v2.4.0.6
Fair Value
6 Months Ended
Jun. 30, 2012
Fair Value

Note 10 –Fair Value:

Accounting guidance establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

 

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

Investment Securities: The fair values of securities available-for-sale are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). One corporate security is valued using Level 3 inputs as there is no readily observable market activity. Management determines the value of this security based on expected cash flows, the credit quality of the security and current market interest rates.

 

Derivatives: The Bank’s derivative instruments consist of over-the-counter interest-rate swaps that trade in liquid markets. The fair value of the derivative instruments is primarily measured by obtaining pricing from broker-dealers recognized to be market participants. The pricing is derived from market observable inputs that can generally be verified and do not typically involve significant judgment by the Bank. This valuation method is classified as Level 2 in the fair value hierarchy.

 

Impaired Loans: At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for loan losses. For collateral dependent loans, fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

  

Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at the lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

 

Loans Held For Sale: Loans held for sale are carried at the lower of cost or fair value, which is evaluated on a pool-level basis. The fair value of loans held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan or other observable market data, such as outstanding commitments from third party investors (Level 2).

 

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):

 

          Fair Value Measurements at  
          June 30, 2012 Using:  
                Significant        
          Quoted Prices in     Other     Significant  
    Total     Active Markets for     Observable     Unobservable  
    June 30,     Identical Assets     Inputs     Inputs  
    2012     (Level 1)     (Level 2)     (Level 3)  
Assets                                
Investment securities available-for-sale                                
U.S. government sponsored entities and agencies   $ 136,155     $ 0     $ 136,155     $ 0  
U.S. government agency mortgage backed     184,107       0       184,107       0  
Corporate     1,060       0       0       1,060  
Derivatives     1,596       0       1,596       0  
Total   $ 322,918     $ 0     $ 321,858     $ 1,060  
                                 
Liabilities                                
Derivatives   $ 1,596     $ 0     $ 1,596     $ 0  
Total   $ 1,596     $ 0     $ 1,596     $ 0  

 

          Fair Value Measurements at  
          December 31, 2011 Using:  
                Significant        
          Quoted Prices in     Other     Significant  
    Total     Active Markets for     Observable     Unobservable  
    December 31,     Identical Assets     Inputs     Inputs  
    2011     (Level 1)     (Level 2)     (Level 3)  
Assets                                
Investment securities available-for-sale                                
U.S. government sponsored entities and agencies   $ 169,460       0       169,460       0  
U.S. government agency mortgage backed     151,992       0       151,992       0  
Corporate     1,060       0       0       1,060  
Derivatives     1,349       0       1,349       0  
Total   $ 323,861       0       322,801       1,060  
                                 
Liabilities                                
Derivatives   $ 1,349       0       1,349       0  
Total   $ 1,349             1,349       0  

  

There were no transfers between Level 1 and Level 2 during 2012 or 2011.

 

There were no gains or losses for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the quarter ended June 30, 2012.

 

There were no changes in unrealized gains and losses recorded in earnings for the quarter ended June 30, 2012 for Level 3 assets and liabilities that are still held at June 30, 2012.

 

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the period ended June 30 (in thousands):

 

    Corporate Securities  
    6/30/12     12/31/11  
             
Balance of recurring Level 3 assets at January 1   $ 1,060     $ 1,060  
Total gains or losses for the period:                
Included in earnings                
Included in other comprehensive income                
Purchases     0       0  
Sales     0       0  
Issuances     0       0  
Settlements     0       0  
Transfers into Level 3     0       0  
Transfers out of Level 3     0       0  
                 
Balance of recurring Level 3 assets at December 31   $ 1,060     $ 1,060  

 

The following table presents quantitative information about recurring Level 3 fair value measurements at June 30, 2012 (in thousands):

 

        Valuation           
    Fair value     Technique(s)   Unobservable Input(s)   Value  
                     
Corporate security   $ 1,060     Discounted cash flow   Probability of default     0 %

 

The interest rate on this security is based on interest rates paid for securities with similar credit characteristics, but the probability of default is determined through a credit quality review rather than formal ratings or other observable inputs. The interest rate adjusts to reflect current market conditions of highly rated investments, if probability of default changed significantly, the interest rate would adjust accordingly and the fair value would be updated. Management reviews this interest rate and the security’s credit quality quarterly and a market value adjustment is made if necessary pursuant to this review.

  

Assets and Liabilities Measured on a Non-Recurring Basis

(Dollars in thousands)

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

 

          Fair Value Measurements at  
          June 30, 2012 Using:  
                Significant        
          Quoted Prices in     Other     Significant  
    Total     Active Markets for     Observable     Unobservable  
    June 30     Identical Assets     Inputs     Inputs  
    2012     (Level 1)     (Level 2)     (Level 3)  
Assets                                
Impaired loans:                                
Commercial   $ 419     $ 0     $ 75     $ 344  
Nonresidential real estate     0                          
Owner occupied properties     7,884       0       605       7,279  
Non owner occupied properties     7,669       0       906       6,763  
Residential real estate                                
Home equity lines of credit     0       0       0       0  
Multifamily properties     1,543       0       0       1,543  
Other     3,162       0       2,672       490  
Construction     3,493       0       2,801       692  
Total   $ 24,170     $ 0     $ 7,059     $ 17,111  

 

          Fair Value Measurements at  
          December 31, 2011 Using:  
                Significant        
          Quoted Prices in     Other     Significant  
    Total     Active Markets for     Observable     Unobservable  
    December 31     Identical Assets     Inputs     Inputs  
    2011     (Level 1)     (Level 2)     (Level 3)  
Assets                                
Impaired loans                                
Commercial   $ 383     $ 0     $ 0     $ 383  
Nonresidential real estate     0                          
Owner occupied properties     8,320       0       0       8,320  
Non owner occupied properties     5,858       0       375       5,483  
Residential real estate                                
Home equity lines of credit     0       0       0       0  
Multifamily properties     0       0       0       0  
Other     3,332       0       1,832       1,500  
Construction     3,787       0       214       3,573  
Total   $ 21,680     $ 0     $ 2,421     $ 19,259  

  

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a gross carrying amount of $31,686,000 with a valuation allowance of $7,516,000, resulting in an increase in provision for loan losses of $73,000 for the first half of 2012. As of December 31, 2011, impaired loans had a gross carrying amount of $29,124,000, with a valuation allowance of $7,443,000, resulting in an increase in provision for loan losses of $1,699,000.

 

Values for collateral dependent loans are generally based on appraisals obtained from licensed real estate appraisers and in certain circumstances consideration of offers obtained to purchase properties prior to foreclosure or other factors management deems relevant to arrive at a representative fair value.  Appraisals for commercial real estate generally use three methods to derive value: cost, sales or market comparison and income approach.  The cost method bases value on the cost to replace the current property.  The market comparison approach evaluates the sales price of similar properties in the same market area.  The income approach considers net operating income generated by the property and an investor’s required return.  The final fair value is based on a reconciliation of these three approaches. The loans classified as Level 2 had current and viable appraisals, while loans classified as Level 3 had older appraisals and required the use of other unobservable inputs with additional discounts ranging from 5% to10%.

 

The following table presents quantitative information about recurring Level 3 fair value measurements at June 30, 2012 (in thousands):

  Fair
Value
    Valuation Technique(s)     Unobservable Input(s)      Value  
Assets                                
Impaired Loans:                                
Commercial     344     Cost, sales, income approach     adjustments for comparable properties, market conditions       5-10%  
Nonresidential real estate                                
Owner occupied properties     7,279     Cost, sales, income approach     adjustments for comparable properties, market conditions       5-10%  
Non owner occupied properties     6,763     Cost, sales, income approach     adjustments for comparable properties, market conditions       5-10%  
Residential real estate                                
Home equity lines of credit                                
Multifamily properties     1,543     Cost, sales, income approach     adjustments for comparable properties, market conditions       5-10%  
Other     490     Cost, sales, income approach     adjustments for comparable properties, market conditions       5-10%  
Construction     692     Cost, sales, income approach     adjustments for comparable properties, market conditions       5-10%  
Total     17,111                          

  

The carrying amounts and estimated fair values of financial instruments at June 30, 2012 and December 31, 2011 are as follows (in thousands):

 

          Fair Value Measurements at  
          June 30, 2012 Using:  
    Carrying Value     Level 1     Level 2     Level 3     Total  
(Dollars in thousands)                              
Financial assets                                        
Cash and cash equivalents   $ 66,719     $ 66,719     $     $     $ 66,719  
Interest-bearing deposits with Banks     250               250               250  
Securities available-for-sale     321,322               320,262       1,060       321,322  
Securities held-to-maturity     54,882               56,746               56,746  
Federal Home Loan Bank stock     5,099       N/A                       N/A  
Loans held for sale     13,983               13,983               13,983  
Loans, net     1,125,387               1,111,953       17,111       1,129,064  
Accrued interest receivable     4,684               4,684               4,684  
Derivative assets     1,596               1,596               1,596  
Financial liabilities                                        
Deposits   $ (1,455,328 )   $ (1,081,198 )   $ (374,130 )   $       $ (1,455,328 )
Short-term borrowings     (24,373 )             (24,373 )             (24,373 )
Notes payable     (48,727 )             (21,497 )     (22,355 )     (43,852 )
Accrued interest payable     (1,201 )             (1,201 )             (1,201 )
Standby letters of credit     (180 )             (180 )             (180 )
Derivative liabilities     (1,596 )             (1,596 )             (1,596 )

 

          Fair Value Measurements at  
          December 31, 2011 Using:  
    Carrying Value     Level 1     Level 2     Level 3     Total  
(Dollars in thousands)                              
Financial assets                                        
Cash and cash equivalents   $ 135,964     $ 135,964     $     $     $ 135,964  
Interest-bearing deposits with Banks     250               250               250  
Securities available-for-sale     322,512               321,452       1,060       322,512  
Securities held-to-maturity     48,975               50,643               50,643  
Federal Home Loan Bank stock     5,099       N/A                       N/A  
Loans held for sale     8,920               8,920               8,920  
Loans, net     1,111,666               1,093,529       19,259       1,112,788  
Accrued interest receivable     4,887               4,887               4,887  
Derivative assets     1,349               1,349               1,349  
Financial liabilities                                        
Deposits   $ (1,498,821 )   $ (1,092,434 )   $ (408,859 )   $     $ (1,501,293 )
Short-term borrowings     (29,300 )             (29,300 )             (29,300 )
Notes payable     (48,739 )             (27,477 )     (18,476 )     (45,953 )
Accrued interest payable     (1,582 )             (1,582 )             (1,582 )
Standby letters of credit     (263 )             (263 )             (263 )
Derivative liabilities     (1,349 )             (1,349 )             (1,349 )

  

The estimated fair value approximates carrying amounts for all items except those described below. The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. Estimated fair value for both securities available-for-sale and held-to-maturity is as previously described for securities available-for-sale. It is not practicable to determine the fair value of Federal Home Loan Bank stock due to restrictions placed on its transferability. Fair values of loans, excluding loans held for sale, are estimated as set forth below:

 

For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 2 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 2 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price. The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification. The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in either a Level 1 or Level 2 classification. The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date resulting in either a Level 2 or Level 3 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 3 classification. The carrying amounts of federal funds purchased, borrowings under repurchase agreements and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification. The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification. The fair values of the Company’s subordinated debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification. Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material. Estimated fair value of standby letters of credit are based on their current unearned fee balance. Estimated fair value for commitments to make loans and unused lines of credit are considered nominal. Estimated fair value for derivatives is determined as previously described above.