Note 3 – Debt and Equity Securities

The amortized cost and estimated fair value of investments in debt securities, all of which are classified as available-for-sale, are as follows:

(in thousands)	Amortized cost		Gross unrealized					Estimated fair value		Other-than- temporary impairments in AOCI
(in thousands)	Amortized cost		Gains		Losses			Estimated fair value		Other-than- temporary impairments in AOCI
September 30, 2014
U.S. Treasury bonds	$	70,909	$	732	$	(318	)	$	71,323	$	—
Municipal bonds		534,865		10,668		(897	)		544,636		—
Foreign bonds		199,882		1,378		(163	)		201,097		—
Governmental agency bonds		204,546		942		(3,261	)		202,227		—
Governmental agency mortgage-backed securities		1,522,943		5,287		(13,388	)		1,514,842		—
Non-agency mortgage-backed securities (1)		17,246		1,362		(1,057	)		17,551		19,877
Corporate debt securities		546,209		6,983		(3,984	)		549,208		—
	$	3,096,600	$	27,352	$	(23,068	)	$	3,100,884	$	19,877
December 31, 2013
U.S. Treasury bonds	$	66,400	$	669	$	(685	)	$	66,384	$	—
Municipal bonds		491,143		5,113		(10,291	)		485,965		—
Foreign bonds		221,298		1,836		(626	)		222,508		—
Governmental agency bonds		267,713		233		(5,401	)		262,545		—
Governmental agency mortgage-backed securities		1,426,489		2,074		(25,254	)		1,403,309		—
Non-agency mortgage-backed securities (1)		19,658		1,167		(1,803	)		19,022		20,743
Corporate debt securities		355,893		7,279		(3,088	)		360,084		—
	$	2,848,594	$	18,371	$	(47,148	)	$	2,819,817	$	20,743

(1)

At September 30, 2014, the $17.2 million amortized cost is net of $1.0 million in other-than-temporary impairments determined to be credit related which have been recognized in earnings for the nine months ended September 30, 2014. At September 30, 2014 and December 31, 2013, the $1.1 million and $1.8 million, respectively, of gross unrealized losses related to securities determined to be other-than-temporarily impaired. The $19.9 million and $20.7 million other-than-temporary impairments recorded in accumulated other comprehensive income (loss) (“AOCI”) at September 30, 2014 and December 31, 2013, respectively, which relate to non-agency mortgage-backed securities, represent the amount of other-than-temporary impairment losses recognized in AOCI which were not included in earnings as the losses were not considered to be credit related.

The cost and estimated fair value of investments in equity securities, all of which are classified as available-for-sale, are as follows:

	Cost		Gross unrealized					Estimated fair value
(in thousands)	Cost		Gains		Losses			Estimated fair value
September 30, 2014
Preferred stocks	$	15,664	$	1,294	$	(200	)	$	16,758
Common stocks		368,594		17,028		(8,639	)		376,983
	$	384,258	$	18,322	$	(8,839	)	$	393,741
December 31, 2013
Preferred stocks	$	9,915	$	1,567	$	(397	)	$	11,085
Common stocks		324,184		25,137		(2,363	)		346,958
	$	334,099	$	26,704	$	(2,760	)	$	358,043

The Company had the following unrealized gains (losses) as of September 30, 2014 and December 31, 2013:


(in thousands)	As of September 30, 2014		As of December 31, 2013
Debt securities for which an OTTI has been recognized	$	324	$	(625	)
Debt securities—all other		3,960		(28,152	)
Equity securities		9,483		23,944
	$	13,767	$	(4,833	)

Sales of debt and equity securities resulted in realized gains of $9.9 million and $3.4 million and realized losses of $1.7 million and $9.7 million for the three months ended September 30, 2014 and 2013, respectively, and realized gains of $24.6 million and $15.6 million and realized losses of $6.1 million and $11.7 million for the nine months ended September 30, 2014 and 2013, respectively.

The Company had the following gross unrealized losses as of September 30, 2014 and December 31, 2013:

	Less than 12 months					12 months or longer					Total
(in thousands)	Estimated fair value		Unrealized losses			Estimated fair value		Unrealized losses			Estimated fair value		Unrealized losses
September 30, 2014
Debt securities:
U.S. Treasury bonds	$	14,107	$	(81	)	$	16,465	$	(237	)	$	30,572	$	(318	)
Municipal bonds		74,804		(429	)		31,327		(468	)		106,131		(897	)
Foreign bonds		31,320		(132	)		3,947		(31	)		35,267		(163	)
Governmental agency bonds		32,030		(164	)		129,625		(3,097	)		161,655		(3,261	)
Governmental agency mortgage-backed securities		420,991		(2,535	)		357,138		(10,853	)		778,129		(13,388	)
Non-agency mortgage-backed securities		2,041		(7	)		6,063		(1,050	)		8,104		(1,057	)
Corporate debt securities		298,259		(3,797	)		12,327		(187	)		310,586		(3,984	)
Total debt securities		873,552		(7,145	)		556,892		(15,923	)		1,430,444		(23,068	)
Equity securities		264,336		(8,638	)		4,069		(201	)		268,405		(8,839	)
Total	$	1,137,888	$	(15,783	)	$	560,961	$	(16,124	)	$	1,698,849	$	(31,907	)
December 31, 2013
Debt securities:
U.S. Treasury bonds	$	37,492	$	(685	)	$	—	$	—		$	37,492	$	(685	)
Municipal bonds		230,180		(8,938	)		27,687		(1,353	)		257,867		(10,291	)
Foreign bonds		56,579		(626	)		—		—			56,579		(626	)
Governmental agency bonds		203,011		(5,375	)		131		(26	)		203,142		(5,401	)
Governmental agency mortgage-backed securities		838,411		(20,970	)		124,425		(4,284	)		962,836		(25,254	)
Non-agency mortgage-backed securities		—		—			12,086		(1,803	)		12,086		(1,803	)
Corporate debt securities		129,394		(2,422	)		12,500		(666	)		141,894		(3,088	)
Total debt securities		1,495,067		(39,016	)		176,829		(8,132	)		1,671,896		(47,148	)
Equity securities		85,112		(2,718	)		1,046		(42	)		86,158		(2,760	)
Total	$	1,580,179	$	(41,734	)	$	177,875	$	(8,174	)	$	1,758,054	$	(49,908	)

Substantially all securities in the Company’s non-agency mortgage-backed portfolio are senior tranches and all were investment grade at the time of purchase, however, all have subsequently been downgraded to below investment grade. The table below summarizes the composition of the Company’s non-agency mortgage-backed securities as of September 30, 2014, by collateral type and year of issuance.

(in thousands, except number of securities)	Number of Securities		Amortized Cost		Estimated Fair Value
Non-agency mortgage-backed securities:
Prime single family residential:
2007		1	$	3,129	$	2,643
2006		3		8,079		7,755
2005		1		639		620
Alt-A single family residential:
2007		1		5,399		6,533
		6	$	17,246	$	17,551

The amortized cost and estimated fair value of debt securities at September 30, 2014, by contractual maturities, are as follows:

(in thousands)	Due in one year or less		Due after one through five years		Due after five through ten years		Due after ten years		Total
U.S. Treasury bonds
Amortized cost	$	9,805	$	37,719	$	20,956	$	2,429	$	70,909
Estimated fair value	$	9,884	$	37,671	$	21,109	$	2,659	$	71,323
Municipal bonds
Amortized cost	$	16,092	$	249,478	$	160,318	$	108,977	$	534,865
Estimated fair value	$	16,211	$	252,825	$	164,186	$	111,414	$	544,636
Foreign bonds
Amortized cost	$	42,387	$	138,724	$	15,349	$	3,422	$	199,882
Estimated fair value	$	42,602	$	139,741	$	15,333	$	3,421	$	201,097
Governmental agency bonds
Amortized cost	$	3,773	$	116,699	$	72,092	$	11,982	$	204,546
Estimated fair value	$	3,786	$	115,437	$	70,495	$	12,509	$	202,227
Corporate debt securities
Amortized cost	$	20,744	$	236,608	$	253,537	$	35,320	$	546,209
Estimated fair value	$	20,966	$	239,858	$	252,722	$	35,662	$	549,208
Total debt securities excluding mortgage-backed securities
Amortized cost	$	92,801	$	779,228	$	522,252	$	162,130	$	1,556,411
Estimated fair value	$	93,449	$	785,532	$	523,845	$	165,665	$	1,568,491
Total mortgage-backed securities
Amortized cost									$	1,540,189
Estimated fair value									$	1,532,393
Total debt securities
Amortized cost									$	3,096,600
Estimated fair value									$	3,100,884

Mortgage-backed securities, which include contractual terms to maturity, are not categorized by contractual maturity because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Other-than-temporary impairment — debt securities

If the Company intends to sell a debt security in an unrealized loss position or determines that it is more likely than not that the Company will be required to sell a debt security before it recovers its amortized cost basis, the debt security is other-than-temporarily impaired and it is written down to fair value with all losses recognized in earnings. As of September 30, 2014, the Company did not intend to sell any debt securities in an unrealized loss position and it is not more likely than not that the Company will be required to sell debt securities before recovery of their amortized cost basis.

If the Company does not expect to recover the amortized cost basis of a debt security with declines in fair value (even if the Company does not intend to sell the debt security and it is not more likely than not that the Company will be required to sell the debt security), the losses the Company considers to be the credit portion of the other-than-temporary impairment loss (“credit loss”) is recognized in earnings and the non-credit portion is recognized in other comprehensive income. The credit loss is the difference between the present value of the cash flows expected to be collected and the amortized cost basis of the debt security. The cash flows expected to be collected are discounted at the rate implicit in the security immediately prior to the recognition of the other-than-temporary impairment.

Expected future cash flows for debt securities are based on qualitative and quantitative factors specific to each security, including the probability of default and the estimated timing and amount of recovery. The detailed inputs used to project expected future cash flows may be different depending on the nature of the individual debt security.

The Company determines if a non-agency mortgage-backed security in a loss position is other-than-temporarily impaired by comparing the present value of the cash flows expected to be collected from the security to its amortized cost basis. If the present value of the cash flows expected to be collected exceed the amortized cost of the security, the Company concludes that the security is not other-than-temporarily impaired. The Company performs this analysis on all non-agency mortgage-backed securities in its portfolio that are in an unrealized loss position. For the securities that were determined not to be other-than-temporarily impaired at September 30, 2014, the present value of the cash flows expected to be collected exceeded the amortized cost of each security.

Cash flows expected to be collected for each non-agency mortgage-backed security are estimated by analyzing loan-level detail to estimate future cash flows from the underlying assets, which are then applied to the security based on the underlying contractual provisions of the securitization trust that issued the security (e.g., subordination levels, remaining payment terms, etc.). The Company uses third-party software to determine how the underlying collateral cash flows will be distributed to each security issued from the securitization trust. The primary assumptions used in estimating future collateral cash flows are prepayment speeds, default rates and loss severity. In developing these assumptions, the Company considers the financial condition of the borrower, loan to value ratio, loan type and geographical location of the underlying property. The Company utilizes publicly available information related to specific assets, generally available market data such as forward interest rate curves and securities, loans and property data and market analytics tools provided through a third party.

The table below summarizes the primary assumptions used at September 30, 2014 in estimating the cash flows expected to be collected for these securities.


	Weighted average			Range
Prepayment speeds		9.9	%	8.1	%	–	10.8	%
Default rates		2.7	%	1.3	%	–	4.9	%
Loss severity		18.0	%	2.8	%	–	30.5	%

As a result of the Company’s security-level review, the Company did not recognize any other-than-temporary impairments considered to be credit related on its non-agency mortgage-backed securities for the three months ended September 30, 2014, and recognized $1.0 million of other-than-temporary impairments in earnings for the nine months ended September 30, 2014. The Company did not recognize any other-than-temporary impairments considered to be credit related for the three and nine months ended September 30, 2013. It is possible that the Company could recognize additional other-than-temporary impairment losses on securities it owns at September 30, 2014 if future events or information cause it to determine that a decline in fair value is other-than-temporary.

The following table presents the change in the credit portion of the other-than-temporary impairments recognized in earnings on debt securities for which a portion of the other-than-temporary impairments related to other factors was recognized in other comprehensive income (loss) for the three and nine months ended September 30, 2014 and 2013.

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
(in thousands)	2014		2013		2014		2013
Cumulative credit loss on debt securities held at beginning of period	$	17,511	$	16,478	$	16,478	$	16,478
Addition to credit loss for which an other-than-temporary impairment was previously recognized		—		—		1,033		—
Cumulative credit loss on debt securities held at end of period	$	17,511	$	16,478	$	17,511	$	16,478

Other-than-temporary impairment — equity securities

When a decline in the fair value of an equity security, including common and preferred stock, is considered to be other-than-temporary, such equity security is written down to its fair value. When assessing if a decline in fair value is other-than-temporary, the factors considered include the length of time and extent to which fair value has been below cost, the probability that the Company will be unable to collect all amounts due under the contractual terms of the security, the seniority of the securities, issuer-specific news and other developments, the financial condition and prospects of the issuer (including credit ratings), macro-economic changes (including the outlook for industry sectors, which includes government policy initiatives) and the Company’s ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery.

When an equity security has been in an unrealized loss position for greater than twelve months, the Company’s review of the security includes the above noted factors as well as other evidence that might exist supporting the view that the security will recover its value in the foreseeable future, typically within the next twelve months. If objective, substantial evidence does not indicate a likely recovery during that timeframe, the Company’s policy is that such losses are considered other-than-temporary and therefore an impairment loss is recorded. For the three and nine months ended September 30, 2014 and 2013, the Company did not record other-than-temporary impairment losses related to its equity securities.

Fair value measurement

The Company classifies the fair value of its debt and equity securities using a three-level hierarchy for fair value measurements that distinguishes between market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The hierarchy level assigned to each security in the Company’s available-for-sale portfolio is based on management’s assessment of the transparency and reliability of the inputs used in the valuation of such instrument at the measurement date. The three hierarchy levels are defined as follows:

Level 1—Valuations based on unadjusted quoted market prices in active markets for identical securities.

Level 2—Valuations based on observable inputs (other than Level 1 prices), such as quoted prices for similar assets at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly.

Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement, and involve management judgment.

If the inputs used to measure fair value fall into different levels of the fair value hierarchy, a financial security’s hierarchy level is based upon the lowest level of input that is significant to the fair value measurement. The valuation techniques and inputs used to estimate the fair value of the Company’s debt and equity securities are summarized as follows:

Debt Securities

The fair value of debt securities was based on the market values obtained from independent pricing services that were evaluated using pricing models that vary by asset class and incorporate available trade, bid and other market information and price quotes from well-established independent broker-dealers. The independent pricing services monitor market indicators, industry and economic events, and for broker-quoted only securities, obtain quotes from market makers or broker-dealers that they recognize to be market participants. The pricing services utilize the market approach in determining the fair value of the debt securities held by the Company. The Company obtains an understanding of the valuation models and assumptions utilized by the services and has controls in place to determine that the values provided represent fair value. The Company’s validation procedures include comparing prices received from the pricing services to quotes received from other third party sources for certain securities with market prices that are readily verifiable. If the price comparison results in differences over a predefined threshold, the Company will assess the reasonableness of the changes relative to prior periods given the prevailing market conditions and assess changes in the issuers’ credit worthiness, performance of any underlying collateral and prices of the instrument relative to similar issuances. To date, the Company has not made any material adjustments to the fair value measurements provided by the pricing services.

Typical inputs and assumptions to pricing models used to value the Company’s U.S. Treasury bonds, municipal bonds, foreign bonds, governmental agency bonds, governmental agency mortgage-backed securities and corporate debt securities include, but are not limited to, benchmark yields, reported trades, broker-dealer quotes, credit spreads, credit ratings, bond insurance (if applicable), benchmark securities, bids, offers, reference data and industry and economic events. For mortgage-backed securities, inputs and assumptions may also include the structure of issuance, characteristics of the issuer, collateral attributes and prepayment speeds. The fair value of non-agency mortgage-backed securities was obtained from the independent pricing services referenced above and subject to the Company’s validation procedures discussed above. However, since these securities were not actively traded and there were fewer observable inputs available requiring the pricing services to use more judgment in determining the fair value of the securities, they were classified as Level 3.

The significant unobservable inputs used in the fair value measurement of the Company’s non-agency mortgage-backed securities include prepayment rates, default rates and loss severity in the event of default. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for default rates is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates.

Equity Securities

The fair value of equity securities, including preferred and common stocks, were based on quoted market prices for identical assets that are readily and regularly available in an active market.

The following table presents the Company’s available-for-sale investments measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013, classified using the three-level hierarchy for fair value measurements:

(in thousands)	Estimated fair value		Level 1		Level 2		Level 3
September 30, 2014
Debt securities:
U.S. Treasury bonds	$	71,323	$	––	$	71,323	$	––
Municipal bonds		544,636		––		544,636		––
Foreign bonds		201,097		––		201,097		––
Governmental agency bonds		202,227		––		202,227		––
Governmental agency mortgage-backed securities		1,514,842		––		1,514,842		––
Non-agency mortgage-backed securities		17,551		––		––		17,551
Corporate debt securities		549,208		––		549,208		––
		3,100,884		––		3,083,333		17,551
Equity securities:
Preferred stocks		16,758		16,758		––		––
Common stocks		376,983		376,983		––		––
		393,741		393,741		––		––
	$	3,494,625	$	393,741	$	3,083,333	$	17,551

(in thousands)	Estimated fair value		Level 1		Level 2		Level 3
December 31, 2013
Debt securities:
U.S. Treasury bonds	$	66,384	$	––	$	66,384	$	––
Municipal bonds		485,965		––		485,965		––
Foreign bonds		222,508		––		222,508		––
Governmental agency bonds		262,545		––		262,545		––
Governmental agency mortgage-backed securities		1,403,309		––		1,403,309		––
Non-agency mortgage-backed securities		19,022		––		—		19,022
Corporate debt securities		360,084		––		360,084		—
		2,819,817		––		2,800,795		19,022
Equity securities:
Preferred stocks		11,085		11,085		––		––
Common stocks		346,958		346,958		––		––
		358,043		358,043		––		––
	$	3,177,860	$	358,043	$	2,800,795	$	19,022

The Company did not have any transfers in and out of Level 1, Level 2 and Level 3 measurements during the three and nine months ended September 30, 2014 and 2013. The Company’s policy is to recognize transfers between levels in the fair value hierarchy at the end of the reporting period.

The following table presents a summary of the changes in fair value of Level 3 available-for-sale investments for the three and nine months ended September 30, 2014 and 2013:

	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
(in thousands)	2014			2013			2014			2013
Non-agency mortgage-backed securities:
Fair value at beginning of period	$	17,994		$	20,611		$	19,022		$	21,846
Total gains/(losses) (realized and unrealized):
Included in earnings:
Net other-than-temporary impairment losses recognized in earnings		—			—			(1,033	)		—
Included in other comprehensive income		252			907			941			1,028
Settlements		(695	)		(1,215	)		(1,379	)		(2,571	)
Fair value at end of period	$	17,551		$	20,303		$	17,551		$	20,303
Unrealized gains (losses) included in earnings for the period relating to Level 3 available-for-sale investments that were still held at the end of the period:
Net other-than-temporary impairment losses recognized in earnings	$	—		$	—		$	(1,033	)	$	—

The Company did not purchase or sell any non-agency mortgage-backed securities during the three and nine months ended September 30, 2014 and 2013.