First Financial Bancorp Reports Second Quarter 2013 Financial Results

CINCINNATI, July 25, 2013 /PRNewswire/ -- First Financial Bancorp (Nasdaq: FFBC) ("First Financial" or the "Company") announced today financial and operational results for the second quarter 2013.

Second quarter net income was $15.8 million and earnings per diluted common share were $0.27.  This compares with first quarter net income of $13.8 million and earnings per diluted common share of $0.24 and second quarter 2012 net income of $17.8 million and earnings per diluted common share of $0.30.

• Quarterly adjusted pre-tax, pre-provision income increased 4.7% to $26.4 million, or 1.68% of average assets
• Continued solid quarterly performance
  • Quarterly results included several items which reduced earnings per diluted share by $0.02
  • Return on average assets of 1.01%; 1.08% as adjusted for the items noted below
  • Return on average tangible common equity of 10.54%; 11.30% as adjusted for the items noted below
• Capital ratios remain strong
  • Tangible common equity to tangible assets of 9.62%
  • Tier 1 capital ratio of 15.41%
  • Total risk-based capital ratio of 16.68%
• Total uncovered loan portfolio growth of 16.5% on an annualized basis
  • Strong performance in specialty finance, commercial real estate and traditional C&I with solid contributions from construction and residential mortgage
  • Uncovered loan growth exceeded the covered loan decline for the third consecutive quarter as total loans increased $67.8 million
• Quarterly net interest margin of 4.02%
  • Decline of 2 bps compared to the linked quarter
  • Strong growth in uncovered loans helped to offset impact of covered loan decline
  • Cost of interest-bearing deposits declined 6 bps during the quarter to 0.35%
  • Yield on uncovered loan portfolio declined 4 bps to 4.56%
• Total nonperforming loans declined $2.3 million during the quarter, which represents 2.22% of total loans compared to 2.38% for the linked quarter

During the quarter, the Company incurred certain pre-tax expenses resulting from its efficiency initiative of $1.5 million.  Approximately $0.5 million was related to employee benefit expenses associated with staffing reductions and $1.0 million was related to real estate expenses associated with banking center consolidation and closure plans.  Additionally, the Company incurred pre-tax pension settlement charges of $4.3 million resulting from recent employee-driven activity.  The Company also recognized other pre-tax income not expected to recur of $0.4 million and gains of $0.2 million resulting from sales of investment securities.  In the aggregate, these items reduced pre-tax earnings by $5.2 million, or $0.06 per diluted share after taxes.

The Company also enhanced its valuation methodology related to certain estimates of its of cash flows and impairment associated with the covered loan portfolio during the quarter.  As a result of these enhancements, the allowance for loan losses related to FDIC covered loans was reduced by $7.8 million with an equivalent amount reflected in the negative provision for covered loan losses for the quarter.  The Company also recognized the corresponding reduction in the FDIC indemnification asset of $6.3 million related to this change in estimate with an equivalent amount reflected in the negative FDIC loss sharing income for the quarter.  In the aggregate, these items increased pre-tax earnings by $1.6 million, or $0.02 per diluted share after taxes.

The Company's income tax expense for the second quarter benefitted from a favorable tax reversal related to an intercompany tax obligation associated with an unconsolidated former Irwin subsidiary as well as other nonrecurring items associated with favorable tax changes and recent tax planning strategies.  In the aggregate, these items reduced the Company's quarterly income tax expense by $1.1 million, or $0.02 per diluted share.

The board of directors has authorized a regular dividend of $0.15 per common share and a variable dividend of $0.12 per common share for the next regularly scheduled dividend, payable on October 1, 2013 to shareholders of record as of August 30, 2013.  As previously disclosed, this will be the last variable dividend paid with subsequent quarterly dividends expected to be comprised solely of the regular dividend.

Under the announced share repurchase plan, the Company repurchased 291,400 shares during the second quarter at an average price of $15.47 per share.  When combined with the regular and variable dividends paid to shareholders, First Financial returned 130.1% of quarterly net income to shareholders during the second quarter.

The Company continued to make progress on its efficiency initiative during the quarter.  Adjusting for expenses covered under loss sharing agreements, noninterest expense items discussed above, OREO costs and other operating expense variances that were primarily timing-related differences, noninterest expense declined $0.9 million during the quarter.  The timing-related expenses, totaling $1.6 million in the aggregate, were unrelated to initiatives associated with the $17.1 million annual cost savings target.  The Company estimates that it has achieved $15.0 million of annualized run rate savings to date and remains on track to realize 85% of the annual target in 2013.  All initiatives related to the annual target have been implemented and opportunities for further efficiencies are currently under review.

Claude Davis, President and Chief Executive Officer, commented, "On a reported basis, quarterly net income increased $2.0 million, or 14.5%, compared to the prior quarter.  Adjusting for the effects of expenses related to our efficiency initiative and other items incurred during the quarter, net income increased $2.1 million, or 13.8%, compared to the linked quarter, driven primarily by a rebound in fee revenue which more than offset the modest decline in net interest income.

"Net interest income declined $0.6 million, or 1.0%, and net interest margin declined 2 bps to 4.02% compared to the linked quarter.  While we continue to see a significant difference in the yields on new loan originations compared to loans that payoff, our strong loan growth helped to mitigate the impact of both the continued low rate environment and the decline in our covered loan portfolio.

"We were very pleased with our asset generation during the quarter as uncovered loans increased $133.3 million, or 16.5% on an annualized basis.  This marks the third consecutive quarter that our growth in uncovered loans has outpaced the decline in the covered loan portfolio.  Total loans increased $67.8 million, or 6.9% on an annualized basis, which is a respectable achievement in its own right.  Almost all lending areas of the Company contributed to the quarterly growth led by strong performance in our specialty finance and commercial real estate portfolios.  Specialty finance balances increased $43.2 million during the quarter, or 33.9% on a linked quarter basis, and investment CRE balances increased $36.0 million, or 4.7% on a linked quarter basis.

"Due to our initiative in late 2012 to pre-fund the investment portfolio's expected 12 month cash flows with wholesale borrowings, we were in a modest liability sensitive position as of March 31, 2013.  Early in the second quarter, we began to unwind the pre-funding initiative, as evidenced by the declines in average balances of both the investment portfolio and short-term borrowings.  As of June 30, 2013, we anticipate that we will be approximately neutral on our asset/liability position under a +100 bp parallel rate shift and asset sensitive under a +200 bp rate shift.  We continue to execute on deleverage strategies but will remain prudent in managing our balance sheet given strong loan demand and rational deposit pricing."

NET INTEREST INCOME AND NET INTEREST MARGIN

Net interest income for the second quarter was $58.1 million as compared to $58.7 million for the first quarter and $64.8 million for the second quarter 2012.  Compared to the linked quarter, total interest income declined $1.2 million, or 1.9%, and total interest expense declined $0.6 million, or 12.4%.  Net interest margin was 4.02% for the second quarter 2013 as compared to 4.04% for the first quarter 2013 and 4.49% for the second quarter 2012.

Interest income earned on loans decreased $1.0 million, or 1.8%, compared to the prior quarter.  The lower interest income earned on loans and modest decline in net interest margin was driven primarily by a 9.8% decrease in the average balance of covered loans outstanding and a 42 bp decline in the yield earned on the portfolio.

Growth in average uncovered loan balances of $109.3 million, or 3.4% on a linked quarter basis, and higher loan fees helped to partially offset the impact on net interest income and margin from the decline in covered loans during the quarter.  The yield earned on the uncovered portfolio declined 4 bps during the quarter.

Interest income earned from investment securities declined slightly during the quarter despite a decrease of $133.6 million, or 7.3%, in average balances as the yield earned on the portfolio increased 10 bps to 2.08%, helping to mitigate the impact on net interest margin of lower yields earned on loans.

Interest expense and net interest margin continued to benefit from declining deposit costs.  The average balance of interest-bearing deposits increased 0.2% compared to the prior quarter as a $50.7 million increase in average interest-bearing demand, savings and money market balances were partially offset by a decline of $43.2 million in average time deposit balances during the quarter.  The cost of funds related to interest-bearing deposits decreased 6 bps to 35 bps compared to 41 bps for the linked quarter.

NONINTEREST INCOME

The following table presents noninterest income for the three months ended June 30, 2013 and for the trailing four quarters, adjusted to exclude the impact of covered loan activity and other select items on the Company's reported balance.  

Excluding the items highlighted in Table I, noninterest income earned in the second quarter was $16.4 million compared to $14.3 million in the first quarter and $16.5 million in the second quarter 2012.  The increase of $2.1 million compared to the linked quarter was driven by higher service charges on deposits, bankcard income, net gains from sales of residential mortgages, client derivative fees and a credit valuation adjustment related to client derivatives, partially offset by lower trust and wealth management fees.  

NONINTEREST EXPENSE

The following table presents noninterest expense for the three months ended June 30, 2013 and for the trailing four quarters, adjusted to exclude the impact of covered asset activity and other select items on the Company's reported balance.

Excluding the items highlighted in Table II, noninterest expense in the second quarter was $48.1 million as compared to $47.7 million in the first quarter and $51.0 million in the second quarter 2012.  The increase of $0.4 million compared to the linked quarter was due primarily to higher marketing and other miscellaneous expenses, partially offset by lower salaries and employee benefits, uncovered OREO and equipment expenses.  Expenses associated with the efficiency initiative and other staffing-related changes include $0.5 million of employee benefit expenses related to staffing reductions and $1.0 million of real estate expenses associated with banking center consolidation and closure plans.

During the quarter, the Company recognized $4.3 million of pension settlement charges associated with recent employee-related actions and the resulting lump-sum distributions from its pension plan.  Pension settlement charges are an acceleration of previously deferred costs that would have been recognized in future periods and are determined in accordance with FASB ASC Topic 715, Compensation - Retirement Benefits.  As First Financial has exceeded the annual accounting threshold for lump-sum distributions, it will recognize a proportionate share of any further lump-sum distributions from its pension plan as additional pension settlement charges through the remainder of 2013.

INCOME TAXES

For the second quarter, income tax expense was $6.5 million, resulting in an effective tax rate of 29.0%, compared with income tax expense of $6.4 million and an effective tax rate of 31.5% during the first quarter and $8.7 million and an effective tax rate of 32.8% during the second quarter 2012.  The lower second quarter tax rate resulted from a favorable tax reversal related to an intercompany tax obligation associated with an unconsolidated former Irwin subsidiary as well as other nonrecurring items associated with favorable tax changes and recent tax planning strategies.  In the aggregate, these items reduced the Company's quarterly income tax expense by $1.1 million.  The Company anticipates this will be the last meaningful adjustment related to the resolution of the former Irwin subsidiary and that a normalized effective tax rate in future periods is estimated to be 34.5%.

CREDIT QUALITY – EXCLUDING COVERED ASSETS

The following table presents certain credit quality metrics related to the Company's uncovered loan portfolio as of June 30, 2013 and the trailing four quarters.

Net Charge-offs

For the second quarter, net charge-offs increased $1.2 million, or 46.0%, to $3.7 million compared to the linked quarter due to increases in commercial real estate and C&I net charge-offs, partially offset by lower home equity net charge-offs.  The increase was driven primarily by a $0.9 million charge-off related to a nonaccrual commercial real estate credit.

Nonperforming Assets

Nonaccrual loans, including nonaccrual troubled debt restructurings, decreased $2.4 million, or 3.8%, to $62.0 million as of June 30, 2013 from $64.5 million as of March 31, 2013.  Contributing to the decline was a $1.5 million paydown related to a commercial relationship classified as a nonaccrual troubled debt restructuring.  Other activity included the addition to nonaccrual loans of a $2.0 million commercial real estate credit that was offset by reductions resulting from paydowns or transfers to OREO.

OREO decreased $0.2 million, or 1.6%, to $11.8 million during the second quarter as resolutions and valuation adjustments of $2.2 million exceeded $2.0 million of additions during the quarter.  Additions were driven by two properties totaling $1.6 in the aggregate and resolutions included three properties totaling $1.0 million in the aggregate for the quarter.

Classified assets as of June 30, 2013 declined to $129.8 million, or 0.5%, from $130.4 million for the linked quarter and decreased $15.8 million, or 10.8%, from $145.6 million as of June 30, 2012.  Classified assets are defined by the Company as nonperforming assets plus performing loans internally rated substandard or worse.

Delinquent Loans

As of June 30, 2013, loans 30-to-89 days past due totaled $13.4 million, or 0.40% of period-end loans, as compared to $18.2 million, or 0.56%, as of March 31, 2013 and $26.0 million, or 0.86%, as of June 30, 2012.  The decline of $4.8 million, or 26.4%, during the second quarter was driven primarily by the reclassification of a $2.0 million commercial real estate credit to nonaccrual status as well as a commercial real estate credit and an equipment finance credit, totaling $1.9 million in the aggregate, where the borrowers made payments to bring the loans current.

Provision for Loan & Lease Losses

Second quarter provision expense related to uncovered loans and leases was $2.4 million as compared to $3.0 million for the linked quarter and $8.4 million for the comparable year-over-year quarter.  Provision expense is a result of the Company's modeling efforts to estimate the period-end allowance for loan and lease losses.  As a percentage of net charge-offs, second quarter provision expense equaled 65.7%.

LOANS (EXCLUDING COVERED LOANS)

The following table presents the loan portfolio, excluding covered loans, as of June 30, 2013, March 31, 2013 and June 30, 2012. 

Loans, excluding covered loans, totaled $3.4 billion as of June 30, 2013, increasing $133.3 million, or 16.5% on an annualized basis, compared to the linked quarter and $369.5 million, or 12.3%, compared to June 30, 2012.  The increase relative to the linked quarter was driven by growth in specialty finance, commercial real estate and traditional C&I with continued solid performance from construction and residential mortgage lending.

INVESTMENTS

The following table presents a summary of the total investment portfolio at June 30, 2013.  

The investment portfolio decreased $113.0 million, or 6.5%, during the second quarter as $54.9 million of purchases were offset by sales, amortizations and paydowns.  In addition, the Company sold $19.9 million of agency MBS and CMOs during the quarter in order to enhance liquidity and reduce prepayment and premium risks, recognizing a pre-tax gain of $0.2 million.  The organic runoff of principal and interest payments in the investment portfolio is complementing loan demand as the Company manages the potential impact of rising long-term interest rates on its interest rate sensitivity position and capital.  This decline could be accelerated in the future depending on the Company's view of forward rates.  As of June 30, 2013, the overall duration of the investment portfolio increased to 4.0 years compared to 3.1 years as of March 31, 2013.  The yield earned on the portfolio during the quarter increased 10 bps to 2.08% from 1.98% for the linked quarter, driven partially by stabilization in premium amortization.  Due to an increase in interest rates and a widening of spreads for fixed income securities during the quarter, the net unrealized gain included in accumulated other comprehensive loss related to the investment portfolio of $9.4 million as of March 31, 2013 declined $15.2 million to a net unrealized loss of $5.8 million as of June 30, 2013.

DEPOSITS

Non-time deposit balances totaled $3.8 billion as of June 30, 2013, consistent with balances as of March 31, 2013, as increases in commercial balances of $29.7 million and public fund balances of $13.0 million were offset by a decrease in consumer balances of $42.9 million.

Time deposit balances decreased $51.4 million, or 5.0%, compared to the linked quarter due primarily to a decline in consumer balances of $56.6 million, offset by an increase in public fund balances of $10.7 million.

The low interest rate environment continued to have a positive impact on the Company's deposit costs as the total cost of deposit funding declined to 27 bps for the quarter, a decrease of 5 bps compared to the prior quarter and 22 bps compared to the second quarter 2012.

CAPITAL MANAGEMENT

The following table presents First Financial's regulatory and other capital ratios as of June 30, 2013, March 31, 2013 and June 30, 2012.

Shareholders' equity decreased $6.2 million during the quarter due primarily to the change in the unrealized gain/loss related to the investment portfolio, regular and variable dividends declared during the quarter and share repurchases. This decline was partially offset by net income and a $10.4 million adjustment related to the Company's updated pension plan assumptions reflecting the recent change in long-term interest rates and their estimated impact on the benefit obligation.  The Company's tangible common equity ratio increased during the quarter as the decline in period end tangible assets outweighed the decline in tangible equity.  The tier 1 capital and total risk-based capital ratios declined during the quarter due primarily to an increase in risk-weighted assets.  Regulatory capital ratios as of June 30, 2013 are considered preliminary pending the filing of the Company's regulatory reports.  

Teleconference / Webcast Information

First Financial's senior management will host a conference call to discuss the Company's financial and operating results on Friday, July 26, 2013 at 8:30 a.m. Eastern Time.  Members of the public who would like to listen to the conference call should dial (888) 317-6016 (U.S. toll free), (855) 669-9657 (Canada toll free) or +1 (412) 317-6016 (International) (no passcode required).  The number should be dialed five to ten minutes prior to the start of the conference call.  The conference call will also be accessible as an audio webcast via the Investor Relations section of the Company's website at www.bankatfirst.com.  A replay of the conference call will be available beginning one hour after the completion of the live call through August 12, 2013 at (877) 344-7529 (U.S. toll free) and +1 (412) 317-0088 (International); conference number 10031278.  The webcast will be archived on the Investor Relations section of the Company's website through July 26, 2014.

Press Release and Additional Information on Website

This press release as well as supplemental information and any non-GAAP reconciliations related to this release is available to the public through the Investor Relations section of First Financial's website at www.bankatfirst.com/investor.

Forward-Looking Statement

Certain statements contained in this release which are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act (the ''Act'').  In addition, certain statements in future filings by First Financial with the SEC, in press releases, and in oral and written statements made by or with the approval of First Financial which are not statements of historical fact constitute forward-looking statements within the meaning of the Act.  Examples of forward-looking statements include, but are not limited to, projections of revenues, income or loss, earnings or loss per share, the payment or non-payment of dividends, capital structure and other financial items, statements of plans and objectives of First Financial or its management or board of directors and statements of future economic performances and statements of assumptions underlying such statements.  Words such as ''believes,'' ''anticipates,'' "likely," "expected," ''intends,'' and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.  Management's analysis contains forward-looking statements that are provided to assist in the understanding of anticipated future financial performance.  However, such performance involves risks and uncertainties that may cause actual results to differ materially.  Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:

• management's ability to effectively execute its business plan;
• the risk that the strength of the United States economy in general and the strength of the local economies in which we conduct operations may continue to deteriorate resulting in, among other things, a further deterioration in credit quality or a reduced demand for credit, including the resultant effect on our loan portfolio, allowance for loan and lease losses and overall financial performance;
• U.S. fiscal debt and budget matters;
• the ability of financial institutions to access sources of liquidity at a reasonable cost;
• the impact of recent upheaval in the financial markets and the effectiveness of domestic and international governmental actions taken in response, and the effect of such governmental actions on us, our competitors and counterparties, financial markets generally and availability of credit specifically, and the U.S. and international economies, including potentially higher FDIC premiums arising from increased payments from FDIC insurance funds as a result of depository institution failures;
• the effect of and changes in policies and laws or regulatory agencies (notably the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act);
• the effect of the current low interest rate environment or changes in interest rates on our net interest margin and our loan originations and securities holdings;
• our ability to keep up with technological changes;
• failure or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers;
• our ability to comply with the terms of loss sharing agreements with the FDIC;
• mergers and acquisitions, including costs or difficulties related to the integration of acquired companies and the wind-down of non-strategic operations that may be greater than expected, such as the risks and uncertainties associated with the Irwin Mortgage Corporation bankruptcy proceedings and other acquired subsidiaries;
• the risk that exploring merger and acquisition opportunities may detract from management's time and ability to successfully manage our Company;
• expected cost savings in connection with the consolidation of recent acquisitions may not be fully realized or realized within the expected time frames, and deposit attrition, customer loss and revenue loss following completed acquisitions may be greater than expected;
• our ability to increase market share and control expenses;
• the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as the Financial Accounting Standards Board and the SEC;
• adverse changes in the creditworthiness of our borrowers and lessees, collateral values, the value of investment securities and asset recovery values, including the value of the FDIC indemnification asset and related assets covered by FDIC loss sharing agreements;
• adverse changes in the securities, debt and/or derivatives markets;
• our success in recruiting and retaining the necessary personnel to support business growth and expansion and maintain sufficient expertise to support increasingly complex products and services;
• monetary and fiscal policies of the Board of Governors of the Federal Reserve System (Federal Reserve) and the U.S. government and other governmental initiatives affecting the financial services industry;
• unpredictable natural or other disasters could have an adverse effect on us in that such events could materially disrupt our operations or our vendors' operations or willingness of our customers to access the financial services we offer;
• our ability to manage loan delinquency and charge-off rates and changes in estimation of the adequacy of the allowance for loan losses; and
• the costs and effects of litigation and of unexpected or adverse outcomes in such litigation.

In addition, please refer to our Annual Report on Form 10-K for the year ended December 31, 2012, as well as our other filings with the SEC, for a more detailed discussion of these risks and uncertainties and other factors. Such forward-looking statements are meaningful only on the date when such statements are made, and First Financial undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such a statement is made to reflect the occurrence of unanticipated events.

About First Financial Bancorp

First Financial Bancorp is a Cincinnati, Ohio based bank holding company.  As of June 30, 2013, the Company had $6.3 billion in assets, $4.0 billion in loans, $4.8 billion in deposits and $695 million in shareholders' equity.  The Company's subsidiary, First Financial Bank, N.A., founded in 1863, provides banking and financial services products through its three lines of business: commercial, retail and wealth management.  The commercial and retail units provide traditional banking services to business and consumer clients.  First Financial Wealth Management provides wealth planning, portfolio management, trust and estate, brokerage and retirement plan services and had approximately $2.5 billion in assets under management as of June 30, 2013.  The Company's strategic operating markets are located in Ohio, Indiana and Kentucky where it operates 110 banking centers.  Additional information about the Company, including its products, services and banking locations is available at www.bankatfirst.com.

SUPPLEMENTAL INFORMATION ON COVERED ASSETS

ACCELERATED DISCOUNT ON LOAN PREPAYMENTS AND DISPOSITIONS

During the second quarter, First Financial recognized approximately $1.9 million in accelerated discount from covered loans, net of the corresponding adjustment on the FDIC indemnification asset.  Accelerated discount is recognized when covered loans, which are recorded on the Company's balance sheet at an amount less than the unpaid principal balance, prepay at an amount greater than their recorded book value.  Prepayments can occur through either customer driven payments before the maturity date or loan sales.  The amount of discount attributable to the credit loss component of each loan varies and the recognized amount is offset by a related reduction in the FDIC indemnification asset.  Accelerated discount recognized during the quarter resulted primarily from loan prepayments.

NET INTEREST MARGIN IMPACT

Net interest margin is affected by certain activity related to the covered loan portfolio.  The majority of these loans are accounted for under FASB ASC Topic 310-30 and, as such, the Company is required to periodically update its forecast of expected cash flows from these loans.  Impairment, as a result of a decrease in expected cash flows, is recognized as provision expense in the period it is measured and has no impact on net interest margin.  Improvements in expected cash flows, in excess of any prior impairment, are recognized on a prospective basis through an upward adjustment to the yield earned on the portfolio.  Impairment and improvement are both partially offset by the impact of changes in the value of the FDIC indemnification asset.  Impairment is partially offset by an increase to the FDIC indemnification asset as a result of FDIC loss sharing income.  Improvement, which is reflected as a higher yield, is partially offset by a lower yield earned on the FDIC indemnification asset until the next periodic valuation of the loans and the indemnification asset.  The weighted average yield of the acquired loan portfolio may also be subject to change as loans with higher yields pay down more quickly or slowly than loans with lower yields.

The following table shows the estimated yield earned by the Company on its covered and uncovered loan portfolios and the FDIC indemnification asset for the three months ended June 30, 2013.

COVERED ASSETS

The following table presents the covered loan portfolio as of June 30, 2013, March 31, 2013 and June 30, 2012.

As of June 30, 2013, 15.5% of the Company's total loans were covered loans.  During the second quarter, the total balance of covered loans decreased $65.5 million, or 9.5%, compared to the prior quarter.  As required under the loss sharing agreements, First Financial must file monthly certifications with the FDIC on single-family residential loans and quarterly certifications on all other loans.  The payment of claims is subject to the FDIC's review for compliance with the loss sharing agreements and to date, all certifications have been filed in a timely manner and without significant issues.

Covered OREO decreased $6.9 million, or 23.4%, during the second quarter to $22.5 million as of June 30, 2013 as resolutions and valuation adjustments of $13.1 million exceeded additions of $6.2 million during the quarter.  Additionally, the Company recognized a net gain on sales of covered OREO of $2.2 million during the quarter.  The net gain was offset by a corresponding reduction in FDIC loss sharing income of approximately 80% of the net gains recognized.

ALLOWANCE FOR LOAN AND LEASE LOSSES - COVERED

Under the applicable accounting guidance, the allowance for loan losses related to covered loans is a result of impairment identified in ongoing valuation procedures and is generally recognized in the current period as provision expense.  However, if improvement is noted in a loan pool that had previously experienced impairment, the amount of improvement is recognized as a reduction to the applicable period's provision expense.  Additional improvement beyond previously recorded impairment is reflected as a yield adjustment on a prospective basis.  The timing inherent in this accounting treatment may result in earnings volatility in future periods.

The following table presents activity in the allowance for loan losses related to covered loans for the three months ended June 30, 2013 and for the trailing three quarters.  

As a percentage of total covered loans, the allowance for loan losses totaled 5.30% as of June 30, 2013 compared to 6.61% as of March 31, 2013.

During the quarter, the Company implemented certain enhancements to its valuation methodology and the estimation of impairment to place greater emphasis on changes in total expected cash flows and less emphasis on changes in the net present value of expected cash flows.  As a result of these changes in estimates, the allowance for loan losses related to covered loans was reduced by $7.8 million with an equivalent amount reflected in the negative provision for covered loan losses for the quarter.  The Company also recognized a corresponding reduction in the FDIC indemnification asset of $6.3 million related to these changes in estimates with an equivalent amount reflected in the negative FDIC loss sharing income for the quarter.

Net charge-offs on covered loans during the second quarter were $4.3 million compared to $8.7 million for the first quarter, a decrease of $4.5 million, or 51.3%.  During the second quarter, the Company recognized a negative provision expense of $8.3 million compared to a provision expense of $9.0 million for the linked quarter.  The difference between provision expense and net charge-offs primarily relates to the quarterly re-estimation of cash flow expectations required under FASB ASC Topic 310-30.

In addition to the provision expense, the Company incurred loss sharing and covered asset expenses of $1.6 million, consisting primarily of credit expenses, offset by $2.2 million of net gains related to covered OREO.  The negative FDIC loss sharing income for the quarter reflects the quarterly re-estimation of expected cash flows, including the enhancements to the quarterly estimation discussed above, as well as the corresponding offset related to the net gains on sales of covered OREO and loss sharing and covered asset expenses.

SOURCE First Financial Bancorp