Fair Value of Financial Instruments

12 Months Ended

Dec. 31, 2012

Fair Value of Financial Instruments [Abstract]

Fair Value of Financial Instruments

Note 15 — Fair Value of Financial Instruments

The Company records investments available for sale, loans held-for-sale, certain impaired loans, OREO and mortgage servicing rights at fair value. Fair value measurement is determined based on the assumptions that market participants would use in pricing the asset or liability in an exchange. The definition of fair value includes the exchange price which is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal market for the asset or liability. Market participant assumptions include assumptions about risk, the risk inherent in a particular valuation technique used to measure fair value and/or the risk inherent in the inputs to the valuation technique, as well as the effect of credit risk on the fair value of liabilities. The Company uses three levels of the fair value inputs to measure assets, as described below.

Basis of Fair Value Measurement:

Level 1 – Valuations based on quoted prices in active markets for identical investments.

Level 2 – Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Level 2 inputs include: (i) quoted prices for similar investments in active markets; (ii) quoted prices for identical investments traded in non-active markets (i.e., dealer or broker markets); and (iii) inputs other than quoted prices that are observable or inputs derived from or corroborated by market data for substantially the full term of the investment.

Level 3 – Valuations based on inputs that are unobservable, supported by little or no market activity, and significant to the overall fair value measurement.

The following table presents the carrying amounts and fair values of the Company's financial instruments. ASC 820, "Fair Value Measurements and Disclosures," present requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term "fair value:" (in thousands)

	Level in	December 31, 2012				December 31, 2011
	Fair Value	Carrying		Fair		Carrying		Fair
	Heirarchy	Amount		Value		Amount		Value
Cash and due from banks	Level 1	$	384,656	$	384,656	$	172,559	$	172,559
Cash equivalents	Level 2		1,150		1,150		-		-
Federal Reserve Bank, Federal Home Loan Bank and other stock	N/A		3,043		N/A		2,536		N/A
Investment securities held to maturity	Level 2		8,035		8,861		9,315		10,161
Investment securities available for sale	Level 2		402,353		402,353		291,210		291,210
Investment securities available for sale	Level 3		-		-		7,994		7,994
Loans held-for-sale	Level 3		907		907		-		-
Loans, net of allowance	Level 2		762,999		787,597		929,696		960,070
Accrued interest and loan fees receivable	Level 2		4,883		4,883		6,885		6,885
Non-maturity deposits	Level 2		1,187,383		1,187,383		1,056,923		1,056,923
Time deposits	Level 2		243,731		245,595		254,949		257,267
Accrued interest payable	Level 2		237		237		348		348

Fair value estimates are made at a specific point in time and may be based on judgments regarding losses expected in the future, risk, and other factors that are subjective in nature. The methods and assumptions used to produce the fair value estimates follow.

Short-term financial instruments are valued at the carrying amounts included in the condensed consolidated statements of condition, which are reasonable estimates of fair value due to the relatively short term nature of the instruments. This approach applies to cash and cash equivalents; accrued interest and loan fees receivable; non-interest-bearing demand deposits; N.O.W., money market, and saving accounts; and accrued interest payable. Certificates of deposit are valued using a replacement cost of funds approach.

Fair values are estimated for portfolios of loans with similar characteristics. The fair value of performing loans was calculated by discounting projected cash flows through their estimated maturity using market discount rates that reflect the general credit and interest rate characteristics of the loan. category. The maturity horizon is based on the Bank's history of repayments for each type of loan and an estimate of the effect of current economic conditions. Fair value for significant non-performing loans is based on recent external appraisals of collateral, if any. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the associated risk. Assumptions regarding credit risk, cash flows, and discount rates are made using availablemarket information and specific borrower information.

The fair value of loans held-for-sale is based upon binding contracts from third party investors.

Assets measured at fair value on a non-recurring basis are as follows: (in thousands)

Fair Value Measurements Using
			Significant
			Unobservable
			Inputs
Description	December 31, 2012		(Level 3)
Impaired loans	$	9,390	$	9,390
Other real estate owned		1,572		1,572
Total	$	10,962	$	10,962
Fair Value Measurements Using
			Significant
			Unobservable
			Inputs
Description	December 31, 2011		(Level 3)
Impaired loans	$	118,613	$	118,613
Other real estate owned		1,800		1,800
Total	$	120,413	$	120,413

 

OREO properties are initially recorded at fair value, less estimated costs to sell when acquired, establishing a new cost basis. Adjustments to OREO are measured at fair value, less estimated costs to sell. Fair values are generally based on third party appraisals or realtor evaluations of the property. These appraisals and evaluations may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less estimated costs to sell, an impairment loss is recognized through a valuation allowance, and the property is reported as non-recurring Level 3.

Loans identified as impaired are measured using one of three methods: the loan's observable market price, the fair value of collateral or the present value of expected future cash flows. Those measured using the loan's observable market price or the fair value of collateral are recorded at fair value. For each period presented, no impaired loans were measured using the loan's observable market price. If an impaired loan has had a charge-off or if the fair value of the collateral is less than the recorded investment in the loan, the Company establishes a specific reserve and reports the loan as non-recurring Level 3. The fair value of collateral of impaired loans is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

The following tables summarize fair value measurements on a recurring basis as of December 31, 2012 and 2011: (in thousands)

Fair Value Measurements Using
				Significant Other			Significant
				Observable Inputs			Unobservable Inputs
Description	December 31, 2012			(Level 2)			(Level 3)
U.S. Treasury Securities		$	500		$	500		$	-
U.S. Government Agency securities			65,078			65,078			-
Corporate bonds			16,198			16,198			-
Collateralized mortgage obligations			89,692			89,692			-
Mortgage-backed securities			62,450			62,450			-
Obligations of states and political subdivisions			168,435			168,435			-
Loans held-for-sale			907			-			907
Mortgage servicing rights			1,856			-			1,856
Total		$	405,116		$	402,353		$	2,763

Fair Value Measurements Using
				Significant Other			Significant
				Observable Inputs			Unobservable Inputs
Description	December 31, 2011			(Level 2)			(Level 3)
Obligations of states and political subdivisions		$	171,992		$	171,992		$	-
Collateralized mortgage obligations			126,770			118,776			7,994
Mortgage-backed securities			442			442			-
Mortgage servicing rights			1,623			-			1,623
Total		$	300,827		$	291,210		$	9,617

For the year ended December 31, 2012, there were no longer any investment securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) due to the sale of two private label CMOs during the third quarter of 2012 as part of management's efforts to reduce overall balance sheet risk. These securities had previously been written down by $1.1 million in the fourth quarter of 2011 due to OTTI evident at that time. The Company owns no other private label CMOs.

The tables below present reconciliations for the CMOs measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2012 and 2011: (in thousands)

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Balance at January 1, 2012	$	7,994
Other-than-temporary impairment		-
Included in other comprehensive income		-
Sales		(7,994	)
Balance at December 31, 2012	$	-
Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Balance at January 1, 2011	$	-
Transferred in from level 2		7,994
Other-than-temporary impairment		-
Included in other comprehensive income		-
Sales		-
Balance at December 31, 2011	$	7,994

The types of instruments valued based on quoted market prices in active markets include most U.S. Treasury securities. Such instruments are generally classified within Level 1 and Level 2 of the fair value hierarchy. The Company does not adjust the quoted price for such instruments.

The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include U.S. Government agency securities, state and municipal obligations, mortgage-backed securities, collateralized mortgage obligations and corporate bonds. Such instruments are generally classified within Level 2 of the fair value hierarchy.

The types of instruments valued based on significant unobservable inputs that reflect the Company's own assumptions about the assumptions that market participants would use in pricing an asset or liability are generally classified within Level 3 of the fair value hierarchy. The significant unobservable inputs used in the fair value measurements of the Company's Level 3 CMOs at December 31, 2011 were voluntary prepayment rates, conditional default rates and loss severity in the event of default. Significant increases or decreases in any of those inputs in isolation would result in a significantly higher or lower fair value measurement. Generally, a change in the assumption used for the conditional default rates is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for voluntary prepayment rates.

ASC 820 provides additional guidance in determining fair values when the volume and level of activity for the asset or liability have significantly decreased, particularly when there is no active market or where the price inputs being used represent distressed sales. It also provides guidelines for making fair value measurements more consistent with principles, reaffirming the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets become inactive.

The fair value of commitments to extend credit was estimated by either discounting cash flows or using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the current creditworthiness of the counter-parties. The estimated fair value of written financial guarantees and letters of credit is based on fees currently charged for similar agreements. The fees charged for the commitments were not material in amount.