The following table shows a comparison of amortized cost and fair values of investment securities at December 31, 2013 and 2012:

 

 

Proceeds from sales of available-for-sale securities and the realized gains and losses are as follows:

 

 

 

The following table shows the Corporation’s securities with gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized position, at December 31, 2013 and 2012: 

 

 

Management systematically evaluates securities for impairment on a quarterly basis.  Based upon application of accounting guidance for subsequent measurement in ASC Topic 320 (ASC Section 320-10-35), management assesses whether (i) the Corporation has the intent to sell a security being evaluated and (ii) it is more likely than not that the Corporation will be required to sell the security prior to its anticipated recovery.  If neither applies, then declines in the fair values of securities below their cost that are considered other-than-temporary declines are split into two components.  The first is the loss attributable to declining credit quality.  Credit losses are recognized in earnings as realized losses in the period in which the impairment determination is made.  The second component consists of all other losses, which are recognized in other comprehensive loss.  In estimating OTTI losses, management considers (a) the length of time and the extent to which the fair value has been less than cost, (b) adverse conditions specifically related to the security, an industry, or a geographic area, (c) the historic and implied volatility of the fair value of the security, (d) changes in the rating of the security by a rating agency, (e) recoveries or additional declines in fair value subsequent to the balance sheet date, (f) failure of the issuer of the security to make scheduled interest or principal payments, and (g) the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future.  Management also monitors cash flow projections for securities that are considered beneficial interests under the guidance of ASC Subtopic 325-40, Investments – Other – Beneficial Interests in Securitized Financial Assets, (ASC Section 325-40-35).

 

Management believes that the valuation of certain securities is a critical accounting policy that requires significant estimates in preparation of its consolidated financial statements.  Management utilizes an independent third party to prepare both the impairment valuations and fair value determinations for its collateralized debt obligation (“CDO “) portfolio consisting of pooled trust preferred securities.  Based on management’s review of the third party evaluations, management believes that there were no material differences in the valuations between December 31, 2013 and December 31, 2012.

 

U.S. Government Agencies - Ten U.S. government agencies have been in a slight unrealized loss position for less than 12 months as of December 31, 2013.  There were two agency securities for which the cost has been less than market value for a period longer than 12 months.  These securities are of the highest investment grade and the Corporation does not intend to sell them, and it is not more likely than not that the Corporation will be required to sell them before recovery of their amortized cost basis, which may be at maturity.  Therefore, no OTTI existed at December 31, 2013. 

 

Residential Mortgage-Backed Agencies - Seventeen residential mortgage-backed agencies have been in an unrealized loss position for less than 12 months as of December 31, 2013.  Six residential mortgage-backed agencies have been in an unrealized loss position for a period of 12 months or longer.  All of these securities are of the highest investment grade and the Corporation does not intend to sell them, nor is it more likely than not that the Corporation will be required to sell them before recovery of their amortized cost basis, which may be at maturity.  Therefore, no OTTI existed at December 31, 2013.

 

Commercial Mortgage-Backed Agencies - Eleven commercial mortgage-backed agencies have been in an unrealized loss position for less than 12 months as of December 31, 2013.  There were no commercial mortgage-backed agency securities in an unrealized loss position for 12 months or more.  The securities are of the highest investment grade and the Corporation does not intend to sell them, and it is not more likely than not that the Corporation will be required to sell the securities before recovery of their amortized cost basis, which may be at maturity.  Accordingly, management does not consider these investments to be other-than-temporarily impaired at December 31, 2013.

 

Collateralized Mortgage Obligations  – One collateralized mortgage obligation security at December 31, 2013 has been in an unrealized loss position for 12 months or more.  Four collateralized mortgage obligation securities have been in a slight unrealized loss position for less than 12 months as of December 31, 2013.  The Corporation does not intend to sell these securities and it is not more likely than not that the Corporation will be required to sell them before recovery of their amortized cost basis, which may be at maturity.  Accordingly, management does not consider these investments to be other-than-temporarily impaired at December 31, 2013.

 

Obligations of State and Political Subdivisions – At December 31, 2013, there were seven municipal bonds that were impaired for a period of less than twelve months.  The Corporation owns two tax increment fund bonds in the held to maturity portfolio.  One of these bonds has been in an unrealized loss position for a period greater than 12 months.  This bond is not rated by the rating agencies and was underwritten by the Corporation prior to purchase and is periodically reviewed for credit quality.  Therefore, management does not consider this investment to be other-than-temporarily impaired at December 31, 2013.

 

Collateralized Debt Obligations - The $20.4 million in unrealized losses greater than 12 months at December 31, 2013 relates to 17 pooled trust preferred securities that comprise the CDO portfolio.  See Note 24 for a discussion of the methodology used by management to determine the fair values of these securities.  The Corporation did not record any credit-related non-cash OTTI charges for the years ended December 31, 2013 or 2012. The unrealized losses on the remaining securities in the portfolio are primarily attributable to continued depression in market interest rates, marketability, liquidity and the current economic environment. 

Management systematically evaluates securities for impairment on a quarterly basis.  Based upon application of Topic 320 (ASC Section 320-10-35), management must assess whether (i) we have the intent to sell the security and (ii) it is more likely than not that we will be required to sell the security prior to its anticipated recovery.  If neither applies, then declines in the fair value of securities below their cost that are considered other-than-temporary declines are split into two components.  The first is the loss attributable to declining credit quality.  Credit losses are recognized in earnings as realized losses in the period in which the impairment determination is made.  The second component consists of all other losses.  The other losses are recognized in other comprehensive income.  In estimating OTTI charges, management considers (a) the length of time and the extent to which the fair value has been less than cost, (b) adverse conditions specifically related to the security, an industry, or a geographic area, (c) the historic and implied volatility of the security, (d) changes in the rating of a security by a rating agency, (e) recoveries or additional declines in fair value subsequent to the balance sheet date, (f) failure of the issuer of the security to make scheduled interest payments, and (g) the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future.  Due to the duration and the significant market value decline in the pooled trust preferred securities held in our portfolio, we performed more extensive testing on these securities for purposes of evaluating whether or not an OTTI has occurred. 

 

The market for these securities as of December 31, 2013 is not active and markets for similar securities are also not active.  The inactivity was evidenced in 2008 first by a significant widening of the bid-ask spread in the brokered markets in which these securities trade and then by a significant decrease in the volume of trades relative to historical levels.  The new issue market is also inactive, as no new CDOs have been issued since 2007.  There are currently very few market participants who are willing to transact for these securities.  The market values for these securities, or any securities other than those issued or guaranteed by the Treasury, are very depressed relative to historical levels.  Therefore, in the current market, a low market price for a particular bond may only provide evidence of stress in the credit markets in general rather than being an indicator of credit problems with a particular issue.  Given the conditions in the current debt markets and the continued absence of observable transactions in the secondary and new issue markets, management has determined that (i) the few observable transactions and market quotations that are available are not reliable for the purpose of obtaining fair value at December 31, 2013, (ii) an income valuation approach technique (i.e. present value) that maximizes the use of relevant observable inputs and minimizes the use of observable inputs will be equally or more representative of fair value than a market approach, and (iii) the CDO segment is appropriately classified within Level 3 of the valuation hierarchy because management determined that significant adjustments were required to determine fair value at the measurement date.

 

Management utilizes an independent third party to assist the Corporation with both the evaluations of OTTI and the fair value determinations for our CDO portfolio.  Management believes that there were no material differences in the impairment evaluations and pricing between December 31, 2012 and December 31, 2013.

 

The approach of the third party to determine fair value involved several steps, including detailed credit and structural evaluation of each piece of collateral in each bond, default, recovery and prepayment/amortization probabilities for each piece of collateral in the bond, and discounted cash flow modeling.  The discount rate methodology used by the third party combines a baseline current market yield for comparable corporate and structured credit products with adjustments based on evaluations of the differences found in structure and risks associated with actual and projected credit performance of each CDO being valued.  Currently, there is an active and liquid trading market only for stand-alone trust preferred securities.  Therefore, adjustments to the baseline discount rate are also made to reflect the additional leverage found in structured instruments.

 

On December 10, 2013, to implement Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Department of the Treasury, the Federal Deposit Insurance Exchange Commission (the “SEC”) adopted the Volcker Rule.  The Volcker Rule prohibits a banking institution from acquiring or retaining an “ownership interest” in a “covered fund”.  A “covered fund” is (i) an entity that would be an investment company under the Investment Company Act of 1940, as amended, but for the exemptions contained in Section 3(c)(1) or Section 3(c)(7) of that Act, (ii) a commodity pool with certain characteristics, and/or (iii) a non-US entity with certain characteristics that is sponsored or owned by a banking entity located or organized in the US.  The term “ownership interest” is defined as “any equity, partnership, or other similar interest.” 

On January 14, 2014, the five regulatory agencies changed provisions of the Volcker Rule and published a list of CDOs that were exempt under the rule.  After our review of the exempt list, management identified 15 of our 18 holdings that were exempt from the rule.

The 3 remaining holdings owned that were not included on the exempt list were invested in I-Preferred Term Securities I and I-Preferred Term Securities IV.  The underlying issuers of these bonds were primarily insurance companies and not financial institutions.  Since these securities were not included on the published list of exempt CDOs, management needed to determine whether or not these holdings constitute an “ownership interest” as defined above.  To make this determination, management conducted a thorough review of the Indentures and Offering Memorandums for each of these bonds.

The bonds do not represent an equity or partnership interest.  Under the Volcker Rule, an interest will be an “other similar interest” if it exhibits any of the following characteristics on a current, future, or contingent basis:

Based upon review of the legal documents for  I-Preferred Term Securities I and I-Preferred Term Securities IV, neither of these bonds exhibit any of these characteristics and accordingly, do not meet the definition of an “ownership interest” as defined in the Volcker Rule.

In conclusion, as of December 31, 2013 all CDO securities owned by the Company are not subject to application of the Volcker Rule and therefore reaffirm our intent of the ability to hold.

The following table presents a cumulative roll-forward of the amount of non-cash OTTI charges related to credit losses which have been recognized in earnings for the trust preferred securities in the CDO portfolio held and not intended to be sold:

 

 

 

The amortized cost and estimated fair value of securities by contractual maturity at December 31, 2013 are shown in the following table.  Actual maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

At December 31, 2013 and 2012, investment securities with a fair value of $175 million and $157 million, respectively, were pledged as permitted or required to secure public deposits, for securities sold under agreements to repurchase as required or permitted by law and as collateral for borrowing capacity.