Fair Value of Financial Instruments

6 Months Ended

Jun. 30, 2011

Fair Value of Financial Instruments [Abstract]

Fair Value of Financial Instruments

Note 11 - Fair Value of Financial Instruments

The inputs to valuation techniques used to measure fair value are assigned to one of three broad levels:

· Level 1 – quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the reporting date.

· Level 2 – inputs other than quoted prices included within level 1 that are observable for the asset or liability either directly or indirectly.  Level 2 inputs may include quoted prices for similar assets in active markets,  quoted prices for identical assets or liabilities in markets that are not active, inputs other than quoted prices (such as interest rates or yield curves) that are observable for the asset or liability, and inputs that are derived from or corroborated by observable market data.

· Level 3 - inputs that are unobservable for the asset or liability.

The majority of LCNB's financial debt securities are classified as available-for-sale.  The securities are reported at fair value with unrealized holding gains and losses reported net of income taxes in accumulated other comprehensive income.

LCNB utilizes a pricing service for determining the fair values of most of its investment securities.  Fair value for U.S. Treasury notes and corporate securities are determined based on market quotations (level 1).  Fair value for most of the other investment securities is calculated using the discounted cash flow method for each security.  The discount rates for these cash flows are estimated by the pricing service using rates observed in the market (level 2).  Cash flow streams are dependent on estimated prepayment speeds and the overall structure of the securities given existing market conditions.  The investments in mutual funds are considered to have level 3 inputs because LCNB does not have precise information about the methods used by the mutual fund companies to assign fair values or full information on the investments made by the funds.  Additionally, LCNB Corp. owns trust preferred securities in various financial institutions and equity securities in non-financial companies.   Market quotations (level 1) are used to determine fair values for these investments.

The following table summarizes the valuation of LCNB's available-for-sale securities by input levels as of June 30, 2011 and December 31, 2010 (in thousands):

			Fair Value Measurements at Reporting Date Using
	Fair Value Measurements		Quoted Prices  in Active Markets for  Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
June 30, 2011
Available-for-sale securities:
U.S. Treasury notes	$	22,150		22,150		-		-
U.S. Agency notes		108,238		-		108,238		-
U.S. Agency mortgage- backed securities		30,751		-		30,751		-
Corporate securities		1,025		1,025		-		-
Municipal securities:
Non-taxable		65,316		-		65,316		-
Taxable		20,600		-		20,600		-
Mutual funds		1,581		-		-		1,581
Trust preferred securities		600		600		-		-
Equity securities		508		508		-		-
Totals	$	250,769		24,283		224,905		1,581
December 31, 2010
Available-for-sale securities:
U.S. Treasury notes	$	19,585		19,585		-		-
U.S. Agency notes		82,862		-		82,862		-
U.S. Agency mortgage- backed securities		33,094		-		33,094		-
Corporate securities		2,025		2,025		-		-
Municipal securities:
Non-taxable		74,428		-		74,428		-
Taxable		21,968		-		21,968		-
Mutual fund		1,053		-		-		1,053
Trust preferred securities		604		604		-		-
Equity securities		263		263		-		-
Totals	$	235,882		22,477		212,352		1,053

The following table is a reconciliation of the beginning and ending balances of recurring fair value measurements that use significant unobservable inputs (level 3) for the six months ended June 30, 2011 (in thousands):

	Mutual Funds
Beginning balance	$	1,053
Purchases		500
Dividends reinvested		17
Net change in unrealized gains (losses) included in other comprehensive income		11
Ending balance	$	1,581

Assets that may be recorded at fair value on a nonrecurring basis include impaired loans, other real estate owned, and other repossessed assets.  A loan is considered impaired when management believes it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement.  Impaired loans are carried at the present value of estimated future cash flows using the loan's existing rate or the fair value of collateral if the loan is collateral dependent and if this value is less than the loan balance.  When the fair value of the collateral is based on an observable market price or current appraised value, the inputs are considered to be level 2.  When an appraised value is not available and there is not an observable market price, the inputs are considered to be level 3.

Other real estate owned is adjusted to fair value upon transfer of the loan to foreclosed assets, usually based on an appraisal of the property.  Subsequently, foreclosed assets are carried at the lower of carrying value or fair value.  The inputs for a valuation based on current appraised value are considered to be level 2.

The table below presents LCNB's impaired loans, other real estate owned, and repossessed assets measured at fair value on a nonrecurring basis as of June 30, 2011 and December 31, 2010 by the level in the fair value hierarchy within which the inputs for these measurements fall (in thousands):

			Fair Value Measurements at Reporting Date Using
	Fair Value Measurements		Quoted Prices  in Active Markets for  Identical Assets (Level 1)	Significant  Other  Observable  Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
June 30, 2011
Impaired loans	$	7,177	-	1,074	6,103
Other real estate owned		2,088	-	2,088	-
Repossessed assets		138	-	-	138
Totals	$	9,403	-	3,162	6,241
December 31, 2010
Impaired loans	$	4,080	-	1,430	2,650
Other real estate owned		2,088	-	2,088	-
Repossessed assets		26	-	-	26
Totals	$	6,194	-	3,518	2,676

Carrying amounts and estimated fair values of financial instruments as of June 30, 2011 and December 31, 2010 were as follows (in thousand

	June 30, 2011		December 31, 2010
	Carrying Amount	Fair Value		Carrying Amount	Fair Value
FINANCIAL ASSETS:
Cash and cash equivalents	$26,841	26,841		10,999	10,999
Investment securities:
Available-for-sale	250,769	250,769		235,882	235,882
Held-to-maturity	11,243	11,243		12,141	12,141
Federal Reserve Bank stock	941	941		939	939
Federal Home Loan Bank stock	2,091	2,091		2,091	2,091
Loans, net	454,447	468,092		452,350	465,053
FINANCIAL LIABILITIES:
Deposits	678,751	683,295		638,539	642,734
Short-term borrowings	12,198	12,198		21,691	21,691
Long-term debt	22,061	23,052		23,120	24,217

The fair value of off-balance-sheet financial instruments at June 30, 2011 and December 31, 2010 was not material.

Fair values of financial instruments are based on various assumptions, including the discount rate and estimates of future cash flows.  Therefore, the fair values presented may not represent amounts that could be realized in actual transactions.  In addition, because the required disclosures exclude certain financial instruments and all nonfinancial instruments, any aggregation of the fair value amounts presented would not represent the underlying value of LCNB.  The following methods and assumptions were used to estimate the fair value of certain financial instruments:

Cash and cash equivalents

The carrying amounts presented are deemed to approximate fair value.

Investment securities

Fair values for securities, excluding Federal Home Loan Bank and Federal Reserve Bank stock, are based on quoted market prices, if available.  If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities and/or discounted cash flow analyses or other methods.  The carrying value of Federal Home Loan Bank and Federal Reserve Bank stock approximates fair value based on the respective redemptive provisions.

Loans

Fair value is estimated by discounting the future 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, incorporating assumptions of current and projected prepayment speeds.

Deposits

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date.  The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.

Borrowings

The carrying amounts of federal funds purchased, repurchase agreements, and U.S. Treasury demand note borrowings are deemed to approximate fair value of short-term borrowings.  For long-term debt, fair values are estimated based on the discounted value of expected net cash flows using current interest rates.