December 31, 2019. This increase was driven by the issuance of $150.0 million of fixed to floating rate subordinated notes in the second quarter of 2020.

See Note 8 – Borrowings in the Notes to Consolidated Financial Statements for further discussion of First Financial's borrowed funds.

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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, and access to wholesale funding sources.

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 other short and long-term funding sources, which include subordinated notes, longer-term advances from the FRB and FHLB and its short-term line of credit.

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 ability to access the credit markets and potentially increase borrowing costs, negatively impacting 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 September 30, 2020 were as follows:
First Financial Bancorp First Financial Bank
Senior Unsecured Debt BBB+ A-
Subordinated Debt BBB BBB+
Short-Term Debt K2 K2
Deposit N/A A-
Short-Term Deposit N/A K2

For ease of borrowing execution, First Financial utilizes a blanket collateral agreement with the FHLB. First Financial pledged $6.4 billion of certain eligible residential, commercial and farm real estate loans, home equity lines of credit and government, agency and CMBS securities as collateral for borrowings from the FHLB as of September 30, 2020.  

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 AFS totaled $3.0 billion and $2.9 billion at September 30, 2020 and December 31, 2019, respectively.  HTM securities that are maturing within a short period of time can be an additional source of liquidity. As of both September 30, 2020 and December 31, 2019, the Company had no HTM securities maturing within one year.

Other sources of liquidity include cash and due from banks plus interest-bearing deposits with other banks. At September 30, 2020, these balances totaled $245.9 million. First Financial also had unused wholesale funding of $4.4 billion, or 27.6% of total assets, to fund loan and deposit activities in addition to other general corporate requirements.

Certain restrictions exist regarding the Bank's ability to transfer funds to First Financial in the form of cash dividends, loans, other assets or advances and 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 the Bank totaled $80.0 million for the first nine months of 2020.  As of September 30, 2020, the Bank had retained earnings of $642.0 million, of which $144.8 million was available for distribution to First Financial without prior regulatory approval. As an additional source of liquidity, First Financial had $199.5 million in cash at the parent company as of September 30, 2020.

Share repurchases also impact First Financial's liquidity. For further information regarding share repurchases, see the Capital section that follows.

Capital expenditures, such as banking center expansions and technology investments, were $13.4 million and $15.2 million for the first nine months of 2020 and 2019, respectively. 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.
50

CAPITAL

Risk-based capital. The Board of Governors of the Federal Reserve System approved Basel III in order to strengthen the regulatory capital framework for all banking organizations, subject to a phase-in period for certain provisions. Basel III established and defined quantitative measures to ensure capital adequacy. These measures 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).

Basel III includes a minimum ratio of Common equity Tier 1 capital to risk-weighted assets of 7.0% and includes a fully phased-in capital conservation buffer of 2.5% of risk-weighted assets. Further, the minimum ratio of Tier 1 capital to risk-weighted assets is 8.5% and all banks are subject to a 4.0% minimum leverage ratio. The required Total risk-based capital ratio is 10.5%. Failure to maintain the required Common equity Tier 1 capital will result in potential restrictions on a bank’s ability to pay dividends, repurchase stock and pay discretionary compensation to its employees.  The 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.

First Financial's tier 1 capital increased slightly to 12.02% at September 30, 2020 from 11.69% at December 31, 2019. The total capital ratio increased to 15.37% from 13.39% during the same period primarily due to the issuance of subordinated debt in the second quarter of 2020 and quarterly earnings. The leverage ratio was 9.55% at September 30, 2020, which was relatively unchanged from 9.58% as of December 31, 2019. The Company’s tangible common equity ratio decreased to 8.25% at September 30, 2020 from 9.07% at December 31, 2019 primarily due to the adoption of CECL during the period and the impact from PPP activity.

As of September 30, 2020, management believes that First Financial met all capital adequacy requirements to which it was subject.  The Company's most recent regulatory notifications categorized First Financial as "well-capitalized" under the regulatory framework for prompt corrective action. There have been no conditions or events since those notifications that management believes have changed the Company's categorization. Total regulatory capital exceeded the minimum requirement by $541.3 million on a consolidated basis at September 30, 2020. 

The following tables present the actual and required capital amounts and ratios as of September 30, 2020 and December 31, 2019 under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels based on the phase-in provisions of the Basel III Capital Rules as of the period presented. Capital levels required to be considered "well capitalized" are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules.
  Actual Minimum capital
required - Basel III 		PCA requirement to be
considered well
capitalized
(Dollars in thousands) Capital
amount 		Ratio Capital
amount 		Ratio Capital
amount 		Ratio
September 30, 2020            
Common equity Tier 1 capital to risk-weighted assets
Consolidated $ 1,293,716  11.63  % $ 778,369  7.00  % N/A N/A
First Financial Bank 1,395,225  12.55  % 777,993  7.00  % $ 722,422  6.50  %
Tier 1 capital to risk-weighted assets
Consolidated 1,336,497  12.02  % 945,163  8.50  % N/A N/A
First Financial Bank 1,395,329  12.55  % 944,706  8.50  % 889,135  8.00  %
Total capital to risk-weighted assets
Consolidated 1,708,817  15.37  % 1,167,554  10.50  % N/A N/A
First Financial Bank 1,499,615  13.49  % 1,166,990  10.50  % 1,111,419  10.00  %
Leverage ratio
Consolidated 1,336,497  9.55  % 559,984  4.00  % N/A N/A
First Financial Bank 1,395,329  9.97  % 559,720  4.00  % 699,650  5.00  %
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  Actual Minimum capital
required - Basel III 		PCA requirement to be
considered well
capitalized
(Dollars in thousands) Capital
amount 		Ratio Capital
amount 		Ratio Capital
amount 		Ratio
December 31, 2019            
Common equity tier 1 capital to risk-weighted assets
Consolidated $ 1,245,746  11.30  % $ 771,666  7.00  % N/A N/A
First Financial Bank 1,333,978  12.11  % 770,997  7.00  % $ 715,926  6.50  %
Tier 1 capital to risk-weighted assets          
Consolidated 1,288,185  11.69  % 937,023  8.50  % N/A N/A
First Financial Bank 1,334,082  12.11  % 936,211  8.50  % 881,140  8.00  %
Total capital to risk-weighted assets      
Consolidated 1,475,813  13.39  % 1,157,498  10.50  % N/A N/A
First Financial Bank 1,399,817  12.71  % 1,156,496  10.50  % 1,101,425  10.00  %
Leverage ratio      
Consolidated 1,288,185  9.58  % 537,606  4.00  % N/A N/A
First Financial Bank 1,334,082  9.93  % 537,299  4.00  % 671,623  5.00  %

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

Shareholder dividends. First Financial paid a dividend of $0.23 per common share on September 15, 2020 to shareholders of record as of September 1, 2020. Additionally, First Financial's board of directors authorized a dividend of $0.23 per common share, payable on December 15, 2020 to shareholders of record as of December 1, 2020.

Share repurchases. In January 2019, First Financial's board of directors approved a stock repurchase plan, replacing the plan approved in 2012. The 2019 plan authorizes the purchase of up to 5,000,000 shares of the Company's common stock. First Financial did not repurchase any shares under this plan during the three month period ending September 30, 2020, however it repurchased 880,000 shares at an average market price of $18.96 under this plan during the nine month period ending September 30, 2020. First Financial repurchased 1,143,494 shares at an average market price of $23.94 under this plan during the three and nine month periods ended September 30, 2019. At September 30, 2020, 1,366,728 common shares remained available for repurchase under the 2019 plan.

ATM offering. In March 2017, First Financial initiated an "at-the-market" equity offering program to provide flexibility with respect to capital planning and to support future growth. First Financial was not active through the ATM program during the current period.

Shareholders' equity. Total shareholders’ equity was $2.2 billion at both September 30, 2020 and December 31, 2019.

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

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RISK MANAGEMENT

First Financial manages risk through a structured ERM approach that routinely assesses the overall level of risk, identifies specific risks and evaluates specific actions to mitigate those risks. First Financial continues to enhance its risk management capabilities and has embedded risk awareness into the culture of the Company.  First Financial has identified the following types of risk that it monitors in its ERM framework: credit, market, operational, compliance, strategic, reputation, information technology, cyber and legal.

For a full discussion of these risks, see the Enterprise Risk Management section in Management's Discussion and Analysis in First Financial’s 2019 Annual Report on Form 10-K. The sections that follow provide additional discussion related to credit risk and market risk.

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 process, periodically reviewing and approving its credit exposures using credit policies and guidelines approved by the board of directors.  

ACL. The ACL is a reserve accumulated on the Consolidated Balance Sheets through the recognition of the provision for loan and lease losses. First Financial records a provision for loan and lease losses in the Consolidated Statements of Income to maintain the ACL at a level considered sufficient to absorb expected credit losses.

The ACL on loans and leases was $168.5 million as of September 30, 2020 and $57.7 million as of December 31, 2019. As a percentage of period-end loans, the ACL was 1.65% as of September 30, 2020 and 0.63% as of December 31, 2019. As detailed in Note 2 - Accounting Standards Recently Adopted or Issued, $61.5 million of the increase in ACL was attributed to the adoption of CECL, while the remaining increase primarily related to the expected impact from the COVID-19 pandemic.

The Company utilized the revised Moody's September baseline forecast as its R&S forecast in the quantitative model, which included consideration of the impact from both the COVID-19 pandemic and the related government stimulus response. For reasonableness, the Company also considered the impact to the model from alternative, more adverse economic forecasts, slower prepayment speeds and increased default rates. These alternative analyses were utilized to inform the Company's qualitative adjustments. Additionally, First Financial considered its credit exposure to certain industries believed to be at risk for future credit stress related to the COVID-19 pandemic, such as franchise, hotel and investor commercial real estate lending when making qualitative adjustments to the third quarter 2020 ACL model.

The ACL as a percentage of nonaccrual loans was 216.28% at September 30, 2020 and 119.69% at December 31, 2019. The ACL as a percentage of nonperforming loans, including accruing TDRs, rose to 196.69% as of September 30, 2020 from 96.73% as of December 31, 2019. These increases were driven by the increase in the ACL during the period, which more than offset the increases in nonaccrual loans.

The Company recorded net charge-offs of $5.4 million, or 0.21% of average loans and leases on an annualized basis, in the third quarter 2020, compared to net charge-offs of $10.2 million, or 0.45% of average loans and leases on an annualized basis, for the comparable quarter in 2019. For the first nine of 2020, net charge-offs were $7.6 million, or 0.10% of average loans and leases, compared to $26.0 million, or 0.39%, for the same period of 2019.

Provision expense is a product of the Company's ACL model combined with net charge-off activity during the period. Third quarter 2020 provision expense on loans and leases was $15.3 million compared to a provision of $5.2 million during the third quarter in 2019. With moderate net charge-offs during the period, the majority of the third quarter 2020 provision expense was related to the expected economic impact from COVID-19. For the nine months ended September 30, 2020, provision expense on loans and leases was $57.0 million compared to $26.0 million for the same period of 2019, which was driven by the adoption of CECL and the expected impact of the pandemic.

The ACL on unfunded commitments was $14.8 million as of September 30, 2020 and $0.6 million as of December 31, 2019. Additionally, First Financial recorded $1.9 million of provision recapture on unfunded commitments for the three months ended September 30, 2020, compared to an insignificant amount of provision recapture in the comparative period in 2019. Similar to the increase in ACL on loans and leases, the increase in ACL on unfunded commitments was related to the adoption of CECL and consideration of the impact from the COVID-19 pandemic on future credit losses; however, provision expense decreased during the third quarter of 2020 due to elevated levels of prepayment activity in the period, which shortened the estimated weighted average remaining life of the portfolio for modeling purposes. For the nine months ended September 30, 2020,
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provision for credit losses on unfunded commitments was $2.0 million compared to insignificant provision for the same period of 2019.
See Note 5 – Allowance for Credit Losses in the Notes to Consolidated Financial Statements for further discussion of First Financial's ACL.

The table that follows includes the activity in the ACL for the quarterly periods presented.
  Three months ended Nine months ended
  2020 2019 September 30,
(Dollars in thousands) Sep. 30, June 30, Mar. 31, Dec. 31, Sep. 30, 2020 2019
Allowance for credit loss activity  
Balance at beginning of period $ 158,661  $ 143,885  $ 57,650  $ 56,552  $ 61,549  $ 57,650  $ 56,542 
Impact of adopting ASC 326 0  0  61,505  0  0  61,505  0 
Provision for loan losses 15,299  17,859  23,880  4,629  5,228  57,038  25,969 
Gross charge-offs
Commercial and industrial 1,467  1,282  1,091  2,919  9,556  3,840  23,757 
Lease financing 852  0  0  62  0  852  100 
Construction real estate 0  0  0  0  0  0  0 
Commercial real estate 3,789  2,037  4  1,854  535  5,830  1,835 
Residential real estate 22  148  115  167  278  285  510 
Home equity 460  428  267  807  627  1,155  1,784 
Installment 59  7  61  31  65  127  192 
Credit card 171  234  311  319  598  716  1,228 
Total gross charge-offs 6,820  4,136  1,849  6,159  11,659  12,805  29,406 
Recoveries
Commercial and industrial 265  275  2,000  1,796  556  2,540  1,087 
Lease financing 6  0  0  0  0  6  0 
Construction real estate 0  14  0  0  0  14  68 
Commercial real estate 760  424  234  439  347  1,418  674 
Residential real estate 91  93  52  72  64  236  201 
Home equity 209  156  339  243  335  704  1,092 
Installment 35  27  31  49  93  93  202 
Credit card 38  64  43  29  39  145  123 
Total recoveries 1,404  1,053  2,699  2,628  1,434  5,156  3,447 
Total net charge-offs 5,416  3,083  (850) 3,531  10,225  7,649  25,959 
Ending allowance for credit losses $ 168,544  $ 158,661  $ 143,885  $ 57,650  $ 56,552  $ 168,544  $ 56,552 
Net charge-offs to average loans and leases (annualized)  
Commercial and industrial 0.14  % 0.13  % (0.15) % 0.18  % 1.42  % 0.06  % 1.20  %
Lease financing 4.29  % 0.00  % 0.00  % 0.27  % 0.00  % 1.38  % 0.14  %
Construction real estate 0.00  % (0.01) % 0.00  % 0.00  % 0.00  % 0.00  % (0.02) %
Commercial real estate 0.28  % 0.15  % (0.02) % 0.14  % 0.02  % 0.14  % 0.04  %
Residential real estate (0.03) % 0.02  % 0.02  % 0.04  % 0.08  % 0.01  % 0.04  %
Home equity 0.13  % 0.14  % (0.04) % 0.29  % 0.15  % 0.08  % 0.12  %
Installment 0.12  % (0.10) % 0.15  % (0.08) % (0.13) % 0.06  % (0.01) %
Credit card 1.16  % 1.54  % 2.15  % 2.27  % 4.40  % 1.63  % 3.00  %
Total net charge-offs 0.21  % 0.12  % (0.04) % 0.15  % 0.45  % 0.10  % 0.39  %



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MARKET RISK

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, foreign exchange rates and equity prices. The primary source of market risk for First Financial is interest rate risk, which is the risk to earnings and the value of the Company's equity arising from changes in market interest rates. Interest rate risk arises in the normal course of business to the extent that there is a divergence between the amount of interest-earning assets and the amount of interest-bearing liabilities that are prepaid, withdrawn, re-priced or mature in specified periods. First Financial seeks to achieve consistent growth in net interest income and equity while managing volatility from shifts in market interest rates.

First Financial monitors its interest rate risk position using income simulation models and EVE sensitivity analyses that capture both short-term and long-term interest rate risk exposure.  Income simulation involves forecasting NII under a variety of interest rate scenarios. EVE is calculated by discounting the cash flows for all balance sheet instruments under different interest-rate scenarios. First Financial uses EVE sensitivity analysis to understand the impact of changes in interest rates on long-term cash flows, income and capital.  For both NII and EVE modeling, First Financial leverages instantaneous parallel shocks to evaluate interest rate risk exposure across rising and falling rate scenarios. Additional scenarios evaluated include various non-parallel yield curve twists.

First Financial’s interest rate risk models are based on the contractual and assumed cash flows and repricing characteristics for the Company’s assets, liabilities and off-balance sheet exposure. A number of assumptions are also incorporated into the interest rate risk models, including prepayment behaviors and repricing spreads for assets in addition to attrition and repricing rates for liabilities. Assumptions are primarily derived from behavior studies of the Company’s historical client base and are continually refined. Modeling the sensitivity of NII and EVE to changes in market interest rates is highly dependent on the assumptions incorporated into the modeling process.

Non-maturity deposit modeling is particularly dependent on the assumption for repricing sensitivity known as a beta. Beta is the amount by which First Financial’s interest bearing non-maturity deposit rates will increase when short-term interest rates rise. The Company utilized a weighted average deposit beta of 35% in its interest rate risk modeling as of September 30, 2020. First Financial also includes an assumption for the migration of non-maturity deposit balances into CDs for all upward rate scenarios beginning with the +100 bps scenario, thereby increasing deposit costs and reducing asset sensitivity.

Presented below is the estimated impact on First Financial’s NII and EVE position as of September 30, 2020, assuming immediate, parallel shifts in interest rates:
% Change from base case for
immediate parallel changes in rates
 
-100 bps(1)
+100 bps +200 bps
NII-Year 1 (1.28) % 8.04  % 15.20  %
NII-Year 2 (2.13) % 10.73  % 20.56  %
EVE (8.89) % 8.24  % 16.49  %
(1) Because certain current interest rates are at or below 1.00%, the 100 basis point downward shock assumes that certain corresponding interest rates approach an implied floor that, in effect, reflects a decrease of less than the full 100 basis point downward shock.

“Risk-neutral” refers to the absence of a strong bias toward either asset or liability sensitivity. “Asset sensitivity” is when a company's interest-earning assets reprice more quickly or in greater quantities than interest-bearing liabilities. Conversely, “liability sensitivity” is when a company's interest-bearing liabilities reprice more quickly or in greater quantities than interest-earning assets. In a rising interest rate environment, asset sensitivity results in higher net interest income while liability sensitivity results in lower net interest income. In a declining interest rate environment, asset sensitivity results in lower net interest income while liability sensitivity results in higher net interest income.

First Financial was within policy limits set for the disclosed interest rate scenarios as of September 30, 2020. The projected results for NII and EVE reflected an asset sensitive position, which increased further from the prior quarter as the Company continued to see an increase in consumer deposits both in overall balances and as a percentage of total deposits. In the current interest rate environment, First Financial manages its balance sheet with a bias toward asset sensitivity while simultaneously balancing the potential earnings impact of this strategy.

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First Financial continually evaluates the sensitivity of its interest rate risk position to modeling assumptions. The following table reflects First Financial’s estimated NII sensitivity profile as of September 30, 2020 assuming a 25% increase and a 25% reduction to the beta assumption on managed rate deposits:
Beta sensitivity (% change from base)
+100 BP +200 BP
Beta 25% lower Beta 25% higher Beta 25% lower Beta 25% higher
NII-Year 1 9.27  % 6.80  % 16.40  % 14.01  %
NII-Year 2 12.01  % 9.45  % 21.80  % 19.32  %

See the Net Interest Income section of Management’s Discussion and Analysis for further discussion.

CRITICAL ACCOUNTING POLICIES

First Financial’s Consolidated Financial Statements are prepared based on the application of the Company's accounting policies.  These policies require the reliance on estimates and assumptions which are inherently subjective and may be susceptible to significant change.  Changes in underlying factors, assumptions or estimates could have a material impact on First Financial’s future financial condition and results of operations. In management’s opinion, certain accounting policies have a more significant impact than others on First Financial’s financial reporting.  For First Financial, these policies currently include accounting for the ACL - loans and leases, goodwill, pension and income taxes.  These accounting policies are discussed in detail in the Critical Accounting Policies section of Management’s Discussion and Analysis in First Financial’s 2019 Annual Report.  There were no changes to the accounting policies for goodwill, pension and income taxes during the nine months ended September 30, 2020. Subsequent to the adoption of ASC 326 in the first quarter of 2020, the Company's accounting policy for the ACL - loans and leases is now as follows:

Allowance for credit losses - loans and leases. The allowance for credit losses is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Management's determination of the adequacy of the ACL is based on an assessment of the expected credit losses on loan and leases over the expected life of the loan. The ACL is generally increased by provision expense and decreased by charge-offs, net of recoveries of amounts previously charged-off. Loans are charged off when management believes that the collection of the principal amount owed in full, either through payments from the borrower or from the liquidation of collateral, is unlikely. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. Any interest that is accrued but not collected is reversed against interest income when a loan is placed on nonaccrual status, which typically occurs prior to charging off all, or a portion, of a loan. Accrued interest receivable on loans and leases is excluded from the estimate of credit losses.

Management estimates the allowance balance using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience paired with economic forecasts provides the basis for the quantitatively modeled estimation of expected credit losses. First Financial adjusts its quantitative model, as necessary, to reflect conditions not already considered by the quantitative model. These adjustments are commonly known as the Qualitative Framework.

First Financial quantitatively models expected credit loss using Probability of Default (“PD”), Loss Given Default (“LGD”), and Exposure at Default (“EAD”) over the Reasonable and Supportable (“R&S”) forecast, reversion and post-reversion periods.
Utilizing third-party software, the Bank forecasts PD by using a parameterized transition matrix approach. Average transition matrices are calculated over the Through the Cycle ("TTC") period, which was defined as the period from December 2007 to December 2016. TTC transition matrices are adjusted under forward-looking macroeconomic expectations to obtain R&S forecasts.

First Financial is not required to develop forecasts over the full contractual term of the financial asset or group of financial assets. Rather, for periods beyond which the entity is able to make or obtain R&S forecasts of expected credit losses, the Company reverts in a straight line manner over a one year period to an average TTC loss level that is reflective of the prepayment adjusted contractual term of the financial asset or group of financial assets. The R&S forecast period, elected by the bank to be two years, is forecasted using econometric data sourced from an industry-leading independent third party.

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FFB utilizes the non-parametric loss curve approach embedded within the third-party software for estimating LGD. The PD multiplied by LGD produces an expected loss rate that, when calculating the ACL, is applied to contractual loan cash flows, adjusted for expected future rates of principal prepayments.
The Company adjusts its quantitative model for certain qualitative factors to reflect the extent to which management expects current conditions and R&S forecasts to differ from the conditions that existed for the period over which historical information was evaluated. The Qualitative Framework reflects changes related to relevant data, such as changes in asset quality trends, portfolio growth and composition, national and local economic factors, credit policy and administration and other factors not considered in the base model.

Loans that do not share risk characteristics are evaluated on an individual basis. First Financial will typically evaluate on an individual basis any loans that are on nonaccrual, designated as a TDR, or reasonably expected to be designated as a TDR. When management determines that foreclosure is probable or when repayment is expected to be provided substantially through the operation or sale of underlying collateral, expected credit losses are based on the fair value of the collateral at the reporting date, adjusted for selling costs. For loans evaluated on an individual basis that are not determined to be collateral dependent, a discounted cash flow analysis is performed to determine expected credit losses.

Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: management has a reasonable expectation at the reporting date that a troubled debt restructuring will be executed with an individual borrower or the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Company. Credit card receivables do not have stated maturities. In determining the estimated life of a credit card receivable, management first estimates the future cash flows expected to be received and then applies those expected future cash flows to the credit card balance.

To the extent actual outcomes differ from management's estimates, additional provision for credit losses may be required that would impact First Financial's operating results.

ACCOUNTING AND REGULATORY MATTERS

Note 2 - Recently Adopted and Issued Accounting Standards in the Notes to Consolidated Financial Statements discusses new accounting standards adopted by First Financial in 2020, as well as the expected impact of accounting standards issued but not yet adopted.  To the extent the adoption of new accounting standards materially affects financial condition, results of operations or liquidity, the impacts are discussed in the applicable Notes to the Consolidated Financial Statements and sections of Management’s Discussion and Analysis.

FORWARD-LOOKING STATEMENT

Certain statements contained in this report which are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Words such as ‘‘believes,’’ ‘‘anticipates,’’ “likely,” “expected,” “estimated,” ‘‘intends’’ and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.  Examples of forward-looking statements include, but are not limited to, statements we make about (i) our future operating or financial performance, including revenues, income or loss and earnings or loss per share, (ii) future common stock dividends, (iii) our capital structure, including future capital levels, (iv) our plans, objectives and strategies, and (v) the assumptions that underlie our forward-looking statements.

As with any forecast or projection, forward-looking statements are subject to inherent uncertainties, risks and changes in circumstances that may cause actual results to differ materially from those set forth in the forward-looking statements.  Forward-looking statements are not historical facts but instead express only management’s beliefs regarding future results or events, many of which, by their nature, are inherently uncertain and outside of management’s control. It is possible that actual results and outcomes may differ, possibly materially, from the anticipated results or outcomes indicated in these forward-looking statements.  Important factors that could cause actual results to differ materially from those in our forward-looking statements include the following, without limitation:

•economic, market, liquidity, credit, interest rate, operational and technological risks associated with the Company’s business;

•future credit quality and performance, including our expectations regarding future loan losses and our allowance for credit losses;
57

•the effect of and changes in policies and laws or regulatory agencies, including the Dodd-Frank Wall Street Reform and Consumer Protection Act and other legislation and regulation relating to the banking industry; (iv) management’s ability to effectively execute its business plans;

•mergers and acquisitions, including costs or difficulties related to the integration of acquired companies;

•the possibility that any of the anticipated benefits of the Company’s acquisitions will not be realized or will not be realized within the expected time period;

•the effect of changes in accounting policies and practices;

•changes in consumer spending, borrowing and saving and changes in unemployment;

•changes in customers’ performance and creditworthiness;

•the costs and effects of litigation and of unexpected or adverse outcomes in such litigation;  

•current and future economic and market conditions, including the effects of declines in housing prices, high unemployment rates, U.S. fiscal debt, budget and tax matters, geopolitical matters, and any slowdown in global economic growth;

•the adverse impact on the U.S. economy, including the markets in which we operate, of the novel coronavirus, which causes the Coronavirus disease 2019 (“COVID-19”), global pandemic, and the impact of a slowing U.S. economy and increased unemployment on the performance of our loan and lease portfolio, the market value of our investment securities, the availability of sources of funding and the demand for our products;

•our capital and liquidity requirements (including under regulatory capital standards, such as the Basel III capital standards) and our ability to generate capital internally or raise capital on favorable terms;

•financial services reform and other current, pending or future legislation or regulation that could have a negative effect on our revenue and businesses, including the Dodd-Frank Act and other legislation and regulation relating to bank products and services;

•the effect of the current interest rate environment or changes in interest rates or in the level or composition of our assets or liabilities on our net interest income, net interest margin and our mortgage originations, mortgage servicing rights and mortgage loans held for sale;

•the effect of a fall in stock market prices on our brokerage, asset and wealth management businesses;

•a failure in or breach of our operational or security systems or infrastructure, or those of our third-party vendors or other service providers, including as a result of cyber attacks;

•the effect of changes in the level of checking or savings account deposits on our funding costs and net interest margin; and

•our ability to develop and execute effective business plans and strategies.

Additional factors that may cause our actual results to differ materially from those described in our forward-looking statements can be found in the Form 10-K for the year ended December 31, 2019, as well as our other filings with the SEC, which are available on the SEC website at www.sec.gov. All forward-looking statements included in this filing are made as of the date hereof and are based on information available at the time of the filing. Except as required by law, the Company does not assume any obligation to update any forward-looking statement.

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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information contained in “Item 2-Management’s Discussion and Analysis of Financial Condition and Results of Operations—Market Risk” of this report is incorporated herein by reference in response to this item.

ITEM 4.   CONTROLS AND PROCEDURES

Disclosure Controls and Procedures
Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under
Rule 13a-15 of the Securities Exchange Act of 1934, that are designed to cause the material information required to be disclosed by First Financial in the reports it files or submits under the Securities Exchange Act of 1934 to be recorded, processed, summarized, and reported to the extent applicable within the time periods required by the Securities and Exchange Commission’s rules and forms. In designing and evaluating the disclosure controls and procedures, management recognized that a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

As of the end of the period covered by this report, First Financial performed an evaluation under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting
Effective January 1, 2020, First Financial adopted the CECL accounting standard. The Company designed new controls and modified existing controls in conjunction with its adoption. These additional controls over financial reporting included controls over model creation and design, model governance and model assumptions, among others. There were no other changes in First Financial's internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, First Financial's internal control over financial reporting.


59
PART II-OTHER INFORMATION

Item 1.Legal Proceedings.

There have been no material changes to the disclosure in response to "Part I - Item 3. Legal Proceedings" in the Company's Annual Report on Form 10-K for the year ended December 31, 2019.

Item 1A.Risk Factors.

There are a number of factors that may adversely affect the Company's business, financial results, or stock price. See "Risk Factors" as disclosed in response to "Item 1A. to Part I - Risk Factors" of Form 10-K for the year ended December 31, 2019.

There have been no material changes from the risk factors previously disclosed in the “Risk Factors” section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 and updated in the “Risk Factors” section of the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2020.

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds
In January 2019, the First Financial Board of Directors approved a stock repurchase plan pursuant to which the Company is authorized to repurchase up to 5,000,000 shares of stock through December 31, 2020. The Company did not purchase any shares under the Stock Repurchase Plan or otherwise in the third quarter of 2020.

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Item 6.         Exhibits
(a) Exhibits:
Exhibit Number
3.1
3.2
4.1
4.2
10.1
31.1
31.2
32.1
32.2
101.INS XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. *
101.SCH Inline XBRL Taxonomy Extension Schema. *
101.CAL Inline XBRL Taxonomy Extension Calculation Linkbase. *
101.DEF Inline XBRL Taxonomy Extension Definition Linkbase. *
101.LAB Inline XBRL Taxonomy Extension Labels Linkbase. *
101.PRE Inline XBRL Taxonomy Extension Presentation Linkbase. *
104 Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). *
First Financial will furnish, without charge, to a security holder upon request a copy of the documents and will furnish any other Exhibit upon payment of reproduction costs.  Unless as otherwise noted, documents incorporated by reference involve File No. 001-34762.

*    As provided in Rule 406T of Regulation S-T, this information shall not be deemed “filed” for purposes of Section 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934 or otherwise subject to liability under those sections.

** Compensatory plan or arrangement
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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
    FIRST FINANCIAL BANCORP.
    (Registrant)
     
/s/ James M. Anderson   /s/ Scott T. Crawley
James M. Anderson   Scott T. Crawley
Executive Vice President and Chief Financial Officer   First Vice President and Controller
(Principal Accounting Officer)
 
Date 11/6/2020 Date 11/6/2020

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