Fair Value of Financial Instruments

6 Months Ended

Jun. 30, 2012

Fair Value of Financial Instruments [Abstract]

Fair Value of Financial Instruments

Note 12 - Fair Value of Financial Instruments

LCNB measures certain assets at fair value using various valuation techniques and assumptions, depending on the nature of the asset.  Fair value is defined as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.

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.  In addition, LCNB has invested in two mutual funds that invest in debt securities or loans that qualify for credit under the Community Reinvestment Act.  The investment in one of the mutual funds is considered to have level 2 inputs because, among other factors, the fund invests primarily in U.S. Government and Agency Obligations, which are considered to be level 2 investments.  The investment in the other mutual fund is considered to have level 3 inputs because its shares are not traded in an active market, it does not publish a daily net asset value, and it is primarily a loan fund.  Additionally, LCNB 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.

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, 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 following table summarizes the valuation of LCNB's assets recorded at fair value by input levels as of June 30, 2012 and December 31, 2011 (in thousands):

				Fair Value Measurements at the End of the Reporting Period 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)	Total Gains (Losses)
June 30, 2012
Recurring fair value measurements:
Investment securities available-for-sale:
U.S. Treasury notes		$	21,169	21,169	-	-
U.S. Agency notes			101,242	-	101,242	-
U.S. Agency mortgage-backed securities			58,297	-	58,297	-
Corporate securities			6,332	4,140	2,192	-
Municipal securities:
Non-taxable			73,233	-	73,233	-
Taxable			21,178	-	21,178	-
Mutual funds			2,153	-	1,153	1,000
Trust preferred securities			515	515	-	-
Equity securities			1,022	1,022	-	-
Total recurring fair value measurements		$	285,141	26,846	257,295	1,000
Nonrecurring fair value measurements:
Impaired loans		$	1,944	-	830	1,114	-
Other real estate owned and repossessed     assets (a) (b)			2,123	-	2,123	-	(79)
Total nonrecurring fair value measurements		$	4,067	-	2,953	1,114	(79)
December 31, 2011
Recurring fair value measurement:
Investment securities available-for-sale:
U.S. Treasury notes		$	17,550	17,550	-	-
U.S. Agency notes			82,927	-	82,927	-
U.S. Agency mortgage-backed securities			52,287	-	52,287	-
Corporate securities			6,365	4,152	2,213	-
Municipal securities:
Non-taxable			69,703	-	69,703	-
Taxable			21,907	-	21,907	-
Mutual funds			2,125	-	1,125	1,000
Trust preferred securities			564	564	-	-
Equity securities			578	578	-	-
Total recurring fair value measurements		$	254,006	22,844	230,162	1,000
Nonrecurring fair value measurements:
Impaired loans		$	2,563	-	1,300	1,263	-
Other real estate owned and repossessed     assets (c)			1,642	-	1,619	23	31
Total nonrecurring fair value measurements		$	4,205	-	2,919	1,286	31
(a)	Two other real estate owned properties with a total carrying amount of $1,619,000 were written down to their combined fair value of $1,543,000, resulting in an impairment charge of $76,000, which was included in other non-interest expense for the period.
(b)	Repossessed assets with a carrying value of $23,000 were sold for a combined total of $20,000, resulting in a net loss of $3,000, which was included in other non-interest expense for the period.
(c)	Repossessed assets with a carrying value of $117,000 were sold for a combined total of $148,000, resulting in a net gain of $31,000, which was included in other non-interest expense for the period.

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

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

		June 30, 2012				December 31, 2011
	Carrying		Fair		Carrying		Fair
		Amount		Value	Amount		Value
FINANCIAL ASSETS:
Cash and cash equivalents	$	26,896		26,896		19,535	19,535
Investment securities:
Available-for-sale		285,141		285,141		254,006	254,006
Held-to-maturity		11,474		11,474		10,734	10,734
Federal Reserve Bank stock		949		949		940	940
Federal Home Loan Bank stock		2,091		2,091		2,091	2,091
Loans, net		458,629		______		458,331	470,846
FINANCIAL LIABILITIES:
Deposits		710,656		______		663,562	669,383
Short-term borrowings		13,142		13,142		21,596	21,596
Long-term debt		20,391		______		21,373	22,570

The fair value of off-balance-sheet financial instruments at June 30, 2012 and December 31, 2011 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.  These current rates approximate market rates.

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, which approximates market rates.

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.

The following table summarizes the categorization by input level as of June 30, 2012 and December 31, 2011 of LCNB's financial assets and liabilities not recorded at fair value but for which fair value is disclosed (in thousands):

			Fair Value Measurements at the End of the Reporting Period 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, 2012
Assets:
Loans, net	$	______	-	______	-
Investment securities, non-taxable,     held-to-maturity		11,474	-	-	11,474
Federal Reserve Bank stock		949	949	-	-
Federal Home Loan Bank stock		2,091	2,091	-	-
Liabilities:
Deposits		______	-	______	-
Long-term debt		______	-	______	-
December 31, 2011
Assets:
Loans, net	$	468,283	-	468,283	-
Investment securities, non-taxable,     held-to-maturity		10,734	-	-	10,734
Federal Reserve Bank stock		940	940	-	-
Federal Home Loan Bank stock		2,091	2,091	-	-
Liabilities:
Deposits		669,383	-	669,383	-
Long-term debt		22,570	-	22,570	-