Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2011

Fair Value of Financial Instruments [Abstract]

Fair Value of Financial Instruments

Note 11 - Fair Value of Financial Instruments

The inputs to valuation techniques used to measure fair value are assigned to one of three broad levels:

· Level 1 – quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the reporting date.

· Level 2 – inputs other than quoted prices included within level 1 that are observable for the asset or liability either directly or indirectly.  Level 2 inputs may include quoted prices for similar assets in active markets,  quoted prices for identical assets or liabilities in markets that are not active, inputs other than quoted prices (such as interest rates or yield curves) that are observable for the asset or liability, and inputs that are derived from or corroborated by observable market data.

· Level 3 - inputs that are unobservable for the asset or liability.

The majority of LCNB's financial debt securities are classified as available-for-sale.  The securities are reported at fair value with unrealized holding gains and losses reported net of income taxes in accumulated other comprehensive income.

LCNB utilizes a pricing service for determining the fair values of most of its investment securities.  Fair value for U.S. Treasury notes and corporate securities are determined based on market quotations (level 1).  Fair value for most of the other investment securities is calculated using the discounted cash flow method for each security.  The discount rates for these cash flows are estimated by the pricing service using rates observed in the market (level 2).  Cash flow streams are dependent on estimated prepayment speeds and the overall structure of the securities given existing market conditions.  The investments in mutual funds are considered to have level 3 inputs because LCNB does not have precise information about the methods used by the mutual fund companies to assign fair values or full information on the investments made by the funds.  Additionally, LCNB Corp. owns trust preferred securities in various financial institutions and equity securities in non-financial companies.   Market quotations (level 1) are used to determine fair values for these investments.

The following table summarizes the valuation of LCNB's available-for-sale securities by input levels as of September 30, 2011 and December 31, 2010 (in thousands):

			Fair Value Measurements at Reporting Date Using
	Fair Value Measurements		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
September 30, 2011
Available-for-sale securities:
U.S. Treasury notes	$	17,519		17,519		-		-
U.S. Agency notes		104,100		-		104,100		-
U.S. Agency mortgage- backed securities		47,672		-		47,672		-
Corporate securities		6,359		6,359		-		-
Municipal securities:
Non-taxable		67,299		-		67,299		-
Taxable		22,400		-		22,400		-
Mutual funds		1,616		-		-		1,616
Trust preferred securities		575		575		-		-
Equity securities		477		477		-		-
Totals	$	268,017		24,930		241,471		1,616
December 31, 2010
Available-for-sale securities:
U.S. Treasury notes	$	19,585		19,585		-		-
U.S. Agency notes		82,862		-		82,862		-
U.S. Agency mortgage- backed securities		33,094		-		33,094		-
Corporate securities		2,025		2,025		-		-
Municipal securities:
Non-taxable		74,428		-		74,428		-
Taxable		21,968		-		21,968		-
Mutual fund		1,053		-		-		1,053
Trust preferred securities		604		604		-		-
Equity securities		263		263		-		-
Totals	$	235,882		22,477		212,352		1,053

The following table is a reconciliation of the beginning and ending balances of recurring fair value measurements that use significant unobservable inputs (level 3) for the nine months ended September 30, 2011 and 2010 (in thousands):

	Nine Months Ended September 30,
	2011		2010
	Mutual Funds		Total		Mutual Funds		Equity Securities
Beginning balance	$	1,053		561		538		23
Purchases		500		-		-		-
Dividends reinvested		25		14		14		-
Net change in unrealized gains (losses) included in other comprehensive income		38		18		18		-
Ending balance	$	1,616		593		570		23

Assets that may be recorded at fair value on a nonrecurring basis include impaired loans, other real estate owned, and other repossessed assets.  A loan is considered impaired when management believes it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement.  Impaired loans are carried at the present value of estimated future cash flows using the loan's existing rate or the fair value of collateral if the loan is collateral dependent and if this value is less than the loan balance.  When the fair value of the collateral is based on an observable market price or current appraised value, the inputs are considered to be level 2.  When an appraised value is not available and there is not an observable market price, the inputs are considered to be level 3.

Other real estate owned is adjusted to fair value upon transfer of the loan to foreclosed assets, usually based on an appraisal of the property.  Subsequently, foreclosed assets are carried at the lower of carrying value or fair value.  The inputs for a valuation based on current appraised value are considered to be level 2.

The table below presents LCNB's impaired loans, other real estate owned, and repossessed assets measured at fair value on a nonrecurring basis as of September 30, 2011 and December 31, 2010 by the level in the fair value hierarchy within which the inputs for these measurements fall (in thousands):

			Fair Value Measurements at Reporting Date Using
	Fair Value Measurements		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
September 30, 2011
Impaired loans	$	5,168		-		1,167		4,001
Other real estate owned		2,088		-		2,088		-
Repossessed assets		8		-		-		8
Totals	$	7,264		-		3,255		4,009
December 31, 2010
Impaired loans	$	4,080		-		1,430		2,650
Other real estate owned		2,088		-		2,088		-
Repossessed assets		26		-		-		26
Totals	$	6,194		-		3,518		2,676

Carrying amounts and estimated fair values of financial instruments as of September 30, 2011 and December 31, 2010 were as follows (in thousands):

	September 30, 2011				December 31, 2010
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
FINANCIAL ASSETS:
Cash and cash equivalents	$	32,657		32,657		10,999		10,999
Investment securities:
Available-for-sale		268,017		268,017		235,882		235,882
Held-to-maturity		11,133		11,133		12,141		12,141
Federal Reserve Bank stock		941		941		939		939
Federal Home Loan Bank stock		2,091		2,091		2,091		2,091
Loans, net		446,295		459,453		452,350		465,053
FINANCIAL LIABILITIES:
Deposits		689,697		695,965		638,539		642,734
Short-term borrowings		12,386		12,386		21,691		21,691
Long-term debt		21,718		22,986		23,120		24,217

The fair value of off-balance-sheet financial instruments at September 30, 2011 and December 31, 2010 was not material.

Fair values of financial instruments are based on various assumptions, including the discount rate and estimates of future cash flows.  Therefore, the fair values presented may not represent amounts that could be realized in actual transactions.  In addition, because the required disclosures exclude certain financial instruments and all nonfinancial instruments, any aggregation of the fair value amounts presented would not represent the underlying value of LCNB.  The following methods and assumptions were used to estimate the fair value of certain financial instruments:

Cash and cash equivalents

The carrying amounts presented are deemed to approximate fair value.

Investment securities

Fair values for securities, excluding Federal Home Loan Bank and Federal Reserve Bank stock, are based on quoted market prices, if available.  If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities and/or discounted cash flow analyses or other methods.  The carrying value of Federal Home Loan Bank and Federal Reserve Bank stock approximates fair value based on the respective redemptive provisions.

Loans

Fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, incorporating assumptions of current and projected prepayment speeds.

Deposits

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date.  The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.

Borrowings

The carrying amounts of federal funds purchased, repurchase agreements, and U.S. Treasury demand note borrowings are deemed to approximate fair value of short-term borrowings.  For long-term debt, fair values are estimated based on the discounted value of expected net cash flows using current interest rates.