Note 9 - Fair Value Of Assets And Liabilities

3 Months Ended

Mar. 31, 2012

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 in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy. There have been no significant changes in the valuation techniques during the period ended March 31, 2012.

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, quoted prices of securities with similar characteristics, or discounted cash flows.  For those securities, the inputs used by the pricing service to determine fair values may include one, or a combination of, observable inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference date market research publications.  These securities are classified within Level 2 of the valuation hierarchy. 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 March 31, 2012 and December 31, 2011 (in thousands):

March 31, 2012	Fair Value Measurements Using
(in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
			(Level 1)		(Level 2)		(Level 3)
Available-for-sale securities
United States Government and federal agency and U.S. Government sponsored enterprises (GSEs)	$	80,972	$	-	$	80,972	$	-
State and Municipal		94,014		-		94,014		-
Collateral mortgage obligations:
GSE Residential		109,296		-		109,296		-
Total	$	284,282	$	-	$	284,282	$	-

December 31, 2011	Fair Value Measurements Using
(in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
			(Level 1)		(Level 2)		(Level 3)
Available-for-sale securities
United States Governmentand federal agency and U.S. Government sponsored enterprises (GSEs)	$	78,022	$	-	$	78,022	$	-
State and Municipal		95,483		-		95,483		-
Collateral mortgage obligations:
GSE Residential		78,242		-		78,242		-
Total	$	251,747	$	-	$	251,747	$	-

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 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. The Corporation considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect the fair value.  Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary.   Appraisals are reviewed for accuracy and consistency.  Appraisers are selected from the list of approved appraisers by management. The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral.

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 $32,856 for the quarter ended March 31, 2012, compared to $2,147 for the year ended December 31, 2011.

Mortgage Servicing Rights - Mortgage servicing rights do not trade in an active open market with readily observable prices. Accordingly, 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 noninterest 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. Estimated fair value of other real estate owned is based on appraisals or evaluations.  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.  Appraisals are reviewed for accuracy and consistency.   Appraisers are selected from the list of approved appraisers maintained by management. Fair value adjustments on other real estate owned were 5,227 for the quarter ended March 31, 2011 and $4,199 for the year ended December 31, 2011.

The following table presents the quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements at March 31, 2012 (in thousands):

March 31, 2012
	Fair Value at March 31, 2012		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
Impaired loans (collateral dependent)	$	47	Market comparable properties	Comparability adjustments (%)	25-40% (32%)
Other real estate owned		1,871	Market comparable properties	Marketability discount	not available

The following table presents the fair value measurements of assets measured at fair value on a nonrecurring basis and the level within the ASC 820 fair value hierarchy in which fair value measurments fell at March 31, 2012 and December 31, 2011 (in thousands):

March 31, 2012
	Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans (collateral dependent)	$	47		-		-	$	47
Mortgage servicing rights		2,420		-		-		2,420
Other real estate owned		1,871		-		-		1,871

December 31, 2011
(in thousands)	Fair Value Measurements Using
			Quoted Prices in				Significant
			Active Markets for		Significant Other		Unobservable
	Fair Value		Identical Assets		Observable Inputs		Inputs
			(Level 1)		(Level 2)		(Level 3)
Impaired loans (collateral dependent)	$	32,903		-		-	$	32,903
Mortgage servicing rights		2,437		-		-		2,437
Other real estate owned		7,098		-		-		7,098

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, were 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 following table presents estimated fair values of the Corporation’s financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at March 31, 2012 and December 31, 2012 (in thousands):

March 31, 2012			Fair Value Measurements Using:
	Carrying Amount		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial Assets:
Cash and due from banks	$	11,986	$	11,986	$	-	$	-
Interest-bearing deposits in financial institutions		90,956		90,956		-		-
Held to maturity investment securities		7,893		-		7,994		-
Loans, net, including loans held for sale		542,500		-		-		596,512
Accrued interest receivable		5,029		-		5,029		-
Financial Liabilities:
Non-interest bearing demand deposits	$	173,816	$	-	$	173,816	$	-
Interest-bearing deposits		748,008		-		751,268		-
Borrowings		87,497		-		-		87,497
Accrued interest payable		714		-		714		-
Unrecognized financial instruments (net of contract amount):
Commitments to originate loans	$	-	$	-	$	-	$	-
Lines of credit		-		-		-		-
Letters of credit		-		-		-		-

December 31, 2011
	Carrying Value		Fair Value
Financial Assets:
Cash and due from banks	$	16,307	$	16,307
Interest-bearing deposits in financial institutions		46,988		46,988
Investment securities		261,583		261,689
Loans, net, including loans held-for-sale		592,828		658,359
Accrued interest receivable		6,453		6,453
Financial Liabilities:
Non-interest-bearing demand deposits	$	171,939	$	171,939
Interest-bearing deposits		745,356		750,355
Borrowings		84,835		84,829
Accrued interest payable		877		877
Unrecognized financial instruments (net of contract amount):
Commitments to originate loans		-0-		-0-
Lines of credit		-0-		-0-
Letters of credit		-0-		-0-

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.