Note 6—Fair Value

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

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 company's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

The fair values of securities available-for-sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique 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).

The fair value of non-performing loans receivable held-for-sale is generally based upon the fair value of the collateral which is obtained from 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 appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

Impaired loans, other than performing TDRs, are generally collateral dependent and, as such, are carried at the estimated fair value of the collateral less estimated selling costs. Fair values are estimated through current appraisals, broker opinions or automated valuation models and adjusted as necessary, by management, to reflect current market conditions and, as such, are classified as Level 3.

Nonrecurring adjustments to certain commercial and residential real estate properties classified as real estate owned ("REO") are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated future net servicing income (Level 3 inputs).

Assets Measured on a Recurring Basis

Assets measured at fair value on a recurring basis are summarized below:


			Fair Value Measurements
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(In thousands)
Assets at December 31, 2011:
Securities available-for-sale—residential mortgage-backed	$	17,910	$	-	$	17,910	$	-
Securities available-for-sale—U.S. government and federal agency		1,069		-		1,069		-
Mortgage servicing rights		363		-		-		363
Assets at December 31, 2010:
Securities available-for-sale—residential mortgage-backed	$	10,524	$	-	$	10,524	$	-
Mortgage servicing rights		487		-		-		487

The table below presents a reconciliation of the mortgage servicing rights asset which is measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31:


	2011			2010
	(In thousands)
Balance at January 1,	$	487		$	450
Additions		-			79
Other changes in fair value		(124	)		(42	)

Balance at December 31,	$	363		$	487

Assets Measured on a Non- Recurring Basis

The following table provides information regarding the carrying values of our assets measured at fair value on a non-recurring basis at the dates indicated. The fair value measurement for all of these assets falls within Level 3 of the fair value hierarchy.


	December 31,
	2011		2010
	(In thousands)
Assets:
Non-performing loans receivable held-for-sale, net:
Five or more units	$	1,540	$	366
Commercial real estate		472		-
Church		3,198		4,783
Impaired loans carried at fair value of collateral:
One to four units		6,188		3,775
Five or more units		903		1,606
Commercial real estate		1,914		2,542
Church		10,339		5,591
Commercial		-		2,826
Consumer		-		749
Real estate owned:
One to four units		758		1,086
Five or more units		-		260
Commercial real estate		3,338		568
Church		2,914		1,122

The following table provides information regarding our assets measured at fair value on a non-recurring basis at December 31, 2011 and 2010, and the losses recognized on these assets for the years ended December 31, 2011 and 2010.


	Principal Amount at December 31, 2011		Valuation Allowance at December 31, 2011		Losses for the year ended December 31, 2011
	(In thousands)
Non-performing loans receivable held-for-sale, net (1)	$	5,268	$	58	$	689
Impaired loans carried at fair value of collateral (2)		20,958		1,614		9,347
Real estate owned (3)		7,046		36		2,343

Total	$	33,272	$	1,708	$	12,379

(1)	Losses are charged to provision for losses on loans receivable held-for-sale.

(2)	Losses are charged against the allowance for loan losses. Includes $10.3 million of loans that were carried at cost as the fair value of the collateral on these loans exceeded the book value as a result of charge-offs.

(3)	Losses are charged against the allowance for loan losses in the case of a write-down upon the transfer of a loan to REO. Losses subsequent to the transfer of a loan to REO are charged to provision for losses on REO.


	Principal Amount at December 31, 2010		Valuation Allowance at December 31, 2010		Losses for the year ended December 31, 2010
	(In thousands)
Non-performing loans receivable held-for-sale, net (1)	$	5,918	$	769	$	902
Impaired loans carried at fair value of collateral (2)		21,509		4,420		4,829
Real estate owned (3)		3,090		54		1,102

Total	$	30,517	$	5,243	$	6,833

(1)	Losses are charged to provision for losses on loans receivable held-for-sale.

(2)	Losses are charged against the allowance for loan losses. Includes $5.4 million of loans that were carried at cost as the fair value of the collateral on these loans exceeded the book value as a result of charge-offs.

(3)	Losses are charged against the allowance for loan losses in the case of a write-down upon the transfer of a loan to REO. Losses subsequent to the transfer of a loan to REO are charged to provision for losses on REO.

Fair Values of Financial Instruments

The carrying amounts and estimated fair values of financial instruments, at December 31, 2011 and December 31, 2010 were as follows:


	December 31, 2011						December 31, 2010
	Carrying Amount			Estimated Fair Value			Carrying Amount			Estimated Fair Value
	(In thousands)
Financial Assets:
Cash and cash equivalents	$	31,597		$	31,597		$	21,978		$	21,978
Securities available-for-sale		18,979			18,979			10,524			10,524
Securities held-to-maturity		-			-			12,737			13,261
Loans receivable held for sale, net		13,857			13,857			29,411			29,411
Loans receivable, net		326,323			326,643			382,616			384,274
Federal Home Loan Bank stock		4,089			N/A			4,089			N/A
Accrued interest receivable		1,698			1,698			2,216			2,216
Financial Liabilities:
Deposits	$	(294,686	)	$	(294,313	)	$	(348,445	)	$	(347,373	)
Federal Home Loan Bank advances		(83,000	)		(88,911	)		(87,000	)		(91,615	)
Junior subordinated debentures		(6,000	)		(5,319	)		(6,000	)		(4,609	)
Other borrowings		(5,000	)		(4,434	)		(5,000	)		(4,979	)
Advance payments by borrowers for taxes and insurance		(813	)		(813	)		(272	)		(272	)
Accrued interest payable		(1,302	)		(1,302	)		(550	)		(550	)

The methods and assumptions, not previously presented, used to estimate fair value are described as follows:

Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, demand deposits, short term debt, advance payments by borrowers for taxes and insurance, and variable rate loans, deposits and borrowings that reprice frequently and fully. The methods for determining the fair values for securities were described previously. For fixed rate loans and deposits and for variable rate loans and deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk without consideration of widening credit spreads due to market illiquidity. Fair value of debt is based on current rates for similar financing. It was not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability. The fair values of off-balance-sheet items are not considered material (or are based on the current fees or cost that would be charged to enter into or terminate such arrangements) and, as such, they are not presented herein.