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 in AOCI 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.

During the first quarter of 2014, investment securities totaling $31 million were transferred from available for sale to held to maturity. At the time of transfer, the securities were at unrealized losses. In accordance with ASC 320-10-35-10, the securities were transferred at fair value, which became the amortized cost. The discount is then accreted to interest income over the remaining life of the security. The unrealized holding losses at the date of transfer remained in AOCI and are amortized simultaneously against interest income. Those entries offset or mitigate each other. For regulatory capital purposes, the unamortized AOCI related to these securities is treated in the same manner as an available for sale debt security.

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 March 31, 2014 and December 31, 2013 were as follows (in thousands):

	March 31, 2014									December 31, 2013
			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. Government agency securities	$	70,466	$	-	$	(3,705	)	$	66,761	$	109,315	$	-	$	(9,220	)	$	100,095
Obligations of states and political subdivisions		147,472		8,451		-			155,923		148,664		8,499		-			157,163
Collateralized mortgage obligations		27,108		880		(689	)		27,299		30,335		557		(788	)		30,104
Mortgage-backed securities		102,591		18		(4,128	)		98,481		103,332		19		(5,584	)		97,767
Corporate bonds		15,561		241		(118	)		15,684		15,565		264		(178	)		15,651
Total available for sale securities		363,198		9,590		(8,640	)		364,148		407,211		9,339		(15,770	)		400,780
Held to maturity:
U.S. Government agency securities		31,318		-		(165	)		31,153		-		-		-			-
Obligations of states and political subdivisions		14,161		694		-			14,855		11,666		655		(87	)		12,234
Total held to maturity securities		45,479		694		(165	)		46,008		11,666		655		(87	)		12,234
Total investment securities	$	408,677	$	10,284	$	(8,805	)	$	410,156	$	418,877	$	9,994	$	(15,857	)	$	413,014

At March 31, 2014 and December 31, 2013, investment securities carried at $255 million and $292 million, respectively, were pledged for trust deposits, public funds on deposit and as collateral for the derivative swap contracts.

The amortized cost, contractual maturities and estimated fair value of the Company’s investment securities at March 31, 2014 (in thousands) are presented in the table below. Collateralized mortgage obligations (“CMOs”) and mortgage-backed securities (“MBS”) assume maturity dates pursuant to average lives.

	March 31, 2014
	Amortized		Estimated
	Cost		Fair Value
Securities available for sale:
Due in one year or less	$	11,353	$	11,499
Due from one to five years		130,651		136,363
Due from five to ten years		216,194		211,507
Due after ten years		5,000		4,779
Total securities available for sale		363,198		364,148
Securities held to maturity:
Due in one year or less		627		632
Due from one to five years		6,584		7,175
Due from five to ten years		15,154		15,010
Due after ten years		23,114		23,191
Total securities held to maturity		45,479		46,008
Total investment securities	$	408,677	$	410,156

The proceeds from sales of securities available for sale and the associated net realized gains are shown below for the periods indicated (in thousands):

	Three Months Ended March 31,
	2014		2013

Proceeds	$	-	$	10,475

Gross realized gains	$	-	$	359
Gross realized losses		-		-
Net realized gains	$	-	$	359

Information pertaining to securities with unrealized losses at March 31, 2014 and December 31, 2013, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows (in thousands):

	Less than 12 months				12 months or longer				Total
	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
March 31, 2014	Fair value		Losses		Fair value		Losses		Fair value		Losses
U.S. Government agency securities	$	88,511	$	3,273	$	9,403	$	597	$	97,914	$	3,870
Collateralized mortgage obligations		-		-		8,634		689		8,634		689
Mortgage-backed securities		85,484		3,566		12,739		562		98,223		4,128
Corporate bonds		2,409		44		2,926		74		5,335		118
Total	$	176,404	$	6,883	$	33,702	$	1,922	$	210,106	$	8,805

	Less than 12 months				12 months or longer				Total
	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
December 31, 2013	Fair value		Losses		Fair value		Losses		Fair value		Losses
U.S. Government agency securities	$	86,590	$	7,726	$	13,505	$	1,494	$	100,095	$	9,220
Obligations of states and political subdivisions		3,932		87		-		-		3,932		87
Collateralized mortgage obligations		2,935		160		5,713		628		8,648		788
Mortgage-backed securities		84,869		4,850		12,637		734		97,506		5,584
Corporate bonds		8,681		178		-		-		8,681		178
Total	$	187,007	$	13,001	$	31,855	$	2,856	$	218,862	$	15,857

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 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 AOCI, 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.

The corporate bonds at unrealized losses for twelve months or longer in the table above carry investment grade ratings by all major credit rating agencies including both Moody’s and Standard & Poor’s. The unrealized losses on these bonds were a result of the current interest rate environment and the corresponding shape of the yield curve. The losses were not related to a deterioration of the quality of the issuer or any company-specific adverse events. All other securities at unrealized losses for twelve months or longer are issued or guaranteed by U.S. Government agencies or sponsored enterprises and the related unrealized losses resulted solely from the current interest rate environment and the corresponding shape of the yield curve.

Upon review of the considerations mentioned here, no OTTI was deemed to be warranted at March 31, 2014.

The Bank was a member of the Visa USA payment network and was issued Class B shares upon Visa’s initial public offering in March 2008. The Visa Class B shares are transferable only under limited circumstances until they can be converted into shares of the publicly traded class of stock. This conversion 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 into 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 its Visa Class B shares on its balance sheet at zero value.

During the second and third quarters of 2013, the Bank sold 100,000 Visa Class B shares to another Visa USA member financial institution at a gross pre-tax gain of approximately $7.8 million which was recorded in non-interest income in the Company’s statement of operations. In conjunction with the sale, the Company entered into derivative swap contracts with the purchaser of these Visa Class B shares which provide for settlements between the purchaser and the Company based upon a change in the ratio for conversion of Visa Class B shares into Visa Class A shares.

Also during the second and third quarters of 2013, the Company recorded a total of $932 thousand in operating expenses and in other liabilities on the balance sheet, representing the estimate of the Company’s exposure to the settlement of the Visa litigation or the derivative liability. A relatively high degree of subjectivity was used in estimating the fair value of this derivative liability, but management believes that the estimate of its fair value was reasonable based on the available information. The present value of estimated future fees to be paid to the derivative counterparty, or carrying costs, calculated by reference to the market price of the Visa Class A shares at a fixed rate of interest are expensed as incurred. For the three months ended March 31, 2014, $59 thousand in such carrying costs was expensed.

Management believes that the estimate of the Company’s exposure to the Visa indemnification and fees associated with the derivatives are adequate based on current information. However, future developments in the litigation could require potentially significant changes to the estimate.

The Company has pledged U.S. Government agency securities held in its available for sale portfolio, with a market value of approximately $3 million at March 31, 2014, as collateral for the derivative swap contracts.

At March 31, 2014, the Company still owned 38,638 Visa Class B shares subsequent to the sales described here. Based on the existing transfer restriction and the uncertainty of the litigation, these Visa Class B shares continue to be carried on the Company’s balance sheet at zero value. Upon termination of the existing transfer restriction and settlement of the litigation, and to the extent that the Company continues to own such Visa Class B shares in the future, the Company expects to record its Visa Class B shares at fair value.