Note 4: Investment Securities

The amortized costs and approximate fair values, together with gross unrealized gains and losses on securities, are as follows:



	September 30, 2014
		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Available for Sale Securities
Mortgage-backed securities
Government-sponsored agencies	$	113,082	$	2,269	$	(598)	$	114,753
Collateralized mortgage obligations
Government-sponsored agencies		98,705		1,199		(1,298)		98,606
Federal agencies		4		-		-		4
Municipal obligations		27,259		1,711		(15)		28,955
Corporate obligations		24,150		94		(2,506)		21,738
Total investment securities	$	263,200	$	5,273	$	(4,417)	$	264,056



	December 31, 2013
		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Available for Sale Securities
Mortgage-backed securities
Government-sponsored agencies	$	104,006	$	1,700	$	(2,189)	$	103,517
Collateralized mortgage obligations
Government-sponsored agencies		108,305		1,207		(1,934)		107,578
Federal agencies		5,005		-		(231)		4,774
Municipal obligations		27,357		257		(276)		27,338
Corporate obligations		24,648		18		(3,525)		21,141
Total investment securities	$	269,321	$	3,182	$	(8,155)	$	264,348

The amortized cost and fair value of securities available for sale at September 30, 2014, 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
Description Securities	Amortized Cost		Fair Value
Security obligations due
One to five years	$	9,598	$	9,634
Five to ten years		10,778		10,864
After ten years		31,037		30,199
		51,413		50,697
Mortgage-backed securities
Government-sponsored agencies		113,082		114,753
Collateralized mortgage obligations
Government-sponsored agencies		98,705		98,606
Totals	$	263,200	$	264,056

The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $0 and $2.5 million at September 30, 2014 and December 31, 2013, respectively.

Proceeds from sales of securities available for sale for the three and nine months ended September 30, 2014 and 2013 were $2.8 million and $26.0 million compared to $21.7 million and $53.2 million, respectively. Gross gains of $75,000 and $643,000 compared to $436,000 and $898,000 for the three and nine months ended September 30, 2014 and 2013, respectively, were recognized on those sales. Gross losses of $0 and $207,000 compared to $0 and $63,000 for the three and nine months ended September 30, 2014 and 2013, respectively, were recognized on those sales.

All mortgage-backed securities and collateralized-mortgage obligations held by the Company as of September 30, 2014 were in government-sponsored or federal agency securities.

Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at September 30, 2014 and December 31, 2013 was $96.4 million and $147.8 million, which is approximately 36.5 percent and 55.9 percent of the Company’s investment portfolio at those dates.

Based on our evaluation of available evidence, including recent changes in market interest rates, management believes the declines in fair value for these securities, for the periods presented, 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.

During the first nine months of 2014 and 2013, the Bank determined that its holdings in trust preferred securities had no further other-than-temporary impairment.

The following tables show the gross unrealized losses and fair value of the Company’s investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2014 and December 31, 2013:



	September 30, 2014
	Less than 12 Months				12 Months or More				Total
		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Available for Sale
Mortgage-backed securities
Government-sponsored agencies	$	10,387	$	(98)	$	29,284	$	(500)	$	39,671	$	(598)
Collateralized mortgage obligations
Government-sponsored agencies		12,910		(168)		34,981		(1,130)		47,891		(1,298)
Federal agencies		4		-		-		-		4		-
Municipal obligations		-		-		623		(15)		623		(15)
Corporate obligations		-		-		8,188		(2,506)		8,188		(2,506)
Total temporarily impaired securities	$	23,301	$	(266)	$	73,076	$	(4,151)	$	96,377	$	(4,417)


	December 31, 2013
	Less than 12 Months				12 Months or More				Total
		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Available for Sale
Mortgage-backed securities
Government-sponsored agencies	$	67,130	$	(2,189)	$	-	$	-	$	67,130	$	(2,189)
Collateralized mortgage obligations
Government-sponsored agencies		51,753		(1,934)		-		-	$	51,753	$	(1,934)
Federal agencies		4,769		(231)						4,769		(231)
Municipal obligations		11,264		(245)		741		(31)		12,005		(276)
Corporate obligations		8,849		(151)		3,336		(3,374)		12,185		(3,525)
Total temporarily impaired securities	$	143,765	$	(4,750)	$	4,077	$	(3,405)	$	147,842	$	(8,155)

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

The unrealized losses on the Company’s investment in MBSs, CMOs and Federal Agencies were caused by interest rate changes. The Company expects to recover the amortized cost basis over the term of the securities. Because (1) the decline in market value is attributable to changes in interest rates and not credit quality, (2) the Company does not intend to sell the investments and (3) 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 at maturity, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2014.

Corporate Obligations

The Company’s unrealized loss on investments in corporate obligations primarily relates to investments in pooled trust preferred securities. The unrealized losses were primarily caused by (1) a decrease in performance and regulatory capital resulting from exposure to subprime mortgages and (2) 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, 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 these investments and it is likely that the Company will not be required to sell the investments before recovery of its new, lower amortized cost basis, which may be at maturity, it does not consider the remainder of the investments to be other-than-temporarily impaired at September 30, 2014.

Other-Than-Temporary Impairment (OTTI)

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 whether it 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. For securities that are a beneficial interest in securitized financial assets, the Company uses the beneficial interests in securitized financial asset impairment model. For securities where the security is not a beneficial interest in securitized financial assets, the Company uses debt and equity securities impairment model.

The Company conducts periodic 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 private-label mortgage-backed securities and trust preferred securities.

MutualFirst Financial 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.

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
	September 30,
	2014		2013
Credit losses on debt securities held
Beginning of period	$	705	$	1,205
Reductions related to actual losses incurred		-		-
As of September 30,	$	705	$	1,205



	Accumulated Credit Losses
	Nine Months Ended
	September 30,
	2014		2013
Credit losses on debt securities held
Beginning of year	$	1,205	$	1,205
Reductions related to actual losses incurred		(500)		-
As of September 30,	$	705	$	1,205

Pooled Trust Preferred Securities. The Company has invested in pooled trust preferred securities. At September 30, 2014, the current book balance of our pooled trust preferred securities was $6.2 million. The original par value of these securities was $7.0 million prior to the OTTI write-downs in 2011 and earlier, based on valuations by a third party. OTTI taken on trust preferred securities previously was the result of deterioration in the performance of the underlying collateral. The deterioration was the result of increased defaults and deferrals of dividend payments in that year, creating credit impairment along with weakening financial performance of performing collateral, increasing the risk of future deferrals of dividends and defaults. No additional OTTI was determined in the first nine months of 2014. All pooled trust preferred securities owned by the Bank are exempt from the Volcker Rule.

The following table provides additional information related to the Bank’s investment in trust preferred securities as of September 30, 2014.



Deal Name	Class	Original Par		Book Value		Fair Value		Unrealized gain (loss)		Realized Losses YTD		Lowest Ratings	Number of Banks / Insurance Cos. Currently Performing	Total Number of Banks and Insurance Cos. In Issuance (Unique)	Actual Deferrals/ Defaults (as a % of original collateral)		Total Projected Defaults (as a % of performing collateral) (1)		Excess subordination (after taking into account best estimate of future deferrals/ defaults) (2)
	(Dollars in Thousands)
Alesco Preferred Funding IX	B+		1,000		909		559		(350)		-	B2	41	52	14.69	%	15.78	%	54.50	%
Preferred Term Securities XIII	Caa1		1,000		767		423		(344)		-	Ca	44	61	25.75	%	20.21	%	4.36	%
Preferred Term Securities XVIII	Ca		1,000		917		430		(487)		-	Ca	52	72	22.51	%	10.03	%	6.43	%
Preferred Term Securities XXVII	Caa3		1,000		710		386		(324)		-	C	33	46	22.62	%	16.29	%	10.02	%
U.S. Capital Funding I	B3		3,000		2,891		1,936		(955)		-	Caa1	28	33	9.44	%	8.60	%	8.90	%
		$	7,000	$	6,194	$	3,734	$	(2,460)	$	-

(1) A 10% recovery is applied to all projected defaults by depository institutions. A 15% recovery is applied to all projected defaults by insurance companies. No recovery is applied to current defaults.

(2) 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.

Note 1: