Investments

The amortized cost and estimated fair values of the Company's securities are shown in the following table (in thousands):



	September 30, 2014								December 31, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Securities available-for-sale:
U.S. Treasuries and U.S.
government agencies	$	1,923	$	20	$	—	$	1,943	$	2,317	$	48	$	—	$	2,365
Obligations of states and
political subdivisions	41,096		729		13		41,812		41,027		627		106		41,548
Mortgage-backed securities:
U.S. government agencies	183,470		2,950		3,123		183,297		282,653		2,765		7,310		278,108
Private label	1,767		11		—		1,778		2,184		16		3		2,197
Trust preferred
securities	10,164		300		1,648		8,816		12,943		2,113		1,900		13,156
Corporate securities	7,802		203		375		7,630		9,788		183		843		9,128
Total Debt Securities	246,222		4,213		5,159		245,276		350,912		5,752		10,162		346,502
Marketable equity securities	2,447		1,250		—		3,697		3,334		1,339		—		4,673
Investment funds	1,525		—		17		1,508		1,525		—		40		1,485
Total Securities
Available-for-Sale	$	250,194	$	5,463	$	5,176	$	250,481	$	355,771	$	7,091	$	10,202	$	352,660



	September 30, 2014								December 31, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Securities held-to-maturity
Mortgage-backed securities
US government agencies	$	89,193	$	1,443	$	—	$	90,636	$	—	$	—	$	—	$	—
Trust preferred securities	3,896		811		—		4,707		4,117		1,218		—		5,335
Total Securities
Held-to-Maturity	$	93,089	$	2,254	$	—	$	95,343	$	4,117	$	1,218	$	—	$	5,335

Other investment securities:
Non-marketable equity securities	$	14,234	$	—	$	—	$	14,234	$	13,343	$	—	$	—	$	13,343
Total Other Investment
Securities	$	14,234	$	—	$	—	$	14,234	$	13,343	$	—	$	—	$	13,343

Securities with limited marketability, such as stock in the Federal Reserve Bank or the Federal Home Loan Bank, are carried at cost and are reported as non-marketable equity securities in the table above.

Certain investment securities owned by the Company were in an unrealized loss position (i.e., amortized cost basis exceeded the estimated fair value of the securities). The following table shows 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 (in thousands):



	September 30, 2014
	Less Than Twelve Months				Twelve Months or Greater				Total
	Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss
Securities available-for-sale:
Obligations of states and political subdivisions	$	1,641	$	3	$	445	$	10	$	2,086	$	13
Mortgage-backed securities:
U.S. Government agencies	22,774		341		80,798		2,782		103,572		3,123
Trust preferred securities	368		144		4,805		1,504		5,173		1,648
Corporate securities	—		—		4,363		375		4,363		375
Investment funds	—		—		1,483		17		1,483		17
Total	$	24,783	$	488	$	91,894	$	4,688	$	116,677	$	5,176



	December 31, 2013
	Less Than Twelve Months				Twelve Months or Greater				Total
	Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss
Securities available-for-sale:
Obligations of states and political subdivisions	$	5,600	$	87	$	243	$	19	$	5,843	$	106
Mortgage-backed securities:
U.S. Government agencies	195,661		7,113		5,040		197		200,701		7,310
Private label	1,491		3		—		—		1,491		3
Trust preferred securities	—		—		4,400		1,900		4,400		1,900
Corporate securities	5,881		843		—		—		5,881		843
Investment funds	$	1,460	$	40	$	—	$	—	1,460		40
Total	$	210,093	$	8,086	$	9,683	$	2,116	$	219,776	$	10,202

Marketable equity securities consist of investments made by the Company in equity positions of various regional community bank holding companies, with ownership positions ranging from nominal to a 4% ownership position in First National Corporation (FXNC).

During the nine months ended September 30, 2014 and 2013, the Company had no credit-related net investment impairment losses. Also, for the year ended December 31, 2013, the Company had no credit-related net investment impairment losses.

Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other-than-temporary would be reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers, among other things (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition, capital strength, and near-term (12 months) prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology that may impair the earnings potential of the investment or the discontinuance of a segment of the business that may affect the future earnings potential; (iii) the historical volatility in the market value of the investment and/or the liquidity or illiquidity of the investment; (iv) adverse conditions specifically related to the security, an industry, or a geographic area; or (v) the intent to sell the investment security and if it’s more likely than not that the Company will not have to sell the security before recovery of its cost basis. In addition, management also employs a continuous monitoring process in regards to its marketable equity securities, specifically its portfolio of regional community bank holding company stocks. Although the regional community bank holding company stocks that are owned by the Company are publicly traded, the trading activity for these stocks is minimal, with trading volumes of less than 0.2% of each respective company being traded on a daily basis. As part of management’s review process for these securities, management reviews the financial condition of each respective regional community bank for any indications of financial weakness.

Management has the ability and intent to hold the securities classified as held to maturity until they mature, at which time the Company will receive full value for the securities. Furthermore, as of September 30, 2014, management does not intend to sell an impaired security and it is not more than likely that it will be required to sell the security before the recovery of its amortized cost basis. The unrealized losses on debt securities are primarily the result of interest rate changes, credit spread widening on agency-issued mortgage related securities, general financial market uncertainty and market volatility. These conditions will not prohibit the Company from receiving its contractual principal and interest payments on its debt securities. The fair value is expected to recover as the securities approach their maturity date or repricing date. As of September 30, 2014, management believes the unrealized losses detailed in the table above are temporary and no impairment loss has been recognized in the Company’s consolidated income statement. 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 of the other-than-temporary impairment is identified, while any noncredit loss will be recognized in other comprehensive income.

At September 30, 2014, the book value of the Company’s five pooled trust preferred securities totaled $2.5 million with an estimated fair value of $1.4 million. All of these securities are mezzanine tranches. Pooled trust preferred securities represent beneficial interests in securitized financial assets that the Company analyzes within the scope of ASC 320, “Investments-Debt and Equity Securities” and are evaluated quarterly for other-than-temporary-impairment (“OTTI”). Management performs an analysis of OTTI utilizing its internal methodology as described below to estimate expected cash flows to be received in the future. The Company reviews each of its pooled trust preferred securities to determine if an OTTI charge would be recognized in current earnings in accordance with ASC 320, “Investments-Debt and Equity Securities”. There is a risk that collateral deterioration could cause the Company to recognize additional OTTI charges in earnings in the future.

When evaluating pooled trust preferred securities for OTTI, the Company determines a credit related portion and a noncredit related portion. The credit related portion is recognized in earnings and represents the difference between the present value of expected future cash flows and the amortized cost basis of the security. The noncredit related portion is recognized in other comprehensive income, and represents the difference between the book value and the fair value of the security less the amount of the credit related impairment. The determination of whether it is probable that an adverse change in estimated cash flows has occurred is evaluated by comparing estimated cash flows to those previously projected as further described below. The Company considers this process to be its primary evidence when determining whether credit related OTTI exists. The results of these analyses are significantly affected by other variables such as the estimate of future cash flows, credit worthiness of the underlying issuers and determination of the likelihood of defaults of the underlying collateral.

The Company utilizes a third party model to compute the present value of expected cash flows which considers the structure and term of each of the five respective pooled trust preferred securities and the financial condition of the underlying issuers. Specifically, the third party model details interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities. For issuing banks that have defaulted, management generally assumes no recovery. For issuing banks that have deferred its interest payments, management excludes the collateral balance associated with these banks and assumes no recoveries of such collateral balance in the future unless otherwise noted. The exclusion of such issuing banks in a current deferral position is based on such bank experiencing a certain level of financial difficulty that raises doubt about its ability to satisfy its contractual debt obligation, and accordingly, the Company excludes the associated collateral balance from its estimate of expected cash flows. Other assumptions used in the estimate of expected cash flows include expected future default rates and prepayments. Specifically, the model assumes annual prepayments of 1.0% with 100% at maturity and assumes 150 basis points of additional annual defaults from banks that are currently not in default or deferral. In addition, the model assumes no recoveries except for one trust preferred security which assumes that one of the banks currently deferring will cure such positions. Management compares the present value of expected cash flows to those previously projected to determine if an adverse change in cash flows has occurred. If an adverse change in cash flows has occurred, management determines the credit loss to be recognized in the current period and the portion related to noncredit factors to be recognized in other comprehensive income.

The following table presents a progression of the credit loss component of OTTI on debt and equity securities recognized in earnings during the nine months ended September 30, 2014 and for the year ended December 31, 2013 (in thousands). The credit loss component represents the difference between the present value of expected future cash flows and the amortized cost basis of the security. The credit component of OTTI recognized in earnings during a period is presented in two parts based upon whether the credit impairment in the current period is the first time the security was credit impaired (initial credit impairment) or if there is additional credit impairment on a security that was credit impaired in previous periods.



	Debt Securities		Equity Securities			Total
Balance at January 1, 2013	$	21,186	$	4,813		$	25,999
Additions:
Initial credit impairment	—		—			—
Additional credit impairment	—		—			—
Deductions:
Sold	—		(115		)	(115		)
Balance at December 31, 2013	21,186		4,698			25,884
Additions:
Initial credit impairment	—		—			—
Additional credit impairment	—		—			—
Deductions:
Sold	—		(2,251		)	(2,251		)
Balance at September 30, 2014	$	21,186	$	2,447		$	23,633

The following table presents additional information about the Company’s trust preferred securities with a credit rating of below investment grade as of September 30, 2014 (dollars in thousands):



Deal Name	Type	Class	Original Cost		Amortized Cost		Fair Value		Difference (1)		Lowest Credit Rating	# of issuers currently performing	Actual deferrals/defaults (as a % of original dollar)		Expected deferrals/defaults (as a % of remaining performing collateral)			Excess Subordination as a Percentage of Current Performing Collateral (4)
	Pooled trust preferred securities:
	Other-than-temporarily impaired
	Available for Sale:
P1	Pooled	Mezz	$	698	$	75	$	353	278		Caa1	6	19.5	%	20.0	%	⁽²⁾	65.7	%
P2	Pooled	Mezz	2,535		—		—		—		Ca	4	22.3	%	—	%	⁽²⁾	—	%
P3	Pooled	Mezz	2,962		1,419		636		(783	)	Caa3	17	22.6	%	8.2	%	⁽²⁾	43.5	%
P4	Pooled	Mezz	4,060		400		119		(281	)	Ca	9	19.2	%	7.1	%	⁽³⁾	26.9	%
P5	Pooled	Mezz	5,877		512		368		(144	)	Ca	7	19.8	%	20.0	%	⁽²⁾	62.7	%
	Held to Maturity:
P6	Pooled	Mezz	1,351		43		707		664		Caa1	6	19.5	%	20.0	%	⁽²⁾	65.7	%
P7	Pooled	Mezz	3,367		—		—		—		Ca	4	22.3	%	—	%	⁽²⁾	—	%
	Single issuer trust preferred securities
	Available for sale:
S5	Single		261		235		249		14		NR	1	—	%	—	%
	Held to Maturity:
S9	Single		4,000		4,000		4,000		—		NR	1	—	%	—	%


(1)	The differences noted consist of unrealized gains (losses) recorded at September 30, 2014 and noncredit other-than-temporary impairment losses recorded subsequent to April 1, 2009 that have not been reclassified as credit losses.


(2)	Performing collateral is defined as total collateral minus all collateral that has been called, is currently deferring, or currently in default. This model for this security assumes that all collateral that is currently deferring will default with a zero recovery rate. The underlying issuers can cure, thus this bond could recover at a higher percentage upon default than zero.


(3)	Performing collateral is defined as total collateral minus all collateral that has been called, is currently deferring, or currently in default. The model for this security assumes that one of the banks that is currently deferring will cure. If additional underlying issuers cure, this bond could recover at a higher percentage.

(4)

Excess subordination is defined as the additional defaults/deferrals necessary in the next reporting period to deplete the entire credit enhancement (excess interest and over-collateralization) beneath our tranche within each pool to the point that would cause a "break in yield." This amount assumes that all currently performing collateral continues to perform. A break in yield means that our security would not be expected to receive all the contractual cash flows (principal and interest) by maturity. The "percent of current performing collateral" is the ratio of the "excess subordination amount" to current performing collateral—a higher percent means there is more excess subordination to absorb additional defaults/deferrals, and the better our security is protected from loss.

The amortized cost and estimated fair value of debt securities at September 30, 2014, by contractual maturity, are shown in the following table (in thousands). Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties. Mortgage-backed securities have been allocated to their respective maturity groupings based on their contractual maturity.



	Amortized Cost		Estimated Fair Value
Securities Available-for-Sale
Due in one year or less	$	8,246	$	8,289
Due after one year through five years	19,515		20,162
Due after five years through ten years	27,059		27,672
Due after ten years	191,402		189,153
	$	246,222	$	245,276
Securities Held-to-Maturity
Due in one year or less	$	—
Due after one year through five years	—
Due after five years through ten years	—
Due after ten years	93,089		95,343
	$	93,089	$	95,343

Gross gains and gross losses realized by the Company from investment security transactions are summarized in the table below (in thousands). The specific identification method is used to determine the cost basis of securities sold.



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2014		2013		2014		2013

Gross realized gains	$	71	$	—	$	972	$	93
Gross realized losses	—		—		—		—
Net investment security gains	$	71	$	—	$	972	$	93

The carrying value of securities pledged to secure public deposits and for other purposes as required or permitted by law approximated $272 million and $278 million at September 30, 2014 and December 31, 2013, respectively.

Statement of Cash Flows - Investing Activities - Supplemental Information

During the second quarter, the Company transferred certain securities from available-for-sale to held-to-maturity. The non-cash transfers of securities into the held-to-maturity categories from available-for-sale were made at fair value on the date of the transfer. The securities had an aggregate fair value of $83.4 million, with an aggregate net unrealized loss of $0.1 million on the date of transfer. The net unamortized, unrealized loss on the transferred securities included in accumulated other comprehensive income in the accompanying balance sheet as of September 30, 2014 totaled $0.1 million. This amount will be amortized out of accumulated other comprehensive income over the remaining life of the underlying securities as an adjustment of the yield on those securities.