Note 9 - Fair Value Of Assets And Liabilities

3 Months Ended

Sep. 30, 2011

Fair Value Disclosures [Text Block]

NOTE 9 -- FAIR VALUE OF ASSETS AND LIABILITIES

ASC 820, “Fair Value Measurements,” defines the 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.

In accordance with ASC 820, the Corporation groups its financial assets and financial liabilities measured 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.  Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 Valuations for assets and liabilities traded in less active dealer or broker markets.  Valuations are obtained from third party pricing services for identical or comparable assets or liabilities which use 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 and 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.

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized on the accompanying Condensed Consolidated Balance Sheet.

Available-for-Sale Securities

The fair values of available-for-sale securities are determined by various valuation methodologies.  Where quoted market prices are available in an active market, securities are classified within Level 1.  The Corporation has no securities classified within Level 1.  If quoted market prices are not available, then fair values are estimated by using pricing models or quoted prices of securities with similar characteristics.  Level 2 securities include obligations of U.S. government corporations and federal agency and U.S. Government sponsored enterprises (GSEs), obligations of states and political subdivisions, and GSE residential collateralized mortgage obligations.  In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.  The Corporation has no securities classified within Level 3.

The following table presents the Corporation’s assets that are measured at fair value on a recurring basis and the level within the ASC 820 hierarchy in which the fair value measurements fall as of September 30, 2011 and December 31, 2010 (in thousands):

September 30, 2011	Fair Value Measurements Using
(in thousands)			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
Available-for-sale securities
United States Government and federal agency and U.S. Government sponsored enterprises (GSEs)	$	81,486	$	-	$	81,486	$	-
State and Municipal		94,742		-		94,742		-
Collateralized mortgage obligations:		-		-		-		-
GSE Residential		78,039		-		78,039		-
Total	$	254,267	$	-	$	254,267	$	-

December 31, 2010	Fair Value Measurements Using
(in thousands)			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
Available-for-sale securities
United States Government and federal agency and U.S. Government sponsored enterprises (GSEs)	$	78,204	$	-	$	78,204	$	-
State and Municipal		115,654		-		115,654		-
Collateralized mortgage obligations:		-		-		-		-
GSE Residential		54,894		-		54,894		-
Total	$	248,752	$	-	$	248,752	$	-

Following is a description of the valuation methodologies used for assets measured at fair value on a non-recurring basis and recognized in the accompanying Condensed Consolidated Balance Sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.

Impaired Loans (Collateral Dependent) - Loans for which it is probable that the Corporation 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 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.  Fair value adjustments on impaired loans were $51,089 for the nine months ended September 30, 2011, $3,304 for the three months ended September 30, 2011, and $16,040 for the year ended December 31, 2010.

Mortgage Servicing Rights - The fair value used to determine the valuation allowance is estimated using discounted cash flow models. The valuation models incorporate assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses.  These variables change from quarter to quarter as market conditions and projected interest rates change and may have an adverse impact on the value of the mortgage servicing rights and may result in a reduction to non-interest income.  Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the hierarchy.

Other Real Estate Owned - Other real estate owned acquired through loan foreclosure is initially recorded at fair value less costs to sell when acquired, establishing a new cost basis.  The adjustment at the time of foreclosure is recorded through the allowance for loan losses.  Due to the subjective nature of establishing the fair value when the asset is acquired, the actual fair value of the other real estate owned or foreclosed asset could differ from the original estimate and is classified within Level 3 of the hierarchy.  If it is determined the fair value declines subsequent to foreclosure, a valuation allowance is recorded through non-interest expense.  Operating costs associated with the assets after acquisition are also recorded as non-interest expense.  Gains and losses on the disposition of other real estate owned and foreclosed assets are netted and posted to non-interest expense.  Fair value adjustments on other real estate owned were $3,032 for the nine months ended September 30, 2011, $3,163 for the three months ended September 30, 2011 and $14,759 for the year ended December 31, 2010.

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 at September 30, 2011 and December 31, 2010 (in thousands):

September 30, 2011
(in thousands)			Fair Value Measurements Using
			Quoted Prices in				Significant
			Active Markets for		Significant Other		Unobservable
			Identical Assets		Observable Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
Impaired loans (collateral dependent)	$	81,845		-		-	$	81,845
Mortgage servicing rights		2,612		-		-		2,612
Other real estate owned		5,931		-		-		5,931

December 31, 2010
(in thousands)			Fair Value Measurements Using
			Quoted Prices in				Significant
			Active Markets for		Significant Other		Unobservable
			Identical Assets		Observable Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
Impaired loans (collateral dependent)	$	30,756		-		-	$	30,756
Mortgage servicing rights		3,385		-		-		3,385
Other real estate owned		2,899		-		-		2,899

ASC 825, "Disclosures about Fair Value of Financial Instruments," requires all entities to disclose the estimated fair value of their financial instrument assets and liabilities.  For the Corporation, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in ASC 825.  Many of the Corporation's financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction.  It is also the Corporation's general practice and intent to hold its financial instruments to maturity and to not engage in trading or sales activities except for loans held-for-sale and available-for-sale securities.  Therefore, significant estimations and assumptions, as well as present value calculations, are used by the Corporation for the purposes of this disclosure.

Estimated fair values have been determined by the Corporation using the best available data and an estimation methodology suitable for each category of financial instruments.  For those loans and deposits with floating interest rates, it is presumed that estimated fair values generally approximate the recorded book balances.  The estimation methodologies used, the estimated fair values and the recorded book balances at September 30, 2011 and December 31, 2010, are as follows:

	September 30, 2011				December 31, 2010
	Carrying		Fair		Carrying		Fair
(in thousands)	Value		Value		Value		Value
Financial Assets:
Cash and due from banks	$	18,400	$	18,400	$	12,992	$	12,992
Interest-bearing deposits in financial institutions		65,969		65,969		30,888		30,888
Investment securities		265,611		265,748		260,939		261,224
Loans, net, including loans held for sale		624,155		628,250		679,863		684,438
Accrued interest receivable		7,179		7,179		7,482		7,482
Total financial assets	$	981,314	$	985,546	$	992,164	$	997,024
Financial Liabilities:
Non-interest bearing demand deposits	$	149,361	$	149,361	$	138,683	$	138,683
Interest-bearing deposits		789,864		792,460		824,278		827,266
Borrowings		85,800		85,848		71,559		71,615
Accrued interest payable		1,204		1,204		1,335		1.335
Total financial liabilities	$	1,026,229	$	1,028,873	$	1,035,855	$	1,038,899
Unrecognized financial instruments (net of contract amount)
Commitments to originate loans	$	-	$	-	$	-	$	-
Lines of credit		-		-		-		-
Letters of credit		-		-		-		-

Financial instruments actively traded in a secondary market have been valued using quoted available market prices. Cash and due from banks, interest-bearing time deposits in other banks, federal funds sold, loans held-for-sale and interest receivable are valued at book value, which approximates fair value.

Financial liability instruments with stated maturities have been valued using a present value discounted cash flow analysis with a discount rate approximating current market for similar liabilities. Interest payable is valued at book value, which approximates fair value.

Financial liability instruments with no stated maturities have an estimated fair value equal to both the amount payable on demand and the recorded book balance.

The net loan portfolio has been valued using a present value discounted cash flow.  The discount rate used in these calculations is the current rate at which similar loans would be made to borrowers with similar credit ratings, same remaining maturities and assumed prepayment risk.

The fair value of commitments to originate loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.  For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.  The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.
 

Changes in assumptions or estimation methodologies may have a material effect on these estimated fair values.

The Corporation's remaining assets and liabilities, which are not considered financial instruments, have not been valued differently than has been customary with historical cost accounting.  No disclosure of the relationship value of the Corporation's core deposit base is required by ASC 825.

Fair value estimates are based on existing balance sheet financial instruments, without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments.  For example, the subsidiary bank has a large fiduciary services department that contributes net fee income annually.  The fiduciary services department is not considered a financial instrument, and its value has not been incorporated into the fair value estimates.  Other significant assets and liabilities that are not considered financial assets or liabilities include the mortgage banking operation, brokerage network, deferred taxes, premises and equipment and goodwill.  In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

Management believes that reasonable comparability between financial institutions may not be likely, due to the wide range of permitted valuation techniques and numerous estimates which must be made, given the absence of active secondary markets for many of the financial instruments.  This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.