FAIR VALUE MEASUREMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS

9 Months Ended

Sep. 30, 2012

FAIR VALUE MEASUREMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS [Abstract]

FAIR VALUE MEASUREMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS

NOTE 7—FAIR VALUE MEASUREMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS

The following tables present information about the Company's financial instruments measured at fair value as of September 30, 2012 and December 31, 2011. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement hierarchy has been established for inputs in 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). Determination of the appropriate level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement for the instrument or security.

The fair value hierarchy levels are summarized below:

· Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.

· Level 2 inputs are inputs that are observable for the asset or liability, either directly or indirectly.

· Level 3 inputs are unobservable and contain assumptions of the party assessing the fair value of the asset or liability.

Assets measured at fair value on a recurring basis, segregated by fair value hierarchy level are summarized below:

	Fair value hierarchy levels						Balance as of
	Level 1		Level 2		Level 3		September 30, 2012
	(in thousands)
Assets
Investment securities available for sale
State and political subdivisions	$	—	$	57,573	$	—	$	57,573
Residential mortgage-backed securities issued by quasi-governmental agencies		—		45,044		—		45,044
Residential real estate mortgage-backed securities privately issued		—		4,340		—		4,340
Total investment securities available for sale	$	—	$	106,957	$	—	$	106,957
Loans available for sale
Residential mortgages	$	—	$	860	$	—	$	860

	Fair value hierarchy levels						Balance as of
	Level 1		Level 2		Level 3			December 31, 2011
	(in thousands)
Assets
Investment securities available for sale
U.S. Government and federal agencies	$	—	$	3,030	$	—	$	3,030
State and political subdivisions		—		55,091		—		55,091
Residential mortgage-backed securities issued by quasi-governmental agencies		—		47,494		—		47,494
Residential real estate mortgage-backed securities privately issued		—		8,888		—		8,888
Total investment securities available for sale	$	—	$	114,503	$	—	$	114,503
Loans available for sale
Residential mortgages	$	—	$	488	$	—	$	488

Investment securities available for sale and mortgage-backed securities available for sale are valued primarily by a third party pricing agent. U.S. Government and federal agency and corporate debt securities are primarily priced through a multi-dimensional relational model, a Level 2 hierarchy, which incorporates dealer quotes and other market information including, defined sector breakdown, benchmark yields, base spread, yield to maturity, and corporate actions. State and political subdivision securities are also valued within the Level 2 hierarchy using inputs with a series of matrices that reflect benchmark yields, ratings updates, and spread adjustments. Mortgage-backed securities include Government National Mortgage Association ("GNMA"), Federal Home Loan Mortgage Corporation ("FHLMC") and Federal National Mortgage Association ("FNMA") certificates and privately issued real estate mortgage investment conduits which are valued under a Level 2 hierarchy using a matrix correlation to benchmark yields, spread analysis, and prepayment speeds.

Assets measured at fair value on a nonrecurring basis segregated by fair value hierarchy level at September 30, 2012 are summarized below:

	Fair value hierarchy levels						Balance as of
	Level 1		Level 2		Level 3		September 30, 2012
	(in thousands)
Assets
Impaired loans	$	—	$	—	$	9,444	$	9,444
Real estate acquired through foreclosure		—		—		7,619		7,619
Mortgage servicing rights		—		864		—		864

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Bank has utilized Level 3 inputs to determine fair value at September 30, 2012:

		Fair value		Valuation	Unobservable	Range of
Description		estimate		technique	Input	inputs
	(in thousands)
Impaired loans		$	9,444	Appraisal of collateral	Discount rate to reflect current market conditions and ultimate recoverability		5%-15	%
Real estate acquired through foreclosure			7,619	Appraisal of collateral	Discount rate to reflect current market conditions and liquidation expenses		5%-20	%

The fair value of impaired loans and real estate acquired through foreclosure is generally determined through independent appraisals of the underlying collateral, which generally include level 3 inputs which are not identifiable. Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses are presented as a percent of the appraised value.

Assets measured at fair value on a nonrecurring basis segregated by fair value hierarchy level at December 31, 2011 are summarized below:

	Fair value hierarchy levels						Balance as of
	Level 1		Level 2		Level 3		December 31, 2011
	(in thousands)
Assets
Impaired loans	$	—	$	—	$	8,091	$	8,091
Real estate acquired through foreclosure		—		—		11,730		11,730
Mortgage servicing rights		—		763		—		763

Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of the recorded investment in the loan or fair value. Real estate acquired through foreclosure is initially valued at the lower of the recorded investment in the loan or fair value at foreclosure less costs to sell and subsequently adjusted for further decreases in market value, if necessary. Fair value is determined by using the value of the collateral securing the loans and is therefore classified as a Level 3 hierarchy. The value of the real estate securing impaired loans and real estate acquired through foreclosure is based on appraisals prepared by qualified independent licensed appraisers contracted by the Company to perform the assessment.

The Company initially recognizes and measures servicing assets based on the fair value of the servicing right at the time the loan is sold. The Company uses the amortized cost method for subsequent measurement of its servicing assets and evaluates the recorded value for impairment quarterly. The Company retains a qualified valuation service to calculate the amortized cost and to determine the fair value of the mortgage servicing rights. The valuation service utilizes discounted cash flow analyses, adjusted for prepayment speeds, market discount rates and conditions existing in the secondary servicing market. Hence, the fair value of mortgage servicing rights is deemed a Level 2 hierarchy. The amortized cost basis of the Company's mortgage servicing rights was $1.2 million and $1.0 million at September 30, 2012 and December 31, 2011, respectively. The fair value of the mortgage servicing rights was $864,000 and $763,000 at September 30, 2012 and December 31, 2011, respectively, and was included in other assets in the consolidated balance sheets.

In addition to financial instruments recorded at fair value in the Company's financial statements, disclosure of the estimated fair value of all of an entity's assets and liabilities considered to be financial instruments is also required. For the Bank, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments. However, many such instruments lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. Also, it is the Company's general practice and intent to hold its financial instruments to maturity or available for sale and to not engage in trading or significant sales activities. For fair value disclosure purposes, the Company substantially utilized the established fair value measurement hierarchy.

Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. In addition, there may not be reasonable comparability between entities due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values.

Fair values have been estimated using data which management considered the best available, as generally provided by estimation methodologies deemed suitable for the pertinent category of financial instrument. The recorded carrying amounts and fair values segregated by fair value hierarchy level at September 30, 2012 are summarized below:

	Carrying		Fair		Fair value hierarchy levels
	value		value		Level 1		Level 2		Level 3
Assets	(in thousands)
Cash and cash equivalents	$	3,712	$	3,712	$	3,712	$	—	$	—
Investment securities		57,573		57,573		—		57,573		—
Mortgage-backed securities		51,463		51,802		—		51,802		—
Loans receivable		534,838		552,583		—		860		551,723
Liabilities
Deposits with stated maturities	$	152,011	$	153,834	$	—	$	—	$	153,834
Borrowings with stated maturities		75,156		75,816		—		—		75,816
Deposits with no stated maturities		381,262		381,262		381,262		—		—

The recorded carrying amounts and fair values at December 31, 2011 are summarized below:

	At December 31, 2011
	Carrying value		Fair value
	(in thousands)
Assets
Cash and cash equivalents	$	14,928	$	14,928
Investment securities		58,121		58,121
Mortgage-backed securities		58,970		59,310
Loans receivable		494,613		516,359
Liabilities
Deposits with stated maturities	$	181,074	$	183,306
Borrowings with stated maturities		46,908		48,092
Deposits with no stated maturities		370,214		370,214

The fair value of cash and cash equivalents equals historical book value. The fair value of investment and mortgage-backed securities is described and presented under fair value measurement guidelines as discussed earlier.

The fair value of loans receivable has been estimated using the present value of cash flows, discounted at the approximate current market rates, and giving consideration to estimated prepayment risk but not adjusted for credit risk. Loans receivable also includes loans receivable held for sale.

The fair value of deposits and borrowings with stated maturities has been estimated using the present value of cash flows, discounted at rates approximating current market rates for similar liabilities. Fair value of deposits and borrowings with floating interest rates is generally presumed to approximate the recorded carrying amounts.

The fair value of deposits with no stated maturities is generally presumed to approximate the carrying amount (the amount payable on demand). The fair value of deposits with floating interest rates is generally presumed to approximate the recorded carrying amounts.

The Bank's remaining assets and liabilities are not considered financial instruments. No disclosure of the relationship value of the Bank's depositors or customers is required.