3. INVESTMENT SECURITIES

At the time of purchase of a security, the Company designates the security as either available for sale or held to maturity, depending upon investment objectives, liquidity needs and intent. Securities held to maturity are stated at cost, adjusted for premium amortized or discount accreted, if any. The Company has the positive intent and ability to hold such securities to maturity. Securities available for sale are stated at estimated fair value. Unrealized gains and losses are excluded from income and reported net of tax as accumulated other comprehensive income (loss) as a separate component of stockholders’ equity until realized. Changes in unrealized gains and losses are reported, net of tax, in the consolidated statements of comprehensive income (loss). Interest earned on securities is included in interest income. Realized gains and losses on the sale of securities are reported in the consolidated statements of operations and determined using the adjusted cost of the specific security sold.

The amortized cost, estimated fair value and gross unrealized gains and losses of the Company’s investment securities available for sale and held to maturity at September 30, 2013 and December 31, 2012 follow (in thousands).

	September 30, 2013									December 31, 2012
			Gross		Gross			Estimated				Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair		Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value		Cost		Gains		Losses			Value
Available for sale:
U.S. Treasury securities	$	-	$	-	$	-		$	-	$	500	$	-	$	-		$	500
U.S. Government agency securities		109,338		-		(6,828	)		102,510		65,085		70		(77	)		65,078
Obligations of states and political subdivisions		150,955		8,828		-			159,783		155,121		13,314		-			168,435
Collateralized mortgage obligations		36,208		716		(660	)		36,264		87,624		2,148		(80	)		89,692
Mortgage-backed securities		104,176		31		(4,222	)		99,985		61,750		766		(66	)		62,450
Corporate bonds		15,568		259		(218	)		15,609		15,701		497		-			16,198
Total available for sale securities		416,245		9,834		(11,928	)		414,151		385,781		16,795		(223	)		402,353
Held to maturity:
Obligations of states and political subdivisions		7,150		643		-			7,793		8,035		826		-			8,861
Total investment securities	$	423,395	$	10,477	$	(11,928	)	$	421,944	$	393,816	$	17,621	$	(223	)	$	411,214

At September 30, 2013 and December 31, 2012, investment securities carried at $273 million and $286 million, respectively, were pledged to secure trust deposits and public funds on deposit.

The amortized cost, contractual maturities and estimated fair value of the Company’s investment securities at September 30, 2013 (in thousands) are presented in the table below. Collateralized mortgage obligations (“CMOs”) and mortgage-backed securities (“MBS”) assume maturity dates pursuant to average lives.

	September 30, 2013
	Amortized		Estimated
	Cost		Fair Value
Securities available for sale:
Due in one year or less	$	18,003	$	18,252
Due from one to five years		123,574		129,476
Due from five to ten years		251,818		245,440
Due after ten years		22,850		20,983
Total securities available for sale		416,245		414,151
Securities held to maturity:
Due in one year or less		777		790
Due from one to five years		6,168		6,784
Due from five to ten years		205		219
Total securities held to maturity		7,150		7,793
Total investment securities	$	423,395	$	421,944

The proceeds from sales of securities available for sale and the associated net realized gains (losses) follow (in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2013		2012			2013		2012

Proceeds	$	-	$	3,584		$	13,427	$	3,584

Gross realized gains	$	3	$	-		$	395	$	-
Gross realized losses		-		162			-		162
Net realized gains (losses)	$	3	$	(162	)	$	395	$	(162	)

The table below indicates the length of time individual securities, both held to maturity and available for sale, have been held in a continuous unrealized loss position at the date indicated (in thousands).

	Less than 12 months				12 months or longer				Total
September 30, 2013	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
Type of securities	Fair value		Losses		Fair value		Losses		Fair value		Losses
U.S. Government agency securities	$	102,510	$	6,828	$	-	$	-	$	102,510	$	6,828
Collateralized mortgage obligations		8,900		660		-		-		8,900		660
Mortgage-backed securities		94,848		4,143		4,764		79		99,612		4,222
Corporate bonds		8,672		218		-		-		8,672		218
Total	$	214,930	$	11,849	$	4,764	$	79	$	219,694	$	11,928

	Less than 12 months				12 months or longer				Total
December 31, 2012	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
Type of securities	Fair value		Losses		Fair value		Losses		Fair value		Losses
U.S. Government agency securities	$	28,958	$	77	$	-	$	-	$	28,958	$	77
Collateralized mortgage obligations		7,878		80		-		-		7,878		80
Mortgage-backed securities		14,098		66		-		-		14,098		66
Total	$	50,934	$	223	$	-	$	-	$	50,934	$	223

The Company’s management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. All of the Company’s investment securities classified as available-for-sale or held-to-maturity are evaluated for OTTI under FASB Accounting Standards Codification (“ASC”) 320, “Accounting for Certain Investments in Debt and Equity Securities.” In determining OTTI under ASC 320, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than amortized cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an OTTI decline exists involves a high degree of subjectivity and judgment and is based on information available to management at a point in time. An OTTI is deemed to have occurred if there has been an adverse change in the remaining expected future cash flows.

When an OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the OTTI is recognized in earnings equal to the entire difference between the investment’s amortized cost and its estimated fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost less any current-period loss, the OTTI is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable tax benefit. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

Upon review of the considerations mentioned here, no OTTI was deemed to be warranted at September 30, 2013.

The Bank was a member of the Visa USA payment network and was issued Class B shares upon Visa, Inc.’s (“VISA”) initial public offering in March 2008. The VISA Class B shares that the Company owns are transferable only under limited circumstances until they can be converted into shares of the publicly traded class of stock. This cannot happen until the settlement of certain litigation, which is indemnified by VISA members. Since its initial public offering, VISA has funded a litigation reserve based upon a change in the ratio for conversion of VISA Class B shares to VISA Class A shares. At its discretion, Visa may continue to increase the conversion rate in connection with any settlements in excess of amounts then in escrow for that purpose and reduce the conversion rate to the extent that it adds any funds to the escrow in the future. Based on the existing transfer restriction and the uncertainty of the litigation the Company has recorded these shares at zero in the accompanying statement of condition.

On July 30, 2013, the Bank sold 50,000 VISA Class B shares at a gross pre-tax gain of approximately $3.8 million, which was recorded in non-interest income in the Company’s statement of operations in the third quarter of 2013. In conjunction with the sale, the Company entered into a swap contract with the purchaser that requires a payment to the counterparty in the event that VISA makes subsequent revisions to the conversion ratio for its Class B shares. The Company also recorded a contingent liability of $460 thousand, representing the Company’s estimate of its potential future exposure to the counterparty for settlement of the VISA litigation. This exposure represents cash payments required as the result of potential future conversion rate changes. The Company recorded an operating expense in the third quarter of 2013 in connection with this liability. Management believes that the Company’s estimated exposure to the VISA indemnification is adequate based on current information; however, future developments in the litigation disclosed by VISA could require potentially significant changes to this estimate. The carrying costs of required payments to the counterparty, calculated by reference to the market price of the Class A common shares at a fixed rate of interest, are expensed as incurred. These payments approximate $25 thousand per quarter; the pro-rata amount of $13 thousand was recorded in the quarter ended September 30, 2013.

The Company has pledged a U.S. Government agency security held in its available for sale portfolio, with a market value of approximately $1.4 million at September 30, 2013, as collateral for this transaction.

At September 30, 2013 the Company continued to own 88,638 VISA Class B shares subsequent to the sale described above. These shares remain restricted because of the continuing uncertainty of the litigation pending against Visa, Inc. Accordingly, the Company continues to record its VISA Class B shares at zero pending the outcome of the litigation. To the extent that the Company continues to own VISA Class B shares in the future, the Company expects to record the fair value of those shares upon expiration of the foregoing restriction. (See also Subsequent Event footnote contained herein.)