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Fair Value of Financial Instruments
9 Months Ended
Sep. 30, 2012
Fair Value of Financial Instruments [Abstract]  
Fair Value of Financial Instruments

(9) Fair Value Of Financial Instruments

Fair Value Hierarchy

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

     
Level 1   Valuation is based upon quoted prices for identical instruments traded in active markets.
   
Level 2   Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
   
Level 3   Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

Fair value estimates are made by management at a specific point in time, based on relevant information about the financial instrument and the market. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument nor are potential taxes and other expenses that would be incurred in an actual sale considered. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions and/or the methodology used could significantly affect the estimates disclosed. Similarly, the fair values disclosed could vary significantly from amounts realized in actual transactions.

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of September 30, 2012 and December 31, 2011. For short-term financial assets such as cash and cash equivalents, accrued interest receivable and loans held for sale the carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization. For financial liabilities such as noninterest-bearing demand, interest-bearing demand, savings deposits, short-term borrowing and accrued interest payable the carrying amount is a reasonable estimate of fair value due to these products having no stated maturity.

The fair value of investment securities available-for-sale are recorded at fair value utilizing Level 1, Level 2 and Level 3 inputs and is described in more detail below.

The fair value of net loans is based on estimated cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. This does not include consideration of liquidity that market participants would use to value such loans. The estimated fair values of time deposits and long-term obligations are based on estimated cash flows discounted at market interest rates.

The fair value of off-balance sheet financial instruments is considered immaterial. These off-balance sheet financial instruments are commitments to extend credit and are either short-term in nature or subject to immediate repricing.

 

The following table presents the carrying values and estimated fair values of the Company’s financial instruments at September 30, 2012 and December 31, 2011:

 

                                         
    September 30, 2012  
    Carrying           Fair Value Measurements Using  
(Dollars in thousands)   Amount     Fair Value     Level 1     Level 2     Level 3  

Assets

                                       

Cash and cash equivalents

  $ 66,667     $ 66,667     $ 66,667     $ —       $ —    

Investment securities

    284,963       284,963       125,654       157,379       1,930  

FHLB stock

    4,150       4,150       —         4,150       —    

Accrued interest receivable

    4,928       4,928       —         4,928       —    

Net loans

    505,549       502,415       —         —         502,415  

Loans held for sale

    2,379       2,379       —         2,379       —    

Liabilities

                                       

Demand, noninterest bearing deposits

  $ 152,495     $ 152,495     $ —       $ 152,495     $ —    

Demand, interest-bearing deposits

    288,829       288,829       —         288,829       —    

Savings deposits

    59,016       59,016       —         59,016       —    

Time deposits

    279,073       284,706       —         284,706       —    

Accrued interest payable

    510       510       —         510       —    

Short-term borrowing

    41,827       41,827       —         41,827       —    

Long-term borrowing

    16,000       16,714       —         16,714       —    

 

                                         
    December 31, 2011  
    Carrying           Fair Value Measurements Using  
(Dollars in thousands)   Amount     Fair Value     Level 1     Level 2     Level 3  

Assets

                                       

Cash and cash equivalents

  $ 24,731     $ 24,731     $ 24,731     $ —       $ —    

Investment securities

    339,450       339,450       151,714       186,094       1,642  

FHLB stock

    3,456       3,456       —         3,456       —    

Accrued interest receivable

    5,308       5,308       —         5,308       —    

Net loans

    484,450       482,851       —         —         482,851  

Loans held for sale

    2,866       2,866       —         2,866       —    

Liabilities

                                       

Demand, noninterest bearing deposits

  $ 135,732     $ 135,732     $ —       $ 135,732     $ —    

Demand, interest-bearing deposits

    270,119       270,119       —         270,119       —    

Savings deposits

    55,517       55,517       —         55,517       —    

Time deposits

    336,277       343,374       —         343,374       —    

Accrued interest payable

    519       519       —         519       —    

Short-term borrowing

    11,679       11,679       —         11,679       —    

Long-term borrowing

    25,500       26,296       —         26,296       —    

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

There were no changes to the techniques used to measure fair value during the period.

Following is a description of valuation methodologies used for assets recorded at fair value.

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Mortgage Banking Activity

The Company enters into interest rate lock commitments and commitments to sell mortgages. At September 30, 2012 and December 31, 2011, the amount of fair value associated with these interest rate lock commitments was $136 thousand and $76 thousand, respectively, which is included in other assets. Fair value associated with the interest rate lock commitments are classified as Level 3 measurements due to the use of significant management judgment and estimation. Forward loan sale commitments have been deemed insignificant for both periods.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, market price and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2012, the majority of the total impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. The fair values of impaired loans are generally based on judgment and therefore are considered to be Level 3 assets.

Real Estate and Repossessions Acquired in Settlement of Loans

Foreclosed assets are adjusted to fair value upon transfer of the loans to other real estate owned. Real estate acquired in settlement of loans is recorded initially at estimated fair value of the property less estimated selling costs at the date of foreclosure. The initial recorded value may be subsequently reduced by additional allowances, which are charged to earnings if the estimated fair value of the property less estimated selling costs declines below the initial recorded value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3. The fair values of foreclosed assets are generally based on judgment and therefore are considered to be Level 3 assets.

 

Assets recorded at fair value on a recurring basis

 

                                 
September 30, 2012   Total     Level 1     Level 2     Level 3  
    (Dollars in thousands)  

Investment Securities Available-for-Sale

       

Obligations of states and political subdivisions

  $ 25,770     $ —       $ 25,770     $ —    

Mortgage-backed securities

    104,725       —         104,725       —    

SBA-backed securities

    127,241       125,654       1,587       —    

Corporate bonds

    27,227       —         25,297       1,930  
   

 

 

   

 

 

   

 

 

   

 

 

 

Total Securities

    284,963       125,654       157,379       1,930  

Interest rate lock commitments

    136       —         —         136  
   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets at fair value

  $ 285,099     $ 125,654     $ 157,379     $ 2,066  
   

 

 

   

 

 

   

 

 

   

 

 

 
         
December 31, 2011   Total     Level 1     Level 2     Level 3  
    (Dollars in thousands)  

Investment Securities Available-for-Sale

       

Government-sponsored enterprises and FFCB bonds

  $ 1,032     $ —       $ 1,032     $ —    

Obligations of states and political subdivisions

    28,718       6,752       21,966       —    

Mortgage-backed securities

    132,292       —         132,292       —    

SBA-backed securities

    146,637       144,962       1,675       —    

Corporate bonds

    30,771       —         29,129       1,642  
   

 

 

   

 

 

   

 

 

   

 

 

 

Total Securities

    339,450       151,714       186,094       1,642  

Interest rate lock commitments

    76       —         —         76  
   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets at fair value

  $ 339,526     $ 151,714     $ 186,094     $ 1,718  
   

 

 

   

 

 

   

 

 

   

 

 

 

 

Assets recorded at fair value on a nonrecurring basis

 

                                 
September 30, 2012   Total     Level 1     Level 2     Level 3  
    (Dollars in thousands)  

Impaired Loans

       

Real estate—construction and land development

  $ 5,230     $ —       $ —       $ 5,230  

Real estate—secured by residential properties

    5,962       —         —         5,962  

Real estate—secured by nonfarm nonresidential properties

    8,926       —         —         8,926  

Commercial and industrial

    4       —         —         4  
   

 

 

   

 

 

   

 

 

   

 

 

 

Total impaired loans

    20,122       —         —         20,122  

Real estate and repossessions acquired in settlement of loans

                               

Total real estate and repossessions acquired in settlement of loans

    7,118       —         —         7,118  
   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets at fair value

  $ 27,240     $ —       $ —       $ 27,240  
   

 

 

   

 

 

   

 

 

   

 

 

 
         
December 31, 2011   Total     Level 1     Level 2     Level 3  
    (Dollars in thousands)  

Impaired Loans

       

Real estate—construction and land development

  $ 9,169     $ —       $ —       $ 9,169  

Real estate—secured by residential properties

    3,893       —         —         3,893  

Real estate—secured by nonfarm nonresidential properties

    8,805       —         —         8,805  

Commercial and industrial

    196       —         —         196  
   

 

 

   

 

 

   

 

 

   

 

 

 

Total impaired loans

    22,063       —         —         22,063  

Real estate and repossessions acquired in settlement of loans

                               

Real estate and repossessions acquired in settlement of loans

    6,573       —         —         6,573  
   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets at fair value

  $ 28,636     $ —       $ —       $ 28,636  
   

 

 

   

 

 

   

 

 

   

 

 

 

 

As of September 30, 2012 there were $6.8 million of Level 2 investment securities available for sale that were reported as Level 1 as of December 31, 2011. These obligations of states and political subdivisions were transferred from Level 1 to Level 2 during the first nine months of 2012 because the December 31, 2011 pricing was based on the Company’s actual trades for the securities at initial purchase while the September 30, 2012 pricing was through a pricing system.

During the first nine months of 2012 and 2011 there were no investment securities transferred in or out of Level 3. The tables below present a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three and nine month periods of 2012 and 2011.

 

                         
    Corporate
Bonds
    Interest Rate
Lock
Commitments
    Total  
    (Dollars in thousands)  

Balance, December 31, 2011

  $ 1,642     $ 76     $ 1,718  

Total gains or losses (realized/unrealized):

                       

Included in earnings

    —         55       55  

Included in other comprehensive income

    196       —         196  

Purchases, issuances, and settlements

    —         —         —    

Transfers in to/out of Level 3

    —         —         —    
   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2012

  $ 1,838     $ 131     $ 1,969  
   

 

 

   

 

 

   

 

 

 

Total gains or losses (realized/unrealized):

                       

Included in earnings

    —         5       5  

Included in other comprehensive income

    92       —         92  

Purchases, issuances, and settlements

    —         —         —    

Transfers in to/out of Level 3

    —         —         —    
   

 

 

   

 

 

   

 

 

 

Balance, September 30, 2012

  $ 1,930     $ 136     $ 2,066  
   

 

 

   

 

 

   

 

 

 
       
    Corporate
Bonds
    Interest Rate
Lock
Commitments
    Total  
    (Dollars in thousands)  

Balance, December 31, 2010

  $ 1,716     $ 101     $ 1,817  

Total gains or losses (realized/unrealized):

                       

Included in earnings

    —         (31     (31

Included in other comprehensive income

    (225     —         (225

Purchases, issuances, and settlements

    —         —         —    

Transfers in to/out of Level 3

    —         —         —    
   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2011

  $ 1,491     $ 70     $ 1,561  
   

 

 

   

 

 

   

 

 

 

Total gains or losses (realized/unrealized):

                       

Included in earnings

    —         26       26  

Included in other comprehensive income

    97       —         97  

Purchases, issuances, and settlements

    1,500       —         1,500  

Transfers in to/out of Level 3

    —         —         —    
   

 

 

   

 

 

   

 

 

 

Balance, September 30, 2011

  $ 3,088     $ 96     $ 3,184  
   

 

 

   

 

 

   

 

 

 

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of September 30, 2012, the significant unobservable inputs used in the fair value measurements were as follows:

 

                         

Level 3 Assets with Significant Unobservable Inputs

  Fair
Value
At  9/30/2012
    Valuation
Technique
  Significant
Unobservable
Inputs
  Significant
Unobservable
Input Value
 

Corporate Bonds

  $ 1,030     Fundamental Analysis
Pricing Model
  Spread    
 
+500 BBB
Bank Paper
  
  
                Yield     8.50
         

Corporate Bonds

    900     Fundamental Analysis
Pricing Model
  Spread    
 
+600 LIBOR
Index
  
  
                Yield     6.33
         

Interest Rate Lock Commitments

    136     Pricing Model   Weighted average Closing Ratio     90
         

Impaired Loans

    20,122     Discounted

appraisals (1)

  Appraisal adjustments(2)     6% to 93
         

OREO

    7,118     Discounted

appraisals (1)

  Appraisal adjustments(2)     5% to 70

 

(1) Fair value is generally based on appraisals of the underlying collateral but is also based on discounted cash flows for some loans.
(2) Appraisals may be adjusted by management for customized discounting criteria, estimated sales costs, and proprietary qualitative adjustments.

 

The significant unobservable inputs used in the fair value measurement of the Company’s Corporate Bonds are the yield expected to be earned on the bonds and the spread. The yield is applied to a discounted cash flow in order to arrive at a price and corresponding market value. A discount margin represents a spread over the floating rate index. Spread represents an additional yield that is applied over a comparable security or curve (such as the treasury curve). Yield of the comparable or curve plus the “spread” in basis points is equal to the yield or discount rate applied in a discounted cash flow in order to arrive at a price and corresponding market value. The spread is based on various factors such as liquidity, earning history and capital ratios.

The significant unobservable input used in the fair value measurement of the Company’s interest rate lock commitments (IRLC) is the closing ratio, which represents the percentage of loans currently in a lock position which management estimates will ultimately close. Generally the fair value of an IRLC is positive if the prevailing interest rate is lower than the IRLC rate. The fair value would be negative if the prevailing rate was higher. When a higher percentage of loans are estimated to close, the increase in the closing ratio will result in a positive effect to fair value. The closing ratio is dependent upon the loan processing stage that a loan is currently in and the change in prevailing interest rates from the time of the rate lock.

Impaired loans and real estate and repossessions acquired in settlement of loans classified as Level 3 are based on management’s judgment and estimation.