3. Securities

Securities available for sale consist of the following:

	Amortized		Unrealized
	Cost		Gains		Losses		Fair Value
	(In thousands)
September 30, 2012
U.S. agency	$	45,615	$	77	$	55	$	45,637
U.S. agency residential mortgage-backed		131,427		1,204		11		132,620
Private label residential mortgage-backed		9,503		-		1,201		8,302
Obligations of states and political subdivisions		39,733		699		71		40,361
Trust preferred		4,702		-		1,436		3,266
Total	$	230,980	$	1,980	$	2,774	$	230,186

December 31, 2011
U.S. agency	$	24,980	$	58	$	21	$	25,017
U.S. agency residential mortgage-backed		93,415		1,007		216		94,206
Private label residential mortgage-backed		11,066		-		2,798		8,268
Obligations of states and political subdivisions		26,865		510		58		27,317
Trust preferred		4,697		-		2,061		2,636
Total	$	161,023	$	1,575	$	5,154	$	157,444

Our investments' gross unrealized losses and fair values aggregated by investment type and length of time that individual securities have been at a continuous unrealized loss position follows:

	Less Than Twelve Months				Twelve Months or More				Total
			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
	(In thousands)

September 30, 2012
U.S. agency	$	13,065	$	55	$	-	$	-	$	13,065	$	55
U.S. agency residential mortgage-backed		2,653		1		10,264		10		12,917		11
Private label residential mortgage-backed						8,300		1,201		8,300		1,201
Obligations of states and political subdivisions		7,387		71						7,387		71
Trust preferred						3,266		1,436		3,266		1,436
Total	$	23,105	$	127	$	21,830	$	2,647	$	44,935	$	2,774

December 31, 2011
U.S. agency	$	9,974	$	21	$	-	$	-	$	9,974	$	21
U.S. agency residential mortgage-backed		42,500		216		-		-		42,500		216
Private label residential mortgage-backed		163		90		8,102		2,708		8,265		2,798
Obligations of states and political subdivisions		-		-		1,729		58		1,729		58
Trust preferred		591		1,218		2,045		843		2,636		2,061
Total	$	53,228	$	1,545	$	11,876	$	3,609	$	65,104	$	5,154

Our portfolio of available-for-sale securities is reviewed quarterly for impairment in value. In performing this review management considers (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) the impact of changes in market interest rates on the market value of the security and (4) an assessment of whether we intend to sell, or it is more likely than not that we will be required to sell a security in an unrealized loss position before recovery of its amortized cost basis. For securities that do not meet the aforementioned recovery criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income or loss.

U.S. agency and U.S. agency residential mortgage-backed securities — at September 30, 2012 we had three U.S. agency and three U.S. agency residential mortgage-backed securities whose fair market value is less than amortized cost. The U.S. Agency securities were purchased on September 28, 2012 and the impairment is primarily attributed to bid-offer spread. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Private label residential mortgage backed securities — at September 30, 2012 we had eight securities whose fair value is less than amortized cost. Two of the issues are rated by a major rating agency as investment grade while four are below investment grade and two are split rated. Four of these bonds have impairment in excess of 10% and all of these holdings have been impaired for more than 12 months.

The unrealized losses are largely attributable to credit spread widening on these securities since their acquisition. Prices for these bonds did improve notably during the third quarter of 2012, due in part to the Federal Reserve Bank's recent announcement of a third round of quantitative easing and improving fundamentals in the housing market. The underlying loans within these securities include Jumbo (74%) and Alt A (26%) at September 30, 2012.

	September 30, 2012					December 31, 2011
			Net					Net
	Fair		Unrealized			Fair		Unrealized
	Value		Gain (Loss)			Value		Gain (Loss)
	(In thousands)

Private label residential mortgage-backed
Jumbo	$	6,128	$	(879	)	$	6,454	$	(1,937	)
Alt-A		2,174		(322	)		1,814		(861	)

Seven of the private label residential mortgage-backed transactions have geographic concentrations in California, ranging from 22% to 58% of the collateral pool. Typical exposure levels to California (median exposure is 47%) are consistent with overall market collateral characteristics. Three transactions have modest exposure to Florida, ranging from 5% to 7% and one transaction has modest exposure to Nevada (5%). The underlying collateral pools do not have meaningful exposure to Arizona, Michigan or Ohio. None of the issues involve subprime mortgage collateral. Thus the impact of this market segment is only indirect, in that it has impacted liquidity and pricing in general for private label residential mortgage-backed securities. The majority of transactions are backed by fully amortizing loans. However, six transactions have concentrations in loans that pay interest only for a specified period of time and will fully amortize thereafter ranging from 31% to 94% (at origination date). The structure of the residential mortgage securities portfolio provides protection to credit losses. The portfolio primarily consists of senior securities as demonstrated by the following: super senior (22%), senior (43%), senior support (25%) and mezzanine (10%). The mezzanine class is from a seasoned transaction (97 months) with a significant level of subordination (8.69%). Except for the additional discussion below relating to other than temporary impairment, each private label residential mortgage-backed security has sufficient credit enhancement via subordination to reasonably assure full realization of book value. This assertion is based on a transaction level review of the portfolio.

Individual security reviews include: external credit ratings, forecasted weighted average life, recent prepayment speeds, underwriting characteristics of the underlying collateral, the structure of the securitization and the credit performance of the underlying collateral. The review of underwriting characteristics considers: average loan size, type of loan (fixed or ARM), vintage, rate, FICO, loan-to-value, scheduled amortization, occupancy, purpose, geographic mix and loan documentation. The review of the securitization structure focuses on the priority of cash flows to the bond, the priority of the bond relative to the realization of credit losses and the level of subordination available to absorb credit losses. The review of credit performance includes: current period as well as cumulative realized losses; the level of severe payment problems, which includes other real estate (ORE), foreclosures, bankruptcy and 90 day delinquencies; and the level of less severe payment problems, which consists of 30 and 60 day delinquencies.

All of these securities are receiving some principal and interest payments. Most of these transactions are passthrough structures, receiving pro rata principal and interest payments from a dedicated collateral pool for loans that are performing. The nonreceipt of interest cash flows is not expected and thus not presently considered in our discounted cash flow methodology discussed below.

In addition to the review discussed above, all private label residential mortgage-backed securities are reviewed for OTTI utilizing a cash flow projection. The cash flow analysis forecasts cash flow from the underlying loans in each transaction and then applies these cash flows to the bonds in the securitization. The cash flows from the underlying loans considers contractual payment terms (scheduled amortization), prepayments, defaults and severity of loss given default. The analysis uses dynamic assumptions for prepayments, defaults and loss severity. Near term prepayment assumptions are based on recently observed prepayment rates. More weight is given to longer term historic performance (12 months). In some cases, recently observed prepayment rates are lower than historic norms due to the absence of new jumbo loan issuances. This loan market is heavily dependent upon securitization for funding, and new securitization transactions have been minimal. Our model projections anticipate that prepayment rates gradually revert to historical levels. For seasoned ARM transactions, normalized prepayment rates range from 12% to 18% CPR which is at the lower end of historically observed speeds for seasoned ARM collateral. For fixed rate collateral (one transaction), the prepayment speeds are projected to rise modestly.

Default assumptions are largely based on the volume of existing real-estate owned, pending foreclosures and severe delinquencies. Other considerations include the quality of loan underwriting, recent default experience, realized loss performance and the volume of less severe delinquencies. Default levels generally are projected to remain elevated or increase for a period of time sufficient to address the level of distressed loans in the transaction. Our projections expect defaults to then decline, generally beginning in year three. Current loss severity assumptions are based on recent observations when meaningful data is available. Loss severity is expected to remain elevated for the next three years. Severity is expected to decline beginning in year four as the back log of foreclosure and distressed sales clear the market. Except for three securities discussed in further detail below (all three are currently below investment grade), our cash flow analysis forecasts complete recovery of our cost basis for each reviewed security.

At September 30, 2012 three below investment grade private label residential mortgage-backed securities with fair values of $3.6 million, $1.9 million and $0.1 million, respectively and unrealized losses of $0.4 million, $0.1 million and $0.03 million, respectively (amortized cost of $4.0 million, $2.0 million and $0.1 million, respectively) had losses that were considered other than temporary.

The underlying loans in the first transaction are 30 year fixed rate jumbos with an average FICO of 744 and an average loan-to-value ratio of 72%. The loans backing this transaction were originated in 2007 and this is our only security backed by 2007 vintage loans. We believe that this vintage is a key differentiating factor between this security and the others in our portfolio that do not have unrealized losses that are considered OTTI. The bond is a senior security that is receiving principal and interest payments similar to principal reductions in the underlying collateral. The cash flow analysis described above calculated $0.715 million of cumulative credit related OTTI as of September 30, 2012 on this security. $0.070 million and $0.004 million of this credit related OTTI was recognized in our Condensed Consolidated Statements of Operations during the three months ended September 30, 2012 and 2011, respectively and $0.240 million and $0.056 million of this credit related OTTI was recognized during the nine months ended September 30, 2012 and 2011, respectively, with the balance being recognized in previous periods. The remaining non-credit related unrealized loss was attributed to other factors and is reflected in other comprehensive income (loss) during those same periods.

The underlying loans in the second transaction are 30 year hybrid ARM Alt-A with an average FICO of 717 and an average loan-to-value ratio of 78%. The loans backing this transaction were originated in 2005. The bond is a super senior security that is receiving principal and interest payments similar to principal reductions in the underlying collateral. The cash flow analysis described above calculated $0.457 million of cumulative credit related OTTI as of September 30, 2012 on this security. There was no credit related OTTI recognized in our Condensed Consolidated Statements of Operations during the three months ended September 30, 2012 and 2011 while $0.032 million and zero of this credit related OTTI was recognized during the nine months ended September 30, 2012 and 2011, respectively, with the balance being recognized in previous periods. The remaining non-credit related unrealized loss was attributed to other factors and is reflected in other comprehensive income (loss) during those same periods.

The underlying loans in the third transaction are 30 year hybrid ARM jumbos with an average FICO of 738 and an average loan-to-value ratio of 57%. The loans backing this transaction were originated in 2005. The bond is a senior support security that is receiving principal and interest payments similar to principal reductions in the underlying collateral. The cash flow analysis described above calculated $0.380 million of cumulative credit related OTTI as of September 30, 2012 on this security. There was no credit related OTTI recognized in our Condensed Consolidated Statements of Operations during the three months ended September 30, 2012 and 2011, while $0.060 million and $0.090 million of this credit related OTTI was recognized during the nine months ended September 30, 2012 and 2011, respectively, with the balance being recognized in previous periods. The remaining non-credit related unrealized loss was attributed to other factors and is reflected in other comprehensive income (loss) during those same periods.

As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no other declines discussed above are deemed to be other than temporary.

Obligations of states and political subdivisions — at September 30, 2012 we had seven municipal securities whose fair value is less than amortized cost. The unrealized losses are largely attributed to widening of market spreads. Six of the impaired securities are rated by a major rating agency as investment grade. The non rated security has a periodic internal credit review according to established procedures. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Trust preferred securities — at September 30, 2012 we had four securities whose fair value is less than amortized cost. All of our trust preferred securities are single issue securities issued by a trust subsidiary of a bank holding company. The pricing of trust preferred securities over the past several years has suffered from credit spread widening fueled by uncertainty regarding potential losses of financial companies and the absence of a liquid functioning secondary market.

One of the four securities is rated by two major rating agencies as investment grade, while one is rated below investment grade by two major rating agencies and the other two are non-rated. The non-rated issues are relatively small banks and were never rated. The issuers of these non-rated trust preferred securities, which had a total amortized cost of $2.8 million and total fair value of $1.8 million as of September 30, 2012, continue to have satisfactory credit metrics and one continues to make interest payments. One non-rated issue began deferring dividend payments in the third quarter of 2011 apparently due to an increase in non-performing assets. Nevertheless, this issuer continues to have satisfactory capital measures and interim profitability.

The following table breaks out our trust preferred securities in further detail as of September 30, 2012 and December 31, 2011:

	September 30, 2012					December 31, 2011
			Net					Net
	Fair		Unrealized			Fair		Unrealized
	Value		Gain (Loss)			Value		Gain (Loss)
	(In thousands)

Trust preferred securities
Rated issues	$	1,474	$	(421	)	$	1,405	$	(484	)
Unrated issues - no OTTI		1,792		(1,015	)		1,231		(1,577	)

We recorded credit related OTTI charges in earnings on securities available for sale of $0.070 million and $0.004 during the three month periods ended September 30, 2012 and 2011, respectively and $0.332 million and $0.146 million during the nine month periods ended September 30, 2012 and 2011, respectively (see discussion above).

A roll forward of credit losses recognized in earnings on securities available for sale for the three and nine month periods ended September 30, follows:

	Three months ended				Nine months ended
	September 30,				September 30,
	2012		2011		2012		2011
	(In thousands)
Balance at beginning of period	$	1,732	$	852	$	1,470	$	710
Additions to credit losses on securities for which no previous OTTI was recognized		-		-		-		-
Increases to credit losses on securities for which OTTI was previously recognized		70		4		332		146
Balance at end of period	$	1,802	$	856	$	1,802	$	856

The amortized cost and fair value of securities available for sale at September 30, 2012, by contractual maturity, follow. The actual maturity may differ from the contractual maturity because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized		Fair
	Cost		Value
	(In thousands)
Maturing within one year	$	1,620	$	1,633
Maturing after one year but within five years		6,604		6,818
Maturing after five years but within ten years		25,922		26,106
Maturing after ten years		55,904		54,707
		90,050		89,264
U.S. agency residential mortgage-backed		131,427		132,620
Private label residential mortgage-backed		9,503		8,302
Total	$	230,980	$	230,186

Gains and losses realized on the sale of securities available for sale are determined using the specific identification method and are recognized on a trade-date basis. A summary of proceeds from the sale of securities available for sale and gains and losses for the nine month periods ended September 30, follows:

			Realized
	Proceeds		Gains		Losses(1)
	(In thousands)
2012	$	37,176	$	1,193	$	-
2011		70,322		279		75

(1)	Losses in 2012 and 2011 exclude $0.332 million and $0.146 million, respectively of credit related OTTI recognized in earnings.

During 2012 and 2011 our trading securities consisted of various preferred stocks. During the first nine months of 2012 and 2011 we recognized gains (losses) on trading securities of ($0.039) million and $0.067 million, respectively, that are included in net gains (losses) on securities in the Condensed Consolidated Statements of Operations. Both of these amounts, relate to gains (losses) recognized on trading securities still held at each respective period end.