10-Q 1 cvcy-2013q210q.htm 10-Q CVCY-2013. Q2 10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
(Mark One)
 
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE QUARTERLY PERIOD ENDED June 30, 2013
 
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE TRANSITION PERIOD FROM                        TO
 
COMMISSION FILE NUMBER: 000—31977
 
CENTRAL VALLEY COMMUNITY BANCORP
(Exact name of registrant as specified in its charter)
 
California
 
77-0539125
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
7100 N. Financial Dr, Suite 101, Fresno, California
 
93720
(Address of principal executive offices)
 
(Zip code)
 
Registrant’s telephone number (559) 298-1775
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ý  No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ý  No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company x
(Do not check if a smaller reporting company)
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o No  ý
As of August 08, 2013 there were 10,912,735 shares of the registrant’s common stock outstanding.

1



CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
 
2013 QUARTERLY REPORT ON FORM 10-Q
 
TABLE OF CONTENTS
 
 


2

PART 1: FINANCIAL INFORMATION
 

ITEM 1: FINANCIAL STATEMENTS

CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
 
(In thousands, except share amounts)
 
June 30, 2013
 
December 31, 2012
 
 
(Unaudited)
 
 
ASSETS
 
 

 
 

Cash and due from banks
 
$
16,492

 
$
22,405

Interest-earning deposits in other banks
 
20,929

 
30,123

Federal funds sold
 
30

 
428

Total cash and cash equivalents
 
37,451

 
52,956

Available-for-sale investment securities (Amortized cost of $377,074 at June 30, 2013 and $381,074 at December 31, 2012)
 
374,840

 
393,965

Loans, less allowance for credit losses of $9,601 at June 30, 2013 and $10,133 at December 31, 2012
 
395,343

 
385,185

Bank premises and equipment, net
 
6,370

 
6,252

Bank owned life insurance
 
12,356

 
12,163

Federal Home Loan Bank stock
 
3,802

 
3,850

Goodwill
 
23,577

 
23,577

Core deposit intangibles
 
483

 
583

Accrued interest receivable and other assets
 
17,150

 
11,697

Total assets
 
$
871,372

 
$
890,228

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 

 
 

Deposits:
 
 

 
 

Non-interest bearing
 
$
222,181

 
$
240,169

Interest bearing
 
516,216

 
511,263

Total deposits
 
738,397

 
751,432

Short-term borrowings
 
—

 
4,000

Junior subordinated deferrable interest debentures
 
5,155

 
5,155

Accrued interest payable and other liabilities
 
16,278

 
11,976

Total liabilities
 
759,830

 
772,563

Commitments and contingencies (Note 9)
 


 


Shareholders’ equity:
 
 

 
 

Preferred stock, no par value, $1,000 per share liquidation preference; 10,000,000 shares authorized, Series C, issued and outstanding: 7,000 shares at June 30, 2013 and December 31, 2012
 
7,000

 
7,000

Common stock, no par value; 80,000,000 shares authorized; issued and outstanding: 9,649,600 at June 30, 2013 and 9,558,746 at December 31, 2012
 
41,422

 
40,583

Retained earnings
 
64,435

 
62,496

Accumulated other comprehensive (loss) income, net of tax
 
(1,315
)
 
7,586

Total shareholders’ equity
 
111,542

 
117,665

Total liabilities and shareholders’ equity
 
$
871,372

 
$
890,228

 
See notes to unaudited consolidated financial statements.

3


CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
 
 
For the Three Months
Ended June 30,
 
For the Six Months Ended June 30,
(In thousands, except share and per share amounts) 
 
2013
 
2012
 
2013
 
2012
INTEREST INCOME:
 
 
 
 
 
 

 
 

Interest and fees on loans
 
$
5,435

 
$
6,053

 
$
10,846

 
$
12,137

Interest on deposits in other banks
 
29

 
16

 
59

 
34

Interest on Federal funds sold
 
—

 
1

 
—

 
1

Interest and dividends on investment securities:
 
 
 
 
 
 
 
 
Taxable
 
352

 
880

 
753

 
1,953

Exempt from Federal income taxes
 
1,398

 
1,078

 
2,736

 
2,115

Total interest income
 
7,214

 
8,028

 
14,394

 
16,240

INTEREST EXPENSE:
 
 
 
 
 
 

 
 

Interest on deposits
 
312

 
455

 
605

 
936

Interest on junior subordinated deferrable interest debentures
 
24

 
26

 
49

 
55

Other
 
—

 
37

 
17

 
73

Total interest expense
 
336

 
518

 
671

 
1,064

Net interest income before provision for credit losses
 
6,878

 
7,510

 
13,723

 
15,176

PROVISION FOR CREDIT LOSSES
 
—

 
100

 
—

 
500

Net interest income after provision for credit losses
 
6,878

 
7,410

 
13,723

 
14,676

NON-INTEREST INCOME:
 
 
 
 
 
 

 
 

Service charges
 
673

 
676

 
1,371

 
1,365

Appreciation in cash surrender value of bank owned life insurance
 
97

 
96

 
193

 
190

Loan placement fees
 
214

 
99

 
379

 
227

Net realized gain on sale of assets
 
1

 
4

 
1

 
4

Net gain on disposal of other real estate owned
 
—

 
14

 
—

 
12

Net realized gains on sales of investment securities
 
320

 
97

 
1,133

 
444

Federal Home Loan Bank dividends
 
32

 
3

 
54

 
7

Other income
 
491

 
482

 
923

 
880

Total non-interest income
 
1,828

 
1,471

 
4,054

 
3,129

NON-INTEREST EXPENSES:
 
 
 
 
 
 

 
 

Salaries and employee benefits
 
3,974

 
3,957

 
7,868

 
8,086

Occupancy and equipment
 
901

 
877

 
1,802

 
1,758

Regulatory assessments
 
154

 
169

 
297

 
325

Data processing expense
 
289

 
283

 
592

 
577

Advertising
 
80

 
140

 
222

 
280

Audit and accounting fees
 
136

 
125

 
271

 
253

Legal fees
 
71

 
54

 
102

 
82

Merger expenses
 
380

 
—

 
513

 
—

Other real estate owned, net
 
—

 
9

 
—

 
72

Amortization of core deposit intangibles
 
50

 
50

 
100

 
100

Other expense
 
1,189

 
1,054

 
2,390

 
2,103

Total non-interest expenses
 
7,224

 
6,718

 
14,157

 
13,636

Income before provision for income taxes
 
1,482

 
2,163

 
3,620

 
4,169

Provision for income taxes
 
195

 
454

 
550

 
747

Net income
 
$
1,287

 
$
1,709

 
$
3,070

 
$
3,422

Preferred stock dividends and accretion
 
88

 
87

 
175

 
175

Net income available to common shareholders
 
$
1,199

 
$
1,622

 
$
2,895

 
$
3,247

Net income per common share:
 
 
 
 
 
 

 
 

Basic earnings per share
 
$
0.13

 
$
0.17

 
$
0.30

 
$
0.34

Weighted average common shares used in basic computation
 
9,587,376

 
9,592,045

 
9,573,257

 
9,581,172

Diluted earnings per share
 
$
0.12

 
$
0.17

 
$
0.30

 
$
0.34

Weighted average common shares used in diluted computation
 
9,644,938

 
9,618,976

 
9,629,771

 
9,604,056

Cash dividend per common share
 
$
0.05

 
$
—

 
$
0.10

 
$
—

 
See notes to unaudited consolidated financial statements.

4


CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
 
 
 
For the Three Months
Ended June 30,
 
For the Six Months Ended June 30,
(In thousands)
 
2013
 
2012
 
2013
 
2012
Net income
 
$
1,287

 
$
1,709

 
$
3,070

 
$
3,422

Other Comprehensive Income (Loss):
 
 
 
 
 
 
 
 
Unrealized gains (losses) on securities:
 
 
 
 
 
 
 
 
Unrealized holdings gains (losses)
 
(11,921
)
 
1,602

 
(13,992
)
 
4,192

Less: reclassification for net gains included in net income
 
320

 
97

 
1,133

 
444

Other comprehensive income (loss), before tax
 
(12,241
)
 
1,505

 
(15,125
)
 
3,748

Tax benefit (expense) related to items of other comprehensive income
 
5,037

 
(620
)
 
6,224

 
(1,543
)
Total other comprehensive income (loss)
 
(7,204
)
 
885

 
(8,901
)
 
2,205

Comprehensive income (loss)
 
$
(5,917
)
 
$
2,594

 
$
(5,831
)
 
$
5,627


See notes to unaudited consolidated financial statements.




5

CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
 
 
For the Six Months Ended June 30,
(In thousands)
 
2013
 
2012
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 

 
 

Net income
 
$
3,070

 
$
3,422

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
 

Net (decrease) increase in deferred loan fees
 
(162
)
 
170

Depreciation
 
501

 
486

Accretion
 
(385
)
 
(346
)
Amortization
 
4,675

 
3,376

Stock-based compensation
 
50

 
64

Tax benefit from exercise of stock options
 
(16
)
 
(20
)
Provision for credit losses
 
—

 
500

Net realized gains on sales of available-for-sale investment securities
 
(1,133
)
 
(444
)
Net gain on sale and disposal of equipment
 
(1
)
 
(4
)
Net gain on sale of other real estate owned
 
—

 
(12
)
Increase in bank owned life insurance, net of expenses
 
(193
)
 
(190
)
Net (increase) decrease in accrued interest receivable and other assets
 
(205
)
 
14

Net decrease in prepaid FDIC assessments
 
1,542

 
257

Net decrease in accrued interest payable and other liabilities
 
(124
)
 
(8,521
)
(Benefit from) provision for deferred income taxes
 
(548
)
 
261

Net cash provided by (used in) operating activities
 
7,071

 
(987
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 

 
 

Purchases of available-for-sale investment securities
 
(75,306
)
 
(41,120
)
Proceeds from sales or calls of available-for-sale investment securities
 
35,853

 
7,499

Proceeds from maturity and principal repayments of available-for-sale investment securities
 
44,822

 
40,365

Net (increase) decrease in loans
 
(9,997
)
 
8,790

Proceeds from sale of other real estate owned
 
—

 
251

Purchases of premises and equipment
 
(620
)
 
(900
)
Purchases of bank owned life insurance
 
—

 
(116
)
FHLB stock redeemed (purchased)
 
48

 
(957
)
Proceeds from sale of premises and equipment
 
1

 
4

Net cash provided by (used in) investing activities
 
(5,199
)
 
13,816

CASH FLOWS FROM FINANCING ACTIVITIES:
 
 

 
 

Net decrease in demand, interest bearing and savings deposits
 
(18,308
)
 
(5,105
)
Net increase (decrease) in time deposits
 
5,273

 
(5,130
)
Repayments of short-term borrowings to Federal Home Loan Bank
 
(4,000
)
 
—

Proceeds from exercise of stock options
 
773

 
241

Excess tax benefit from exercise of stock options
 
16

 
20

Cash dividend payments on common stock
 
(956
)
 
—

Cash dividend payments on preferred stock
 
(175
)
 
(175
)
Net cash used in financing activities
 
(17,377
)
 
(10,149
)
(Decrease) increase in cash and cash equivalents
 
(15,505
)
 
2,680

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
 
52,956

 
44,804

CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
37,451

 
$
47,484

SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION:
 
 

 
 

Cash paid during the period for:
 
 

 
 

Interest
 
$
750

 
$
1,089

Income taxes
 
$
940

 
$
760

Non-cash investing and financing activities:
 
 

 
 

Transfer of loans to other real estate owned
 
$
—

 
$
2,337

Purchases of Available-for-sale investment securities, not yet settled
 
$
4,425

 
$
—

Accrued preferred stock dividends
 
$
87

 
$
87

 
See notes to unaudited consolidated financial statements.

6



Note 1.  Basis of Presentation
 
The interim unaudited consolidated financial statements of Central Valley Community Bancorp and subsidiary have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC). These interim consolidated financial statements include the accounts of Central Valley Community Bancorp and its wholly owned subsidiary Central Valley Community Bank (the Bank) (collectively, the Company). All significant intercompany accounts and transactions have been eliminated in consolidation.  Certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) have been omitted. The Company believes that the disclosures are adequate to make the information presented not misleading. These interim consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s 2012 Annual Report to Shareholders on Form 10-K. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the Company’s financial position at June 30, 2013, and the results of its operations and its cash flows for the three and six month interim periods ended June 30, 2013 and 2012 have been included. Certain reclassifications have been made to prior year amounts to conform to the 2013 presentation. Reclassifications had no effect on prior period net income or shareholders’ equity. The results of operations for interim periods are not necessarily indicative of results for the full year.
     The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
     Management has determined that since all of the banking products and services offered by the Company are available in each branch of the Bank, all branches are located within the same economic environment, and management does not allocate resources based on the performance of different lending or transaction activities, it is appropriate to aggregate the Bank branches and report them as a single operating segment. No customer accounts for more than 10 percent of revenues for the Company or the Bank.
  
Impact of New Financial Accounting Standards
 
Presentation of Comprehensive Income
 
In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (“Topic 220”) - Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASU 2013-02”). This ASU requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts. ASU 2013-02 is effective prospectively for annual and interim periods beginning after December 15, 2012. The Company adopted this standard on January 1, 2013. The adoption of this ASU did not have a material impact on the Company’s financial position, results of operations, or cash flows.

Note 2.  Share-Based Compensation
 
For the six month periods ended June 30, 2013 and 2012, share-based compensation cost recognized was $50,000 and $64,000, respectively. For the three month periods ended June 30, 2013 and 2012, share-based compensation cost recognized was $25,000 and $14,000 , respectively. The recognized tax benefits for stock option compensation expense were $9,000 and $11,000, respectively, for the six month periods ended June 30, 2013 and 2012. For the quarter ended June 30, 2013 and 2012,the recognized tax benefits for stock option compensation expense were $5,000 and $2,000, respectively. 
The Company bases the fair value of the options granted on the date of grant using a Black-Scholes Merton option pricing model that uses assumptions based on expected option life and the level of estimated forfeitures, expected stock volatility, risk free interest rate, and dividend yield.  The expected term and level of estimated forfeitures of the Company’s options are based on the Company’s own historical experience.  Stock volatility is based on the historical volatility of the Company’s stock.  The risk-free rate is based on the U. S. Treasury yield curve for the periods within the contractual life of the options in effect at the time of grant.  The compensation cost for options granted is based on the weighted average grant date fair value per share.

7

     No options to purchase shares of the Company’s common stock were issued in the first six months of 2013 and 2012 from either of the Company’s stock based compensation plans. 
A summary of the combined activity of the Company’s Stock Based Compensation Plans for the six month period ended June 30, 2013 follows:
 
 
 
Shares
 
Weighted
Average
Exercise Price
 
Weighted
Average
Remaining
Contractual
Term (Years)
 
Aggregate
Intrinsic Value (In thousands)
Options outstanding at January 1, 2013
 
499,289

 
$
8.78

 
 
 
 

Options exercised
 
(90,854
)
 
$
8.51

 
 
 
 

Options forfeited
 
(21,380
)
 
$
8.83

 
 
 
 

Options outstanding at June 30, 2013
 
387,055

 
$
8.84

 
5.19
 
$
879

Options vested or expected to vest at June 30, 2013
 
379,784

 
$
8.87

 
5.13
 
$
333

Options exercisable at June 30, 2013
 
251,555

 
$
9.70

 
3.42
 
$
493

 
The total intrinsic value of 90,854 options exercised in the six months ended June 30, 2013 was $73,000.
     Cash received from options exercised for the six months ended June 30, 2013 and 2012 was $773,000 and $241,000, respectively.  The actual tax benefit realized for the tax deductions from options exercised totaled $16,000 and $20,000 for the six months ended June 30, 2013 and 2012, respectively.
     As of June 30, 2013, there was $318,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under both plans.  The cost is expected to be recognized over a weighted average period of 3.56 years.
 
Note 3. Earnings Per Share
 
Basic earnings per share (EPS), which excludes dilution, is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period.  Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as stock options, stock appreciation rights settled in stock or restricted stock awards, result in the issuance of common stock which shares in the earnings of the Company. 
     A reconciliation of the numerators and denominators of the basic and diluted EPS computations is as follows:
 
Basic Earnings Per Share
 
For the Three Months
Ended June 30,
 
For the Six Months Ended June 30,
(In thousands, except share and per share amounts)
 
2013
 
2012
 
2013
 
2012
Net Income
 
$
1,287

 
$
1,709

 
$
3,070

 
$
3,422

Less: Preferred stock dividends and accretion
 
(88
)
 
(87
)
 
(175
)
 
(175
)
Income available to common shareholders
 
$
1,199

 
$
1,622

 
$
2,895

 
$
3,247

Weighted average shares outstanding
 
9,587,376

 
9,592,045

 
9,573,257

 
9,581,172

Basic earnings per share
 
$
0.13

 
$
0.17

 
$
0.30

 
$
0.34

 

8

Diluted Earnings Per Share
 
For the Three Months
Ended June 30,
 
For the Six Months Ended June 30,
(In thousands, except share and per share amounts)
 
2013
 
2012
 
2013
 
2012
Net Income
 
$
1,287

 
$
1,709

 
$
3,070

 
$
3,422

Less: Preferred stock dividends and accretion
 
(88
)
 
(87
)
 
(175
)
 
(175
)
Income available to common shareholders
 
$
1,199

 
$
1,622

 
$
2,895

 
$
3,247

Weighted average shares outstanding
 
9,587,376

 
9,592,045

 
9,573,257

 
9,581,172

Effect of dilutive stock options
 
57,562

 
26,931

 
56,514

 
22,884

Weighted average shares of common stock and common stock equivalents
 
9,644,938

 
9,618,976

 
9,629,771

 
9,604,056

Diluted earnings per share
 
$
0.12

 
$
0.17

 
$
0.30

 
$
0.34


During the six month periods ended June 30, 2013 and 2012, options to purchase 206,085 and 377,129 shares of common stock, respectively, were not factored into the calculation of dilutive stock options because they were anti-dilutive. 
 
Note 4.  Investments
 
The investment portfolio consists primarily of U.S. Government sponsored entity and agency securities collateralized by residential mortgage obligations, private label residential mortgage backed securities (PLRMBS), and obligations of states and political subdivisions securities, all of which are classified as available-for-sale.  As of June 30, 2013, $102,764,000 of these securities were held as collateral for borrowing arrangements, public funds, and for other purposes.
     The fair value of the available-for-sale investment portfolio reflected a net unrealized loss of $2,234,000 at June 30, 2013 compared to an unrealized gain of $12,891,000 at December 31, 2012.
     The following table sets forth the carrying values and estimated fair values of our investment securities portfolio at the dates indicated (in thousands): 
 
 
June 30, 2013
Available-for-Sale Securities
 
Amortized Cost
 
Gross
Unrealized
 Gains
 
Gross
Unrealized
Losses
 
Estimated
 Fair Value
Debt securities:
 
 

 
 

 
 

 
 

U.S. Government agencies
 
$
14,621

 
$
235

 
$
(3
)
 
$
14,853

Obligations of states and political subdivisions
 
170,005

 
4,362

 
(6,476
)
 
167,891

U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations
 
179,620

 
828

 
(2,076
)
 
178,372

Private label residential mortgage backed securities
 
5,232

 
859

 
(4
)
 
6,087

Other equity securities
 
7,596

 
41

 
—

 
7,637

 
 
$
377,074

 
$
6,325

 
$
(8,559
)
 
$
374,840

 
 
 
December 31, 2012
Available-for-Sale Securities
 
Amortized Cost
 
Gross
Unrealized
 Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Debt securities:
 
 

 
 

 
 

 
 

U.S. Government agencies
 
$
9,443

 
$
34

 
$
(23
)
 
$
9,454

Obligations of states and political subdivisions
 
151,312

 
10,751

 
(385
)
 
161,678

U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations
 
206,465

 
3,152

 
(1,107
)
 
208,510

Private label residential mortgage backed securities
 
6,258

 
323

 
(206
)
 
6,375

Other equity securities
 
7,596

 
352

 
—

 
7,948

 
 
$
381,074

 
$
14,612

 
$
(1,721
)
 
$
393,965



9

Proceeds and gross realized gains (losses) from the sales or calls of investment securities for the periods ended June 30, 2013 and 2012 are shown below (in thousands):
 
 
For the Three Months
Ended June 30,
 
For the Six Months Ended June 30,
Available-for-Sale Securities
 
2013
 
2012
 
2013
 
2012
Proceeds from sales or calls
 
$
13,696

 
$
3,107

 
$
35,853

 
$
7,499

Gross realized gains from sales or calls
 
395

 
157

 
1,401

 
566

Gross realized losses from sales or calls
 
(75
)
 
(60
)
 
(268
)
 
(122
)

The provision for income taxes includes $466,000 and $183,000 income tax impact from the reclassification of unrealized net gains on available-for-sale securities to realized net gains on available-for-sale securities for the six months ended June 30, 2013 and 2012. The provision for income taxes includes $132,000 and $40,000 income tax impact from the reclassification of unrealized net gains on available-for-sale securities to realized net gains on available-for-sale securities for the three months ended June 30, 2013 and 2012.
Investment securities with unrealized losses as of the dates indicated are summarized and classified according to the duration of the loss period as follows (in thousands): 
 
 
June 30, 2013
 
 
Less than 12 Months
 
12 Months or More
 
Total
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
Available-for-Sale Securities
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
Debt securities:
 
 

 
 

 
 

 
 

 
 

 
 

U.S. Government agencies
 
$
1,100

 
$
(3
)
 
$
—

 
$
—

 
$
1,100

 
$
(3
)
Obligations of states and political subdivisions
 
93,119

 
(6,476
)
 
—

 
—

 
93,119

 
(6,476
)
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations
 
111,634

 
(1,868
)
 
14,626

 
(208
)
 
126,260

 
(2,076
)
Private label residential mortgage backed securities
 
—

 
—

 
231

 
(4
)
 
231

 
(4
)
 
 
$
205,853

 
$
(8,347
)

$
14,857

 
$
(212
)
 
$
220,710

 
$
(8,559
)

 
 
December 31, 2012
 
 
Less than 12 Months
 
12 Months or More
 
Total
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
Available-for-Sale Securities
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
Debt securities:
 
 

 
 

 
 

 
 

 
 

 
 

U.S. Government agencies
 
$
3,590

 
$
(23
)
 
$
—

 
$
—

 
$
3,590

 
$
(23
)
Obligations of states and political subdivisions
 
30,572

 
(385
)
 
—

 
—

 
30,572

 
(385
)
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations
 
76,764

 
(809
)
 
18,024

 
(298
)
 
94,788

 
(1,107
)
Private label residential mortgage backed securities
 
—

 
—

 
2,886

 
(206
)
 
2,886

 
(206
)
 
 
$
110,926

 
$
(1,217
)
 
$
20,910

 
$
(504
)
 
$
131,836

 
$
(1,721
)

     We periodically evaluate each investment security for other-than-temporary impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations.  Under ASC 320-10, the portion of the impairment that is attributable to a shortage in the present value of expected future cash flows relative to the amortized cost should be recorded as a current period charge to earnings.  The discount rate in this analysis is the original yield expected at time of purchase.
     As of June 30, 2013, the Company performed an analysis of the investment portfolio to determine whether any of the investments held in the portfolio had an other-than-temporary impairment (OTTI). Management evaluated all available-for-sale investment securities with an unrealized loss at June 30, 2013 and identified those that had an unrealized loss for at least a

10

consecutive 12 month period, which had an unrealized loss at June 30, 2013 greater than 10% of the recorded book value on that date, or which had an unrealized loss of more than $10,000.  Management also analyzed any securities that may have been downgraded by credit rating agencies.  Management retained the services of a third party in June 2013 to provide independent valuation and OTTI analysis on certain PLRMBS.
For those bonds that met the evaluation criteria, management obtained and reviewed the most recently published national credit ratings for those bonds.  For those bonds that were municipal debt securities with an investment grade rating by the rating agencies, management also evaluated the financial condition of the municipality and any applicable municipal bond insurance provider and concluded that no credit related impairment existed.
The evaluation for PLRMBS includes estimating projected cash flows that the Company is likely to collect based on an assessment of all available information about the applicable security on an individual basis, the structure of the security, and certain assumptions, such as the remaining payment terms for the security, prepayment speeds, default rates, loss severity on the collateral supporting the security based on underlying loan-level borrower and loan characteristics, expected housing price changes, and interest rate assumptions, to determine whether the Company will recover the entire amortized cost basis of the security.  In performing a detailed cash flow analysis, the Company identified the best estimate of the cash flows expected to be collected.  If this estimate results in a present value of expected cash flows (discounted at the security’s original yield) that is less than the amortized cost basis of the security, an OTTI is considered to have occurred.
     To assess whether it expects to recover the entire amortized cost basis of its PLRMBS, the Company performed a cash flow analysis for all of its PLRMBS as of June 30, 2013.  In performing the cash flow analysis for each security, the Company uses a third-party model. The model considers borrower characteristics and the particular attributes of the loans underlying the Company’s securities, in conjunction with assumptions about future changes in home prices and other assumptions, to project prepayments, default rates, and loss severities.
     The month-by-month projections of future loan performance are allocated to the various security classes in each securitization structure in accordance with the structure’s prescribed cash flow and loss allocation rules.  When the credit enhancement for the senior securities in a securitization is derived from the presence of subordinated securities, losses are allocated first to the subordinated securities until their principal balance is reduced to zero.  The projected cash flows are based on a number of assumptions and expectations, and the results of these models can vary significantly with changes in assumptions and expectations.  The scenario of cash flows determined based on the model approach described above reflects a best-estimate scenario.
     At each quarter end, the Company compares the present value of the cash flows expected to be collected on its PLRMBS to the amortized cost basis of the securities to determine whether a credit loss exists.
The unrealized losses associated with PLRMBS are primarily driven by projected collateral losses, credit spreads, and changes in interest rates.  The Company assesses for credit impairment using a discounted cash flow model.  The key assumptions include default rates, severities, discount rates and prepayment rates.  Losses are estimated by forecasting the performance of the underlying mortgage loans for each security.  The forecasted loan performance is used to project cash flows to the various tranches in the structure.  Based upon management’s assessment of the expected credit losses of these securities given the performance of the underlying collateral compared with our credit enhancement (which occurs as a result of credit loss protection provided by subordinated tranches), the Company expects to recover the entire amortized cost basis of these securities, with the exception of certain securities for which OTTI was previously recorded.

U.S. Government Agencies

At June 30, 2013, the Company held five U.S. Government agency securities, of which one was in a loss position for less than 12 months and none were in a loss position nor had been in a loss position for 12 months or more. The unrealized losses on the Company’s investments in direct obligations of U.S. government agencies were caused by interest rate changes. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized costs of the investment. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2013.

Obligations of States and Political Subdivisions
 
At June 30, 2013, the Company held 199 obligations of states and political subdivision securities of which 72 were in a loss position for less than 12 months and none were in a loss position nor had been in a loss position for 12 months or more. The unrealized losses on the Company’s investments in obligations of states and political subdivision securities were caused by interest rate changes. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell, and it is more likely than not that it will not be required to sell those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2013.
 

11

U.S. Government Sponsored Entities and Agencies Collateralized by Residential Mortgage Obligations
 
At June 30, 2013, the Company held 182 U.S. Government sponsored entity and agency securities collateralized by residential mortgage obligations of which 58 were in a loss position for less than 12 months and 19 have been in a loss position for more than 12 months. The unrealized losses on the Company’s investments in U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations were caused by interest rate changes. The contractual cash flows of those investments are guaranteed by an agency or sponsored entity of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Company’s investment. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell, and it is more likely than not that it will not be required to sell those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2013.
 
Private Label Residential Mortgage Backed Securities
 
At June 30, 2013, the Company had a total of 22 PLRMBS with a remaining principal balance of $5,232,000 and a net unrealized gain of approximately $855,000.  One of these securities accounted for $4,000 of unrealized loss at June 30, 2013 offset by 21 of these securities with gains totaling $859,000.  Eight of these PLRMBS with a remaining principal balance of $4,068,000 had credit ratings below investment grade.  The Company continues to perform extensive analyses on these securities. No credit related OTTI charges related to PLRMBS were recorded during the six month period ended June 30, 2013.
     PLRMBS as of June 30, 2013 with credit ratings below investment grade are summarized in the table below (dollars in thousands):
 
Description 
 
Book
Value
 
Market Value
 
Unrealized
Gain
(Loss)
 
Rating
 
Agency
 
12 Month
Historical
Prepayment
Rates %
 
Projected
Default
Rates %
 
Projected
Severity
Rates %
 
Original
Purchase
Price %
 
Current
Credit
Enhancement
%
PHHAM
 
$
1,585

 
1,781

 
$
196

 
D
 
Fitch
 
16.85

 
20.23

 
51.00

 
97.25

 
—

CWALT 1
 
552

 
608

 
56

 
D
 
Fitch
 
14.99

 
24.05

 
47.15

 
100.73

 
—

CWALT 2
 
236

 
232

 
(4
)
 
D
 
Fitch
 
17.71

 
23.11

 
55.38

 
101.38

 
(1.24
)
FHAMS
 
1,430

 
1,753

 
323

 
D
 
Fitch
 
14.70

 
18.83

 
53.90

 
95.00

 
(0.96
)
BAALT
 
23

 
28

 
5

 
C
 
Fitch
 
13.39

 
11.65

 
57.09

 
97.24

 
1.41

ABFS
 
147

 
284

 
137

 
D
 
S&P
 
8.99

 
40.55

 
46.75

 
97.46

 
—

CWALT 3
 
57

 
61

 
4

 
B1
 
Moodys
 
21.17

 
11.15

 
28.12

 
94.47

 
10.54

CONHE
 
38

 
59

 
21

 
Caa2
 
Moodys
 
4.10

 
6.92

 
46.75

 
86.39

 
—

 
 
$
4,068

 
$
4,806

 
$
738

 
 
 
 
 
 

 
 
 
 

 
 

 
 

 
The following tables provide a roll forward for the three and six month periods ended June 30, 2013 and 2012 of investment securities credit losses recorded in earnings. The beginning balance represents the credit loss component for which OTTI occurred on debt securities in prior periods.  Additions represent the first time a debt security was credit impaired or when subsequent credit impairments have occurred on securities for which OTTI credit losses have been previously recognized.
 
 
 
For the Three Months
Ended June 30,
 
For the Six Months Ended June 30,
(In thousands)
 
2013
 
2012
 
2013
 
2012
Beginning balance
 
$
800

 
$
783

 
$
783

 
$
783

Amounts related to credit loss for which an OTTI charge was not previously recognized
 
—

 
—

 
17

 
—

Increases to the amount related to credit loss for which OTTI was previously recognized
 
—

 
—

 
—

 
—

Realized losses for securities sold
 
—

 
—

 
—

 
—

Ending balance
 
$
800

 
$
783

 
$
800

 
$
783



12

The amortized cost and estimated fair value of investment securities at June 30, 2013 by contractual maturity is shown below (in thousands).  Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.
 
June 30, 2013
 
Amortized Cost
 
Estimated Fair
Value
Within one year
 
$
150

 
$
150

After one year through five years
 
12,688

 
13,578

After five years through ten years
 
23,314

 
24,187

After ten years
 
133,853

 
129,976

 
 
170,005

 
167,891

Investment securities not due at a single maturity date:
 
 

 
 

U.S. Government agencies
 
14,621

 
14,853

U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations
 
179,620

 
178,372

Private label residential mortgage backed securities
 
5,232

 
6,087

Other equity securities
 
7,596

 
7,637

 
 
$
377,074

 
$
374,840

 


Note 5.  Fair Value Measurements
 
Fair Value Hierarchy
 
Fair value is 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. In accordance with applicable guidance, the Company groups its assets and liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.  Valuations within these levels are based upon:
 
Level 1 — Quoted market prices (unadjusted) for identical instruments traded in active exchange markets that the Company has the ability to access as of the measurement date.
 
Level 2 — Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable or can be corroborated by observable market data.
 
Level 3 — Model-based techniques that use at least one significant assumption not observable in the market.  These unobservable assumptions reflect the Company’s estimates of assumptions that market participants would use on pricing the asset or liability.  Valuation techniques include management judgment and estimation which may be significant.

Management monitors the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another. In such instances, we report the transfer at the beginning of the reporting period.

The estimated carrying and fair values of the Company’s financial instruments are as follows (in thousands):

13

 
 
 
June 30, 2013
 
 
Carrying
Amount
 
Fair Value
(In thousands)
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial assets:
 
 

 
 

 
 

 
 
 
 

Cash and due from banks
 
$
16,492

 
$
16,492

 
$
—

 
$
—

 
$
16,492

Interest-earning deposits in other banks
 
20,929

 
20,929

 
—

 
—

 
20,929

Federal funds sold
 
30

 
30

 
—

 
—

 
30

Available-for-sale investment securities
 
374,840

 
7,637

 
367,203

 
—

 
374,840

Loans, net
 
395,343

 
—

 
—

 
397,401

 
397,401

Federal Home Loan Bank stock
 
3,802

 
N/A

 
N/A

 
N/A

 
N/A

Accrued interest receivable
 
4,496

 
20

 
2,737

 
1,739

 
4,496

Financial liabilities:
 
 

 
 

 
 

 
 
 
 

Deposits
 
738,397

 
596,249

 
142,303

 
—

 
738,552

Junior subordinated deferrable interest debentures
 
5,155

 
—

 
—

 
2,487

 
2,487

Accrued interest payable
 
120

 
—

 
96

 
24

 
120


 
 
December 31, 2012
 
 
Carrying
Amount
 
Fair Value
(In thousands)
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial assets:
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
 
$
22,405

 
$
22,405

 
$
—

 
$
—

 
$
22,405

Interest-earning deposits in other banks
 
30,123

 
30,123

 
—

 
—

 
30,123

Federal funds sold
 
428

 
428

 
—

 
—

 
428

Available-for-sale investment securities
 
393,965

 
7,948

 
386,017

 
—

 
393,965

Loans, net
 
385,185

 
—

 
—

 
388,834

 
388,834

Federal Home Loan Bank stock
 
3,850

 
N/A

 
N/A

 
N/A

 
N/A

Accrued interest receivable
 
4,267

 
22

 
2,395

 
1,850

 
4,267

Financial liabilities:
 
 
 
 
 
 
 
 
 
 
Deposits
 
751,432

 
614,556

 
137,401

 
—

 
751,957

Short-term borrowings
 
4,000

 
—

 
4,016

 
—

 
4,016

Junior subordinated deferrable interest debentures
 
5,155

 
—

 
—

 
2,990

 
2,990

Accrued interest payable
 
174

 
—

 
149

 
25

 
174


These estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments.  In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.
These estimates are made at a specific point in time based on relevant market data and information about the financial instruments.  Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision.  Changes in assumptions could significantly affect the fair values presented.
    
The methods and assumptions used to estimate fair values are described as follows:

(a) Cash and Cash Equivalents — The carrying amounts of cash and due from banks, interest-earning deposits in other banks, and Federal funds sold approximate fair values and are classified as Level 1.


14

(b) Available-for-Sale Investment Securities — Available-for-sale investment securities in Level 1 are mutual funds and fair values are based on quoted market prices for identical instruments traded in active markets. Fair values for available-for-sale investment securities classified in Level 2 are based on quoted market prices for similar securities in active markets. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators.

(c) Loans — Fair values of loans are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are initially valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for loan losses. For collateral dependent loans, fair value is commonly based on recent real estate appraisals. 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. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management's historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

(d) FHLB Stock — It is not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability.

(e) Deposits — Fair value of demand deposit, savings, and money market accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount), resulting resulting in a Level 1 classification. Fair value for fixed and variable rate certificates of deposit are estimated using discounted cash flow analyses using interest rates offered at each reporting date by the Company for certificates with similar remaining maturities resulting in a Level 2 classification.

(f) Short-Term Borrowings — The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.

(g) Other Borrowings — The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

The fair values of the Company’s Subordinated Debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

(h) Accrued Interest Receivable/Payable — The fair value of accrued interest receivable and payable is based on the fair value hierarchy of the related asset or liability.

(i) Off-Balance Sheet Instruments — Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.
 
Assets Recorded at Fair Value
 
The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of June 30, 2013:
 
Recurring Basis
 
The Company is required or permitted to record the following assets at fair value on a recurring basis under other accounting pronouncements as of June 30, 2013 (in thousands).
 

15

Description
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Available-for-sale securities
 
 

 
 

 
 

 
 

Debt Securities:
 
 

 
 

 
 

 
 

U.S. Government agencies
 
$
14,853

 
$
—

 
$
14,853

 
$
—

Obligations of states and political subdivisions
 
167,891

 
—

 
167,891

 
—

U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations
 
178,372

 
—

 
178,372

 
—

Private label residential mortgage backed securities
 
6,087

 
—

 
6,087

 
—

Other equity securities
 
7,637

 
7,637

 
—

 
—

Total assets measured at fair value on a recurring basis
 
$
374,840

 
$
7,637

 
$
367,203

 
$
—

 
Securities in Level 1 are mutual funds and fair values are based on quoted market prices for identical instruments traded in active markets.  Fair values for available-for-sale investment securities in Level 2 are based on quoted market prices for similar securities in active markets. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators.
Management evaluates the significance of transfers between levels based upon the nature of the financial instrument and size of the transfer relative to total assets, total liabilities or total earnings. During the six months ended June 30, 2013, no transfers between levels occurred.
There were no Level 3 assets measured at fair value on a recurring basis at June 30, 2013. Also there were no liabilities measured at fair value on a recurring basis at June 30, 2013.
 

Non-recurring Basis
 
The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a non-recurring basis. These include assets and liabilities that are measured at the lower of cost or fair value that were recognized at fair value which was below cost at June 30, 2013 (in thousands).

Description
 
Fair
Value
 
Level 1
 
Level 2
 
Level 3
Impaired loans:
 
 

 
 

 
 

 
 

Commercial:
 
 

 
 

 
 

 
 

Commercial and industrial
 
$
929

 
$
—

 
$
—

 
$
929

Agricultural production
 
—

 
—

 
—

 
—

Total commercial
 
929

 
—

 
—

 
929

Real estate:
 
 

 
 

 
 

 
 

Owner occupied
 
—

 
—

 
—

 
—

Real estate-construction and other land loans
 
—

 
—

 
—

 
—

Commercial real estate
 
—

 
—

 
—

 
—

Agricultural real estate
 
—

 
—

 
—

 
—

Other
 
—

 
—

 
—

 
—

Total real estate
 
—

 
—

 
—

 
—

Consumer:
 
 

 
 

 
 

 
 

Equity loans and lines of credit
 
78

 
—

 
—

 
78

Consumer and installment
 
—

 
—

 
—

 
—

Total consumer
 
78

 
—

 
—

 
78

Lease financing receivable
 
—

 
—

 
—

 
—

Total impaired loans
 
1,007

 
—

 
—

 
1,007

Other real estate owned
 
—

 
—

 
—

 
—

Total assets measured at fair value on a non-recurring basis
 
$
1,007

 
$
—

 
$
—

 
$
1,007



16

At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for loan losses. For collateral dependent loans, fair value is commonly based on recent real estate appraisals. 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. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. The fair value of impaired loans is based on the fair value of the collateral. Impaired loans were determined to be collateral dependent and categorized as Level 3 due to ongoing real estate market conditions resulting in inactive market date, which in turn required the use of unobservable inputs and assumptions in fair value measurements. Impaired loans evaluated under the discounted cash flow method are excluded from the table above. The discounted cash flow methods as prescribed by topic 310 is not a fair value measurement since the discount rate utilized is the loan's effective interest rate which is not a market rate. There were no changes in valuation techniques used during the six months period ended June 30, 2013.
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 assumptions and approaches utilized in the appraisal as well as the overall resulting fair value is compared with independent data sources such as recent market data or industry-wide statistics.    
Impaired loans that are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal balance of $1,451,000 with a valuation allowance of $444,000 at June 30, 2013, resulting in no provision for credit losses for the period ended June 30, 2013, down to their fair value of $1,007,000.  The valuation allowance represents specific allocations for the allowance for credit losses for impaired loans.

The following tables present information about the Company's assets and liabilities measured at fair value on a recurring and nonrecurring basis as of December 31, 2012:

Recurring Basis
 
The Company is required or permitted to record the following assets at fair value on a recurring basis under other accounting pronouncements (in thousands).
 
Description
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Available-for-sale securities
 
 

 
 

 
 

 
 

Debt Securities:
 
 

 
 

 
 

 
 

U.S. Government agencies
 
$
9,454

 
$
—

 
$
9,454

 
$
—

Obligations of states and political subdivisions
 
161,678

 
—

 
161,678

 
—

U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations
 
208,510

 
—

 
208,510

 
—

Private label residential mortgage backed securities
 
6,375

 
—

 
6,375

 
—

Other equity securities
 
7,948

 
7,948

 
—

 
—

Total assets measured at fair value on a recurring basis
 
$
393,965

 
$
7,948

 
$
386,017

 
$
—

 
Securities in Level 1 are mutual funds and fair values are based on quoted market prices for identical instruments traded in active markets.  Fair values for available-for-sale investment securities in Level 2 are based on quoted market prices for similar securities in active markets. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators.
     Management evaluates the significance of transfers between levels based upon the nature of the financial instrument and size of the transfer relative to total assets, total liabilities or total earnings. During the year ended December 31, 2012, no transfers between levels occurred.
There were no Level 3 assets measured at fair value on a recurring basis at December 31, 2012. Also there were no liabilities measured at fair value on a recurring basis at December 31, 2012.


17

Non-recurring Basis
 
The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a non-recurring basis.  These include assets and liabilities that are measured at the lower of cost or fair value that were recognized at fair value which was below cost at December 31, 2012 (in thousands).

Description
 
Fair
Value
 
Level 1
 
Level 2
 
Level 3
Impaired loans:
 
 

 
 

 
 

 
 

Commercial:
 
 

 
 

 
 

 
 

Commercial and industrial
 
$
—

 
$
—

 
$
—

 
$
—

Agricultural production
 
—

 
—

 
—

 
—

Total commercial
 
—

 
—

 
—

 
—

Real estate:
 
 

 
 

 
 

 
 

Owner occupied
 
194

 
—

 
—

 
194

Real estate-construction and other land loans
 
4,863

 
—

 
—

 
4,863

Commercial real estate
 
—

 
—

 
—

 
—

Agricultural real estate
 
—

 
—

 
—

 
—

Other
 
—

 
—

 
—

 
—

Total real estate
 
5,057

 
—

 
—

 
5,057

Consumer:
 
 

 
 

 
 

 
 

Equity loans and lines of credit
 
233

 
—

 
—

 
233

Consumer and installment
 
—

 
—

 
—

 
—

Total consumer
 
233

 
—

 
—

 
233

Lease financing receivable
 
—

 
—

 
—

 
—

Total impaired loans
 
5,290

 
—