Note 14 – Fair Value

Generally accepted accounting principles provide entities the option to measure eligible financial assets, financial liabilities and commitments at fair value (i.e. the fair value option), on an instrument-by-instrument basis, that are otherwise not permitted to be accounted for at fair value under other accounting standards. The election to use the fair value option is available when an entity first recognizes a financial asset or financial liability or upon entering into a commitment. Subsequent changes in fair value must be recorded in earnings. The Company applies the fair value option on residential mortgage loans held for sale. The fair value option on residential mortgage loans allows the recognition of gains on sale of mortgage loans to more accurately reflect the timing and economics of the transaction.

The standard for fair value measurement establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described on the following page.

Basis of Fair Value Measurement:

Level 1- Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2- Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability;

Level 3- Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported by little or no market activity).

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

Changes to interest rates may result in changes in the cash flows due to prepayments or extinguishments, which could result in higher or lower measurements of the fair values.

Assets and Liabilities

Mortgage loans held for sale

Mortgage loans held for sale are valued based on quotations from the secondary market for similar instruments and are classified as Level 2 of the fair value hierarchy.

Investments available-for-sale

U.S. government agencies, mortgage-backed securities and corporate debt

Valuations are based on active market data and use of evaluated broker pricing models that vary based by asset class and includes available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary models, descriptive terms and conditions databases coupled with extensive quality control programs. Multiple quality control evaluation processes review available market, credit and deal level information to support the evaluation of the security. If there is a lack of objectively verifiable information available to support the valuation, the evaluation of the security is discontinued. Additionally, proprietary models and pricing systems, mathematical tools, actual transacted prices, integration of market developments and experienced evaluators are used to determine the value of a security based on a hierarchy of market information regarding a security or securities with similar characteristics. The Company does not adjust the quoted price for such securities. Such instruments are generally classified within Level 2 of the fair value hierarchy.

State and municipal securities

Proprietary valuation matrices are used for valuing all tax-exempt municipals that can incorporate changes in the municipal market as they occur. Market evaluation models include the ability to value bank qualified municipals and general market municipals that can be broken down further according to insurer, credit support, state of issuance and rating to incorporate additional spreads and municipal curves. Taxable municipals are valued using a third party model that incorporates a methodology that captures the trading nuances associated with these bonds. Such instruments are generally classified within Level 2 of the fair value hierarchy.

Trust preferred securities

In active markets, these types of instruments are valued based on quoted market prices that are readily accessible at the measurement date and are classified within Level 1 of the fair value hierarchy. Positions that are not traded in active markets or are subject to transfer restrictions are valued or adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management uses a process that employs certain assumptions to determine the present value. For further information, refer to Note 2 – Investments. Positions that are not traded in active markets or are subject to transfer restrictions are classified within Level 3 of the fair value hierarchy.

Interest rate swap agreements

Interest rate swap agreements are measured by alternative pricing sources with reasonable levels of price transparency in markets that are not active. Based on the complex nature of interest rate swap agreements, the markets these instruments trade in are not as efficient and are less liquid than that of the more mature Level 1 markets. These markets do however have comparable, observable inputs in which an alternative pricing source values these assets in order to arrive at a fair market value. These characteristics classify interest rate swap agreements as Level 2.

Assets Measured at Fair Value on a Recurring Basis

The following tables set forth the Company’s financial assets and liabilities at the dates indicated that were accounted for or disclosed at fair value. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement:



		September 30, 2014
(In thousands)		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs		Total
						(Level 3)
Assets
Residential mortgage loans held for sale	$	-	$	6,656	$	-	$	6,656
Investments available-for-sale:
U.S. government agencies		-		140,716		-		140,716
State and municipal		-		167,585		-		167,585
Mortgage-backed		-		379,904		-		379,904
Corporate debt		-		2,002		-		2,002
Trust preferred		-		-		1,177		1,177
Marketable equity securities		-		723		-		723
Interest rate swap agreements		-		1,446		-		1,446

Liabilities
Interest rate swap agreements	$	-	$	(1,446)	$	-	$	(1,446)

		December 31, 2013
(In thousands)		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs		Total
						(Level 3)
Assets
Residential mortgage loans held for sale	$	-	$	8,365	$	-	$	8,365
Investments available-for-sale:
U.S. government agencies		-		139,466		-		139,466
State and municipal		-		165,428		-		165,428
Mortgage-backed		-		442,250		-		442,250
Corporate debt		-		2,004		-		2,004
Trust preferred		-		-		1,413		1,413
Marketable equity securities		-		723		-		723
Interest rate swap agreements		-		1,608		-		1,608

Liabilities
Interest rate swap agreements	$	-	$	(1,608)	$	-	$	(1,608)

The following table provides unrealized losses included in assets measured in the Condensed Consolidated Statements of Condition at fair value on a recurring basis for the period indicated:



		Significant Unobservable Inputs
(In thousands)		(Level 3)
Investments available-for-sale:
Balance at January 1, 2014	$	1,413
Total OTTI included in earnings		-
Principal redemption		(352)
Total unrealized losses included in other comprehensive income (loss)		116
Balance at September 30, 2014	$	1,177

Assets Measured at Fair Value on a Nonrecurring Basis

The following table sets forth the Company’s financial assets subject to fair value adjustments (impairment) on a nonrecurring basis at the date indicated that are valued at the lower of cost or market. Assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement:



		September 30, 2014
(In thousands)		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total		Total Losses

Impaired loans	$	-	$	-	$	11,220	$	11,220	$	21,384
Other real estate owned		-		-		1,762		1,762		(227)
Total	$	-	$	-	$	12,982	$	12,982	$	21,157


		December 31, 2013
(In thousands)		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total		Total Losses

Impaired loans	$	-	$	-	$	11,011	$	11,011	$	17,655
Other real estate owned		-		-		1,338		1,338		(309)
Total	$	-	$	-	$	12,349	$	12,349	$	17,346

At September 30, 2014, impaired loans totaling $38.6 million were written down to fair value of $34.3 million as a result of specific loan loss allowances of $4.3 million associated with the impaired loans which was included in the allowance for loan losses. Impaired loans totaling $32.5 million were written down to fair value of $29.5 million at December 31, 2013 as a result of specific loan loss allowances of $3.0 million associated with the impaired loans.

Loan impairment is measured using the present value of expected cash flows, the loan’s observable market price or the fair value of the collateral (less selling costs) if the loans are collateral dependent. 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 client’s business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the factors identified above. Valuation techniques are consistent with those techniques applied in prior periods.

Other real estate owned (“OREO”) is adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair value. The estimated fair value for other real estate owned included in Level 3 is determined by independent market based appraisals and other available market information, less cost to sell, that may be reduced further based on market expectations or an executed sales agreement. If the fair value of the collateral deteriorates subsequent to initial recognition, the Company records the OREO as a non-recurring Level 3 adjustment. Valuation techniques are consistent with those techniques applied in prior periods.

Fair Value of Financial Instruments

The Company discloses fair value information about financial instruments for which it is practicable to estimate the value, whether or not such financial instruments are recognized on the balance sheet. Fair value is the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation, and is best evidenced by a quoted market price, if one exists.

Quoted market prices, where available, are shown as estimates of fair market values. Because no quoted market prices are available for a significant portion of the Company's financial instruments, the fair value of such instruments has been derived based on the amount and timing of future cash flows and estimated discount rates.

Present value techniques used in estimating the fair value of many of the Company's financial instruments are significantly affected by the assumptions used. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate cash settlement of the instrument. Additionally, the accompanying estimates of fair values are only representative of the fair values of the individual financial assets and liabilities, and should not be considered an indication of the fair value of the Company.

The carrying amounts and fair values of the Company’s financial instruments at the dates indicated are presented in the following table:



						Fair Value Measurements
		September 30, 2014				Quoted Prices in
				Estimated		Active Markets for		Significant Other		Significant
		Carrying		Fair		Identical Assets		Observable Inputs		Unobservable Inputs
(In thousands)		Amount		Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets
Investments held-to-maturity and other equity securities	$	258,762	$	260,202	$	-	$	260,202	$	-
Loans, net of allowance		2,938,338		2,882,093		-		-		2,882,093
Other assets		88,031		88,031		-		88,031		-

Financial Liabilities
Time Deposits	$	450,654	$	450,323	$	-	$	450,323	$	-
Securities sold under retail repurchase agreements and federal funds purchased		71,384		71,384		-		71,384		-
Advances from FHLB		558,000		580,738		-		580,738		-
Subordinated debentures		35,000		12,652		-		-		12,652

						Fair Value Measurements
		December 31, 2013				Quoted Prices in
				Estimated		Active Markets for		Significant Other		Significant
		Carrying		Fair		Identical Assets		Observable Inputs		Unobservable Inputs
(In thousands)		Amount		Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets
Investments held-to-maturity and other equity securities	$	265,325	$	256,694	$	-	$	256,694	$	-
Loans, net of allowance		2,784,266		2,692,877		-		-		2,692,877
Other assets		86,213		86,213		-		86,213		-

Financial Liabilities
Time Deposits	$	465,737	$	465,392	$	-	$	465,392	$	-
Securities sold under retail repurchase agreements and federal funds purchased		53,842		53,842		-		53,842		-
Advances from FHLB		615,000		641,901		-		641,901		-
Subordinated debentures		35,000		11,376		-		-		11,376

The following methods and assumptions were used to estimate the fair value of each category of financial instruments for which it is practicable to estimate that value:

Investments held-to-maturity and other equity securities: The fair value of marketable securities is based on quoted market prices, prices quoted for similar instruments, and prices obtained from independent pricing services.

Loans: For certain categories of loans, such as mortgage, installment and commercial loans, the fair value is estimated by discounting the expected future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and similar remaining maturities. Expected cash flows were projected based on contractual cash flows, adjusted for estimated prepayments. These amounts are presented net of the allowance for loan losses.

Other assets: The investment in bank-owned life insurance represents the cash surrender value of the policies at September 30, 2014 and December 31, 2013 as determined by the each insurance carrier.

Time Deposits: The fair value of time deposits is estimated by discounting their cash flows based on their future maturities.

Securities sold under agreements to repurchase and federal funds purchased: The fair value and the carrying value are the same due to the short maturities of those instruments.

Advances from FHLB: The fair value of the Federal Home Loan Bank of Atlanta (“FHLB”) advances is estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms. The Company's credit risk is not material to calculation of fair value because the FHLB borrowings are collateralized. The Company classifies advances from the Federal Home Loan Bank of Atlanta within Level 2 of the fair value hierarchy since the fair value of such borrowings is based on rates currently available for borrowings with similar terms and remaining maturities.

Subordinated debentures: The fair value is estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms. The subordinated debentures are classified as Level 3 in the fair value hierarchy due to the lack of market activity of such instruments.