Disclosures About Fair Value of Assets and Liabilities

9 Months Ended

Sep. 30, 2012

Disclosures About Fair Value of Assets and Liabilities

Note 6: Disclosures About Fair Value of Assets and Liabilities

FASB Codification Topic 820 (ASC 820),Fair Value Measurements and Disclosures, defines fair value as 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.  ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  

The standard describes three levels of inputs that may be used to measure fair value:

Level 1	Quoted prices in active markets for identical assets or liabilities
Level 2	Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
Level 3	Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

Items Measured at Fair Value on a Recurring Basis

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

Available-for-Sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy.  The Company uses a third-party provider to provide market prices on its securities.  Level 1 securities include the marketable equity securities.  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.  Level 2 securities include mortgage-backed, collateralized mortgage obligations, small business administration, marketable equity, municipal, federal agency and certain corporate obligation securities.  In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include certain corporate obligation securities.

Third party vendors compile prices from various sources and may apply such techniques as matrix pricing to determine the value of identical or similar investment securities (Level 2). Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather relying on investment securities relationship to other benchmark quoted investment securities. Any investment security not valued based upon the methods above are considered Level 3.

Fair value determinations for Level 3 measurements of securities are the responsibility of the Treasury function of the Company.  The Company contracts with a pricing specialist to generate fair value estimates on a monthly basis.  The Treasury function of the Company challenges the reasonableness of the assumptions used and reviews the methodology to ensure the estimated fair value complies with accounting standards generally accepted in the United States, analyzes the changes in fair value and compares these changes to internally developed expectations and monitors these changes for appropriateness.

The following table presents the fair value measurement of assets measured at fair value on a recurring basis and the level within the ASC 820 fair value hierarchy used for such fair value measurements:

			Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
September 30, 2012
Mortgage-backed securities
Government sponsored agencies	$	187,439	$	-	$	187,439	$	-
Collateralized mortgage obligations
Government sponsored agencies		128,964		-		128,964		-
Federal agencies		3,018		-		3,018		-
Municipals		3,272		-		3,272		-
Small Business Administration		9		-		9		-
Corporate obligations		20,161		-		17,753		2,408
Available-for-sale securities	$	342,863	$	-	$	340,455	$	2,408
December 31, 2011
Mortgage-backed securities
Government sponsored agencies	$	202,846	$	-	$	202,846	$	-
Collateralized mortgage obligations
Government sponsored agencies		100,061		-		100,061		-
Federal agencies		2,002		-		2,002		-
Municipals		3,558		-		3,558		-
Small Business Administration		12		-		12		-
Corporate obligations		22,399		-		19,945		2,454
Available-for-sale securities	$	330,878	$	-	$	328,424	$	2,454

The following is a reconciliation of the beginning and ending balances for the three months ended September 30, 2012 and 2011 of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs:

	2012		2011
Beginning balance	$	2,264	$	2,958
Total realized and unrealized gains and losses
Included in net income		-		-
Included in other comprehensive loss		144		(418	)
Purchases, issuances and settlements		-		13
Ending balance	$	2,408	$	2,553
Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets still held at the reporting date	$	-	$	-

The following is a reconciliation of the beginning and ending balances for the nine months ended September 30, 2012 and 2011 of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs:

	2012			2011
Beginning balance	$	2,454		$	2,645
Total realized and unrealized gains and losses
Included in net income		-			(193	)
Included in other comprehensive loss		(36	)		57
Purchases, issuances and settlements		(10	)		44
Ending balance	$	2,408		$	2,553
Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets still held at the reporting date	$	-		$	(193	)

Items Measured at Fair Value on a Non-Recurring Basis

From time to time, certain assets may be recorded at fair value on a non-recurring basis.  These non-recurring fair value adjustments typically are a result of the application of lower of cost or fair value accounting or a write-down occurring during the period.  The following is a description of the valuation methodologies used for certain assets that are recorded at fair value.

Impaired Loans (Collateral Dependent)

Loans for which it is probable that Mutual will not collect all principal and interest due according to contractual terms are measured for impairment.  Allowable methods for determining the amount of impairment include estimating fair value include using the fair value of the collateral for collateral dependent loans.

If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized.  This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.

Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method. 

Other Real Estate Owned

The fair value of real estate is generally determined based on appraisals by qualified licensed appraisers. The appraisers typically determine the value of the real estate by utilizing an income or market valuation approach. If an appraisal is not available, the fair value may be determined by using a cash flow analysis.

The estimated fair value of other real estate owned is based on current appraisal, less discount to reflect realizable value and estimated cost to sell.  Other real estate owned is classified within Level 3 of the fair value hierarchy.  Appraisals of other real estate owned are obtained when the real estate is acquired and subsequently as deemed necessary by the asset classification committee.  The Risk Management division reviews the appraisals for accuracy and consistency.  Appraisals are selected from the list of approved appraisers maintained by the Board.  The reductions in fair value of other real estate owned were $456,000 and $276,000 for the nine months ended September 30, 2012 and 2011, respectively. The changes were recorded as adjustments to current earnings through other real estate owned related expenses.

Mortgage Servicing Rights

We initially measure our mortgage servicing rights at fair value, and amortize them over the period of estimated net servicing income. They are periodically assessed for impairment based on fair value at the reporting date. Mortgage-servicing rights do not trade in an active market with readily observable prices. Accordingly, the fair value is estimated based on a valuation model which calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, market discount rates, cost to service, float earnings rates and other ancillary income, including late fees. The fair value measurements are classified as Level 3.

The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the ASC 820 fair value hierarchy in which the fair value measurements fall:

			Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
September 30, 2012
Impaired loans (collateral dependent)	$	7,235	$	-	$	-	$	7,235
Foreclosed real estate		2,136		-		-		2,136
Mortgage servicing rights		2,109						2,109
December 31, 2011
Impaired loans (collateral dependent)	$	16,511	$	-	$	-	$	16,511
Foreclosed real estate		202		-		-		202
Mortgage-servicing rights		2,626		-		-		2,626

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements.

	Fair Value at September 30, 2012		Valuation Technique	Unobservable Inputs	Range
Trust Preferred Securities	$	2,408	Discounted cash flow	Discount rate Constant prepayment rate Cumulative projected prepayments Probability of default Projected cures given deferral Loss severity		9.0% - 16.0% 2.0%  30.0% 1.5%-2.4% 0%-15.0% 56.7% – 81.4%
Impaired loans (collateral dependent)	$	7,235	Third party valuations	Discount to reflect realizable value		0%-40%
Foreclosed real estate	$	2,136	Third party valuations	Discount to reflect realizable value less estimated selling costs		0%-25%
Mortgage servicing rights	$	2,109	Third party valuations	Prepayment speeds Discount rates Servicing fee		220%-700% 9.0% 0.25%

The estimated fair values of the Company’s financial instruments not carried at fair value in the consolidated condensed balance sheets as of dates noted below are as follows:

	Carrying				Fair Value Measurements Using
September 30,  2012	Amount		Fair Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	44,319	$	44,319	$	44,319	$	-	$	-
Loans held for sale		4,072		4,216		-		4,216		-
Loans		947,375		977,803		-		-		977,803
FHLB stock		14,391		14,391		-		14,391		-
Interest receivable		3,930		3,930		-		3,930		-
Liabilities
Deposits		1,193,031		1,210,969		596,913		-		614,056
FHLB advances		113,194		115,174		-		115,174		-
Other borrowings		11,812		13,006		-		13,006		-
Interest payable		447		447		-		447		-
Advances by borrowers for taxes and insurance		2,675		2,675		-		2,675		-

	December 31, 2011
	Carrying Amount		Fair Value
Assets
Cash and cash equivalents	$	55,223	$	55,223
Interest-bearing deposits		1,415		1,415
Loans held for sale		1,441		1,459
Loans		900,460		921,212
FHLB stock		14,391		14,391
Interest receivable		4,248		4,248
Liabilities
Deposits	$	1,166,637	$	1,132,031
FHLB advances		101,451		103,980
Other borrowings		12,410		13,083
Interest payable		340		340
Advances by borrowers for taxes and insurance		1,720		1,720

The following methods and assumptions were used to estimate the fair value of each class of financial instruments listed above:

Cash and Cash Equivalents - The fair value of cash and cash equivalents approximates carrying value.

Interest-Bearing Deposits - The fair value of interest-bearing deposits approximates carrying value.

Loans Held For Sale - Fair values are based on current investor purchase commitments.

Loans - The fair value for loans is estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.

FHLB Stock - Fair value of FHLB stock is based on the price at which it may be resold to the FHLB.

Interest Receivable/Payable - The fair values of interest receivable/payable approximate carrying values.

Deposits - The fair values of noninterest-bearing, interest-bearing demand and savings accounts are equal to the amount payable on demand at the balance sheet date.  Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on such time deposits.

Federal Home Loan Bank Advances - The fair value of these borrowings are estimated using a discounted cash flow calculation, based on current rates for similar debt for periods comparable to the remaining terms to maturity of these advances.

Other Borrowings - The fair value of other borrowings are estimated using a discount calculation based on current rates.

Advances by Borrowers for Taxes and Insurance - The fair value approximates carrying value.

Off-Balance Sheet Commitments - Commitments include commitments to purchase and originate mortgage loans, commitments to sell mortgage loans, and standby letters of credit and are generally of a short-term nature.  The fair values of such commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.  The fair value of commitments is immaterial.