Fair Value Measurements

3 Months Ended

Mar. 31, 2012

Fair Value Measurements

9.      Fair Value Measurements

ASC Topic 820, Fair Value Measurements and Disclosures, provides a framework for measuring fair value under U.S. generally accepted accounting principles (“GAAP”).

The Company groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the observability of the assumptions used to determine fair value:

Level 1 – Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange.  Level 1 also includes U.S. Treasury Notes and U.S. Government and agency mortgage-backed securities that are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 – Valuations for assets and liabilities with inputs that are observable either directly or indirectly for substantially the full term or valuations obtained from third party pricing services based on quoted market prices for comparable assets or liabilities. Level 2 also includes assets and liabilities traded in inactive markets.

There were no transfers of assets and liabilities between Level 1 and Level 2 during the three months ended March 31, 2012.

Level 3 – Valuations for assets and liabilities with inputs that are unobservable, which are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and are not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets and liabilities.

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

	Fair Value Measurements Using
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
	March 31, 2012		(Level 1)		(Level 2)		(Level 3)
Assets (market approach)	(Dollars In Thousands)
Securities available-for-sale
Equity securities by industry type:
Financial	$	626	$	626	$	-	$	-
Total equity securities	$	626	$	626	$	-	$	-
	Fair Value Measurements Using
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
	December 31, 2011		(Level 1)		(Level 2)		(Level 3)
Assets (market approach)	(Dollars In Thousands)
Securities available-for-sale
Equity securities by industry type:
Financial	$	613	$	613	$	-	$	-
Total equity securities	$	613	$	613	$	-	$	-

The Company may be required, from time to time, to measure certain other financial assets on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. The following table summarizes the fair value hierarchy used to determine each adjustment and the carrying value of the related individual assets:

	Fair Value Measurements Using
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
	March 31, 2012		(Level 1)		(Level 2)		(Level 3)
	(Dollars In Thousands)
Assets
Impaired loans with a valuation allowance, net	$	1,547	$	-	$	1,547	$	-
Other real estate owned		901		-		901		-
Loans held for sale		1,604		-		1,604		-
Mortgage servicing rights		450		-		450		-
	Fair Value Measurements Using
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
	December 31, 2011		(Level 1)		(Level 2)		(Level 3)
	(Dollars In Thousands)
Assets
Impaired loans with a valuation allowance, net	$	2,296	$	-	$	2,296	$	-
Other real estate owned		913		-		913		-
Loans held for sale		1,635		-		1,635		-
Mortgage servicing rights		360		-		360		-

The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:

Mortgage servicing rights. Mortgage servicing rights represent the value associated with servicing residential mortgage loans. Servicing assets and servicing liabilities are reported using the amortization method. In evaluating the carrying values of the mortgage servicing rights, the Company obtains third party valuations based on loan level data including note rate, type and term of the underlying loans. As such, the Company classifies mortgage servicing rights as nonrecurring Level 2.

Loans held for sale. Loans held for sale are recorded at the lower of carrying value or market value. The fair value of mortgage loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies mortgage loans held for sale as nonrecurring Level 2.

Other real estate owned.  Real estate acquired through foreclosure is initially recorded at market value. The fair value of other real estate owned is based on property appraisals and an analysis of similar properties currently available. As such, the Company records other real estate owned as nonrecurring Level 2.

Impaired loans. A loan is considered to be impaired when it is probable that all of the principal and interest due under the original underwriting terms of the loan may not be collected. Impairment is measured based on the fair value of the underlying collateral. As such, the Company records impaired loans as nonrecurring Level 2.

A valuation reserve was included in the allowance for loan losses for the above impaired loans of $403,000 and $615,000 as of March 31, 2012 and December 31, 2011, respectively. The amount of impaired loans represents the carrying value, net of the related allowance for loan losses on impaired loans, for which adjustments are based on the appraised value of the collateral, which is based on the market approach of valuation. The market value approach is used to value OREO.

ASC Topic 825, Fair Value Measurements and Disclosures, requires disclosures of fair value information about financial instruments, whether or not recognized in the balance sheet, if the fair values can be reasonably determined. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques using observable inputs when available. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

Cash and cash equivalents. The carrying amounts of cash equivalents and due from banks approximate their relative fair values.

Investment securities. The fair values of investment securities are estimated by independent providers. In obtaining such valuation information from third parties, the Company has evaluated their valuation methodologies used to develop the fair values in order to determine whether the valuations are representative of an exit price in the Company’s principal markets. The Company’s principal markets for its securities portfolios are the secondary institutional markets, with an exit price that is predominately reflective of bid level pricing in those markets. Fair values are calculated based on the value of one unit without regard to any premium or discount that may result from concentrations of ownership of a financial instrument, possible tax ramifications, or estimated transaction costs. If these considerations had been incorporated into the fair value estimates, the aggregate fair value could have been changed. The carrying values of restricted equity securities approximate fair values.

Loans and loans held for sale. Fair values are estimated for portfolios of loans with similar financial characteristics. The fair values of performing loans are calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest risk inherent in the loan. The estimates of maturity are based on the Company’s historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of the current economic and lending conditions, and the effects of the estimated prepayments. Fair values for significant non-performing loans are based on estimated cash flows and are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information. Management has made estimates of fair value using discount rates that it believes to be reasonable. However, because there is no market for many of these financial instruments, Management has no basis to determine whether the fair value presented above would be indicative of the value negotiated in an actual sale.

Mortgage servicing rights. Mortgage servicing rights represent the value associated with servicing residential mortgage loans. Servicing assets and servicing liabilities are reported using the amortization method. In evaluating the carrying values of the mortgage servicing rights, the Company obtains third party valuations based on loan level data including note rate, type and term of the underlying loans. As such, the Company classifies mortgage servicing rights as nonrecurring Level 2.

Accrued interest receivable. The fair value estimate of this financial instrument approximates the carrying value as this financial instrument has a short maturity. It is the Company’s policy to stop accruing interest on loans for which it is probable that the interest is not collectable. Therefore, this financial instrument has been adjusted for estimated credit loss.

Deposits. The fair value of deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value estimates do not include the benefit that results from the low-cost funding provided by the deposits compared to the cost of borrowing funds in the market. If that value were considered, the fair value of the Company’s net assets could increase.

Borrowed funds. The fair value of borrowed funds is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently available for borrowings of similar remaining maturities.

Accrued interest payable. The fair value estimate approximates the carrying amount as this financial instrument has a short maturity.

Off-balance-sheet instruments. Off-balance-sheet instruments include loan commitments. Fair values for loan commitments have not been presented as the future revenue derived from such financial instruments is not significant.

Limitations. Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These values do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on Management’s judgments regarding future expected loss experience, 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 these estimates. Fair value estimates are based on existing on- and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial instruments include the deferred tax asset, premise and equipment, and other real estate owned. In addition, tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.

The carrying amounts and estimated fair values of the Company's financial instruments are as follows:

	March 31, 2012
	Fair Value Measurements Using
					Quoted
					Prices in
					Active		Significant
					Markets for		Other		Significant
					Identical		Observable		Unobservable
					Assets		Inputs		Inputs
	Carrying Amount		Total Fair Value		(Level 1)		(Level 2)		(Level 3)
	(Dollars In Thousands)
Financial assets:
Cash and cash equivalents	$	55,574	$	55,574	$	55,574	$	-	$	-
Securities available-for-sale		626		626		626		-		-
Securities held-to-maturity		62,353		68,309		-		68,309		-
FHLB stock		4,277		4,277		-		4,277		-
Residential real estate		122,409		122,118		-		-		122,118
Residential construction		5,839		5,838		-		-		5,838
Commercial real estate		177,813		177,274		-		-		177,274
Commercial construction		35,970		36,273		-		-		36,273
Commercial		78,562		78,677		-		-		78,677
Consumer		2,507		2,537		-		-		2,537
Home equity		29,983		30,137		-		-		30,137
Total loans		453,083		452,854		-		-		452,854
Loans held for sale		1,604		1,604		-		1,604		-
Accrued interest receivable		1,562		1,562		-		1,562		-
Mortgage servicing rights		385		450		-		450		-
Financial liabilities:
Deposits	$	448,617	$	443,105	$	-	$	443,105	$	-
Securities sold under agreements to repurchase		9,883		9,883		-		9,883		-
FHLB long term advances		56,373		58,466		-		58,466		-
Accrued interest payable		167		167		-		167		-

	December 31, 2011
	Carrying Amount		Fair Value
Financial assets:	(Dollars In Thousands)
Cash and cash equivalents	$	6,122	$	6,122
Securities available-for-sale		613		613
Securities held-to-maturity		73,852		80,607
FHLB stock		4,489		4,489
Total loans		443,471		448,781
Loans held for sale		1,635		1,635
Accrued interest receivable		1,527		1,527
Mortgage servicing rights		344		360
Financial liabilities:
Deposits		453,377		454,776
Securities sold under agreements to repurchase		12,340		12,340
FHLB long term advances		59,625		61,540
Accrued interest payable		132		132