FAIR VALUE MEASUREMENT

9 Months Ended

Sep. 30, 2012

Fair Value Disclosures [Abstract]

FAIR VALUE MEASUREMENT

FAIR VALUE MEASUREMENT

Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. Fair value measurements are required to be separately disclosed by level within the fair value hierarchy. The Company bases fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

For assets and liabilities recorded at fair value, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy.

Fair value measurements for assets and liabilities where there exists limited or no observable market data and, therefore, are based primarily upon estimates, are often calculated based on the economic and competitive environment, the characteristics of the asset or liability and other factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values.

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, other real estate owned ("OREO"), 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.

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 — Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange.

Level 2 — Valuations are obtained from readily available pricing sources via independent providers for market transactions involving similar assets or liabilities. The Company’s principal market for these securities is the secondary institutional markets and valuations are based on observable market data in those markets. Level 2 securities include U. S. Agencies, state and municipal bonds and MBS.

Level 3 — Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets.

Assets and Liabilities Measured on a Recurring Basis:

Available for Sales ("AFS") Investment Securities: Investment securities 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 matrix pricing, which is a mathematical technique used widely in the industry 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 1 securities include those traded on nationally recognized securities exchanges, U.S. Treasury securities, and money market funds. Level 2 securities include U.S. Agencies, MBS issued by government sponsored entities, state and municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Mortgage Serving Rights: Mortgage servicing rights do not trade in an active market with readily observable market data.  As a result, the Company estimates the fair value of mortgage servicing rights by using a discounted cash flow model to calculate the present value of estimated future net servicing income.  The Company stratifies its mortgage servicing portfolio on the basis of loan type.  The assumptions used in the discounted cash flow model are those that we believe market participants would use in estimating future net servicing income, including estimates of loan prepayment rates, servicing costs, ancillary income, impound account balances, and discount rates.  Significant assumptions in the valuation of mortgage servicing rights include changes in interest rates, estimated loan repayment rates, and the timing of cash flows, among other factors.  Mortgage servicing rights are classified as Level 3 measurements due to the use of significant unobservable inputs, as well as significant management judgment and estimation.

Assets measured at fair value on a recurring basis as of September 30, 2012 were:

(Dollars in thousands)
Description	September 30, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Recurring:
US Agencies	$	1,370	$	—	$	1,370	$	—
Government sponsored MBS
Residential	58,279		—		58,279		—
Non-Government sponsored MBS
Residential	101		—		101		—
Municipal securities
North Carolina	3,183		—		3,183		—
Mortgage Servicing Rights	41		—		—		41
Total	$	62,974	$	—	$	62,933	$	41

Assets measured at fair value on a recurring basis as of December 31, 2011 were:

(Dollars in thousands)
Description	December 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Recurring:
US Agencies	$	483	$	—	$	483	$	—
Government sponsored MBS
Residential	30,789		—		30,789		—
Non-Government sponsored MBS
Residential	135		—		135		—
Municipal securities
North Carolina	3,702		—		3,702		—
Out of state	2,486		—		2,486		—
Mortgage Servicing Rights	46		—		—		46
	$	37,641	$	—	$	37,595	$	46

The table below displays the change in all recurring Level 3 Assets between December 31, 2011 and September 30, 2012:

(Dollars in thousands)	Mortgage Servicing Rights
Beginning balance (December 31, 2011)	$	46
Amortization	(3		)
Ending Balance (June 30, 2012)	$	43
Amortization	(2		)
Ending Balance (September 30, 2012)	$	41

Assets and Liabilities Measured on a Nonrecurring Basis:

Impaired loans: Impaired loans are evaluated and valued at the time the loan is identified as impaired, and are carried at the lower of cost or market value. Market value is measured based on the value of the collateral securing these loans or net present value of expected future cash flows discounted at the loan’s effective interest rate. Collateral may be real estate and/or business assets including equipment, inventory, and/or accounts receivable. The value of business equipment, inventory, and accounts receivable collateral is based on net book value on the business’ financial statements and, if necessary, discounted based on management’s review and analysis. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and the client’s selling costs and other expenses. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above. The Company records impaired loans as nonrecurring Level 3, when Management believes the underlying collateral is less than the appraised value.

Other real estate owned (“OREO”): Foreclosed assets are adjusted to fair value, less estimated carrying costs and costs to sell, upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of the carrying value or the fair value, less estimated carry costs and costs to sell. Fair value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. The Company records foreclosed assets as nonrecurring Level 3.

Assets measured at fair value on a nonrecurring basis as of September 30, 2012 and December 31, 2011 were:

(Dollars in thousands)
Description	September 30, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Nonrecurring:
Other real estate owned	$	3,072	$	—	$	—	$	3,072
Impaired and TDR Loans:
Commercial	590		—		—		590
Commercial real estate	8,821		—		—		8,821
Faith-based non-profit	13,505		—		—		13,505
Residential real estate	1,844		—		—		1,844
Total	$	27,832	$	—	$	—	$	27,832
Description	December 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Nonrecurring:
Other real estate owned	$	3,215	$	—	$	—	$	3,215
Impaired and TDR Loans:
Commercial	590		—		—		590
Commercial real estate	6,709		—		—		6,709
Faith-based non-profit	13,760		—		—		13,760
Residential real estate	1,637		—		—		1,637
Total	$	25,911	$	—	$	—	$	25,911

Quantitative Information about Level 3 Fair Value Measurements

Description	September 30, 2012		Valuation Technique	Significant Unobservable Inputs	Significant Unobservable Input Value
Nonrecurring:
Other real estate owned	$	3,072	discounted appraisals	collateral discounts	6	-20%
Impaired and TDR loans	24,760		discounted appraisals	collateral discounts	6	-20%
Mortgage Servicing Rights	41		discounted cash flow	Public Securities Association ("PSA") speed	374	%
				cost to service	5.50	%
				investor yield	9.00	%
Total	$	27,873
Description	December 31, 2011		Valuation Technique	Significant Unobservable Inputs	Significant Unobservable Input Value
Nonrecurring:
Other real estate owned	$	3,215	discounted appraisals	collateral discounts	6	-20%
Impaired and TDR loans	22,696		discounted appraisals	collateral discounts	6	-20%
Mortgage Servicing Rights	46		discounted cash flow	PSA speed	306	%
				cost to service	5.50	%
				investor yield	9.00	%
Total	$	25,957

The Company discloses estimated fair values for its significant financial instruments.  The methodologies for estimating the fair value of financial assets and liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above. The methodologies for other financial assets and liabilities are discussed below.

The Company had no transfers between any of the three levels in 2011 or 2012.

Cash and Cash Equivalents: The carrying amount of cash, due from banks, and federal funds sold approximates fair value, and is therefore considered Level 1 input.

Loans (other than impaired), net of allowances for loan losses: Fair values are estimated for portfolios of loans with similar financial characteristics. The majority of the Company’s loans and lending-related commitments are not carried at fair value on a recurring basis on the Consolidated Balance Sheets, nor are they actively traded.

The fair value of performing loans is calculated by discounting scheduled cash flows through their individual contractual maturity, using discount rates that reflect the credit risk, overhead expenses, interest rate earned and again, contractual maturity of each loan. The maturity is based on contractual maturities for each loan, modified as required by an estimate of the effect of historical prepayments and current economic conditions.

For all loans, assumptions regarding the characteristics and segregation of loans, maturities, credit risk, cash flows, and discount rates are determined using specific borrower and other available information and are therefore considered a Level 3 input.

Accrued Interest Receivable and Payable: The fair value of interest receivable and payable is estimated to approximate the carrying amounts and is therefore considered a Level 1 input.

Deposits: The fair value of deposits with no stated maturity, such as demand deposits, checking accounts, savings and money market accounts, is equal to the carrying amount and is therefore considered a Level 1 input. The fair value of certificates of deposit is based on the discounted value of contractual cash flows, where the discount rate is estimated using the market rates currently offered for deposits of similar remaining maturities and is therefore considered a Level 2 input.

Borrowings: The fair value of borrowings is based on the discounted value of estimated cash flows. The discounted rate is estimated using market rates currently offered for similar advances or borrowings and is therefore considered a Level 3 input.

Off-Balance Sheet Instruments: Since the majority of the Company’s off-balance sheet instruments consist of non fee-producing variable rate commitments, the Company has determined they do not have a distinguishable fair value.

As of September 30, 2012 and December 31, 2011, the carrying amounts and associated estimated fair value of financial assets and liabilities of the Company are as follows:

(Dollars in thousands)	September 30, 2012
	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Assets:
Cash and cash equivalents	$	51,516	$	51,516	$	51,516	$	—	$	—
Marketable securities	62,933		62,933		—		62,933		—
Loans, net of allowances for loan losses	175,443		177,389		—		—		177,389
Accrued interest receivable	850		850		850		—		—
Liabilities:
Non-maturity deposits	$	123,304	$	123,304	$	123,304	$	—	$	—
Maturity deposits	138,068		137,853		—		137,853		—
Other borrowings	2,987		2,879		—		—		2,879
Accrued interest payable	81		81		81		—		—
	December 31, 2011
Assets:	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Cash and cash equivalents	$	61,296	$	61,296	$	61,296	$	—	$	—
Marketable securities	37,595		37,595		—		37,595		—
Loans, net of allowances for loan losses	184,234		188,545		—		—		188,545
Accrued interest receivable	764		764		764		—		—
Liabilities:
Non-maturity deposits	$	123,488	$	123,488	$	123,488	$	—	$	—
Maturity deposits	135,656		135,348		—		135,348		—
Other borrowings	2,939		2,676		—		—		2,676
Accrued interest payable	196		196		196		—		—