Note 4. Investments

The investment portfolio serves as a mechanism to invest funds if funding sources out pace lending activity, to provide liquidity for lending and operations, and provide collateral for deposits and borrowings. The Corporation invests in taxable and tax-free debt securities, and equity securities as part of its investment strategy. The mix of taxable and tax-free debt securities are determined by the Bank’s Investment Committee and investing decisions are made as a component of balance sheet management. Debt securities include U.S. Government Agencies, U.S. Government Agency mortgage-backed securities, non-agency mortgage-backed securities, state and municipal government bonds, corporate debt and trust preferred securities. The equity portfolio consists of bank stocks only and is considered to be longer-term with a focus on capital appreciation. All securities are classified as available for sale and all investment balances refer to fair value.

Equities: The equity portfolio was reduced significantly during 2014 as both the Bank and Corporation sold the majority of its holdings. At year-end 2014, only the Bank has any remaining equities – 2 issues from community banks in Pennsylvania. On October 30, 2014, S&T Bancorp Inc. agreed to acquire Integrity Bancshares Inc. (Integrity). The Bank owns shares of Integrity and expects to recognize a pre-tax gain of approximately $628,000, based on the terms of the agreement, upon completion of this transaction in the first quarter of 2015.

Municipal Bonds: The Bank’s municipal bond portfolio is well diversified geographically and is comprised of both tax-exempt (77% of the portfolio) and taxable (23% if the portfolio) municipal bonds. General obligation bonds (69%) and revenue bonds (20%) comprise the largest portions of the portfolio. The portfolio holds 119 issues within 28 states. The largest dollar exposure is to issuers in the state of Texas (fair value of $10.0 million / 20 issues) and Pennsylvania (fair value of $7.1 million / 11 issues). Fifty percent of the portfolio has either private bond insurance or some other type of credit enhancement. When purchasing municipal bonds, the Bank looks primarily to the underlying credit of the issuer as a sign of credit quality and then to any credit enhancement. Approximately $67 million of the portfolio is rated “A” or higher by Moody and the weighted average rating of the portfolio is “Aa2”. The Bank owns four issues for $1.6 million that are not rated by a nationally recognized rating agency.

Trust Preferred Bonds: This sector remains the same as at the prior year end, but the unrealized loss has declined from $871 thousand to $803 thousand year-over-year. The credit ratings for each bond are similar to the ratings one year prior. Trust preferred securities are typically issued by a subsidiary grantor trust of a bank holding company, which uses the proceeds of the equity issuance to purchase deeply subordinated debt issued by the bank holding company. Trust-preferred securities can reflect single entity issues or a group of entities (pooled trust preferred). Pooled trust preferred securities have been the subject of significant write-downs due in some cases from the default of one issuer in the pool that then impairs the entire pool. All of the Bank’s issues are single issuer, variable rate notes with long final maturities (2027-2028) that continue to pay dividends as scheduled.

Mortgage-backed Securities (MBS): This sector holds $81.2 million or 47% of the total portfolio. The majority of this sector ($79.5 million) is comprised of U.S. Government Agency MBS. The Government MBS sector is comprised of mortgage backed securities and collateralized mortgage obligations, both fixed and variable rate. In addition, the Bank holds six private label mortgage-backed securities (PLMBS) with a fair value of $1.7 million and an amortized cost of $1.7 million. The PLMBS bonds paid down by more than $300 thousand in 2014.

The Bank’s PLMBS portfolio is comprised primarily of Alt-A loans. Alt-A loans are first-lien residential mortgages that generally conform to traditional “prime” credit guidelines; however, loan factors such as the loan-to-value ratio, loan documentation, occupancy status or property type cause these loans not to qualify for standard underwriting programs. The Alt-A product in the Bank’s portfolio is comprised of fixed-rate mortgages that were originated between 2004 and 2006 and all were originally rated AAA. The bonds issued in 2006 are experiencing the highest delinquency and loss rates. All of these bonds originally had some type of credit support tranche to absorb any loss prior to losses at the senior tranche held by the Bank, but this has eroded completely on some bonds as they have started to experience losses. The Bank recorded other-than-temporary impairment charges of $20 thousand on one PLMBS in 2014. Based on the performance of some of the PLMBS, it appears as if the underwriting standards that were represented in the offering, and resulted in the AAA rating, were not followed. As a result, the Bank purchased some securities based on these misrepresentations, and it is most likely that these securities would not have been purchased had all the information been reported correctly. The Bank is participating in a lawsuit against certain issuers related to these misrepresentations.

The amortized cost and estimated fair value of investment securities available for sale as of December 31, 2014 and 2013 is as follows:



(Dollars in thousands)			Gross		Gross
	Amortized		unrealized		unrealized		Fair
2014	cost		gains		losses		value
Equity securities	$	274	$	779	$	-	$	1,053
U.S. Government and Agency securities		15,854		173		(64)		15,963
Municipal securities		66,832		1,826		(292)		68,366
Trust preferred securities		5,940		-		(803)		5,137
Agency mortgage-backed securities		78,779		932		(217)		79,494
Private-label mortgage-backed securities		1,675		35		(15)		1,695
Asset-backed securities		45		-		(2)		43
	$	169,399	$	3,745	$	(1,393)	$	171,751



(Dollars in thousands)			Gross		Gross
	Amortized		unrealized		unrealized		Fair
2013	cost		gains		losses		value
Equity securities	$	1,472	$	499	$	(1)	$	1,970
U.S. Government agency securities		11,771		94		(114)		11,751
Municipal securities		56,861		1,400		(1,404)		56,857
Corporate debt securities		1,002		-		(1)		1,001
Trust preferred securities		5,922		-		(871)		5,051
Agency mortgage-backed securities		81,352		726		(1,051)		81,027
Private-label mortgage-backed securities		1,984		16		(31)		1,969
Asset-backed securities		51		-		(3)		48
	$	160,415	$	2,735	$	(3,476)	$	159,674

At December 31, 2014 and 2013, the fair value of investment securities pledged to secure public funds, trust balances, repurchase agreements, deposit and other obligations totaled $91.6 million and $107.6 million, respectively.

The amortized cost and estimated fair value of debt securities at December 31, 2014, by contractual maturity are shown below. Actual maturities may differ from contractual maturities because of prepayment or call options embedded in the securities.




	Amortized		Fair
(Dollars in thousands)	cost		value
Due in one year or less	$	5,645	$	5,723
Due after one year through five years		10,401		10,670
Due after five years through ten years		30,142		30,689
Due after ten years		42,483		42,427
		88,671		89,509
Mortgage-backed securities		80,454		81,189
	$	169,125	$	170,698

The composition of the net realized securities gains (losses) for the years ended December 31, 2014, 2013 and 2012 is as follows:



(Dollars in thousands)	2014		2013		2012
Gross gains realized	$	284	$	185	$	45
Gross losses realized		(4)		(152)		(1)
Net gains realized	$	280	$	33	$	44

Impairment:

The condition of the portfolio at year-end 2014, as measured by the dollar amount of temporarily impaired securities, has weakened. The municipal bond portfolio recorded the largest unrealized loss, but the agency mortgage backed portfolio shows the greatest number of securities with an unrealized loss.

The condition of the portfolio at year-end 2014, as measured by the dollar amount of temporarily impaired securities, has improved significantly. The trust-preferred sector recorded the largest unrealized loss, while the Agency MBS and municipal portfolios contain the greatest number of securities with an unrealized loss.

For securities with an unrealized loss, Management applies a systematic methodology in order to perform an assessment of the potential for other-than-temporary impairment. In the case of debt securities, investments considered for other-than-temporary impairment: (1) had a specified maturity or repricing date; (2) were generally expected to be redeemed at par, and (3) were expected to achieve a recovery in market value within a reasonable period of time. In addition, the Bank considers whether it intends to sell these securities or whether it will be forced to sell these securities before the earlier of amortized cost recovery or maturity. Equity securities are assessed for other-than-temporary impairment based on the length of time of impairment, dollar amount of the impairment and general market and financial conditions relating to specific issues. The impairment identified on debt and equity securities and subject to assessment at December 31, 2014, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.

The unrealized losses in the municipal bond sector decreased significantly from year-end 2014, as did the number of municipal bonds with an unrealized loss. In 2014, intermediate and long-term interest rates increased and this resulted in a decline in value of these fixed rate securities. During 2014, these rates fell and consequently, the value of the portfolio improved. At December 31, 2014, the Bank believes it will be able to collect all interest and principal due on these bonds and that it will not be forced to sell these bonds prior to maturity. Therefore, no other-than-temporary-impairment charges were recorded.

The Agency mortgage-backed securities portfolio has had an $834 thousand decrease in unrealized losses since the end of 2013. The change in value in this sector is driven by market interest rates since these bonds have essentially no credit risk.



	December 31, 2014
	Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
(Dollars in thousands)	Value		Losses		Count	Value		Losses		Count	Value		Losses		Count

U.S. Government and Agency securities	$	4	$	-	1	$	7,207	$	(64)	14	$	7,211	$	(64)	15
Municipal securities		5,651		(33)	9		9,441		(259)	14		15,092		(292)	23
Trust preferred securities		-		-	-		5,137		(803)	7		5,137		(803)	7
Agency mortgage-backed securities		9,304		(60)	13		8,199		(157)	10		17,503		(217)	23
Private-label mortgage-backed securities		-		-	-		540		(15)	1		540		(15)	1
Asset-backed securities		-		-	-		5		(2)	1		5		(2)	1
Total temporarily impaired securities	$	14,959	$	(93)	23	$	30,529	$	(1,300)	47	$	45,488	$	(1,393)	70



	December 31, 2013
	Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
(Dollars in thousands)	Value		Losses		Count	Value		Losses		Count	Value		Losses		Count

Equity securities	$	22	$	(1)	1	$	-	$	-	-	$	22	$	(1)	1
U.S. Government agency securities		3,971		(85)	7		3,807		(29)	7		7,778		(114)	14
Municipal securities		16,770		(1,022)	24		3,160		(382)	4		19,930		(1,404)	28
Corporate debt securities		-		-	-		1,001		(1)	1		1,001		(1)	1
Trust preferred securities		-		-	-		5,051		(871)	7		5,051		(871)	7
Agency mortgage-backed securities		40,395		(999)	38		2,213		(52)	4		42,608		(1,051)	42
Private-label mortgage-backed securities		-		-	-		911		(31)	2		911		(31)	2
Asset-backed securities		-		-	-		48		(3)	3		48		(3)	3
Total temporarily impaired securities	$	61,158	$	(2,107)	70	$	16,191	$	(1,369)	28	$	77,349	$	(3,476)	98

The unrealized loss in the trust preferred sector declined by $68 thousand compared to the prior year-end and market prices continued to show some improvement during the year. All of the Bank’s trust preferred securities are variable rate notes with long maturities (2027 – 2028) from companies that received money (and in some cases paid back) from the Troubled Asset Relief Program (TARP), continue to pay dividends and have raised capital. The credit ratings on this portfolio are similar to the prior year and no bonds have missed or suspended any payments. At December 31, 2014, the Bank believes it will be able to collect all interest and principal due on these bonds and that it will not be forced to sell these bonds prior to maturity. Therefore, no other-than-temporary-impairment charges were recorded.

Trust Preferred Securities


(Dollars in thousands)
Deal Name	Maturity	Single Issuer or Pooled	Class	Amortized Cost		Fair Value		Gross Unrealized Gain (Loss)		Lowest Credit Rating Assigned

BankAmerica Cap III	1/15/2027	Single	Preferred Stock	$	962	$	811	$	(151)	BB
Wachovia Cap Trust II	1/15/2027	Single	Preferred Stock		277		253		(24)	BBB
Huntington Cap Trust	2/1/2027	Single	Preferred Stock		939		795		(144)	BB
Corestates Captl Tr II	2/15/2027	Single	Preferred Stock		935		845		(90)	BBB+
Huntington Cap Trust II	6/15/2028	Single	Preferred Stock		890		768		(122)	BB
Chase Cap VI JPM	8/1/2028	Single	Preferred Stock		962		848		(114)	BBB-
Fleet Cap Tr V	12/18/2028	Single	Preferred Stock		975		817		(158)	BB
				$	5,940	$	5,137	$	(803)

The PLMBS sector continues to show a gross unrealized loss of $15 thousand on one security. The majority of this sector is comprised of “Alt-A” PLMBS. These bonds were all rated AAA at time of purchase but have since experienced rating declines. Some have experienced increased delinquencies and defaults, while others have seen the credit support increase as the bonds paid-down. The Bank monitors the performance of the Alt-A investments on a regular basis and reviews delinquencies, default rates, credit support levels and various cash flow stress test scenarios. In determining the credit related loss, Management considers all principal past due 60 days or more as a loss. If additional principal moves beyond 60 days past due, it will also be considered a loss. As a result of the analysis on PLMBS it was determined that one bond contained losses that were considered other-than-temporary. Management determined $20 thousand was credit related and therefore, recorded an impairment charge of $20 thousand against earnings in 2014. The market for PLMBS continues to be weak and Management believes that this factor accounts for a portion of the unrealized losses that is not attributable to credit issues. Management continues to monitor these securities and it is possible that additional write-downs may occur if current loss trends continue. The Bank is participating in a class-action lawsuit against one PLMBS servicer that centers on defective warranties and representations made as part of the underwriting process. The resolution of this action is unknown at this time.

Private Label Mortgage Backed Securities


(Dollars in thousands)						Gross					Cumulative
	Origination	Amortized		Fair		Unrealized		Collateral	Lowest Credit	Credit	OTTI
Description	Date	Cost		Value		Gain (Loss)		Type	Rating Assigned	Support %	Charges
RALI 2004-QS4 A7	3/1/2004	$	83	$	86	$	3	ALT A	BBB+	12.22	$	-
MALT 2004-6 7A1	6/1/2004		411		421		10	ALT A	CCC	14.14		-
RALI 2005-QS2 A1	2/1/2005		262		274		12	ALT A	CC	5.86		10
RALI 2006-QS4 A2	4/1/2006		555		540		(15)	ALT A	D	-		293
GSR 2006-5F 2A1	5/1/2006		83		89		6	Prime	D	-		15
RALI 2006-QS8 A1	7/28/2006		281		285		4	ALT A	D	-		217
		$	1,675	$	1,695	$	20				$	535

The following table represents the cumulative credit losses on debt securities recognized in earnings as of December 31, 2014.




(Dollars in thousands)	Twelve Months Ended
	2014			2013
Balance of cumulative credit-related OTTI at January 1	$	515	$	490
Additions for credit-related OTTI not previously recognized		20		25
Additional increases for credit-related OTTI previously recognized when there is no intent to sell
and no requirement to sell before recovery of amortized cost basis		-		-
Decreases for previously recognized credit-related OTTI because there was an intent to sell		-		-
Reduction for increases in cash flows expected to be collected		-		-
Balance of credit-related OTTI at December 31	$	535	$	515

The Bank held $438 thousand of restricted stock at the end of 2014. The restricted stock is comprised primarily of an investment in the Federal Home Loan Bank of Pittsburgh (FHLB). FHLB stock is carried at a cost of $100 per share. During 2014, FHLB repurchased $1.5 million in stock and began paying a dividend. FHLB stock is evaluated for impairment primarily based on an assessment of the ultimate recoverability of its cost. As a government sponsored entity, FHLB has the ability to raise funding through the U.S. Treasury that can be used to support it operations. There is not a public market for FHLB stock and the benefits of FHLB membership (e.g., liquidity and low cost funding) add value to the stock beyond purely financial measures. If FHLB stock were deemed to be impaired, the write-down for the Bank could be significant. Management intends to remain a member of the FHLB and believes that it will be able to fully recover the cost basis of this investment.