Investments and Mortgage-backed Securities

12 Months Ended

Dec. 31, 2011

Investments and Mortgage-backed Securities

2.             Investments and Mortgage-backed Securities

There were no securities classified as held to maturity as of December 31, 2011.

Available for Sale - Securities classified as available for sale consisted of the following (in thousands):

	As of December 31, 2011
	Amortized Cost		Gross Unrealized					Fair Value
			Gains		Losses
Investment Securities:
U.S. Agency Obligations	$	1	$	--	$	--		$	1
Government Sponsored Enterprises		87,295		259		(16	)		87,538
Trust Preferred Securities		6,378		--		(2,173	)		4,205
Total Investment Securities		93,674		259		(2,189	)		91,744
Mortgage-backed Securities:
Fannie Mae		17,609		250		(5	)		17,854
Ginnie Mae		29,854		868		(52	)		30,670
Freddie Mac		24,966		305		(13	)		25,258
Collateralized Mortgage Obligations		370		--		(18	)		352
Total Mortgage-backed Securities		72,799		1,423		(88	)		74,134
Total available for sale	$	166,473	$	1,682	$	(2,277	)	$	165,878

There were no securities classified as held to maturity as of December 31, 2010.

Available for Sale - Securities classified as available for sale consisted of the following (in thousands):

	As of December 31, 2010
	Amortized Cost		Gross Unrealized					Fair Value
			Gains		Losses
Investment Securities:
U.S. Agency Obligations	$	2	$	--	$	--		$	2
Government Sponsored Enterprises		55,881		49		(1,158	)		54,772
Trust Preferred Securities		7,271		--		(2,723	)		4,548
Total Investment Securities		63,154		49		(3,881	)		59,322
Mortgage-backed Securities:
Fannie Mae		11,307		270		(119	)		11,458
Ginnie Mae		61,617		180		(485	)		61,312
Freddie Mac		16,216		10		(264	)		15,962
Collateralized Mortgage Obligations		448		--		(33	)		415
Total Mortgage-backed Securities		89,588		460		(901	)		89,147
Total available for sale	$	152,742	$	509	$	(4,782	)	$	148,469

The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2011 (in thousands).

	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Securities Available     for Sale
Government Sponsored Enterprises	$	17,440	$	16	$	--	$	--	$	17,440	$	16
Trust Preferred Securities		--		--		4,205		2,173		4,205		2,173
Mortgage-backed Securities		9,617		70		377		18		9,994		88
Total	$	27,057	$	86	$	4,582	$	2,191	$	31,639	$	2,277

The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2010 (in thousands).

	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Securities Available     for Sale
Government Sponsored Enterprises	$	43,531	$	1,158	$	--	$	--	$	43,531	$	1,158
Trust Preferred Securities		--		--		4,548		2,723		4,548		2,723
Mortgage-backed Securities		59,963		868		444		33		60,407		901
Total	$	103,494	$	2,026	$	4,992	$	2,756	$	108,486	$	4,782

Management reviews securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. The Corporation reviews several items in determining whether its trust preferred securities are other than temporarily impaired.  These items include a valuation of the securities; an analysis of cash flows following the guidance in ASC 320-10-35 to measure credit loss for OTTI purposes; a stress analysis; a summary of deferrals and defaults of the individual issues in the pool; and information regarding the issuers in the pool.  A detailed description of each of these items of evidence is provided below.

Valuation of Securities – The first item reviewed is the fair market value of the security.  If the security is in an unrealized loss position, the Corporation proceeds to analyze the security for other than temporary impairment (“OTTI”) based on the following items.  The pricing of securities is performed by a third party and is considered Level III pricing.

Cash flow analysis – A cash flow analysis following the guidance in ASC 320-10-35 is the primary evidence utilized in determining whether there is a credit-related issue with respect to the security. The basic methodology is to calculate the present value of the cash flows using a current effective yield. This calculation uses assumptions for default rates, prepayment speeds and discount rates. We have used 0% as assumed prepayment rates, default rates ranging from 1.2% to 3.6% and discount rates ranging from 100 basis points to 300 basis points. In conjunction with the process of determining  the key assumptions, the Corporation also reviews the key financial information on the underlying issuers that are the collateral for the investment securities. The result of these analysis are used to determine estimates of default rates and also to provide additional information for consideration in determining the reasonableness of assumed prepayment rates. ASC 320-10-35 is used to measure credit loss for OTTI purposes. The change in the expected cash flows is reviewed to determine if OTTI should be recorded. The result calculated for the current quarter is then compared to the previous quarter's book value to determine if the change is “adverse.” The credit component of any impairment should be the difference between the book value and the projected present value for the current quarter.

The analysis is based on cash flow and utilizes a number of assumptions relating to credit and prepayment.  There are 9 scenarios available within three deal cash flow assumption categories (prepays constant, no prepays, prepays constant utilizing select years and defaults over 5 years and constant thereafter).  Each of these scenarios includes different prepayment assumptions and defaults at various levels in addition to projection of recoveries, if applicable, with a two-year lag.  Scenarios in each category range from a base to worse case in addition to two analyses that project defaults over the course of the following year on a quarterly basis and annually thereafter.

Stress Analysis– The Corporation obtains a stress analysis report of each security.  This report provides a snapshot of the immediate deferrals/defaults that a given pool and tranche/class can withstand before causing either a break in yield or temporary interest shortfall position.  There are various assumptions utilized in this report with respect to prepayments, deferrals/defaults, and recovery rates.

● Break in Yield – This is the level of deferrals/defaults the tranche could experience before the tranche would not receive all of its contractual cash flows (principal and interest) by maturity (not just a temporary interest shortfall but an actual loss in yield on the investment).  In other words, a break in yield occurs when the magnitude of the deferrals/defaults has depleted all of the credit enhancement (excess interest and over-collateralization) beneath the given tranche.

● Temporary Interest Shortfall– A temporary interest shortfall is caused by an amount of deferrals/defaults high enough such that there is insufficient cash flow available to pay current interest on the given tranche or by breaching the principal coverage test of the tranche immediately senior to the given tranche.  Principal coverage tests are set up to protect the Senior and Mezzanine Notes from credit events, providing the most credit protection to the Class A-1 Senior Notes, then to the Class A-2 Senior Notes, then to the Class B notes and so on. Cash flow is diverted from the lowest tranches first then from the successively higher tranches as necessary.

The existence of a break in yield or a temporary interest shortfall is an initial indication that OTTI may exist.

Deferral/Default Summary – The Corporation reviews current information for individual issues to determine the extent of deferrals and or defaults the status of any issuers in the pool, and the impact to the tranche owned by the Corporation. This report lists the issue (i.e., the pool/deal), the amount of deferrals/defaults related to the issue, the issuer that has deferred/defaulted, and the percentage of total current collateral this represents.  Additionally, the report provides the status of the amount in question (i.e. whether it is cured, purchased, in default, or deferred), the projected senior and mezzanine note status for the next payment date, the projected income note status for the next payment date and the next bond payment date. The Corporation compares the information in this report to the assumptions used in the cash flow analysis to ensure that deferral and defaults are correctly reflected in the cash flow analysis.

Issuer Lists –A report listing all of the companies in the pool, along with other relevant information such as organization type (mutual vs. stock), primary geographic location (state), rating, issue amount, years in business and principal line of business. The Corporation reviews the issuer lists for the individual pools held by the Corporation to gain better insight as to the underlying companies, the specific credit characteristics of the collateral underlying each individual security, and to determine risks associated with any concentrations with respect to issue amounts or lines of business.

To determine impairment charges for the Corporation’s collateralized debt obligations (“CDO”), we performed discounted cash flow valuations through a static default model test. The default model used assumed a 3.6% rate, which is three times the historic default rates for all collateralized debt obligations (“CDO”), a 0% recovery on all banks in deferral of interest payments and a 0% prepayment rate. Cash flow valuations with a premium mark up of 300 basis points were also used to determine the fair market values of the Corporation’s collateralized debt obligations. All of the Corporation’s pooled trust preferred securities have the same terms, which is that the securities cannot be redeemed for five years and then can be called quarterly thereafter.  All of the securities are past the five-year no-call period. Valuation documentation for the cash flow analysis is provided by an independent third party.

Amounts in the following table are in thousands.

Security Name	Single/ Pooled	Class Tranche	Amortized Cost		Fair Value		Unrealized Loss		Credit Portion		Other		YTD OTTI Total
Alesco II	Pooled	B-1	$	1,161	$	1,000	$	161	$	191	$	--	$	191
MM Com III	Pooled	B		530		369		162		20		--		20
MM Com IX	Pooled	B-1		22		12		11		164		--		164
Pretzl IV	Pooled	Mezz		152		48		104		--		--		--
Pretzl V	Pooled	Mezz		21		18		3		--		--		--
Pretzl X	Pooled	B-2		492		8		482		57		--		57
Total			$	2,378	$	1,455	$	923	$	432	$	--	$	432

OTTI-Other Than Temporary Impairment

	Lowest Rating (1)	% of Current  Performing			% Deferrals/ Defaults (2)			High			Low			Discount Margin (3)
Alesco II	C		82.64	%		17.36	%		1.20	%		0.40	%		4.65	%
MM Com III	CC		58.89	%		41.11	%		1.20	%		0.40	%		5.05	%
MM Com IX	D		49.32	%		50.68	%		1.20	%		0.40	%		4.80	%
Pretzl IV	CCC		72.93	%		27.07	%		1.50	%		0.75	%		2.25	%
Pretzl V	D		0.00	%		100.00	%		1.50	%		0.75	%		2.10	%
Pretzl X	C		50.02	%		49.98	%		1.50	%		0.75	%		1.70	%

Notes to table above:

(1)    Credit Ratings represent Moody’s and Fitch ratings (S&P does not rate this security)

(2)    The ratio represents the amount of underlying trust preferred collateral not currently making dividend payments. Fewer deferrals/defaults produce a lower ratio.

(3)    Fair market value discount margin to LIBOR

The following table presents the Corporation’s investments by category and the related unrealized gains or losses, net of tax, recognized in other comprehensive losses, credit losses recognized in and credit ratings for each classification of security. Trust preferred securities are divided into pooled and single issue securities. Private label trust preferred securities are $2.0 million each and are evaluated each quarter based on the financial stability of the institution. These securities have no credit rating included in the table below. Agency MBS and agency securities are government guaranteed and therefore, their risk is relatively low.

Amounts in the following table are in millions.

Security Classification	Amortized Cost		Fair Value		OCI			OTTI			AAA		AA			A	Baa1		Ba3		Not Rated		Below Investment Grade
Single issuer trust preferred securities	$	4.0	$	2.8	$	(0.8	)	$	--		$	--	$	--	$	--	$	--	$	--	$	2.8	$	--
Pooled trust preferred securities		2.4		1.4		(0.6	)		(5.4	)		--		--		--		--		--		--		1.4
Agency MBS		72.4		73.8		0.9			--			--		--		--		--		--		73.8		--
Private label CMO		0.4		0.4		--			--			0.4		--		--		--		--		--		--
Treasury/Agency		87.3		87.5		0.1			--			87.5		--		--		--		--		--		--
Total	$	166.5	$	165.9	$	(0.4	)	$	(5.4	)	$	87.9	$	--	$	--	$	--	$	--	$	76.6	$	1.4

OCI-Other Comprehensive Income (loss)  OTTI-Other Than Temporary Impairment

For the year ended December, 31, 2011, the Corporation experienced a credit-related other-than-temporary impairment of $432,000 on the pooled trust preferred securities portfolio and has recorded $5.4 cumulatively since 2008 in this portfolio. All of these securities are in the Corporation’s available for sale portfolio. This was charged to earnings in non-interest income as “Other-than-temporary-impairment write-down on securities”. The total securities impacted by credit-related other-than-temporary impairment have a current carrying value of $1.4 million and represent approximately 0.88% of available for sale securities. We do not intend to sell the remaining debt securities and we believe more likely than not, we will not be required to sell the debt securities before their anticipated recovery.

Proceeds, gross gains and gross losses realized from the sales of securities were as follows for the periods ended (in thousands):

	Years Ended December 31,
	2011		2010
Proceeds	$	77,051	$	89,751
Gross gains		1,125		1,824
Gross losses		–		–
Net gain on investment transactions	$	1,125	$	1,824

The maturities of securities at December 31, 2011 are as follows (in thousands):

	Available for Sale
	Amortized Cost		Fair Value
Due in one year or less	$	35,354	$	35,431
Due after one year through five years		23		24
Due after five years through ten years		31,876		32,042
Due after ten years		99,220		98,381
Total investment and mortgage-backed securitiesbacked securities	$	166,473	$	165,878

The mortgage-backed securities held at December 31, 2011 mature between one and thirty years. The actual lives of those securities may be significantly shorter as a result of principal payments and prepayments. All mortgage-backed securities are U.S. Government securities issued through Fannie Mae, Ginnie Mae, or Freddie Mac.

At December 31, 2011 and 2010, $85.1 million and $78.5 million, respectively, of securities recorded at book value were pledged as collateral for certain deposits and borrowings.

At December 31, 2011, approximately $11.6 million of mortgage-backed securities were adjustable rate securities. The adjustment periods range from monthly to annually and rates are adjusted based on the movement of a variety of indices.

Investments in collateralized mortgage obligations (“CMOs”) had a fair market value of $352,000 at December 31, 2011. These are private label CMO securities that were issued by a large regional bank. Therefore, the fair market value is determined by the current available broker supplied price as an estimate of the amount the Corporation could expect to receive in the open market. These securities are not actively traded as a result of the economic crisis.