Note 11—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"). During 2011, there was no impairment recognized on investment securities; there was $0.4 million in non-credit related gains recorded in OCI on securities previously determined to be impaired. All of the securities for which other-than-temporary impairment was recorded were classified as available-for-sale securities.

In accordance with FASB ASC Topic 320, at the beginning of 2009, the non-credit related portion of other-than-temporary impairment losses recognized in prior year earnings was reclassified as a cumulative effect adjustment that increased retained earnings and decreased accumulated OCI. In 2008, $13.0 million in other-than-temporary impairment charges were recognized, of which $6.5 million related to non-credit related impairment on debt securities. Therefore, the cumulative effect adjustment to retained earnings totaled $6.5 million, or $4.2 million net of tax on January 1, 2009.

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 Consolidated Statements of Operations, 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) losses 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 Consolidated Statements of Operations 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 determine 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 21 "Fair Values of Assets and Liabilities" for additional information.

The following table presents the gross unrealized losses and estimated fair value at December 31, 2011 by investment category and time frame for which the securities have been in a continuous unrealized loss position:


	Less Than 12 Months					12 Months or More					Total
	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 Agencies:
Mortgage-Backed Securities—Residential	$	1,086		$(6	)	$	16	$	0	(a)	$	1,102	$	(6	)
Obligations of U.S. Government-Sponsored Enterprises:
Mortgage-Backed Securities—Residential		25		0	(a)		0		0			25		0
Mortgage-Backed Securities—Commercial		151		(1	)		0		0			151		(1	)
Other Government-Sponsored Enterprises		55,969		(132	)		0		0			55,969		(132	)
Obligations of States and Political Subdivisions		0		0			0		0			0		0
Corporate Securities		4,536		(562	)		0		0			4,536		(562	)
Pooled Trust Preferred Collateralized Debt Obligations		0		0			22,927		(31,785	)		22,927		(31,785	)

Total Securities Available for Sale	$	61,767		$(701	)	$	22,943	$	(31,785	)	$	84,710	$	(32,486	)

(a)	Gross unrealized losses related to these types of securities are less than $1 thousand.

At December 31, 2011, 2% of the total unrealized losses were comprised of fixed income securities issued by U.S. Government agencies and U.S. Government-sponsored enterprises. Pooled trust preferred collateralized debt obligations accounted for 98% and corporate fixed income comprised less than one percent.

Corporate securities, which consisted of single issue trust preferred securities, had a total unrealized loss of $400 thousand as of December 31, 2011. Included in this category are single issue trust preferred securities and corporate debentures issued primarily by money center and large regional banks. As of December 31, 2011, our single issue trust preferred securities had an amortized cost of $11.8 million and an estimated fair value of $11.4 million. After a review of each of the issuer's asset quality, earnings trend and capital position, it was determined that none of these issues were other-than-temporarily impaired. Additionally, all interest payments on these securities are being made as contractually required.

The following table presents the gross unrealized losses and estimated fair value at December 31, 2010 for available-for-sale and securities by investment category and time frame for which the securities had been in a continuous unrealized loss position:


	Less Than 12 Months					12 Months or More					Total
	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 Agencies:
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	)
Obligations of States and Political Subdivisions		0		0			0		0			0		0
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 Available for Sale	$	236,499	$	(3,929	)	$	32,113	$	(32,715	)	$	268,612	$	(36,644	)

As of December 31, 2011, the book value of our pooled trust preferred collateralized debt obligations totaled $54.8 million with an estimated fair value of $23.0 million, which includes securities comprised of 353 banks and other financial institutions. Two of our pooled securities are senior tranches and the remainder are mezzanine tranches. Two of the pooled issues, representing $6.1 million of the $54.8 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 December 31, 2011, after taking into account management's best estimates of future interest deferrals and defaults, eight of our securities had no excess subordination in the tranches we own and six of our securities had excess subordination which ranged from 4% to 303% of the current performing collateral.

The following table provides additional information related to our pooled trust preferred collateralized debt obligations as of December 31, 2011:


Deal	Class	Book Value		Fair Value		Unrealized Gain (Loss)			Moody's/ Fitch Ratings	Number of Banks		Deferrals and Defaults as a % of Current Collateral			Excess Subordination as a % of Current Performing Collateral
(dollars in thousands)
Pre TSL I	Senior	$	2,290	$	2,185	$	(105	)	A2/BBB		24		34.57	%		205.93	%
Pre TSL IV	Mezzanine		1,830		656		(1,174	)	Ca/CCC		6		27.07			82.51
Pre TSL V	Mezzanine		50		53		3		Caa3/D		3		100.00			0.00
Pre TSL VI	Mezzanine		237		225		(12	)	Ca/D		5		12.27			31.12
Pre TSL VII	Mezzanine		3,986		2,399		(1,587	)	Ca/C		17		54.50			0.00
Pre TSL VIII	Mezzanine		1,679		962		(717	)	C/C		35		39.85			0.00
Pre TSL IX	Mezzanine		2,231		789		(1,442	)	Ca/C		48		25.30			4.45
Pre TSL X	Mezzanine		1,342		765		(577	)	C/C		53		44.67			0.00
Pre TSL XII	Mezzanine		5,497		2,541		(2,956	)	Ca/C		77		32.36			0.00
Pre TSL XIII	Mezzanine		11,992		3,917		(8,075	)	Ca/C		63		35.82			0.00
Pre TSL XIV	Mezzanine		12,693		4,288		(8,405	)	Ca/C		63		32.59			14.32
MMCap I	Senior		3,766		3,199		(567	)	A3/BBB		21		41.79			303.07
MMCap I	Mezzanine		841		407		(434	)	Ca/C		21		41.79			0.00
MM Comm IX	Mezzanine		6,328		594		(5,734	)	Ca/D		31		46.50			0.00

Total		$	54,762	$	22,980	$	(31,782	)

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 2011, there were no credit related other-than-temporary impairment charges 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 difference between book value and the present value of future cash flows. The non-credit related portion is recognized in other comprehensive income 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 December 31, 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 in 2011 because of evidence supporting management's estimate of future cash flows indicating 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 evidenced by a reduced level of 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 December 31, 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 which includes each deal's structural features. For collateral issued by financial institutions over $15 billion in asset size, we consider the alternative cost of funding and if that rate is less than the current rate being paid, we incorporate a prepayment in our estimate of future cash flows. The prepayment rates used are 20% in years 2 and 3 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 353 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 December 31, 2011, default probabilities for performing collateral ranged from 0.33% to 75%.

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 December 31, 2011, indicates that no credit related other-than-temporary impairment has occurred on our pooled trust preferred securities since December 31, 2010. Based upon the analysis performed by management as of December 31, 2011, it is probable that eight of our pooled trust preferred securities are expected to experience principal and interest shortfalls. These securities are identified in the table on page 77 with 0% "Excess Subordination as a % of Current Performing Collateral." For the remaining securities in the table, our analysis as of December 31, 2011 indicates it is probable that we will collect all contractual principal and interest payments.

The table below provides a cumulative roll forward of credit losses recognized in earnings for debt securities held and not intended to be sold for the years ended December 31:


	2011			2010		2009
	(dollars in thousands)
Balance, beginning (a)	$	44,850		$	36,161	$	2,516
Credit losses on debt securities for which other-than-temporary impairment was not previously recognized		0			0		28,163
Additional credit losses on debt securities for which other-than-temporary impairment was previously recognized		0			8,689		5,482
Increases in cash flows expected to be collected, recognized over the remaining life of the security (b)		(114	)		0		0

Balance, ending	$	44,736		$	44,850	$	36,161

(a)	The beginning balance represents credit related losses included in other-than-temporary impairment charges recognized on debt securities in prior periods.

(b)	Represents the increase in cash flows recognized in interest income during the period.

On a quarterly basis, management evaluates equity securities for other-than-temporary impairment. For the years ended December 31, 2011 and 2009, there was no impairment recognized on equity securities. In 2010, $0.4 million in other than-temporary impairment charges were recognized on equity securities related to three Pennsylvania based financial institutions. When evaluating equity investments for other-than-temporary impairment we review the severity and duration of decline in fair value, research reports, analysts' recommendations, credit rating changes, news stories, annual reports, regulatory filings, impact of interest rate changes and other relevant information. There were no equity securities in an unrealized loss position as of December 31, 2011 and 2010.