ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

6 Months Ended

Jun. 30, 2012

ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

5. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

FASB ASC No. 820-10 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820-10 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 values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other 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.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Investment Securities: The estimated fair values are based on independent dealer quotations on nationally recognized securities exchanges, if available (Level 1). For securities where quoted prices are not available, fair value is based on matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2).

Derivatives: Represents an interest rate swap and the estimated fair values are based on valuation models using observable market data as of measurement date (Level 2).

Impaired Loans:  At the time a loan is considered impaired, it is valued at the lower of cost or fair value.  For loans that are collateral dependent, the fair value of the collateral is used to determine the fair value of the loan. The fair value of the collateral is determined based upon recent appraised values. 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 independent appraisers to adjust for differences between the comparable sales and income data available. Adjustments may relate to locate, square footage, condition, amenities, market rate of leases as well as timing of comparable sales. Such adjustments are generally capped at 15% of appraised value and typically result in a Level 3 classification of the inputs for determining fair value. The fair value of the loan is compared to the carrying value to determine if any write-down or specific reserve is required. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Appraisals for collateral-dependent impaired loans are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company.  Once received, the Credit Administration department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.  On a quarterly basis, the Company compares the actual selling price of collateral that has been sold to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value.  The most recent analysis performed indicated that a discount of 1-5% should be applied to residential properties with appraisals performed within 12 months and an appreciation of 16-18% should be applied to commercial properties with appraisals performed within 12 months.

Loans Held For Sale:  Loans held for sale are carried at the lower of cost or fair values.  The fair value of loans held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan or other observable market data, such as outstanding commitments from third party investors (Level 3).

Assets and liabilities measured on a recurring basis:

				Fair Value Measurements at
				June 30, 2012 Using:
					Significant
				Quoted Prices In	Other			Significant
				Active Markets for	Observable			Unobservable
	Carrying			Identical Assets	Inputs			Inputs
(In thousands)	Value			(Level 1)	(Level 2)			(Level 3)
Financial Assets:
Available for sale securities:
U.S. GSE securities	$	109,910			$	109,910
State and municipal obligations	63,869				63,869
U.S. GSE residential mortgage-backed securities	31,914				31,914
U.S. GSE residential collateralized mortgage obligations	221,539				221,539
U.S. GSE commercial collateralized mortgage obligations (1)	9,384				9,384
Non Agency commercial mortgage-backed securities	5,062				5,062
Other Asset backed securities	7,815				7,815
Total available for sale	$	449,493			$	449,493
Derivatives	$	(34	)		$	(34	)

			Fair Value Measurements at
			December 31, 2011 Using:
				Significant
			Quoted Prices In	Other		Significant
			Active Markets for	Observable		Unobservable
	Carrying		Identical Assets	Inputs		Inputs
(In thousands)	Value		(Level 1)	(Level 2)		(Level 3)
Financial Assets:
Available for sale securities:
U.S. GSE securities	$	131,674		$	131,674
State and municipal obligations	54,219			54,219
U.S. GSE residential mortgage-backed securities	70,984			70,984
U.S. GSE residential collateralized mortgage obligations	179,325			179,325
U.S. GSE commercial collateralized mortgage obligations (1)	5,237			5,237
Total available for sale	$	441,439		$	441,439

(1)U.S. GSE commercial collateralized mortgage obligations represent securities with multi-family mortgage loans as the collateral.

Assets measured at fair value on a non-recurring basis are summarized below:

			Fair Value Measurements at
			June 30, 2012 Using:
				Significant
			Quoted Prices In	Other	Significant
			Active Markets for	Observable	Unobservable
	Carrying		Identical Assets	Inputs	Inputs
(In thousands)	Value		(Level 1)	(Level 2)	(Level 3)
Impaired loans	$	262			$	262

			Fair Value Measurements at
			December 31, 2011 Using:
				Significant
			Quoted Prices In	Other	Significant
			Active Markets for	Observable	Unobservable
	Carrying		Identical Assets	Inputs	Inputs
(In thousands)	Value		(Level 1)	(Level 2)	(Level 3)
Impaired loans	$	1,868			$	1,868
Loans held for sale	2,300				2,300

Impaired loans with allocated allowance for loan losses at June 30, 2012, had a carrying amount of $0.3 million, which is made up of the outstanding balance of $0.8 million, net of a valuation allowance of $0.5 million. This resulted in an additional provision for loan losses of $0.3 million that is included in the amount reported on the income statement. Impaired loans with allocated allowance for loan losses at December 31, 2011, had a carrying amount of $1.9 million, which is made up of the outstanding balance of $2.1 million, net of a valuation allowance of $0.2 million. This resulted in an additional provision for loan losses of $0.2 million that is included in the amount reported on the income statement.

Loans held for sale at December 31, 2011 had a carrying amount and outstanding balance of $2.3 million. There was no valuation allowance at December 31, 2011. Charge-offs of $0.9 million were incurred on loans transferred to loans held for sale at December 31, 2011. These loans were subsequently sold in January 2012 with no gain or loss incurred.

The Company used the following method and assumptions, not previously presented, in estimating the fair value of its financial instruments:

Cash and Due from Banks and Federal Funds Sold: Carrying amounts approximate fair value, since these instruments are either payable on demand or have short-term maturities. Cash on hand and non-interest due from bank accounts are Level 1 and interest bearing Cash Due from Banks and and Federal Funds Sold are Level 2.

Restricted Securities: It is not practicable to determine the fair value of FHLB, ACBB and FRB stock due to restrictions placed on its transferability.

Loans: The estimated fair values of real estate mortgage loans and other loans receivable are based on discounted cash flow calculations that use available market benchmarks when establishing discount factors for the types of loans resulting in a Level 3 classification. Exceptions may be made for adjustable rate loans (with resets of one year or less), which would be discounted straight to their rate index plus or minus an appropriate spread. All nonaccrual loans are carried at their current fair value. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price and therefore, while permissible for presentation purposed under ASC 825-10, do not conform with ASC 820-10.

Deposits: The estimated fair value of certificates of deposits are based on discounted cash flow calculations that use a replacement cost of funds approach to establishing discount rates for certificates of deposits maturities resulting in a Level 2 classification. Stated value is fair value for all other deposits resulting in a Level 1 classification.

Borrowed Funds: The estimated fair value of borrowed funds are based on discounted cash flow calculations that use a replacement cost of funds approach to establishing discount rates for funding maturities resulting in a Level 2 classification.

Junior Subordinated Debentures: The estimated fair value is based on estimates using market data for similarly risk weighted items and takes into consideration the convertible features of the debentures into common stock of the Company which is an unobservable input resulting in a Level 3 classification.

Accrued Interest Receivable and Payable: For these short-term instruments, the carrying amount is a reasonable estimate of the fair value resulting in a Level 1 or 2 classification.

Off-Balance-Sheet Liabilities: The fair value of off-balance-sheet commitments to extend credit is estimated using fees currently charged to enter into similar agreements. The fair value is immaterial as of June 30, 2012 and December 31, 2011.

Fair value estimates are made at specific points in time and are based on existing on-and off-balance sheet financial instruments. Such estimates are generally subjective in nature and dependent upon a number of significant assumptions associated with each financial instrument or group of financial instruments, including estimates of discount rates, risks associated with specific financial instruments, estimates of future cash flows, and relevant available market information. Changes in assumptions could significantly affect the estimates. In addition, fair value estimates do not reflect the value of anticipated future business, premiums or discounts that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument, or the tax consequences of realizing gains or losses on the sale of financial instruments.

The estimated fair values and recorded carrying amounts of the Bank’s financial instruments at June 30, 2012 and December 31, 2011 are as follows:

			Fair Value Measurements at
			June 30, 2012 Using:
					Significant
			Quoted Prices In		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
(In thousands)	Amount		(Level 1)		(Level 2)		(Level 3)		Total
Financial assets:
Cash and due from banks	$	29,034	$	29,034	$	—	$	—	$	29,034
Interest bearing deposits with banks	35,183		—		35,183		—		35,183
Securities available for sale	449,493		—		449,493		—		449,493
Securities restricted	2,828		n/a		n/a		n/a		n/a
Securities held to maturity	177,922		—		180,344		—		180,344
Loans, net	664,976		—		—		695,024		695,024
Accrued interest receivable	5,029		—		2,797		2,232		5,029
Financial liabilities:
Certificates of deposit	176,585				178,184		—		178,184
Demand and other deposits	1,053,939		1,053,939		—		—		1,053,939
Federal Home Loan Bank term advances	15,000		—		15,017		—		15,017
Repurchase agreements	12,317		—		13,101		—		13,101
Junior Subordinated Debentures	16,002		—		—		17,283		17,283
Accrued interest payable	233		11		222		—		233

	At December 31, 2011
	Carrying		Fair
(In thousands)	Amount		Value
Financial assets:
Cash and due from banks	$	25,921	$	25,921
Interest bearing deposits with banks	53,625		53,625
Securities available for sale	441,439		441,439
Securities restricted	1,660		n/a
Securities held to maturity	169,153		170,952
Loans, net	603,606		632,616
Accrued interest receivable	4,940		4,940
Financial liabilities:
Demand and other deposits	1,188,185		1,190,080
Repurchase agreements	16,897		17,990
Junior Subordinated Debentures	16,002		16,915
Accrued interest payable	319		319