Fair Value

The Company utilizes fair value measurements to record fair value adjustments for certain assets and liabilities and to determine fair value disclosures. Available-for-sale securities, interest rate swaps, mortgage servicing rights, interest rate lock commitments and forward sale loan commitments are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record other assets at fair value, such as loans held-for-investment and certain other assets. These nonrecurring fair value adjustments usually involve writing the asset down to fair value or the lower of cost or market value.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Available-for-Sale Investment Securities

Available-for-sale investment securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security's credit rating, prepayment assumptions, and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets, and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities and private label entities, municipal bonds and corporate debt securities. There have been no changes in valuation techniques for the quarter ended September 30, 2011. Valuation techniques are consistent with techniques used in prior periods.

Interest Rate Locks and Forward Loan Sale Commitments

Sidus, the Company's mortgage lending subsidiary, enters into interest rate lock commitments and commitments to sell mortgages. At September 30, 2011, the amount of fair value associated with these interest rate lock commitments and forward loan sale commitments was $329,739 and $(120,556), respectively. At December 31, 2010, the amount of fair value associated with these interest rate lock commitments and sale commitments was $104,810 and $161,071, respectively. Interest rate locks and forward loan sale commitments are recorded at fair value on a recurring basis. The fair value of forward sales commitments is based on changes in loan pricing between the commitment date and period end, typically month end. The fair value of interest rate lock commitments is based on servicing release premium, origination income net of origination costs, and changes in loan pricing between the commitment date and period end, typically month end. There have been no changes in valuation techniques for the quarter ended September 30, 2011. Valuation techniques are consistent with techniques used in prior periods.



	Interest Rate Lock Commitments
	Level 3
	Fair Value		Fair Value
	(In thousands)
Balance, June 30, 2011 and 2010	$	16	$	394
Gains/losses included in other income	314		694
Transfer in and out	—		—
Balance, September 30, 2011 and 2010	$	330	$	1,088

	Interest Rate Lock Commitments
	Level 3
	Fair Value		Fair Value
	(In thousands)
Balance, December 31, 2010 and 2009	$	105	$	(791	)
Gains/losses included in other income	225		1,879
Transfer in and out	—		—
Balance, September 30, 2011 and 2010	$	330	$	1,088

Mortgage Servicing Rights

Mortgage servicing rights are recorded at fair value on a recurring basis. A valuation of mortgage servicing rights is performed using a pooling methodology. Similar loans are pooled together and evaluated on a discounted earnings basis to determine the present value of future earnings. The present value of the future earnings is the estimated market value for the pool, calculated using consensus assumptions that a third party purchaser would utilize in evaluating a potential acquisition of the servicing. As such, the Company classifies loan servicing rights as Level 3. There have been no changes in valuation techniques for the quarter ended September 30, 2011. Valuation techniques are consistent with techniques used in prior periods.

The following table presents a rollforward of mortgage servicing rights from December 31, 2010 to September 30, 2011 and December 31, 2009 to September 30, 2010 and shows that the mortgage servicing rights are classified as Level 3 as discussed above.



	Level 3
	Fair Value			Fair Value
	(In thousands)
Balance, June 30, 2011 and 2010	$	2,193		$	1,960
Capitalized	71			161
Gains/losses included in other income	(248		)	(80		)
Balance, September 30, 2011 and 2010	$	2,016		$	2,041

	Level 3
	Fair Value			Fair Value
	(In thousands)
Balance, December 31, 2010 and 2009	$	2,144		$	1,918
Capitalized	266			342
Gains/losses included in other income	(394		)	(219		)
Balance, September 30, 2011 and 2010	$	2,016		$	2,041

Mortgage Loans Held-for-Sale

Loans held-for-sale are carried at lower of cost or market value. The fair value of 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 Level 2. At September 30, 2011 and December 31, 2010, the cost of the Company's mortgage loans held-for-sale was less than the market value. Accordingly, at quarter end the Company's loans held-for-sale were carried at cost. There have been no changes in valuation techniques for the quarter ended September 30, 2011. Valuation techniques are consistent with techniques used in prior periods.

Impaired Loans

The Company does not record loans held-for-investment at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with the Receivables topic of the FASB Accounting Standards Codification. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2011, the majority of impaired loans were evaluated based on the fair value of the collateral. The Company records impaired loans as nonrecurring Level 3. There have been no changes in valuation techniques for the quarter ended September 30, 2011. Valuation techniques are consistent with techniques used in prior periods.

Interest Rate Swaps

Interest rate swaps are recorded at fair value on a recurring basis. Fair value measurement is based on discounted cash flow models. All future floating cash flows are projected and both floating and fixed cash flows are discounted to the valuation date. As a result, the Company classifies interest rate swaps as Level 3.

The following table presents a rollforward of interest rate swaps from December 31, 2010 to September 30, 2011, and from December 31, 2009 to June 20, 2010 and shows that the interest rate swaps are classified as Level 3 as discussed above.



	Level 3
	Fair Value- Assets		Fair Value- Liabilities
	(Amounts in thousands)
Balance, June 30, 2011	$	173	$	173
Purchases, sales, issuances and settlements	—		—
Gains/losses included in other income	55		55
Balance, September 30, 2011	$	228	$	228

Balance, June 30, 2010	$	162	$	162
Purchases, sales, issuances and settlements	—		—
Gains/losses included in other income	61		61
Balance, September 30, 2010	$	223	$	223



	Level 3
	Fair Value- Assets		Fair Value- Liabilities
	(Amounts in thousands)
Balance, December 31, 2010	$	159	$	159
Purchases, sales, issuances and settlements	—		—
Gains/losses included in other income	69		69
Balance, September 30, 2011	$	228	$	228

Balance, December 31, 2009	$	—	$	—
Purchases, sales, issuances and settlements	—		—
Gains/losses included in other income	223		223
Balance, September 30, 2010	$	223	$	223

Other Real Estate Owned

Other real estate owned (“OREO”) is adjusted to fair value upon transfer of the loans to OREO on a nonrecurring basis. Subsequently, OREO is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management's estimation of the value of the collateral. The Company records foreclosed assets as nonrecurring Level 3. There have been no changes in valuation techniques for the quarter ended September 30, 2011. Valuation techniques are consistent with techniques used in prior periods.

Assets (liabilities) subjected to recurring fair value adjustments:



September 30, 2011 (in thousands)	Fair Value			Level 1		Level 2			Level 3
Available-for-sale securities:
U.S. government agencies	$	24,013		$	—	$	24,013		$	—
Government sponsored agencies:
Residential mortgage-backed securities	57,185			—		57,185			—
Collateralized mortgage obligations	143,226			—		143,226			—
Private label collateralized mortgage obligations	1,175			—		1,175			—
State and municipal securities	66,369			—		66,369			—
Common and preferred stocks	1,110			1,110		—			—
Interest rate swap agreements	228			—		—			228
Interest rate swap agreements	(228		)	—		—			(228		)
Interest rate lock commitments	330			—		—			330
Forward loan sale commitments	(121		)	—		(121		)	—
Mortgage servicing rights	2,016			—		—			2,016



December 31, 2010 (in thousands)	Fair Value			Level 1		Level 2		Level 3
Available-for-sale securities:
U.S. government agencies	$	14,550		$	—	$	14,550	$	—
Government sponsored agencies:
Residential mortgage-backed securities	52,075			—		52,075		—
Collateralized mortgage obligations	155,926			—		155,926		—
Private label collateralized mortgage obligations	1,705			—		1,705		—
State and municipal securities	72,622			—		72,622		—
Common and preferred stocks	1,124			1,124		—		—
Interest rate swap agreements	159			—		—		159
Interest rate swap agreements	(159		)	—		—		(159		)
Interest rate lock commitments	105			—		—		105
Forward loan sale commitments	161			—		161		—
Mortgage servicing rights	2,144			—		—		2,144

Assets subjected to nonrecurring fair value adjustments:



	Fair Value		Level 1		Level 2		Level 3
September 30, 2011 (Amounts in thousands)
Other real estate owned	$	5,216	$	—	$	—	$	5,216
Impaired loans:
Construction	4,118		—		—		4,118
Commercial real estate:
Non-owner occupied	38		—		—		38
Owner occupied	2,427		—		—		2,427
Commercial	442		—		—		442
Mortgages:
Secured 1-4 family real estate	281		—		—		281
Multifamily	387		—		—		387
Open ended secured 1-4 family	507		—		—		507
Consumer and other	98		—		—		98

December 31, 2010
Other real estate owned	$	2,941	$	—	$	—	$	2,941
Impaired loans:
Construction	8,975		—		—		8,975
Commercial real estate:
Non-owner occupied	5,388		—		—		5,388
Owner occupied	4,217		—		—		4,217
Commercial	4,117		—		—		4,117
Mortgages:
Secured 1-4 family real estate	1,790		—		—		1,790
Multifamily	387		—		—		387
Open ended secured 1-4 family	459		—		—		459
Consumer and other	99		—		—		99

The carrying value of OREO at September 30, 2011 is $21,307,262. At December 31, 2010 the carrying value of OREO was $25,582,234. Other real estate owned with a carrying amounts of $7.5 million were written down to their fair value of $5.2 million for the nine months ended September 30, 2011 and have been included in the table above, resulting in a loss of $2.3 million, which was included in earnings.

There were no transfers between valuation levels for any assets during the quarter ended September 30, 2011 or the quarter ended September 30, 2010. If different valuation techniques are deemed necessary, we would consider those transfers to occur at the end of the period when the assets are valued.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

+ References

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