6. INVESTMENT SECURITIES

QNB engaged in trading activities for its own account. Municipal securities that were held principally for resale in the near term were recorded in the trading account at fair value with changes in fair value recorded in non-interest income. During the second quarter of 2017, QNB Bank redeemed the trading securities portfolio, as lack of volatility and the interest rate environment resulted in the declined performance of the portfolio. The net realized gains were $27,000 for the six months ended June 30, 2017. Interest and dividends were included in interest income.

The amortized cost and estimated fair values of investment debt securities available-for-sale and equity securities at June 30, 2018 and December 31, 2017 were as follows:

			Gross		Gross
			unrealized		unrealized
	Fair		holding		holding			Amortized
June 30, 2018	value		gains		losses			cost
U.S. Government agency	$	69,495	$	—	$	(2,982	)	$	72,477
State and municipal		70,952		236		(662	)		71,378
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed		127,426		95		(5,214	)		132,545
Collateralized mortgage obligations (CMOs)		71,257		11		(3,525	)		74,771
Pooled trust preferred		118		—		(5	)		123
Corporate debt		4,946		14		(103	)		5,035
Equity		9,600		360		(887	)		10,127
Total investment debt securities available-for-sale and equity securities	$	353,794	$	716	$	(13,378	)	$	366,456

			Gross		Gross
			unrealized		unrealized
	Fair		holding		holding			Amortized
December 31, 2017	value		gains		losses			cost
U.S. Government agency	$	70,524	$	—	$	(1,948	)	$	72,472
State and municipal		76,804		717		(113	)		76,200
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed		142,703		195		(2,401	)		144,909
Collateralized mortgage obligations (CMOs)		76,302		29		(2,292	)		78,565
Pooled trust preferred		215		—		(26	)		241
Corporate debt		8,022		6		(37	)		8,053
Equity		4,975		28		(349	)		5,296
Total investment debt securities available-for-sale and equity securities	$	379,545	$	975	$	(7,166	)	$	385,736

The amortized cost and estimated fair value of debt securities available-for-sale by contractual maturity at June 30, 2018 are shown in the following table. 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. Securities are assigned to categories based on contractual maturity except for mortgage-backed securities and CMOs which are based on the estimated average life of these securities and municipal securities that have been pre-refunded.

			Amortized
June 30, 2018	Fair value		cost
Due in one year or less	$	6,938	$	6,922
Due after one year through five years		185,003		191,920
Due after five years through ten years		131,117		135,913
Due after ten years		21,136		21,574
Total investment debt securities available-for-sale	$	344,194	$	356,329

Proceeds from sales of investment debt securities available-for-sale were approximately $1,756,000 and $9,872,000 for the three months ended June 30, 2018 and 2017, respectively. Proceeds from sales of investment equity securities were approximately $678,000 and $752,000 for the three months ended June 30, 2018 and 2017, respectively. Proceeds from sales of investment debt securities available-for-sale were approximately $4,159,000 and $19,358,000 for the six months ended June 30, 2018 and 2017, respectively. Proceeds from sales of investment equity securities were approximately $1,390,000 and $5,262,000 for the six months ended June 30, 2018 and 2017, respectively.

At June 30, 2018 and December 31, 2017, investment debt securities available-for-sale totaling approximately $187,915,000 and $202,887,000, respectively, were pledged as collateral for repurchase agreements and deposits of public funds.

The following table presents information related to the Company’s gains and losses on the sales of equity and debt securities, and losses recognized for the other-than-temporary impairment (“OTTI”) of these investments. Gains and losses on available-for-sale securities are computed on the specific identification method and included in non-interest income. Gross realized losses on equity and debt securities are net of other-than-temporary impairment charges:

	Three months ended June 30, 2018													Three months ended June 30, 2017
					Other-than-														Other-than-
	Gross		Gross		temporary		Gross		Gross					Gross		Gross			temporary
	realized		realized		impairment		unrealized		unrealized			Net		realized		realized			impairment		Net
	gains		losses		losses		gains		losses			gains		gains		losses			losses		gains/(losses)
Equity securities	$	44	$	—	$	—	$	375	$	(334	)	$	85	$	131	$	—		$	—	$	131
Debt securities available-for-sale		4		—		—		—		—			4		431		(447	)		—		(16	)
Total	$	48	$	—	$	—	$	375	$	(334	)	$	89	$	562	$	(447	)	$	—	$	115

	Six months ended June 30, 2018															Six months ended June 30, 2017
						Other-than-															Other-than-
	Gross		Gross			temporary		Gross		Gross						Gross		Gross			temporary
	realized		realized			impairment		unrealized		unrealized			Net			realized		realized			impairment		Net
	gains		losses			losses		gains		losses			gains/(losses)			gains		losses			losses		gains
Equity securities	$	130	$	—		$	—	$	349	$	(554	)	$	(75	)	$	856	$	—		$	—	$	856
Debt securities available-for-sale		25		(22	)		—		—		—			3			509		(501	)		—		8
Total	$	155	$	(22	)	$	—	$	349	$	(554	)	$	(72	)	$	1,365	$	(501	)	$	—	$	864

Tax expense applicable to the net realized gains for the three-month periods ended June 30, 2018 and 2017 were a credit of $14,000 and $48,000, respectively. Tax expense applicable to the net realized gains for the six-month periods ended June 30, 2018 and 2017 were $38,000 and $350,000, respectively.

QNB recognizes OTTI for debt securities classified as available-for-sale in accordance with FASB ASC 320, Investments – Debt and Equity Securities, which requires that we assess whether we intend to sell or it is more likely than not that the Company will be required to sell a security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, the amount of the impairment is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows discounted at the security’s effective yield. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and, therefore, is not required to be recognized as a loss in the income statement but is recognized in other comprehensive income. For equity securities, once a decline in value is determined to be other-than-temporary, the value of the equity security is reduced to fair value and a corresponding charge to earnings is recognized. QNB believes that we will fully collect the carrying value of securities on which we have recorded a non-credit related impairment in other comprehensive income.

The following table presents a roll forward of the credit loss component recognized in earnings. The credit loss component of the amortized cost represents the difference between the present value of expected future cash flows and the amortized cost basis of the security prior to considering credit losses. The beginning balance represents the credit loss component for debt securities for which OTTI occurred prior to the beginning of the year. Credit-impaired debt securities must be presented in two components based upon whether the current period is the first time the debt security was credit-impaired (initial credit impairment) or is not the first time the debt security was credit-impaired (subsequent credit impairments). No credit impairments were recognized on debt securities during first six months of 2018 or 2017. The table presents a summary of the cumulative credit-related other-than-temporary impairment charges recognized as components of earnings for debt securities still held by QNB:

Six months ended June 30,	2018		2017
Balance, beginning of period	$	1	$	1,153
Reductions: sale, collaterized debt obligation		—		(1,152	)
Additions:
Initial credit impairments		—		—
Subsequent credit impairments		—		—
Balance, end of period	$	1	$	1

The following table indicates the length of time individual securities have been in a continuous unrealized loss position at June 30, 2018 and December 31, 2017:


			Less than 12 months					12 months or longer					Total
	No. of		Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
June 30, 2018	securities		value		losses			value		losses			value		losses
U.S. Government agency		53	$	8,731	$	(258	)	$	60,764	$	(2,724	)	$	69,495	$	(2,982	)
State and municipal		99		35,507		(492	)		5,604		(170	)		41,111		(662	)
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed		108		53,757		(1,795	)		71,300		(3,419	)		125,057		(5,214	)
Collateralized mortgage obligations (CMOs)		77		21,839		(712	)		48,757		(2,813	)		70,596		(3,525	)
Pooled trust preferred		1		—		—			118		(5	)		118		(5	)
Corporate debt		4		2,963		(68	)		969		(35	)		3,932		(103	)
Equity		19		4,128		(550	)		832		(337	)		4,960		(887	)
Total		361	$	126,925	$	(3,875	)	$	188,344	$	(9,503	)	$	315,269	$	(13,378	)


			Less than 12 months					12 months or longer					Total
	No. of		Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
December 31, 2017	securities		value		losses			value		losses			value		losses
U.S. Government agency		53	$	10,828	$	(155	)	$	59,696	$	(1,793	)	$	70,524	$	(1,948	)
State and municipal		37		10,577		(49	)		4,446		(64	)		15,023		(113	)
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed		99		61,069		(705	)		72,318		(1,696	)		133,387		(2,401	)
Collateralized mortgage obligations (CMOs)		70		21,660		(349	)		52,833		(1,943	)		74,493		(2,292	)
Pooled trust preferred		1		—		—			215		(26	)		215		(26	)
Corporate debt		4		3,018		(20	)		988		(17	)		4,006		(37	)
Equity		11		2,727		(277	)		275		(72	)		3,002		(349	)
Total		275	$	109,879	$	(1,555	)	$	190,771	$	(5,611	)	$	300,650	$	(7,166	)

Management evaluates debt securities, which are comprised of U.S. Government agencies, state and municipalities, mortgage-backed securities, CMOs and corporate debt securities, for other-than-temporary impairment and considers the current economic conditions, the length of time and the extent to which the fair value has been less than cost, interest rates and the bond rating of each security. The unrealized losses at June 30, 2018 in U.S. Government agency securities, state and municipal securities, mortgage-backed securities, CMOs and corporate debt securities are primarily the result of interest rate fluctuations. If held to maturity, these bonds will mature at par, and QNB will not realize a loss. The Company has the intent to hold the securities and does not believe it will be required to sell the securities before recovery occurs.

The Company’s investment in marketable equity securities primarily consists of investments in large cap stock companies. These equity securities are analyzed for impairment on an ongoing basis. Management believes these equity securities will recover in the foreseeable future. QNB evaluated the near-term prospects of the issuers in relation to the severity and duration of the impairment. Based on that evaluation and the Company’s ability and intent to hold those securities for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider these equity securities to be other-than-temporarily impaired.

QNB holds one pooled trust preferred security as of June 30, 2018. This security has a total amortized cost of approximately $123,000 and a fair value of $118,000. The pooled trust preferred security is available-for-sale securities and is carried at fair value.

The following table provides additional information related to the pooled trust preferred security (PreTSL) as of June 30, 2018:

Deal

Class

Book

value

Fair

value

Unrealized

gains (losses)

Realized

OTTI

credit

loss

(YTD 2018)

Total

recognized

OTTI

credit

loss

Moody's

/Fitch

ratings

Current

number of

performing

banks

Current

number of

performing

insurance

companies

Actual

deferrals

and defaults

as a % of

total

collateral

Total

performing collateral

as a % of

outstanding

bonds

PreTSL IV

Mezzanine

123

118

)

—

)

Ba1/BB

—

0.00

185.4

Mezzanine* - only class of bonds still outstanding (represents the senior-most obligation of the trust)

In June 2017, QNB Bank sold five non-performing pooled trust preferred securities, with $2,235,000 carrying value, recording a loss on sale of $15,000, included in non-interest income in the quarter ended June 30, 2017 consolidated statement of income. Several years ago, QNB had recorded $1,152,000 in OTTI for four of these five bonds, and subsequently applied any cashflow received to the balance of these non-performing, nonaccrual assets. Improvement in market prices for these securities during the second quarter 2017 reduced realized losses, and the reduction of approximately $19,000,000 in risk-based assets required for the bonds drove the decision to redeem these debt securities.

On a quarterly basis we evaluate our debt securities for OTTI, which involves the use of a third-party valuation firm to assist management with the valuation. When evaluating these investments, a credit-related portion and a non-credit related portion of impairment are determined. The credit-related portion is recognized in earnings and represents the expected shortfall in future cash flows. The non-credit related portion is recognized in other comprehensive income and represents the difference between the book value and the fair value of the security less any current quarter credit related impairment. For the quarter and six months ended June 30, 2018 and 2017, no other-than-temporary impairment charges representing credit impairment were recognized on our pooled trust preferred collateralized debt obligations. A discounted cash flow analysis provides the best estimate of credit related OTTI for these securities. Additional information related to this analysis follows.

PreTSL IV is rated lower than AA and measured for OTTI within the scope of ASC 325 (formerly known as EITF 99-20), Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to be Held by a Transferor in Securitized Financial Assets, and Amendments to the Impairment Guidance of EITF Issue No. 99-20 (formerly known as EITF 99-20-1). In addition to discounted cash-flows, QNB considers trends in the financial performance ratios of the bond’s underlying issuers, as well as the bond’s structure (QNB holds the senior-most obligation of the trust for PreTSL IV), determining there is little likelihood of default. In determining whether a credit loss exists, QNB uses its best estimate of the present value of cash flows expected to be collected from the debt security and discounts them at the effective yield implicit in the security at the date of acquisition or the prospective yield for those securities with prior OTTI charges. Lack of liquidity in the market for trust preferred collateralized debt obligations contributed to the temporary impairment of this security. Although classified as available-for-sale, the Company has the intent to hold PreTSL IV and does not believe it will be required to sell it before recovery occurs. QNB could be subject to additional write-downs in the future if additional deferrals and defaults occur.