Fair Value Disclosures

9 Months Ended

Sep. 30, 2012

Fair Value Disclosures [Abstract]

Fair Value Disclosures

Note 11. Fair Value Disclosures

Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. The Corporation determines the fair value of its financial instruments based on the fair value hierarchy. The Corporation maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Corporation. Unobservable inputs are inputs that reflect the Corporation’s assumptions that the market participants would use in pricing the asset or liability based on the best information available in the circumstances, including assumptions about risk. Three levels of inputs are used to measure fair value. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input significant to the fair value measurement. Transfers between levels are recognized at the end of the reporting period.

Level 1:    Valuations are based on quoted prices in active markets for identical assets or liabilities that the Corporation can access at the measurement date. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

Level 2:    Valuations are based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

Level 3:    Valuations are based on inputs that are unobservable and significant to the overall fair value measurement. Assets and liabilities utilizing Level 3 inputs include: financial instruments whose value is determined using pricing models, discounted cash-flow methodologies, or similar techniques, as well as instruments for which the fair value calculation requires significant management judgment or estimation.

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Investment Securities

Where quoted prices are available in an active market for identical instruments, investment securities are classified within Level 1 of the valuation hierarchy. Level 1 investment securities include highly liquid U.S. Treasury securities, most equity securities and money market mutual funds. Mutual funds are registered investment companies which are valued at net asset value of shares on a market exchange as of the close of business at period end. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Examples of instruments, which would generally be classified within Level 2 of the valuation hierarchy, include U.S. Government sponsored enterprises, certain MBS, CMOs, and corporate and municipal bonds and certain equity securities. In cases where there is limited activity or less transparency around inputs to the valuation, investment securities are classified within Level 3 of the valuation hierarchy.

Fair values for securities are determined using independent pricing services and market-participating brokers. The Corporation’s independent pricing service utilizes evaluated pricing models that vary by asset class and incorporate available trade, bid and other market information for structured securities, cash flow and, when available, loan performance data. Because many fixed income securities do not trade on a daily basis, the pricing service’s evaluated pricing applications apply information as applicable through processes, such as benchmarking of like securities, sector groupings, and matrix pricing, to prepare evaluations. If at any time, the pricing service determines that it does have not sufficient verifiable information to value a particular security, the Corporation will utilize valuations from another pricing service. Management has a sufficient understanding of the third party service’s valuation models, assumptions and inputs used in determining the fair value of securities to enable management to maintain an appropriate system of internal control.

On a quarterly basis, the Corporation reviews changes, as submitted by the pricing service, in the market value of its security portfolio. Individual changes in valuations are reviewed for consistency with general interest rate movements and any known credit concerns for specific securities. Additionally, on an annual basis, the Corporation has its security portfolio priced by a second pricing service to determine consistency with another market evaluator, except for municipal bonds which are priced by another service provider on a sample basis. If, on the Corporation’s review or in comparing with another servicer, a material difference between pricing evaluations were to exists, the Corporation may submit an inquiry to its current pricing service regarding the data used to make the valuation of a particular security. If the Corporation determines it has market information that would support a different valuation than its current pricing service’s evaluation it can submit a challenge for a change to that security’s valuation. There were no material differences in valuations noted at September 30, 2012.

Derivative Financial Instruments

The fair values of derivative financial instruments are based upon the estimated amount the Corporation would receive or pay to terminate the contracts or agreements, taking into account current interest rates and, when appropriate, the current creditworthiness of the counterparties. Derivative financial instruments are classified within Level 2 of the valuation hierarchy.

Contingent Consideration Liability

The Corporation estimated the fair value of the contingent consideration liability by using a discounted cash flow model of future contingent payments based on projected revenue related to the acquired business. The fair value of the contingent consideration liability is reviewed on a quarterly basis and any valuation adjustments resulting from a change in the discount rate or change in projected revenue of the acquired business which affect the contingent consideration liability will be recorded through non-interest expense. Due to the significant unobservable input related to the projected revenue, the contingent consideration liability is classified within Level 3 of the valuation hierarchy. An increase in the projected revenue may result in a significantly higher fair value of the contingent consideration liability. Alternatively, a decrease in the projected revenue may result in a significantly lower estimated fair value of the contingent consideration liability.

The following table presents the assets and liabilities measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011, classified using the fair value hierarchy:

	At September 30, 2012
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets/ Liabilities at Fair  Value
Assets:
Available-for-sale securities:
U.S. government treasuries	$	4,952	$	—	$	—	$	4,952
U.S. government corporations and agencies		—		180,523		—		180,523
State and political subdivisions		—		124,196		—		124,196
Residential mortgage-backed securities		—		98,793		—		98,793
Commercial mortgage obligations		—		24,371		—		24,371
Corporate bonds		—		5,006		—		5,006
Money market mutual funds		4,500		—		—		4,500
Equity securities		2,861		—		—		2,861
Total available-for-sale securities		12,313		432,889		—		445,202
Interest rate locks with customers		—		3,420		—		3,420
Total assets	$	12,313	$	436,309	$	—	$	448,622
Liabilities:
Interest rate swap	$	—	$	2,036	$	—	$	2,036
Forward loan commitments		—		1,029		—		1,029
Contingent consideration liability		—		—		876		876
Total liabilities	$	—	$	3,065	$	876	$	3,941

	At December 31, 2011
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets/ Liabilities at Fair  Value
Assets:
Available-for-sale securities:
U.S. government treasuries	$	2,525	$	—	$	—	$	2,525
U.S. government corporations and agencies		—		154,264		—		154,264
State and political subdivisions		—		117,005		—		117,005
Residential mortgage-backed securities		—		78,801		—		78,801
Commercial mortgage obligations		—		61,464		—		61,464
Corporate bonds		—		4,767		—		4,767
Money market mutual funds		3,851		—		—		3,851
Equity securities		2,684		—		—		2,684
Total available-for-sale securities		9,060		416,301		—		425,361
Interest rate locks with customers		—		1,079		—		1,079
Total assets	$	9,060	$	417,380	$	—	$	426,440
Liabilities:
Interest rate swap	$	—	$	1,435	$	—	$	1,435
Forward loan commitments		—		302		—		302
Total liabilities	$	—	$	1,737	$	—	$	1,737

The following table presents a reconciliation for all assets measured at fair value on a recurring basis and for which the Corporation utilized Level 3 inputs to determine fair value for the nine months ended September 30, 2011. There was no activity to report for the three and nine months ended September 30, 2012, or the three months ended September 30, 2011.

	Nine Months Ended September 30, 2011
(Dollars in thousands)	Balance at December 31, 2010		Total Unrealized Gains or (Losses)			Total Realized Gains or (Losses)		Paydowns			Transfers to Level 2			Balance at September 30, 2011
Available-for-sale securities:
Commercial mortgage obligations	$	4,331	$	(26	)	$	—	$	(135	)	$	(4,170	)	$	—
Total Level 3 assets	$	4,331	$	(26	)	$	—	$	(135	)	$	(4,170	)	$	—

Realized gains or losses are recognized in the consolidated statements of income. There were no realized gains or losses recognized on Level 3 assets during the three or nine month periods ended September 30, 2012 or 2011.

On May 31, 2012 and as disclosed in Note 2, as a result of the purchase of Javers Group, the Corporation recorded a contingent consideration liability. The following table presents the change in the balance of the contingent consideration liability for which the Corporation utilized Level 3 inputs to determine fair value on a recurring basis for the nine months ended September 30, 2012:

(Dollars in thousands)
Balance as of December 31, 2011	$	—
Contingent consideration from new acquisition		842
Adjustment of contingent consideration liability		34
Balance as of September 30, 2012	$	876

The following table represents assets measured at fair value on a non-recurring basis as of September 30, 2012 and December 31, 2011.

	At September 30, 2012
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets/Liabilities at Fair Value
Impaired loans held for investment	$	—	$	—	$	40,065	$	40,065
Mortgage servicing rights		—		3,182		—		3,182
Other real estate owned		—		3,301		—		3,301
Total	$	—	$	6,483	$	40,065	$	46,548
	At December 31, 2011
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets/Liabilities at Fair Value
Impaired loans held for investment	$	—	$	—	$	39,948	$	39,948
Mortgage servicing rights		—		2,739		—		2,739
Other real estate owned		—		6,600		—		6,600
Total	$	—	$	9,339	$	39,948	$	49,287

Impaired loans held for investment include those collateral-dependent loans for which the practical expedient was applied, resulting in a fair-value adjustment to the loan. Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or fair value. Fair value is measured based on the value of the collateral securing these loans less cost to sell and is classified at a Level 3 in the fair value hierarchy. The fair value of collateral is based on appraisals performed by qualified licensed appraisers hired by the Corporation. At September 30, 2012, impaired loans held for investment had a carrying amount of $40.8 million with a valuation allowance of $690 thousand. At December 31, 2011, impaired loans held for investment had a carrying amount of $41.2 million with a valuation allowance of $1.3 million.

The Corporation estimates the fair value of mortgage servicing rights using discounted cash flow models that calculate the present value of estimated future net servicing income. The model uses readily available prepayment speed assumptions for the current interest rates of the portfolios serviced. Mortgage servicing rights are classified within Level 2 of the valuation hierarchy. The Corporation reviews the mortgage servicing rights portfolio on a quarterly basis for impairment and the mortgage servicing rights are carried at the lower of amortized cost or estimated fair value. At September 30, 2012, mortgage servicing rights had a carrying amount of $4.2 million with a negative valuation allowance of $980 thousand. At December 31, 2011, mortgage servicing rights had a carrying amount of $3.5 million with a negative valuation allowance of $793 thousand.

The fair value of other real estate owned is estimated based upon its appraised value less costs to sell. The real estate is stated at an amount equal to the loan balance prior to foreclosure, plus costs incurred for improvements to the property but no more than the fair value of the property, less estimated costs to sell. New appraisals are generally obtained on an annual basis. Other real estate owned is classified within Level 2 of the valuation hierarchy. During the third quarter of 2012, two commercial other real estate owned properties with a total carrying amount of $2.3 million were written down to their updated fair value of $1.7 million, resulting in an impairment charge of $621 thousand, which was included in earnings. During the nine months ended September 30, 2012, three commercial other real estate owned properties with a total carrying amount of $5.2 million, were written down to their updated fair values totaling $3.3 million, resulting in impairment charges of $1.9 million, which were included in earnings.

Certain non-financial assets subject to measurement at fair value on a non-recurring basis include goodwill and other intangible assets. During the nine months ended September 30, 2012, there were no triggering events that required valuation of goodwill and other intangible assets.

The following table presents assets and liabilities and off-balance sheet items not measured at fair value on a recurring or non-recurring basis in the Corporation’s consolidated balance sheets but for which the fair value is required to be disclosed as of September 30, 2012 and December 31, 2011. The disclosed fair values are classified using the fair value hierarchy.

	At September 30, 2012
(Dollars in thousands)	Level 1		Level 2			Level 3		Fair Value			Carrying Amount
Assets:
Cash and short-term interest-earning assets	$	63,306	$	—		$	—	$	63,306		$	63,306
Held-to-maturity securities		—		71,741			—		71,741			70,054
Loans held for sale		—		3,670			2,599		6,269			6,146
Net loans and leases held for investment		—		—			1,464,468		1,464,468			1,442,415
Total assets	$	63,306	$	75,411		$	1,467,067	$	1,605,784		$	1,581,921
Liabilities:
Deposits:
Demand and savings deposits, non-maturity	$	1,436,003	$	—		$	—	$	1,436,003		$	1,436,003
Time deposits		—		345,517			—		345,517			341,927
Total deposits		1,436,003		345,517			—		1,781,520			1,777,930
Short-term borrowings		—		109,315			—		109,315			111,551
Long-term borrowings		—		21,339			—		21,339			21,369
Total liabilities	$	1,436,003	$	476,171		$	—	$	1,912,174		$	1,910,850
Off-Balance-Sheet:
Commitments to extend credit	$	—	$	(1,276	)	$	—	$	(1,276	)	$	—
	At December 31, 2011
(Dollars in thousands)	Level 1		Level 2			Level 3		Fair Value			Carrying Amount
Assets:
Cash and short-term interest-earning assets	$	107,377	$	—		$	—	$	107,377		$	107,377
Held-to-maturity securities		—		45,639			—		45,639			45,804
Loans held for sale		—		3,255			—		3,255			3,157
Net loans and leases held for investment		—		—			1,453,129		1,453,129			1,416,536
Total assets	$	107,377	$	48,894		$	1,453,129	$	1,609,400		$	1,572,874
Liabilities:
Deposits:
Demand and savings deposits, non-maturity	$	1,340,732	$	—		$	—	$	1,340,732		$	1,340,732
Time deposits		—		411,818			—		411,818			408,500
Total deposits		1,340,732		411,818			—		1,752,550			1,749,232
Short-term borrowings		—		106,677			—		106,677			109,740
Long-term borrowings		—		27,654			—		27,654			27,494
Total liabilities	$	1,340,732	$	546,149		$	—	$	1,886,881		$	1,886,466
Off-Balance-Sheet:
Commitments to extend credit	$	—	$	(1,227	)	$	—	$	(1,227	)	$	—

The following valuation methods and assumptions were used by the Corporation in estimating its fair value disclosures for financial instruments:

Cash and short-term interest-earning assets: The carrying amounts reported in the balance sheets for cash and due from banks, interest-earning deposits with other banks, and other short-term investments approximates those assets’ fair values. Cash and short-term interest-earning assets are classified within Level 1 in the fair value hierarchy.

Held-to-maturity securities: Fair values for the held-to-maturity investment securities are estimated by using pricing models or quoted prices of securities with similar characteristics and are classified in Level 2 in the fair value hierarchy.

Loans held for sale: The fair value of the Corporation’s loans held for sale are generally determined using a pricing model based on current market information obtained from external sources, including interest rates, bids or indications provided by market participants on specific loans that are actively marketed for sale. The Corporation’s loans held for sale are primarily residential mortgage loans and are generally classified in Level 2 due to the observable pricing data. Loans held for sale are carried at the lower of cost or estimated fair value. At September 30, 2012, nonaccrual commercial loans totaling $2.6 million were transferred to loans held for sale. There were no valuation adjustments for loans held for sale at September 30, 2012 and December 31, 2011.

Loans and leases held for investment: The fair values for loans are estimated using discounted cash flow analyses, using a discount rate based on current interest rates at which similar loans with similar terms would be made to borrowers and include components for credit risk, operating expense and embedded prepayment options. An overall valuation adjustment is made for specific credit risks in addition to general portfolio risk and is significant to the valuation. As permitted, the fair value of the loans and leases are not based on the exit price concept as discussed in the first paragraph of this note. Loans and leases are classified within Level 3 in the fair value hierarchy.

Deposit liabilities: The fair values for demand and savings accounts, with no stated maturities, is the amount payable on demand at the reporting date (carrying value) and are classified within Level 1 in the fair value hierarchy. The carrying amount for demand and savings accounts previously reported at December 31, 2011 included the estimated fair value of the non-financial intangible of $43.1 million which has been excluded for September 30, 2012 and December 31, 2011 presentation purposes. The fair values for time deposits with fixed maturities are estimated by discounting the final maturity using interest rates currently offered for deposits with similar remaining maturities. Time deposits are classified within Level 2 in the fair value hierarchy.

Short-term borrowings: The fair value of securities sold under repurchase agreements are estimated using current market rates for similar borrowings and are classified within Level 2 in the fair value hierarchy. Short-term FHLB advances are estimated using a discounted cash flow analysis based on current market rates for similar borrowings, and include components for operating expense and embedded prepayment options that are observable. Short-term FHLB advances are classified within Level 2 in the fair value hierarchy.

Long-term borrowings: The fair values of the Corporation’s long-term borrowings are estimated using a discounted cash flow analysis based on current market rates for similar borrowings, and include components for credit risk, operating expense, and embedded prepayment options that are observable. Long-term borrowings are classified within Level 2 in the fair value hierarchy.

Off-balance-sheet instruments: Fair values for the Corporation’s off-balance-sheet instruments are based on the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing and are classified within Level 2 in the fair value hierarchy.