Note 4: Investments

The amortized cost and approximate fair values of securities as of June 30, 2013 and December 31, 2012 are as follows.

	June 30, 2013
			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
Available for Sale Securities
Mortgage-backed securities
Government sponsored agencies	$	113,687	$	2,112	$	(1,090)	$	114,709
Collateralized mortgage obligations
Government sponsored agencies		120,710		2,185		(1,081)		121,814
Federal agencies		5,000		-		(198)		4,802
Municipals		10,556		81		(135)		10,502
Small Business Administration		6		-		-		6
Corporate obligations		28,902		194		(3,825)		25,271
Total	$	278,861	$	4,572	$	(6,329)	$	277,104

	December 31, 2012
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
Available for Sale Securities
Mortgage-backed securities
Government sponsored agencies	$	121,260	$	5,115	$	-		$	126,375
Collateralized mortgage obligations
Government sponsored agencies		114,782		3,463		(10	)		118,235
Federal agencies		13,000		8		(2	)		13,006
Municipals		3,129		208		(16	)		3,264
Small Business Administration		8		-		-			8
Corporate obligations		27,488		431		(4,269	)		20,309
Total	$	276,326	$	9,168	$	(4,297	)	$	281,197

The amortized cost and fair value of available-for-sale securities at June 30, 2013, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Available for Sale
	Amortized		Fair
Description Securities	Cost		Value
Security obligations due
One to five years	$	13,930	$	14,054
Five to ten years		15,221		14,985
After ten years		15,307		11,536
		44,458		40,575
Mortgage-backed securities		113,687		114,709
Collateralized mortgage obligations		120,710		121,814
Small Business Administration		6		6
Totals	$	278,861		277,104

The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $2.5 million at June 30, 2013.

Gross gains of $445,000 and $480,000 on proceeds from sales of securities of $31.5 million and $13.2 million were realized for the six months ended June 30, 2013 and 2012, respectively. Losses recognized on the sale of securities for the six months ended June 30, 2013 and 2012 were $63,000 and $0, respectively.

Certain investments in debt and marketable equity securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at June 30, 2013, was $129.9 million, a increase from $13.3 million at December 31, 2012, which is approximately 47% and 9%, respectively, of the Bank's portfolio.

Based on evaluation of available evidence, including recent changes in market interest rates, management believes the declines in fair value for these securities, other than those discussed below, are temporary. Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

The following tables show our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2013 and December 31, 2012:

	June 30, 2013
	Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
Available for Sale
Mortgage-backed securities
Government sponsored agencies	$	51,834	$	(1,090	)	$	-	$	-		$	51,834	$	(1,090	)
Collateralized mortgage obligations
Government sponsored agencies		45,629		(1,081	)		-		-			45,629		(1,081	)
Federal agencies		4,802		(198	)		-		-			4,802		(198	)
Municipals		6,060		(104	)		742		(31	)		6,802		(135	)
Corporate obligations		17,847		(80	)		3,000		(3,745	)		20,847		(3,825	)
Total temporarily impaired securities	$	126,172	$	(2,553	)	$	3,742	$	(3,776	)	$	129,914	$	(6,329	)

	December 31, 2012
	Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
Available for Sale
Mortgage-backed securities
Government sponsored agencies	$	4,962	$	(10	)	$	-	$	-		$	5,076	$	(10	)
Federal Agencies		4,998		(2)								4,998		(2)
Municipals		874		(16	)		-		-			874		(16	)
Corporate obligations		-		-			2,475		(4,269	)		2,475		(4,269	)
Total temporarily impaired securities	$	10,834	$	(28	)	$	2,475	$	(4,269	)	$	13,309	$	(4,297	)

Mortgage-Backed Securities (MBS), Collateralized Mortgage Obligations (CMO) and Federal Agencies

The increase in unrealized losses on the Company’s investment in MBSs and CMOs and the increase in the amount of such investments subject to unrealized losses were caused by interest rate changes. The Company expects to recover the amortized cost basis over the term of the securities. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is more likely than not the Company will not be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2013.

Municipals

The increase in unrealized losses on the Company’s investments in securities of state and political subdivisions and the increase in the amount of such investments subject to unrealized losses were caused by changes in interest rates. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. The Company does not intend to sell the investment and it is not more likely than not that the Company will be required to sell the investment before recovery of its new, lower amortized cost basis, which may be maturity. The Corporation does not consider the investment securities to be other-than-temporarily impaired at June 30, 2013.

Corporate Obligations

The Company’s unrealized loss on investments in corporate obligations primarily relates to investments in pooled trust preferred securities. The increase in investments subject to unrealized losses less than 12 months were caused by interest rate changes. The unrealized losses were primarily caused by (a) a decrease in performance and regulatory capital at the underlying banks resulting from exposure to subprime mortgages and (b) a sector downgrade by several industry analysts. The Company currently expects some of the securities to settle at a price less than the amortized cost basis of the investment (that is, the Company expects to recover less than the entire amortized cost basis of the security). The Company has recognized a loss equal to the credit loss for these securities, establishing a new, and lower amortized cost basis. The credit loss was calculated by comparing expected discounted cash flows based on performance indicators of the underlying assets in the security to the carrying value of the investment. Because the Company does not intend to sell the investments and it is likely the Company will not be required to sell the investments before recovery of its new, lower amortized cost basis, which may be maturity, it does not consider the remainder of the investments to be other-than-temporarily impaired at June 30, 2013.

Mutual evaluates securities for other-than-temporary impairment (“OTTI”) on a quarterly basis. During the quarter ended June 30, 2013, the Bank’s evaluation indicated that there was no other-than-temporary impairment of securities. Impairment on securities is determined after analyzing the estimated cash flows to be received, underlying collateral and determining the amount of additional losses needed in the individual pools to create a shortfall in interest or principal payments. All trust preferred securities were valued using a discounted cash flow analysis as of June 30, 2013.

Other-than-temporary Impairment

Upon acquisition of a security, the Company decides whether it is within the scope of the accounting guidance for beneficial interests in securitized financial assets or will be evaluated for impairment under the accounting guidance for investments in debt and equity securities.

The accounting guidance for beneficial interests in securitized financial assets provides incremental impairment guidance for a subset of the debt securities within the scope of the guidance for investments in debt and equity securities. Where the security is a beneficial interest in securitized financial assets, the Company uses the beneficial interests in securitized financial asset impairment model. Where the security is not a beneficial interest in securitized financial assets, the Company uses the debt and equity securities impairment model.

The Company routinely conducts reviews to identify and evaluate each investment security to determine whether an other-than-temporary impairment has occurred. Economic models are used to determine whether an other-than-temporary impairment has occurred on these securities. While all securities are considered, the securities primarily impacted by other-than-temporary impairment testing are pooled trust preferred securities. For each pooled trust preferred security in the investment portfolio (including but not limited to those whose fair value is less than their amortized cost basis), an extensive, regular review is conducted to determine if an other-than-temporary impairment has occurred. Various inputs to the economic models are used to determine if an unrealized loss is other-than-temporary.

The Bank’s trust preferred securities valuation was prepared by an independent third party. The approach to determining fair value involved several steps including:



Detailed credit and structural evaluation of each piece of collateral in the trust preferred securities;



Collateral performance projections for each piece of collateral in the trust preferred security;



Terms of the trust preferred structure, as laid out in the indenture; and



Discounted cash flow modeling.

MutualFirst 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 primary focus is on the returns a fixed income investor would require in order to allocate capital on a risk adjusted basis. There is currently no active market for pooled trust preferred securities; however, the Company looks principally to market yields for stand-alone trust preferred securities issued by banks, thrifts and insurance companies for which there is an active and liquid market. The next step is to make a series of adjustments to reflect the differences that 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 security. Importantly, as part of the analysis described above, MutualFirst considers the fact that structured instruments frequently exhibit leverage not present in stand-alone instruments, and make adjustments as necessary to reflect this additional risk.

The default and recovery probabilities for each piece of collateral were formed based on the evaluation of the collateral credit and a review of historical industry default data and current/near-term operating conditions. For collateral that has already defaulted, the Company assumed no recovery. For collateral that was in deferral, the Company assumed a recovery of 10% of par for banks, thrifts or other depository institutions, and 15% of par for insurance companies. Although the Company conservatively assumed that the majority of the deferring collateral continues to defer and eventually defaults, we also recognize there is a possibility that some deferring collateral may become current at some point in the future.

Pooled Trust Preferred Securities

At June 30, 2013, MutualFirst had an amortized cost in pooled trust preferred securities of $6.7 million, which had an original par value of $8.0 million. These securities had a fair value of $3.0 million at June 30, 2013. The following table provides additional information related to the Bank’s investment in trust preferred securities as of June 30, 2013:

Deal	Class	Original Par		Book Value		Fair Value		Unrealized Loss		Recognized Losses 2013		Lowest Rating	Number of Banks/Insurance Companies Currently Performing		Actual Deferrals/Defaults (as % of original collateral)			Total Projected Defaults (as a % of performing collateral)^a			Excess Subordination (after taking into account best estimate of future deferrals/defaults)^b

Alesco Preferred Funding IX	A2A	$	1,000	$	905	$	439	$	466	$	-	CCC-		41		16.04	%		15.02	%		48.07	%
Preferred Term Securities XIII	B1		1,000		822		382		440		-	Ca		44		25.56	%		20.84	%		5.30	%
Preferred Term Securities XVIII	C		1,000		917		277		640		-	Ca		48		28.69	%		14.93	%		1.40	%
Preferred Term Securities XXVII	C1		1,000		710		252		458		-	Ca		32		25.08	%		18.83	%		5.99	%
U.S. Capital Funding I	B1		3,000		2,891		1,412		1,479		-	Caa1		29		12.92	%		9.79	%		4.52	%
U.S. Capital Funding III	B1		1,000		500		238		262		-	Ca		28		21.94	%		14.74	%		0.00	%

Total		$	8,000	$	6,745	$	3,000	$	3,745	$	-

(a) A 10% recovery is applied to all projected defaults. A 15% recovery is applied to all projected insurance defaults. No recovery is applied to current defaults.

(b) Excess subordination represents the additional defaults in excess of both current and projected defaults that the CDO can absorb before the bond experiences any credit impairment. Excess subordinated percentage is calculated by (a) determining what percentage of defaults a deal can experience before the bond has credit impairment, and (b) subtracting from this default breakage percentage both total current and expected future default percentages.

Credit Losses Recognized on Investments

Certain debt securities have experienced fair value deterioration due to credit losses, as well as due to other market factors, but are not otherwise other-than-temporarily impaired.

The following table provides information about debt securities for which only a credit loss was recognized in income and other losses are recorded in other comprehensive income.

	Accumulated Credit Losses Three Months Ended June 30,
	2013		2012
Credit losses on debt securities held
Beginning of period	$	1,205	$	1,205
Reductions related to actual losses incurred		-		-

As of June 30,	$	1,205	$	1,205

	Accumulated Credit Losses Six Months Ended June 30,
	2013		2012
Credit losses on debt securities held
Beginning of year	$	1,205	$	3,567
Reductions related to actual losses incurred		-		(2,362	)

As of June 30,	$	1,205	$	1,205