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 mix of securities 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 one community bank stock. The average life of the portfolio is 4.1 years and $75.4 million (fair value) is pledged as collateral for deposits. The Bank has no investments in a single issuer that exceeds 10% of shareholders equity. All securities are classified as available for sale and all investment balances refer to fair value, unless noted otherwise.

The Bank’s private-label mortgage-backed securities (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 $40 thousand on three PLMBS in 2016. 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 following table includes additional detail about the Bank’s PLMBS at December 31, 2016 and 2015.

The amortized cost and estimated fair value of investment securities available for sale as of December 31, 2016 and 2015 is as follows:



(Dollars in thousands)			Gross		Gross
	Amortized		unrealized		unrealized		Fair
2016	cost		gains		losses		value
Equity securities	$	164	$	126	$	-	$	290
U.S. Government and Agency securities		12,598		148		(26)		12,720
Municipal securities		62,763		793		(571)		62,985
Trust preferred securities		5,979		-		(518)		5,461
Agency mortgage-backed securities		61,305		431		(452)		61,284
Private-label mortgage-backed securities		1,053		56		(5)		1,104
Asset-backed securities		33		-		(2)		31
Total	$	143,895	$	1,554	$	(1,574)	$	143,875



(Dollars in thousands)			Gross		Gross
	Amortized		unrealized		unrealized		Fair
2015	cost		gains		losses		value
Equity securities	$	164	$	69	$	-	$	233
U.S. Government and Agency securities		13,705		164		(33)		13,836
Municipal securities		67,851		1,555		(218)		69,188
Trust preferred securities		5,958		-		(669)		5,289
Agency mortgage-backed securities		69,284		621		(386)		69,519
Private-label mortgage-backed securities		1,335		39		(2)		1,372
Asset-backed securities		38		-		(2)		36
Total	$	158,335	$	2,448	$	(1,310)	$	159,473

At December 31, 2016 and 2015, the fair value of investment securities pledged to secure public funds, trust balances, deposit and other obligations totaled $79.1 million and $79.6 million, respectively.

The amortized cost and estimated fair value of debt securities at December 31, 2016, 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	$	2,162	$	2,169
Due after one year through five years		11,038		11,183
Due after five years through ten years		26,176		26,392
Due after ten years		41,997		41,453
		81,373		81,197
Mortgage-backed securities		62,358		62,388
Total	$	143,731	$	143,585

The composition of the net realized securities gains for the years ended December 31, 2016, 2015 and 2014 is as follows:



(Dollars in thousands)	2016		2015		2014
Gross gains realized (including gain on conversion)	$	22	$	736	$	284
Gross losses realized		-		-		(4)
Net gains realized	$	22	$	736	$	280

The 2016 gains were generated from calls on bonds. A gain on conversion of an investment security of $728 thousand was recorded in 2015 when one bank equity stock owned by the Bank was acquired by another bank. The remaining security gains were generated by the sale of equity securities.

Impairment:

The following table reflects the temporary impairment in the investment portfolio, aggregated by investment category, length of time that individual securities have been in a continuous unrealized loss position and the number of securities in each category as of December 31, 2016 and 2015.

The condition of the portfolio at year-end 2016, as measured by the dollar amount of temporarily impaired securities is slightly worse since year-end 2015. The municipal sector recorded the largest unrealized loss. The municipal and Agency MBS sectors 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, 2016, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted. The following table presents the temporary impairment in the security portfolio for the years presented:



	December 31, 2016
	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	$	789	$	(9)	1	$	3,413	$	(17)	10	$	4,202	$	(26)	11
Municipal securities		23,407		(417)	43		1,598		(154)	2		25,005		(571)	45
Trust preferred securities		-		-	-		5,461		(518)	7		5,461		(518)	7
Agency mortgage-backed securities		26,995		(359)	39		4,656		(93)	11		31,651		(452)	50
Private-label mortgage-backed securities		281		(5)	1		-		-	-		281		(5)	1
Asset-backed securities		-		-	-		4		(2)	1		4		(2)	1
Total	$	51,472	$	(790)	84	$	15,132	$	(784)	31	$	66,604	$	(1,574)	115



	December 31, 2015
	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	$	479	$	(1)	3	$	4,364	$	(32)	10	$	4,843	$	(33)	13
Municipal securities		5,806		(35)	8		4,785		(183)	7		10,591		(218)	15
Trust preferred securities		-		-	-		5,289		(669)	7		5,289		(669)	7
Agency mortgage-backed securities		18,977		(215)	29		7,394		(171)	13		26,371		(386)	42
Private-label mortgage-backed securities		-		-	-		246		(2)	1		246		(2)	1
Asset-backed securities		-		-	-		5		(2)	1		5		(2)	1
Total	$	25,262	$	(251)	40	$	22,083	$	(1,059)	39	$	47,345	$	(1,310)	79

The unrealized loss in the trust preferred sector declined by $151 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 from (and in some cases paid back) 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, 2016, 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		Unrealized Gain (Loss)		Lowest Credit Rating Assigned

BankAmerica Cap III	1/15/2027	Single	Preferred Stock	$	967	$	876	$	(91)	BB+
Wachovia Cap Trust II	1/15/2027	Single	Preferred Stock		279		268		(11)	BBB
Huntington Cap Trust	2/1/2027	Single	Preferred Stock		946		830		(116)	BB
Corestates Captl Tr II	2/15/2027	Single	Preferred Stock		943		896		(47)	BBB+
Huntington Cap Trust II	6/15/2028	Single	Preferred Stock		901		822		(79)	BB
Chase Cap VI JPM	8/1/2028	Single	Preferred Stock		966		888		(78)	BBB-
Fleet Cap Tr V	12/18/2028	Single	Preferred Stock		977		881		(96)	BB+
Total				$	5,979	$	5,461	$	(518)

The PLMBS sector continues to show a gross unrealized loss of $5 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 three bonds contained losses that were considered other-than-temporary. Management determined $40 thousand was credit related and therefore, recorded an impairment charge of $40 thousand against earnings in 2016. Management continues to monitor these securities and it is possible that additional write-downs may occur if current loss trends continue.

Private Label Mortgage Backed Securities


(Dollars in thousands)											Cumulative
	Origination	Amortized		Fair		Unrealized		Collateral	Lowest Credit	Credit	OTTI
Description	Date	Cost		Value		Gain (Loss)		Type	Rating Assigned	Support %	Charges
MALT 2004-6 7A1	6/1/2004	$	286	$	281	$	(5)	ALT A	CCC	15.71	$	-
RALI 2005-QS2 A1	2/1/2005		152		166		14	ALT A	CC	2.26		15
RALI 2006-QS4 A2	4/1/2006		386		398		12	ALT A	D	-		323
GSR 2006-5F 2A1	5/1/2006		40		47		7	Prime	D	-		15
RALI 2006-QS8 A1	7/28/2006		189		212		23	ALT A	D	-		242
Total		$	1,053	$	1,104	$	51				$	595

The following table represents the cumulative credit losses on debt securities recognized in earnings as of December 31, 2016.




(Dollars in thousands)	Twelve Months Ended
	2016		2015
Balance of cumulative credit-related OTTI at January 1	$	555	$	535
Additions for credit-related OTTI not previously recognized		40		20
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	$	595	$	555

In 2016, other-than-temporary-impairment charges were recorded on three private-label mortgage-backed securities.

The Bank held $1.8 million of restricted stock at the end of 2016 of which $1.7 million is stock in the Federal Home Loan Bank of Pittsburgh (FHLB). FHLB stock is carried at a cost of $100 per share. 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.