13. FAIR VALUE

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.

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below:

				Fair Value Measurements at
				December 31, 2012 Using:

	Carrying Value			Quoted Prices In Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
(In thousands)
Financial Assets:
Available for sale securities
U.S. GSE securities	$	178,452			178,452
State and municipal obligations	59,963				59,963
U.S. GSE Residential mortgage-backed securities	20,597				20,597
U.S. GSE Residential collateralized mortgage obligations	226,446				226,446
U.S. GSE Commercial mortgage-backed securities	3,138				3,138
U.S. GSE Commercial collateralized mortgage obligations	9,357				9,357
Non Agency commercial mortgage-backed securities	4,989				4,989
Other Asset backed securities	26,128				26,128
Total available for sale	$	529,070			$	529,070

Financial Liabilities:
Derivatives	$	(176	)		$	(176	)

			Fair Value Measurements at
			December 31, 2011 Using:

	Carrying Value		Quoted Prices In Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
(In thousands)
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	5,237			5,237
Total available for sale	$	441,439		$	441,439

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

			Fair Value Measurements at
			December 31, 2012 Using:

	Carrying Value		Quoted Prices In Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
(In thousands)
Impaired loans	$	178			$	178

			Fair Value Measurements at
			December 31, 2011 Using:

	Carrying Value		Quoted Prices In Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
(In thousands)
Impaired loans	$	1,868			$	1,868
Loans held for sale	2,300				2,300

The fair value of the loan is compared to the carrying value to determine if any write-down or specific reserve is required. These methods of fair value measurement for impaired loans are considered level 3 within the fair value hierarchy described in current accounting guidance. Impaired loans with allocated allowance for loan losses at December 31, 2012, had a carrying amount of $0.2 million, which is made up of the outstanding balance of $0.5 million, net of a valuation allowance of $0.3 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. Charge-offs of $0.9 million were incurred on loans transferred to loans held for sale at December 31, 2011. No loans were transferred to loans held for sale in 2012.

The Company used the following method and assumptions 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 Federal Funds Sold are Level 2.

Securities Available for Sale and Held to Maturity: 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).

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

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).

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.

Impaired Loans: For impaired loans, the Company evaluates the fair value of the loan in accordance with current accounting guidance. 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 location, 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. These adjustments as of December 31, 2012 were not material to the financial statements. 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. Management also considers the appraisal values for commercial properties associated with current loan origination activity. Collectively, this information is reviewed to help assess current trends in commercial property values. For each collateral dependent impaired loan, management considers information that relates to the type of commercial property to determine if such properties may have appreciated or depreciated in value since the date of the most recent appraisal. Adjustments to fair value are made only when the analysis indicates a probable decline in collateral values.

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).

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 December 31, 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 values of the Company’s financial instruments are as follows:

Fair Value Measurement at

December 31, 2012 Using:

(In thousands)

Carrying
Amount

Quoted
Prices In
Active
Markets for
Identical
Assets
(Level 1)

Significant
Other
Observable
Inputs
(Level 2)

Significant
Unobservable
Inputs
(Level 3)

Total

Financial Assets:

Cash and due from banks

46,855

—

46,855

Interest bearing deposits with banks

4,394

—

4,394

—

4,394

Securities available for sale

529,070

—

529,070

—

529,070

Securities restricted

2,978

n/a

Securities held to maturity

210,735

—

213,702

—

213,702

Loans, net

784,007

—

807,597

Accrued interest receivable

5,436

—

2,945

2,491

5,436

Financial Liabilities:

Certificates of deposit

157,248

—

158,764

—

158,764

Demand and other deposits

1,252,074

—

1,252,074

Federal funds purchased and Federal Home Loan Bank overnight borrowings

44,500

—

44,500

Federal Home Loan Bank term advances

15,000

—

14,824

—

14,824

Repurchase agreements

12,390

—

13,064

—

13,064

Junior Subordinated Debentures

16,002

—

17,101

Derivatives

176

—

176

—

176

Accrued interest payable

147

146

—

147

December 31,

2011

(In thousands)

Carrying

Fair

Amount

Value

Financial Assets:

Cash and due from banks

25,921

Interest bearing deposits with banks

53,625

Securities available for sale

441,439

Securities restricted

1,660

n/a

Securities held to maturity

169,153

170,952

Loans, net (including loans held for sale)

603,606

632,616

Accrued interest receivable

4,940

Financial liabilities:

Demand and other deposits

1,188,185

1,190,080

Federal funds purchased and Federal Home Loan Bank overnight borrowings

—

Repurchase agreements

16,897

17,990

Junior subordinated debentures

16,002

16,915

Accrued interest payable

319