Investment Securities and Mortgage-Backed Securities

6 Months Ended

Jun. 30, 2011

Investment Securities and Mortgage-Backed Securities [Abstract]

Investment Securities and Mortgage-Backed Securities

Note C  Investment Securities and Mortgage-Backed Securities

Investment securities and mortgage-backed securities consist of the following at June 30, 2011 and December 31, 2010:

	June 30, 2011
	Amortized		Gross Unrealized					Fair
Available-for-sale portfolio:	Cost		Gains		Losses			Value
Investment Securities	(In thousands)
Debt securities:
U. S. Agencies	$	53,118	$	206	$	(60	)	$	53,264
Corporate		25,119		454		(920	)		24,653
Trust preferred securities		6,613		-		(3,006	)		3,607
State and municipal		43,277		885		(276	)		43,886
Small business administration		2,888		9		(28	)		2,869
	$	131,015	$	1,554	$	(4,290	)	$	128,279
Mortgage-Backed Securities
Fannie Mae	$	37,981	$	699	$	(71	)	$	38,609
Freddie Mac		12,695		266		(1	)		12,960
Government National Mortgage Assoc.		25,432		453		(112	)		25,773
Collateralized Mortgage Obligations		2,442		20		(121	)		2,341
	$	78,550	$	1,438	$	(305	)	$	79,683
Total available-for-sale	$	209,565	$	2,992	$	(4,595	)	$	207,962

Held-to-maturity portfolio
Investment Securities
Debt securities:
U. S. Agencies	$	19,623	$	224	$	-	$	19,847
State and municipal		8,211		705		-		8,916
Small business administration		621		-		-		621
	$	28,455	$	929	$	-	$	29,384
Mortgage-Backed Securities
Fannie Mae	$	16,066	$	320	$	-	$	16,386
Freddie Mac		5,300		99		-		5,399
Government National Mortgage Assoc.		6,504		141		-		6,645
	$	27,870	$	560	$	-	$	28,430
Total held-to-maturity	$	56,325	$	1,489	$	-	$	57,814

	December 31, 2010
	Amortized		Gross Unrealized					Fair
Available-for-sale portfolio:	Cost		Gains		Losses			Value
Investment Securities	(In thousands)
Debt securities:
U. S. Agencies	$	70,214	$	136	$	(1,205	)	$	69,145
Corporate		25,139		157		(1,043	)		24,253
Trust preferred securities		6,858		-		(3,454	)		3,404
State and municipal		50,249		529		(1,708	)		49,070
Small business administration		3,027		-		(91	)		2,936
	$	155,487	$	822	$	(7,501	)	$	148,808
Mortgage-Backed Securities
Fannie Mae	$	38,331	$	288	$	(511	)	$	38,108
Freddie Mac		14,928		173		(151	)		14,950
Government National Mortgage Assoc.		22,164		277		(307	)		22,134
Collateralized Mortgage Obligations		3,701		9		(232	)		3,478
	$	79,124	$	747	$	(1,201	)	$	78,670
Total available-for-sale	$	234,611	$	1,569	$	(8,702	)	$	227,478
Held-to-maturity portfolio
Investment Securities
Debt securities:
U. S. Agencies	$	3,998	$	140	$	-		$	4,138
State and municipal		8,270		484		-			8,754
Small business administration		663		-		-			663
	$	12,931	$	624	$	-		$	13,555
Mortgage-Backed Securities
Fannie Mae	$	5,567	$	177	$	-		$	5,744
Freddie Mac		1,306		27		-			1,333
Government National Mortgage Assoc.		4,339		99		-			4,438
	$	11,212	$	303	$	-		$	11,515
Total held-to-maturity	$	24,143	$	927	$	-		$	25,070

The amortized cost and fair value of the investment securities portfolio at June 30, 2011 are shown by contractual maturities.  Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Available for Sale				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(In thousands)
Within one year	$	8,652	$	8,662	$	7	$	7
After one year through five years		15,042		15,303		5,096		5,322
After five years through ten years		56,126		57,045		11,706		12,080
After ten years		51,195		47,269		11,646		11,975
Total	$	131,015	$	128,279	$	28,455	$	29,384

Sales of securities were as follows:

	Three Months Ended					Six Months Ended
	June 30, 2011			June 30, 2010		June 30, 2011			June 30, 2010
	(In thousands)
Proceeds	$	21,724		$	10,648	$	27,403		$	18,988
Gross Gains	$	376		$	442	$	382		$	751
Gross Losses	$	(279	)	$	-	$	(304	)	$	-

Securities with unrealized losses at June 30, 2011 and December 31, 2010, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:

	Less than 12 Months					More than 12 Months					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
	(In thousands)
U.S. Agency	$	11,940	$	(60	)	$	- $		-		$	11,940	$	(60	)
Corporate		8,461		(38	)		1,609		(882	)		10,070		(920	)
Trust preferred securities		-		-			3,607		(3,006	)		3,607		(3,006	)
State and municipal		12,278		(276	)		-		-			12,278		(276	)
Small business administration		1,878		(28	)		-		-			1,878		(28	)
Fannie Mae		5,575		(71	)		-		-			5,575		(71	)
Freddie Mac		2,466		(1	)		-		-			2,466		(1	)
Government National Mortgage Assoc.		5,913		(112	)		-		-			5,913		(112	)
Collateralized mortgage obligations		-		-			1,697		(121	)		1,697		(121	)
Total securities available-for-sale in
an unrealized loss position	$	48,511	$	(586	)	$	6,913	$	(4,009	)	$	55,424	$	(4,595	)

	Less than 12 Months					More than 12 Months					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Value
U.S. Agency	$	50,289	$	(1,205	)	$	-	$	-		$	50,289	$	(1,205	)
Corporate		9,033		(97	)		4,043		(946	)		13,076		(1,043	)
Trust preferred securities		-		-			3,404		(3,454	)		3,404		(3,454	)
State and municipals		32,162		(1,708	)		-		-			32,162		(1,708	)
Small business administration		2,930		(91	)		-		-			2,930		(91	)
Fannie Mae		22,786		(511	)		-		-			22,786		(511	)
Freddie Mac		10,256		(151	)		-		-			10,256		(151	)
Ginnie Mae		11,531		(307	)		-		-			11,531		(307	)
Collateralized mortgage obligations		-		-			2,746		(232	)		2,746		(232	)
Total securities available-for-sale in
an unrealized loss position	$	138,987	$	(4,070	)	$	10,193	$	(4,632	)	$	149,180	$	(8,702	)

Declines in the fair value of securities below their cost that are other-than-temporary are reflected as realized losses.  The Company evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.  For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assess whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis.  If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through

earnings.  For debt securities that do not meet the aforementioned criteria, the amount of the impairment is split into two components as follows:  1) OTTI related to credit loss, which must be recognized in the income statement and 2) other-than temporary impairment (OTTI) related to other factors, which is recognized in other comprehensive income.  The credit loss is defined as the difference between the present value of the cash flows to be collected and the amortized cost basis.

In order to determine OTTI for purchased beneficial interests, that on the purchase date, were not highly rated, the Company compares the present value of the remaining cash flows as estimated at the preceding evaluation date to the current expected remaining cash flows.  OTTI is deemed to have occurred if there is an adverse change in the remaining expected future cash flows.

As of June 30, 2011, the Company’s security portfolio consisted of 368 securities, 66 of which were in an unrealized loss position. The majority of the unrealized losses are related to the Company’s agency, mortgage-backed securities, state and local municipalities, and corporate and trust preferred securities as discussed below.

U.S. Agency and Agency Mortgage-Backed Securities

Fannie Mae, Freddie Mac, Ginnie Mae and the Small Business Administration guarantee the contractual cash flows of our agency and mortgage-backed securities. Fannie Mae and Freddie Mac are institutions which the government has affirmed its commitment to support.  Our Ginnie Mae mortgage-backed securities are backed by the full faith and credit of the U.S. Government.  All of the agency mortgage-backed securities are residential mortgage-backed securities. At June 30, 2011, of the twenty-six U.S. Government sponsored enterprise agency and mortgage-backed securities in an unrealized loss position in our available-for-sale and held-to-maturity portfolios, there were no securities that were in a continuous unrealized loss position for 12 months or more.  The unrealized losses at June 30, 2011 were primarily attributable to changes in interest rates and illiquidity, and not credit quality.  The Company does not have the intent to sell these agency and mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery. The Company does not consider these securities to be other-than-temporarily impaired at June 30, 2011.

Non-Agency Collateralized Mortgage Obligations.

All of our non-agency collateralized mortgage obligations carry various amounts of credit enhancement and none are collateralized with subprime loans.  These securities were purchased based on the underlying loan characteristics such as loan to value ratio, credit scores, property type, location and the level of credit enhancement.  Current characteristics of each security are reviewed regularly by management.  If the level of credit loss coverage is sufficient, it indicates that we will receive all of the originally scheduled cash flows.

At June 30, 2011, of the two non-agency collateralized mortgage obligations in an unrealized loss position; all were in a continuous unrealized loss position of 12 months or more. All were rated above investment grade at time of purchase.  Both are currently rated below investment grade.  We have assessed these securities in an unrealized loss position at June 30, 2011 and determined that the decline in fair value was other than temporary.  The Bank currently has two obligations totaling $1.8 million that based on expected cash flows, delinquencies and credit support the Company has considered impaired.  The unrealized losses at June 30, 2011 and December 31, 2010 were $70,000 and $144,000 respectively.  The securities were in a gross loss position of $121,000 of which $51,000 was recorded as expense for the three and six months ended June 30, 2011. These securities remain available for sale at June 30, 2011.

Corporate Debt and Municipal Securities

At June 30, 2011, of the twenty-nine corporate debt and municipal securities in an unrealized loss position, one was in a continuous unrealized loss position of 12 months or more.  We have assessed this security and determined that the decline in fair value was temporary.  In making this determination, we considered the period of time the security was in a loss position, the percentage decline in comparison with the securities’ amortized cost, the financial condition of the issuer, and the delinquency or default rates based on the applicable bond ratings.  In addition, we do not have the intent to sell this security and it is not more likely than not that we will be required to sell this security before the recovery of their amortized cost basis, which may be at maturity.  The securities whose unrealized loss position exceeds 12 months was a $2.5 million Strats-Goldman Sachs corporation obligation, maturing February 15, 2034 which is a variable rate note based on the 6 month libor.  The current rate on the security is 1.39%.  The unrealized loss at June 30, 2011 and December 31, 2010 was $882,000 and $914,000 respectively.  In addition to the items noted above, we reviewed capital ratios, public filings of the issuer and related trust documents in the review of the unrealized loss.  The security is paying as agreed.

Trust Preferred Securities

The Company currently has $6.6 million invested in nine trust preferred securities as of June 30, 2011 whose unrealized losses have been in a continuous loss position exceeding 12 months or more.  All of the trust preferred securities are pooled issuances. Of the $6.6 million, $3.1 million have variable rates of interest.  All of the securities are on nonaccrual as of June 30, 2011.  The unrealized losses at June 30, 2011 and December 31, 2010 on the nine securities totaled $3.0 million and $3.5 million respectively.

The following table provides detailed information related to the trust preferred securities held as of June 30, 2011:

Description	Class	Book Value (2)	Fair Value	Unrealized Loss	Realized Loss (2) (3)	Lowest Rating (1)	Number of Banks and Insurance Companies Currently Performing	Actual Deferrals and Defaults as % of Original Collateral	Expected Additional Deferrals and Defaults as % of Performing Collateral	Excess Subordination Defaults as % of Performing Collateral
(Dollars In thousands)

Preferred Term Ltd.	Mezz	$	819	$	616	$	(203	)	$	(337	)	Ca	14	42.76	%	28.21	%	-43.97	%
Preferred Term Ltd.	Mezz		1,638		1,182		(456	)		(683	)	Ca	14	42.76	%	28.21	%	-43.97	%
Preferred Term Ltd.	Mezz		1,092		789		(303	)		(456	)	Ca	14	42.76	%	28.21	%	-43.97	%
Preferred Term X	B-3		813		390		(423	)		(1,163	)	C	33	46.56	%	10.42	%	-69.31	%
Preferred Term XV	B-2		634		189		(445	)		(366	)	C	51	35.38	%	20.01	%	-41.17	%
Preferred Term XV	B-3		641		191		(450	)		(359	)	C	51	35.38	%	20.01	%	-41.17	%
Preferred Term XXVI	C-1		673		183		(490	)		(312	)	C	49	27.74	%	14.48	%	-20.78	%
Preferred Term XXVI	D-1		-		-		-			(497	)	N/R	49	27.74	%	14.48	%	-30.33	%
MMCF IX	B-2		303		67		(236	)		(653	)	Caa3	19	42.32	%	23.49	%	-60.80	%
		$	6,613	$	3,607	$	(3,006	)	$	(4,826	)

(1)  The table represents ratings information as of June 30, 2011.  The securities had “investment grade” ratings by Moody’s (Baa2 or better) at time of purchase, but have since been downgraded by the rating agencies.

(2) Book value has been reduced by realized losses to reflect a new amortized cost basis.

(3) Represents life to date cumulative loss recognized in the income statement.

The structuring of trust preferred securities generally provide for a waterfall approach to absorbing losses whereby lower tranches are initially impacted and more senior tranches are impacted after lower tranches can no longer absorb losses.  Likewise, the waterfall approach also applies to principal and interest payments received, as senior tranches have priority over lower tranches in the receipt of payments.  In addition, there may be multiple classes within a single tranche that react differently to assumptions utilized in cash flow models due to the different features of the class such as fixed rate, floating rate, or a combination of both.  In determining the amount of “currently performing” collateral for purposes of the table above, the total amount of issuers’ balances outstanding have been reduced by the amount in deferral and default.  Also, for some of the securities, management has further reduced the total performing balance for the effects of issuers’ subsequent announcements of their intent to defer on the next applicable payment, and for other relevant circumstances through the date of issuance of the financial statements.  Management considered all such announcements and circumstances known to us in evaluating the pooled trust preferred securities for OTTI as of June 30, 2011.

In the table above, “Excess Subordination Defaults as % of Performing Collateral” (Excess Subordination Ratio) was calculated as follows:  Total face value of performing collateral minus face value of all outstanding note balances not subordinate to our investment, divided by total face value of performing collateral.  The Excess Subordination Ratio measures the extent to which there may be tranches within each pooled trust preferred structure available to absorb credit losses before the Company’s securities would be adversely impacted.  In 2008 and 2009, the amount of deferrals and defaults on the pools described above rose significantly, which has resulted in substantial reductions in the amounts of performing collateral.  As a result, the negative Excess Subordination Ratio percentages shown in the table signify there is no support from subordinate tranches available to absorb losses before the Company’s securities would be adversely impacted.  A negative Excess Subordination Ratio is not definitive, in isolation, for determining whether or not OTTI should be recorded for a pooled trust preferred security.  Other factors affect the timing and amount of cash flows available for payments to the note holders (investors); including the excess interest paid by the issuers (the issuers typically pay higher rates of interest than are paid out to the note holders).

The Company uses the OTTI evaluation model to compare the present value of expected cash flows to the previous estimates to ensure there are no adverse changes in cash flows during the quarter.  The OTTI model considers the structure and term of the trust preferred securities and the financial condition of the underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes.  The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities.  Assumptions used in the models are as follows:

	Significant inputs at June 30, 2011
Annual prepayment	1% annually
Projected severity of loss on current defaults	85% - 100%
Projected severity of loss on current deferrals	0% - 100%
Projected severity of loss on specific deferrals	0% -  80%
Projected additional defaults thereafter	0.375% applied annually
Projected severity of loss on additional defaults	0% - 100%
Present value discount rates for OTTI	4.87% - 9.91%
Present value discount rates for fair value	15%

The Company reviews the assumptions quarterly for reasonableness and will update those assumptions that management believes have changed given market conditions, changes in deferral and defaults, as well as other factors that can impact these assumptions.  The discount rates range can vary depending on the index the instruments are tied to as well as the spread for each instrument. The Company 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 Company looks principally to market yields to maturity for investment grade and non investment grade trust preferred securities for which there is an active and liquid market. The next step is to make a series of adjustments to reflect the differences that nevertheless 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 securities. In addition, utilization of the individual trust preferred investment’s interest crediting rate and if applicable, margin index is utilized in calculating the expected cash flows.

Prepayments can occur at the discretion of the issuer on predetermined call increments.  The call provision allows the issuer to prepay some or the entire outstanding debt obligation on the fifth year and every fifth year thereafter.  Due to the general weakness of the financial sector and the regulatory requirements to maintain and increase the capitalization of U.S. banks, the Company concluded that the issuers were unlikely to prepay their outstanding debt obligation and thereby reducing their individual capital ratios during this difficult economic cycle.

The Company reviews each issuer individually for projected future deferrals and defaults.  The purpose of the individual issuer review is to determine if an individual issuer demonstrates a significant likelihood of potential deferral/default so as to require a further addition to the projected additional default percentages as outlined in the table above.  This review includes obtaining quarterly financial information and monitoring new releases and pertinent information relative to those issuers.  The Company specifically reviews certain financial ratios including Fitch Score and “Texas Ratio” as well as capital adequacy and participation in the Troubled Asset Relief Program of each issuer.  The Company believes the “Texas Ratio (“TR”)” is a prominent indicator of the stress a financial institution is experiencing.  The TR is calculated by dividing nonperforming assets and loans, including past due 90 days or more, by the sum of tangible equity and loan loss reserves. Management judgmentally establishes various credit criteria, and combinations of credit criteria and those issuers meeting some combination of such criteria are considered additional deferrals as of the reporting date.  Based on the results of this analysis, the Company ensures that actual deferrals/defaults as well as forecasted deferrals/defaults of specific institutions are appropriately factored into the cash flow projections for each security.   The default and recovery probabilities for each piece of collateral were formed based on the evaluation of collateral credit and a review of historical default data and current/near term operating conditions.  There is no recovery estimated for actual defaulted issuers.  Projected deferrals are modeled in a consistent manner with actual deferrals. One of these securities was fully impaired in 2009.   Upon completion of the June 30, 2011 analysis, our model indicated other-than temporary impairment on two of these securities for the quarter ended June 30, 2011, which resulted from management projecting additional defaults and deferrals during the period.

Two of the eight securities had OTTI losses of $235,000 during 2011 of which $30,000 was recorded as expense during the three months ended June 30, 2011.  These eight securities remain classified as available-for-sale at June 30, 2011.  It is possible that the underlying collateral of these securities will perform worse than expectations including an increase in deferrals/defaults above projections, which may lead to adverse changes in cash flows on these securities and potential future other-than-temporary impairment losses.  Events that may trigger material declines in fair value for these securities in the future would include, but are not limited to, deterioration of credit metrics, such as significantly higher levels of defaults, and severity of loss on the underlying collateral and further illiquidity.

The table below presents a roll-forward of the credit losses recognized in earnings for the six months ended June 30, 2011 and 2010 (in thousands):

	June 30, 2011		June 30, 2010
Beginning Balance	$	5,740	$	3,317
Credit loss for which other-than-temporary impairment
was not previously recognized		51
Additional credit loss for which other-than-temporary impairment
was previously recognized		235		1,051
Ending Balance	$	6,026	$	4,368

Unrealized losses on other investments have not been recognized into income because the issuer(s) securities are of investment grade (except as indicated above), management does not intend to sell and it is not more likely than not that management would be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates.  The fair value is expected to recover as the bond(s) approach maturity.