Note 4: Investment Securities

The amortized costs and approximate fair values, together with gross unrealized gains and losses on securities, are as follows:



	June 30, 2015
		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Available for Sale Securities
Mortgage-backed securities
Government-sponsored agencies	$	109,031	$	2,073	$	(509)	$	110,595
Collateralized mortgage obligations
Government-sponsored agencies		85,629		884		(742)		85,771
Federal agencies		4		-		-		4
Municipal obligations		43,554		1,500		(480)		44,574
Corporate obligations		21,777		66		(1,281)		20,562
Total investment securities	$	259,995	$	4,523	$	(3,012)	$	261,506



	December 31, 2014
		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Available for Sale Securities
Mortgage-backed securities
Government-sponsored agencies	$	110,452	$	2,927	$	(89)	$	113,290
Collateralized mortgage obligations
Government-sponsored agencies		97,325		1,270		(836)		97,759
Federal agencies		4		-		-		4
Municipal obligations		27,246		2,013		(7)		29,252
Corporate obligations		21,763		44		(1,306)		20,501
Total investment securities	$	256,790	$	6,254	$	(2,238)	$	260,806

The amortized cost and fair value of securities available for sale at June 30, 2015, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.



	Available for Sale
Description Securities	Amortized Cost		Fair Value
Security obligations due
Within one year		4,488		4,509
One to five years	$	14,491	$	14,577
Five to ten years		2,214		2,373
After ten years		44,142		43,681
		65,335		65,140
Mortgage-backed securities
Government-sponsored agencies		109,031		110,595
Collateralized mortgage obligations
Government-sponsored agencies		85,629		85,771
Totals	$	259,995	$	261,506

Proceeds from sales of securities available for sale for the three and six months ended June 30, 2015 and 2014 were $5.8 million and $13.4 million compared to $7.7 million and $23.2 million, respectively. Gross gains of $125,000 and $366,000 compared to $253,000 and $569,000 for the three and six months ended June 30, 2015 and 2014, respectively, were recognized on those sales. Gross losses of $42,000 and $207,000 for the three and six months ended June 30, 2014 were recognized on those sales. There were no gross losses recognized on the sales of securities for the three and six months ended June 30, 2015.

All mortgage-backed securities and collateralized-mortgage obligations held by the Company as of June 30, 2015 were in government-sponsored or federal agency securities.

Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at June 30, 2015 and December 31, 2014 was $109.7 million and $67.5 million, which is approximately 41.9 percent and 25.9 percent of the Company’s investment portfolio at those dates.

Based on our evaluation of available evidence, including recent changes in market interest rates, management believes the declines in fair value for these securities, for the periods presented, are temporary.

Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

During the first half of 2015 and 2014, the Bank determined that its security holdings had no other-than-temporary impairment.

The following tables show the gross unrealized losses and fair value of the Company’s investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2015 and December 31, 2014:



	June 30, 2015
	Less than 12 Months				12 Months or More				Total
		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Available for Sale
Mortgage-backed securities
Government-sponsored agencies	$	44,845	$	(509)	$	-	$	-	$	44,845	$	(509)
Collateralized mortgage obligations
Government-sponsored agencies		23,968		(211)		23,215		(531)		47,183		(742)
Municipal obligations		14,646		(477)		490		(3)		15,136		(480)
Corporate obligations		-		-		2,522		(1,281)		2,522		(1,281)
Total temporarily impaired securities	$	83,459	$	(1,197)	$	26,227	$	(1,815)	$	109,686	$	(3,012)



	December 31, 2014
	Less than 12 Months				12 Months or More				Total
		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Available for Sale
Mortgage-backed securities
Government-sponsored agencies	$	1,069	$	(9)	$	19,580	$	(80)	$	20,649	$	(89)
Collateralized mortgage obligations
Government-sponsored agencies		5,075		(40)		34,159		(796)	$	39,234	$	(836)
Federal agencies										-		-
Municipal obligations		-		-		631		(7)		631		(7)
Corporate obligations		-		-		6,995		(1,306)		6,995		(1,306)
Total temporarily impaired securities	$	6,144	$	(49)	$	61,365	$	(2,189)	$	67,509	$	(2,238)

Mortgage-Backed Securities (MBS) and Collateralized Mortgage Obligations (CMO)

The unrealized losses on the Company’s investment in MBSs and CMOs were caused by interest rate changes. The Company expects to recover the amortized cost basis over the term of the securities. Because (1) the decline in market value is attributable to changes in interest rates and not credit quality, (2) the Company does not intend to sell the investments and (3) it is more likely than not the Company will not be required to sell the investments before recovery of their amortized cost bases, which may be at maturity, the Company does not consider any of these investments to be other-than-temporarily impaired at June 30, 2015.

Municipals

The decrease in unrealized losses on the Company’s investments in securities of state and political subdivisions were caused by changes in interest rates. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. The Company does not intend to sell the investment and it is more likely than not that the Company will not be required to sell these investments before recovery of its new, lower amortized cost basis, which may be at maturity. The Corporation does not consider these investment securities to be other-than-temporarily impaired at June 30, 2015.

Corporate Obligations

The Company’s unrealized losses on investments in corporate obligations primarily relates to an investment in a pooled trust preferred security. The unrealized losses were primarily caused by (1) a decrease in performance and regulatory capital resulting from exposure to subprime mortgages and (2) a sector downgrade by several industry analysts. The Company currently expects some of the securities to settle at a price less than the amortized cost basis of the investment (that is, the Company expects to recover less than the entire amortized cost basis of the security). The Company has recognized a loss equal to the credit loss for these securities, establishing a new, lower amortized cost basis. The credit loss was calculated by comparing expected discounted cash flows based on performance indicators of the underlying assets in the security to the carrying value of the investment. Because the Company does not intend to sell these investments and it is likely that the Company will not be required to sell the investments before recovery of its new, lower amortized cost basis, which may be at maturity, it does not consider the remainder of these investments to be other-than-temporarily impaired at June 30, 2015.

Other-Than-Temporary Impairment (OTTI)

Upon acquisition of a security, the Company decides whether it is within the scope of the accounting guidance for beneficial interests in securitized financial assets or whether it will be evaluated for impairment under the accounting guidance for investments in debt and equity securities.

The accounting guidance for beneficial interests in securitized financial assets provides incremental impairment guidance for a subset of the debt securities within the scope of the guidance for investments in debt and equity securities. For securities that are a beneficial interest in securitized financial assets, the Company uses the beneficial interests in securitized financial asset impairment model. For securities where the security is not a beneficial interest in securitized financial assets, the Company uses debt and equity securities impairment accounting model.

The Company conducts periodic reviews to identify and evaluate each investment security to determine whether an other-than-temporary impairment has occurred. Economic models are used to determine whether an other-than-temporary impairment has occurred on these securities. While all securities are considered, the securities primarily impacted by other-than-temporary impairment testing are private-label mortgage-backed securities and trust preferred securities.

MutualFirst Financial uses market-based yield indicators as a baseline for determining appropriate discount rates, and then adjusts the resulting discount rates on the basis of its credit and structural analysis of specific trust preferred securities. The primary focus is on the returns a fixed income investor would require in order to allocate capital on a risk adjusted basis. There is currently no active market for pooled trust preferred securities; however, the Company looks principally to market yields for stand-alone trust preferred securities issued by banks, thrifts and insurance companies for which there is an active and liquid market. The next step is to make a series of adjustments to reflect the differences that exist between these products (both credit and structural) and, most importantly, to reflect idiosyncratic credit performance differences (both actual and projected) between these products and the underlying collateral in the specific trust preferred security. Importantly, as part of the analysis described above, MutualFirst considers the fact that structured instruments frequently exhibit leverage not present in stand-alone instruments, and make adjustments as necessary to reflect this additional risk.

Credit Losses Recognized on Investments

Certain debt securities have experienced fair value deterioration due to credit losses, as well as due to other market factors, but are not otherwise other-than-temporarily impaired.

The following table provides information about debt securities for which only a credit loss was recognized in income and other losses are recorded in other comprehensive income.



	Accumulated Credit Losses
	Three Months Ended
	June 30,
	2015		2014
Credit losses on debt securities held
Beginning of period	$	109	$	1,205
Reductions related to actual losses incurred		-		(500)
As of June 30,	$	109	$	705



	Accumulated Credit Losses
	Six Months Ended
	June 30,
	2015		2014
Credit losses on debt securities held
Beginning of year	$	109	$	1,205
Reductions related to actual losses incurred		-		(500)
As of June 30,	$	109	$	705

Pooled Trust Preferred Securities. The Company has invested in pooled trust preferred securities. At June 30, 2015, the current book balance of our pooled trust preferred securities was $3.8 million. The original par value of these securities was $4.0 million prior to the OTTI write-downs in 2011 and earlier. OTTI taken on trust preferred securities previously was the result of deterioration in the performance of the underlying collateral. The deterioration was the result of increased defaults and deferrals of dividend payments in that year, creating credit impairment along with weakening financial performance of performing collateral, increasing the risk of future deferrals of dividends and defaults. No additional OTTI was determined in the first half of 2015. All pooled trust preferred securities owned by the Bank are exempt from the Volcker Rule.

The following table provides additional information related to the Bank’s investment in pooled trust preferred securities as of June 30, 2015:



Deal Name	Class	Original Par		Book Value		Fair Value		Unrealized gain (loss)		Realized Losses YTD		Lowest Current Rating	Number of Banks / Insurance Cos. Currently Performing	Total Number of Banks and Insurance Cos. In Issuance (Unique)	Actual Deferrals/ Defaults (as a % of original collateral)		Total Projected Defaults (as a % of performing collateral) (1)		Excess subordination (after taking into account best estimate of future deferrals/ defaults) (2)
	(Dollars in Thousands)
Alesco Preferred Funding IX	A2A		1,000		912		547		(365)		-	BB+	42	51	10.04	%	12.95	%	55.14	%
U.S. Capital Funding I	B1		3,000		2,891		1,974		(917)		-	B3	28	33	9.44	%	7.02	%	10.33	%
		$	4,000	$	3,803	$	2,521	$	(1,282)	$	-

(1) A 10% recovery is applied to all projected defaults by depository institutions. A 15% recovery is applied to all projected defaults by insurance companies. No recovery is applied to current defaults.

(2) Excess subordination represents the additional defaults in excess of both current and projected defaults that the CDO can absorb before the bond experiences any credit impairment. Excess subordinated percentage is calculated by (a) determining what percentage of defaults a deal can experience before the bond has credit impairment, and (b) subtracting from this default breakage percentage both total current and expected future default percentages.