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Impairment Of Investment Securities | 6 Months Ended
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Jun. 30, 2011
Impairment Of Investment Securities |
Impairment Of Investment Securities | Note 9 Impairment of Investment Securities As required by FASB ASC Topic 320, "Investments – Debt and Equity Securities," credit related other-than-temporary impairment on debt securities is recognized in earnings while non-credit related other-than-temporary impairment on debt securities not expected to be sold is recognized in other comprehensive income ("OCI"). In the second quarter of 2011, no other-than-temporary impairment charges were recognized and $0.5 million in non-credit related gains on our trust preferred collateralized debt obligations that were determined to be impaired in previous periods was recorded in OCI. In the second quarter of 2010, we recorded $2.1 million in other-than-temporary impairment charges. These charges include $2.0 million in credit related other-than-temporary impairment on three trust preferred collateralized debt obligations, $0.1 million recorded on one equity security and a $45 thousand write-down on municipals transferred from held to maturity to available for sale. All of the securities for which other-than-temporary impairment was recorded were classified as available for sale securities. Additionally, $2.3 million in non-credit related gains on securities not expected to be sold was recorded in OCI. First Commonwealth utilizes the specific identification method to determine the net gain or loss on debt securities and the average cost method to determine the net gain or loss on equity securities. In the Condensed Consolidated Statements of Income, the "Change in fair value on impaired securities" line represents the change in fair value of securities impaired in the current or previous periods. The change in fair value includes both non-credit and credit related gains or losses. Credit related losses occur when the entire amortized cost of the security will not be recovered. The "Non-credit related gains on securities not expected to be sold (recognized in other comprehensive income)" line represents the gains and losses on the securities resulting from factors other than credit. The non-credit related gain or loss is disclosed in the Condensed Consolidated Statements of Income and recognized through other comprehensive income. The "Net impairment losses" line represents the credit related losses recognized in total noninterest income for the related period. We review our investment portfolio on a quarterly basis for indications of impairment. This review includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer and whether we are more likely than not to sell the security. We evaluate whether we are more likely than not to sell debt securities based upon our investment strategy for the particular type of security and our cash flow needs, liquidity position, capital adequacy, tax position and interest rate risk position. In addition, the risk of future other-than-temporary impairment may be influenced by additional bank failures, weakness in the U.S. economy, changes in real estate values and additional interest deferrals in our pooled trust preferred collateralized debt obligations. Our pooled trust preferred collateralized debt obligations are beneficial interests in securitized financial assets within the scope of FASB ASC Topic 325, "Investments – Other," and are therefore evaluated for other-than-temporary impairment using management's best estimate of future cash flows. If these estimated cash flows indicate that it is probable that an adverse change in cash flows has occurred, then other-than-temporary impairment would be recognized in accordance with FASB ASC Topic 320. There is a risk that First Commonwealth will record other-than-temporary impairment charges in the future. See Note 12, "Fair Values of Assets and Liabilities," for additional information. The following table presents the gross unrealized losses and estimated fair values at June 30, 2011 by investment category and time frame for which securities have been in a continuous unrealized loss position:
|  | Less Than 12 Months |  |  | 12 Months or More |  |  | Total |
Description of Securities |  | Estimated Fair Value |  |  | Gross Unrealized Losses |  |  | Estimated Fair Value |  |  | Gross Unrealized Losses |  |  | Estimated Fair Value |  |  | Gross Unrealized Losses |
|  | (dollars in thousands) |
Obligations of U.S. Government – Sponsored Enterprises: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Mortgage Backed Securities – Residential |  | $ | 63,715 |  |  | $ | (323 | ) |  | $ | 0 |  |  | $ | 0 |  |  | $ | 63,715 |  |  | $ | (323 | )
Mortgage Backed Securities – Commercial |  |  | 0 |  |  |  | 0 |  |  |  | 165 |  |  |  | (1 | ) |  |  | 165 |  |  |  | (1 | )
Other Government-Sponsored Enterprises |  |  | 78,410 |  |  |  | (290 | ) |  |  | 0 |  |  |  | 0 |  |  |  | 78,410 |  |  |  | (290 | )
Corporate Securities |  |  | 3,799 |  |  |  | (26 | ) |  |  | 4,034 |  |  |  | (64 | ) |  |  | 7,833 |  |  |  | (90 | )
Pooled Trust Preferred Collateralized Debt Obligations |  |  | 0 |  |  |  | 0 |  |  |  | 26,895 |  |  |  | (29,448 | ) |  |  | 26,895 |  |  |  | (29,448 | )
Total Securities |  | $ | 145,924 |  |  | $ | (639 | ) |  | $ | 31,094 |  |  | $ | (29,513 | ) |  | $ | 177,018 |  |  | $ | (30,152 | )
The following table presents the gross unrealized losses and estimated fair values at December 31, 2010 by investment category and time frame for which securities have been in a continuous unrealized loss position:
|  | Less Than 12 Months |  |  | 12 Months or More |  |  | Total |
Description of Securities |  | Estimated Fair Value |  |  | Gross Unrealized Losses |  |  | Estimated Fair Value |  |  | Gross Unrealized Losses |  |  | Estimated Fair Value |  |  | Gross Unrealized Losses |
|  | (dollars in thousands) |
Obligations of U.S. Government – Sponsored Enterprises: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Mortgage Backed Securities – Residential |  | $ | 105,304 |  |  | $ | (2,986 | ) |  | $ | 0 |  |  | $ | 0 |  |  | $ | 105,304 |  |  | $ | (2,986 | )
Mortgage Backed Securities – Commercial |  |  | 182 |  |  |  | (1 | ) |  |  | 0 |  |  |  | 0 |  |  |  | 182 |  |  |  | (1 | )
Other Government - Sponsored Enterprises |  |  | 126,531 |  |  |  | (869 | ) |  |  | 0 |  |  |  | 0 |  |  |  | 126,531 |  |  |  | (869 | )
Corporate Securities |  |  | 4,482 |  |  |  | (73 | ) |  |  | 5,827 |  |  |  | (271 | ) |  |  | 10,309 |  |  |  | (344 | )
Pooled Trust Preferred Collateralized Debt Obligations |  |  | 0 |  |  |  | 0 |  |  |  | 26,286 |  |  |  | (32,444 | ) |  |  | 26,286 |  |  |  | (32,444 | )
Total Securities |  | $ | 236,499 |  |  | $ | (3,929 | ) |  | $ | 32,113 |  |  | $ | (32,715 | ) |  | $ | 268,612 |  |  | $ | (36,644 | )
At June 30, 2011, pooled trust preferred collateralized debt obligations accounted for 98% of total unrealized losses and fixed income securities issued by U.S. Government agencies and U.S. Government-sponsored enterprises accounted for 2%. There were no equity securities in an unrealized loss position. As of June 30, 2011, our corporate securities had an amortized cost and an estimated fair value of $11.8 million and $12.0 million, respectively, and were comprised of single issue trust preferred securities issued primarily by money center and large regional banks. Included in the corporate securities portfolio are investments which had a gross unrealized loss of $0.1 million as of June 30, 2011 and $0.3 million as of December 31, 2010. After a review of each of the issuer's asset quality, earnings trend and capital position, it was determined that none of the issues in an unrealized loss position were other-than-temporarily impaired. Additionally, all interest payments on these securities are being made as contractually required. As of December 31, 2010, our corporate securities were comprised of single issue trust preferred securities as well as some corporate debentures. The single issue trust preferred securities had an amortized cost and estimated fair value of $20.0 million, while our corporate debentures had a book value of $1.2 million and a fair value of $1.3 million. The following table provides information related to our pooled trust preferred collateralized debt obligations as of June 30, 2011: Pooled Trust Preferred Collateralized Debt Obligations (dollars in thousands)
Deal |  | Class |  | Amortized Cost |  |  | Estimated Fair Value |  |  | Unrealized Gain (Loss) |  |  | Moody's/ Fitch Ratings |  |  | Number of Banks |  |  | Deferrals and Defaults as a Percentage of Current Collateral |  |  | Excess Subordination as a Percentage of Current Performing Collateral |
Pre TSL I |  | Senior |  | $ | 2,364 |  |  | $ | 2,158 |  |  | $ | (206 | ) |  |  | A2/BBB |  |  |  | 25 |  |  |  | 39.74 | % |  |  | 290.41 | %
Pre TSL IV |  | Mezzanine |  |  | 1,830 |  |  |  | 794 |  |  |  | (1,036 | ) |  |  | Ca/CCC |  |  |  | 6 |  |  |  | 27.07 | % |  |  | 38.57 | %
Pre TSL V |  | Mezzanine |  |  | 50 |  |  |  | 89 |  |  |  | 39 |  |  |  | Caa3/D |  |  |  | 3 |  |  |  | 100.00 | % |  |  | 0.00 | %
Pre TSL VI |  | Mezzanine |  |  | 234 |  |  |  | 200 |  |  |  | (34 | ) |  |  | Ca/D |  |  |  | 5 |  |  |  | 73.62 | % |  |  | 510.11 | %
Pre TSL VII |  | Mezzanine |  |  | 3,936 |  |  |  | 2,495 |  |  |  | (1,441 | ) |  |  | Ca/C |  |  |  | 18 |  |  |  | 67.87 | % |  |  | 0.00 | %
Pre TSL VIII |  | Mezzanine |  |  | 1,619 |  |  |  | 888 |  |  |  | (731 | ) |  |  | C/C |  |  |  | 34 |  |  |  | 45.91 | % |  |  | 0.00 | %
Pre TSL IX |  | Mezzanine |  |  | 2,227 |  |  |  | 934 |  |  |  | (1,293 | ) |  |  | Ca/C |  |  |  | 48 |  |  |  | 30.50 | % |  |  | 0.00 | %
Pre TSL X |  | Mezzanine |  |  | 1,300 |  |  |  | 783 |  |  |  | (517 | ) |  |  | C/C |  |  |  | 53 |  |  |  | 46.56 | % |  |  | 0.00 | %
Pre TSL XII |  | Mezzanine |  |  | 5,389 |  |  |  | 2,724 |  |  |  | (2,665 | ) |  |  | Ca/C |  |  |  | 77 |  |  |  | 32.69 | % |  |  | 0.00 | %
Pre TSL XIII |  | Mezzanine |  |  | 11,816 |  |  |  | 4,770 |  |  |  | (7,046 | ) |  |  | Ca/C |  |  |  | 64 |  |  |  | 32.31 | % |  |  | 0.00 | %
Pre TSL XIV |  | Mezzanine |  |  | 12,523 |  |  |  | 4,629 |  |  |  | (7,894 | ) |  |  | Ca/C |  |  |  | 64 |  |  |  | 34.98 | % |  |  | 0.00 | %
MMCap I |  | Senior |  |  | 5,958 |  |  |  | 4,986 |  |  |  | (972 | ) |  |  | A3/BBB |  |  |  | 29 |  |  |  | 32.25 | % |  |  | 255.79 | %
MMCap I |  | Mezzanine |  |  | 837 |  |  |  | 452 |  |  |  | (385 | ) |  |  | Ca/C |  |  |  | 29 |  |  |  | 32.25 | % |  |  | 13.70 | %
MM Comm IX |  | Mezzanine |  |  | 6,310 |  |  |  | 1,082 |  |  |  | (5,228 | ) |  |  | Caa3/C |  |  |  | 33 |  |  |  | 42.95 | % |  |  | 0.00 | %
Total |  |  |  | $ | 56,393 |  |  | $ | 26,984 |  |  | $ | (29,409 | ) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
As of June 30, 2011, the book value of our pooled trust preferred collateralized debt obligations totaled $56.4 million with a fair value of $27.0 million, which includes securities comprised of 359 banks and other financial institutions. Two of our pooled securities are senior tranches and the remainder are mezzanine tranches, three of which have no senior class remaining in the issue. Two of the pooled issues, representing $8.3 million of the $56.4 million book value, remain above investment grade. At the time of initial issue, the subordinated tranches ranged in size from approximately 7% to 35% of the total principal amount of the respective securities and no more than 5% of any pooled security consisted of a security issued by any one institution. As of June 30, 2011, after taking into account management's best estimates of future interest deferrals and defaults, nine of our securities had no excess subordination in the tranches we own and five of our securities had excess subordination which ranged from 14% to 510% of the current performing collateral. Lack of liquidity in the market for trust preferred collateralized debt obligations, credit rating downgrades and market uncertainties related to the financial industry are factors contributing to the impairment on these securities. On a quarterly basis we evaluate our debt securities for other-than-temporary impairment. In the first six months of 2011, no credit related other-than-temporary impairment charges were recognized on our pooled trust preferred collateralized debt obligations. When evaluating these investments we determine a credit related portion and a non-credit related portion of other-than-temporary impairment. The credit related portion is recognized in earnings and represents the expected shortfall in future cash flows. The non-credit related portion is recognized in OCI and represents the difference between the fair value of the security and the amount of credit related impairment. A discounted cash flow analysis provides the best estimate of credit related other-than-temporary impairment for these securities. As of June 30, 2011, none of the pooled trust preferred collateralized debt obligations were considered to be nonperforming securities, compared to $15.8 million which were considered nonperforming at December 31, 2010. These securities were returned to performing status because of growing evidence supporting management's estimate of future cash flows which indicate that all remaining principal and interest will be received. Support for these estimates include; no other-than-temporary impairment charges have been recorded since the third quarter of 2010, improvement in the underlying collateral of these bonds has occurred, evidenced by a continued decline in new interest payment deferrals and principal defaults as well as an increase in actual cures of deferring collateral. Additional information related to the discounted cash flow analysis follows: Our pooled trust preferred collateralized debt obligations are measured for other-than-temporary impairment within the scope of FASB ASC Topic 325 by determining whether it is probable that an adverse change in estimated cash flows has occurred. Determining whether there has been an adverse change in estimated cash flows from the cash flows previously projected involves comparing the present value of remaining cash flows previously projected against the present value of the cash flows estimated at June 30, 2011. We consider the discounted cash flow analysis to be our primary evidence when determining whether credit related other-than-temporary impairment exists. Results of a discounted cash flow test are significantly affected by other variables such as the estimate of future cash flows, credit worthiness of the underlying banks and determination of probability of default of the underlying collateral. The following provides additional information for each of these variables:
• |  | Estimate of Future Cash Flows – Cash flows are constructed in an INTEX cash flow model. INTEX is a proprietary cash flow model recognized as the industry standard for analyzing all types of collateralized debt obligations. It includes each deal's structural features updated with trustee information, including asset-by-asset detail, as it becomes available. For collateral issued by financial institutions with over $15 billion in asset size, our estimate of future cash flows includes a 20% prepayment rate in years 3 and 4 and a 2% prepayment rate thereafter. The modeled cash flows are then used to estimate if all the scheduled principal and interest payments of our investments will be returned.
• |  | Credit Analysis – A quarterly credit evaluation is performed for each of the 359 banks comprising the collateral across the various pooled trust preferred securities. Our credit evaluation considers all evidence available to us and includes the nature of the issuer's business, its years of operating history, corporate structure, loan composition, loan concentrations, deposit mix, asset growth rates, geographic footprint and local economic environment. Our analysis focuses on profitability, return on assets, shareholders' equity, net interest margin, credit quality ratios, operating efficiency, capital adequacy and liquidity.
Probability of Default – A probability of default is determined for each bank and is used to calculate the expected impact of future deferrals and defaults on our expected cash flows. Each bank in the collateral pool is assigned a probability of default for each year until maturity. Currently, any bank that is in default is assigned a 100% probability of default and a 0% projected recovery rate. All other banks in the pool are assigned a probability of default based on their unique credit characteristics and market indicators with a 10% projected recovery rate. For the majority of banks currently in deferral we assume the bank continues to defer and will eventually default and therefore a 100% probability of default is assigned. However, for some deferring collateral there is the possibility that they become current on interest or principal payments at some point in the future and in those cases a probability that the deferral will ultimately cure is assigned. The probability of default is updated quarterly. As of June 30, 2011, default probabilities for performing collateral ranged from 0.33% to 95%. Our credit evaluation provides a basis for determining deferral and default probabilities for each underlying piece of collateral. Using the results of the credit evaluation, the next step of the process is to look at pricing of senior debt or credit default swaps for the issuer (or where such information is unavailable, for companies having similar credit profiles as the issuer). The pricing of these market indicators provides the information necessary to determine appropriate default probabilities for each bank. In addition to the above factors, our evaluation of impairment also includes a stress test analysis which provides an estimate of excess subordination for each tranche. We stress the cash flows of each pool by increasing current default assumptions to the level of defaults which results in an adverse change in estimated cash flows. This stressed breakpoint is then used to calculate excess subordination levels for each pooled trust preferred security. The results of the stress test allows management to identify those pools that are at a greater risk for a future break in cash flows so that we can monitor banks in those pools more closely for potential deterioration of credit quality. Our cash flow analysis as of June 30, 2011, indicates no additional credit related other-than-temporary impairment has occurred on our pooled trust preferred securities since December 31, 2010. As a result, no other-than-temporary impairment charges were recognized in the second quarter of 2011. Based upon the analysis performed by management, it is probable that nine of our pooled trust preferred securities will experience principal and interest shortfalls and therefore appropriate other-than-temporary charges were recorded in 2008, 2009 and 2010. These securities are identified in the table on page 18 with 0% "Excess Subordination as a Percentage of Current Performing Collateral." For the remaining securities listed in that table, our analysis as of June 30, 2011 indicates it is probable that we will collect all contractual principal and interest payments. The following provides a cumulative roll forward of credit losses recognized in earnings for debt securities held and not intended to be sold:
|  | For the Three Months Ended June 30, |  |  | For the Six Months Ended June 30, |
|  | 2011 |  |  | 2010 |  |  | 2011 |  |  | 2010 |
|  | (dollars in thousands) |
Balance, beginning (a) |  | $ | 44,850 |  |  | $ | 38,911 |  |  | $ | 44,850 |  |  | $ | 36,161 |
Credit losses on debt securities for which other-than-temporary impairment was not previously recognized |  |  | 0 |  |  |  | 0 |  |  |  | 0 |  |  |  | 0 |
Additional credit losses on debt securities for which other-than-temporary impairment was previously recognized |  |  | 0 |  |  |  | 1,965 |  |  |  | 0 |  |  |  | 4,715 |
Balance, ending |  | $ | 44,850 |  |  | $ | 40,876 |  |  | $ | 44,850 |  |  | $ | 40,876 |
(a) | The beginning balance represents credit related losses included in other-than-temporary impairment charges recognized on debt securities in prior periods. For the six months ended June 30, the beginning balance represents impairment losses taken before January 1 of the respective year.
In the second quarter of 2011, there were no other-than-temporary impairment charges recorded on equity securities. There was $0.1 million of other-than-temporary impairment charges recognized in the second quarter of 2010 on equity securities. On a quarterly basis, management evaluates equity securities for other-than-temporary impairment by reviewing the severity and duration of decline in estimated fair value, research reports, analysts' recommendations, credit rating changes, news stories, annual reports, regulatory filings, impact of interest rate changes and other relevant information. As of June 30, 2011, there are no equity securities in an unrealized loss position.

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