Note 5: Investment Securities

The amortized costs and approximate fair values, together with gross unrealized gains and losses on securities, are in the tables below. All mortgage-backed securities and collateralized mortgage obligations held as of September 30, 2018 and December 31, 2017 were guaranteed by government sponsored entities, government corporations or federal agencies.



	September 30, 2018
		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Available for Sale Securities
Mortgage-backed securities	$	101,729		63		(3,208)	$	98,584
Collateralized mortgage obligations		112,945		11		(3,674)		109,282
Municipal obligations		148,141		861		(2,775)		146,227
Corporate obligations		7,498		33		(877)		6,654
Total investment securities	$	370,313	$	968	$	(10,534)	$	360,747



	December 31, 2017
		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Available for Sale Securities
Mortgage-backed securities	$	68,335	$	225	$	(762)	$	67,798
Collateralized mortgage obligations		88,488		58		(1,296)		87,250
Municipal obligations		107,060		3,709		(274)		110,495
Corporate obligations		12,966		69		(1,200)		11,835
Total investment securities	$	276,849	$	4,061	$	(3,532)	$	277,378

The amortized cost and fair value of securities available for sale at September 30, 2018, 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 of Securities	Amortized Cost		Fair Value
Security obligations due
Within one year	$	501	$	505
One to five years		4,890		4,924
Five to ten years		24,392		24,632
After ten years		125,856		122,820
		155,639		152,881
Mortgage-backed securities		101,729		98,584
Collateralized mortgage obligations		112,945		109,282
Totals	$	370,313	$	360,747

Proceeds from sales of securities available for sale for the three and nine months ended September 30, 2018 were $14.4 million and $57.7 million, respectively. For the three and nine months ended September 30, 2017, proceeds from sales of securities available for sale were $4.0 million and $22.3 million. Gross gains were recognized on the sales for the three and nine months ended September 30, 2018 of $485,000 and $748,000, respectively. Gross gains of $45,000 and $453,000 were recognized for the three and nine months ended September 30, 2017. Gross losses of $79,000 and $82,000 were also recognized on the sales for the three and nine months ended September 30, 2018. There were no gross losses recognized on the sales of securities for the three and nine months ended September 30, 2017.

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, 2018 and December 31, 2017 was $293.6 million and $142.9 million, respectively, which were approximately 81.4% and 51.5%, respectively, 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 fair value for the securities at less than historical cost 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 2018 and 2017, the Bank determined that its security holdings had no 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, 2018 and December 31, 2017:



	September 30, 2018
	Less than 12 Months				12 Months or More				Total
		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Available for Sale Securities
Mortgage-backed securities	$	55,688	$	(1,111)	$	35,394	$	(2,097)	$	91,082	$	(3,208)
Collateralized mortgage obligations		70,680		(1,673)		36,991		(2,001)		107,671		(3,674)
Municipal obligations		81,686		(2,009)		11,018		(766)		92,704		(2,775)
Corporate obligations		-		-		2,120		(877)		2,120		(877)
Total temporarily impaired securities	$	208,054	$	(4,793)	$	85,523	$	(5,741)	$	293,577	$	(10,534)



	December 31, 2017
	Less than 12 Months				12 Months or More				Total
		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Available for Sale Securities
Mortgage-backed securities	$	21,975	$	(127)	$	27,675	$	(635)	$	49,650	$	(762)
Collateralized mortgage obligations		47,153		(400)		28,887		(896)	$	76,040	$	(1,296)
Municipal obligations		4,479		(64)		10,041		(210)		14,520		(274)
Corporate obligations		-		-		2,722		(1,200)		2,722		(1,200)
Total temporarily impaired securities	$	73,607	$	(591)	$	69,325	$	(2,941)	$	142,932	$	(3,532)

Mortgage-Backed Securities (MBS) and Collateralized Mortgage Obligations (CMO)

The unrealized losses on the Company’s investment in MBSs and CMOs were caused by interest rate changes and illiquidity. 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 illiquidity 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 any of these investments to be other-than-temporarily impaired at September 30, 2018.

Municipal Obligations

The unrealized losses on the Company’s investments in securities of state and political subdivisions were caused by changes in interest rates and illiquidity. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the par value of the investments. The Company does not intend to sell these investments and it is more likely than not that the Company will not be required to sell these investments. The Company does not consider any of these investment securities to be other-than-temporarily impaired at September 30, 2018.

Corporate Obligations

The Company’s unrealized losses on investments in corporate obligations primarily relates to a pooled trust preferred security. The unrealized losses were primarily due to illiquidity.

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 that are not a beneficial interest in securitized financial assets, the Company uses debt and equity securities impairment accounting 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.

The Bank’s trust preferred securities valuation was prepared by an independent third party. Their 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 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 little demand 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 makes adjustments as necessary to reflect this additional risk.

Pooled Trust Preferred Securities. The Bank has invested in a pooled trust preferred security. At September 30, 2018, the current book value of our pooled trust preferred security was $3.0 million. The original par value of this security was $3.0 million. The pooled trust preferred security owned was performing as agreed in the first nine months of 2018. As of September 2018, current Moody’s ratings for this bond was B3. The pooled trust preferred security owned by the Bank is exempt from the Volcker Rule.

The following table provides additional information related to the Bank’s investment in a pooled trust preferred security as of September 30, 2018:



Deal Name	Class	Original Par		Book Value		Fair Value		Unrealized Loss		Realized Losses 2018		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)
U.S. Capital Funding I	B1	$	3,000	$	2,997	$	2,120	$	(877)	$	-	Caa1	26	30	7.95	%	5.92	%	12.29	%

(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 collateralized debt obligation can absorb
before the bond experiences any credit impairment. Excess subordinated percentage is calculated by (a) determining what percentage of defaults a pool
can experience before the bond has credit impairment, and (b) subtracting from this default breakage percentage both total current and expected future
default percentages.