Fair Value

6 Months Ended

Jun. 30, 2011

Fair Value [Abstract]

Fair Value

Note F  Fair Value

Fair Value Option

The Company has elected to record at fair value certain preferred and common equity securities, in accordance with accounting guidance, as they do not have stated maturity values and the fair value fluctuates with market changes.  The decision to elect the fair value option is made individually for each instrument and is irrevocable once made.  Changes in fair value for the selected instruments are recorded in earnings.

The following table presents the amount of gains and losses from fair value changes included in income before income taxes for financial assets and liabilities carried at fair value for the six months ended June 30:

	Changes in Fair Values for the six months ended June 30, 2010, for items Measured at Fair Value Pursuant to Election of the Fair Value Option
	Other Gains and (Losses)		Interest Income		Interest Expense		Total Changes In Fair Values Included in Current Period Earnings
	(In thousands)
Assets:
Trading securities	$	803		20		-		823

		Changes in Fair Values for the six months ended June 30, 2011, for items Measured at Fair Value Pursuant to Election of the Fair Value Option
		Other Gains and (Losses)			Interest Income		Interest Expense		Total Changes In Fair Values Included in Current Period Earnings
	(In thousands)
Assets:
Trading securities		$	(744	)		20		-	$	(724	)

Fair Value Measurement

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.  There are three levels of inputs that may be used to measure fair value:

Level 1:  Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2:  Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3:  Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions used to estimate the fair value of items:

Securities:  The fair values of trading securities and securities available for sale are determined by quoted market prices, if available (Level 1 inputs). For securities where quoted prices are not available, fair value is calculated based on market price of similar securities (Level 2).  For securities where quoted prices or market prices are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).  Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit swap and optionality.  Default and deferrals on individual securities are reviewed and incorporated into the calculations.  During times when trading is more liquid, broker quotes are used (if available) to validate the model.

Trust Preferred Securities which are issued by financial institutions and insurance companies were historically priced using Level 2 inputs.  The decline in the level of observable inputs and market activity in this class of investments by the measurement date has been significant and resulted in unreliable external pricing. Broker pricing and bid/ask spreads, when available, vary widely.  The once active market has become comparatively inactive.  As such, these investments are now priced using Level 3 inputs.

The Company has developed an internal model for pricing these securities.  Information such as historical and current performance of the underlying collateral, deferral/default rates, collateral coverage ratios, break in yield calculations, cash flow projections, liquidity and credit premiums required by a market participant, and financial trend analysis with respect to the individual issuing financial institutions and insurance companies, are utilized in determining individual security valuations.  Due to current market conditions as well as the limited trading activity of these securities, the market value of the securities is highly sensitive to assumption changes and market volatility.

For the three and six months ended June 30, 2011, corporate securities are priced using Level 2 inputs.  For the three and six months ended June 30, 2010, there was one corporate security that was priced using Level 3 inputs due to the lack of market of similar type investments.  The Company obtained broker quotes on this investment based on trading desk information in which the prices were heavily influenced by unobservable market inputs.  The security is still owned by the Company but is currently being priced under Level 2 inputs.

Common and preferred equity securities are generally priced using Level 1 or Level 2 inputs due to the market activity of these types of securities.   One of the preferred securities is considered level 3 pricing due to the limited trading activity of the individual security in the market and lack of certain brokers providing quotes on this type of security.  The company does obtain available, if any broker quotes, reviews past history of contractual payments and financial condition of the corporation in determining an appropriate market value for this type of security.

Impaired Loans:  Impaired commercial real estate loans that are measured for impairment using the fair value of collateral for collateral dependent loans, had a principal balance of $1.4 million, with a valuation allowance of $773,000 at June 30, 2011.  Impaired commercial real estate loans had a principal balance of $1.4 million, with a valuation allowance of $98,000 at December 31, 2010.  The increase in the specific allowance resulted in the increase in provisions for loan losses in the current year of $675,000.  Estimates of fair value used for other collateral supporting commercial loans generally is not observable in the marketplace and therefore, such valuations have been classified as Level 3. Impaired commercial loans had a principal balance of $212,000 with a valuation allowance of $109,000 as of June 30, 2011.  Impaired commercial loans had a principal balance of $2.0 million with a valuation allowance of $2.0 million as of December 31, 2010.  This loan was charged off in April 2011.

Loans Servicing Rights:  Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, based on a valuation model that calculates the present value of estimated future net servicing income.

Loans Held for Sale:  Loans held for sale are carried at the lower of cost or fair value, as determined by outstanding loan commitments from third party investors.

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

	Fair Value Measurements at June 30, 2011 Using
Assets:	June 30, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Trading securities	(In thousands)
Common and preferred equities	$	7,635		-	$	5,736	$	1,899
Available-for- sale securities
U.S. Agency		53,264		-		53,264		-
Corporate		24,653		-		24,653		-
Trust preferred securities		3,607		-		-		3,607
State and municipal		43,886		-		43,886		-
Small Business Administration		2,869		-		2,869		-
Residential mortgage-backed securities		77,342		-		77,342		-
Collateralized mortgage obligations		2,341		-		2,341		-
Total	$	215,597	$	-	$	210,091	$	5,506

	Fair Value Measurements at December 31, 2010 Using
Assets:	December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(In thousands)
Trading securities
Common and preferred equities	$	7,691		-	$	5,790	$	1,901
Available-for- sale securities
U.S. Agency		69,145		-		69,145		-
Corporate		24,253		-		24,253		-
Trust preferred securities		3,404		-		-		3,404
State and municipal		49,070		-		49,070		-
Small Business Administration		2,936		-		2,936		-
Residential mortgage-backed securities		75,192		-		75,192		-
Collateralized mortgage obligations		3,478		-		3,478		-
Total	$	235,169	$	-	$	229,864	$	5,305

The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months and six months ended June 30:

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
	Trading Securities			Trust Preferreds			Total
	(In thousands)
Beginning balance January 1, 2011	$	1,901		$	3,404		$	5,305
Total gains or losses (realized/unrealized)
Included in earnings
Interest income on securities		(10	)		-			(10	)
Other changes in fair value		(5	)		-			(5	)
Net impairment losses recognized in earnings		-			(205	)		(205	)
Interest payments applied to principal		-			(6	)		(6	)
Included in other comprehensive income		-			376			376
Ending balance March 31, 2011	$	1,886		$	3,569		$	5,455
Total gains or losses (realized/unrealized)
Included in earnings
Interest income on securities		(10	)		-			(10	)
Other changes in fair value		23			-			23
Net impairment losses recognized in earnings		-			(30	)		(30	)
Interest payments applied to principal		-			(5	)		(5	)
Included in other comprehensive income		-			73			73
Ending balance June 30, 2011	$	1,899		$	3,607		$	5,506

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
	Trading Securities			Corporate			Trust Preferreds			Total
	(In thousands)
Beginning balance January 1, 2010	$	2,059		$	2,250		$	5,921		$	10,230
Total gains or losses (realized/unrealized)
Included in earnings
Interest income on securities		(10	)		-			-			(10	)
Other changes in fair value		(24	)		-			-			(24	)
Net impairment losses recognized in earnings		-			-			(937	)		(937	)
Interest payments applied to principal		-			-			(252	)		(252	)
Included in other comprehensive income		-			-			299			299
Ending balance March 31, 2010	$	2,025		$	2,250		$	5,031		$	9,306
Included in earnings
Interest income on securities		(10	)		-			-			(10	)
Other changes in fair value		(256	)		-			-			(256	)
Net impairment losses recognized in earnings		-			-			(58	)		(58	)
Included in other comprehensive income		-			(850	)		960			110
Ending balance June 30, 2010	$	1,759		$	1,400		$	5,933		$	9,092

For items for which the fair value option has been elected, interest income is recorded within the consolidated statements of income based on the contractual amount of interest income earned on financial assets (except any that are in nonaccrual status). Dividend income is recorded based on cash dividends.  Cash flows from the purchase and sale of securities for which the fair value option has been elected are shown as investing activities in the consolidated statement of cash flows.

Fair Value of Financial Instruments

Carrying amounts and estimated fair values of financial instruments at June 30, 2011 and December 31, 2010 were as follows:

	June 30, 2011				December 31, 2010
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial assets:	(In thousands)
Cash and cash equivalents	$	20,427	$	20,427	$	33,741	$	33,741
Trading securities		7,635		7,635		7,691		7,691
Investment securities, available for sale		207,962		207,962		227,478		227,478
Investment securities, held to maturity		56,325		57,814		24,143		25,070
Loans held for sale		283		306		857		865
Loans receivable, net		280,894		294,084		282,574		297,342
Federal Home Loan Bank stock		2,168		N/A		2,109		N/A
Accrued interest receivable		2,488		2,488		2,455		2,455
Financial liabilities:
Deposits	$	545,700	$	548,780	$	552,164	$	560,226
Federal Home Loan Bank advances		12,000		12,256		12,000		12,308
Accrued interest payable		46		46		53		53

Our fair value estimates are based on our existing on and off balance sheet financial instruments without attempting to estimate the value of any anticipated future business. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on our fair value estimates and have not been considered in these.

Our fair value estimates are made as of the dates indicated, based on relevant market information and information about the financial instruments, including our 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 our

assumptions could significantly affect the estimates. Our fair value estimates, methods, and assumptions are set forth below for each type of financial instrument.

Cash and Cash Equivalents

The carrying value of our cash and cash equivalents approximates fair value because these instruments have original maturities of three months or less.

Investment Securities

We carry our investment securities held to maturity at cost and we carry our investment securities available for sale at fair value. The fair value estimates of these securities are based on quoted market prices of identical assets or liabilities, where available. Where sufficient data is not available to produce a fair valuation, fair value is based on broker quotes of similar assets or liabilities. Broker quotes may be adjusted to ensure that financial instruments are recorded at fair value. Adjustments

may include amounts to reflect counterparty credit quality and our creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. If quoted prices are not available, fair value is based upon valuation models that use cash flow, security structure, and other observable information.

Loans Held for Sale

Loans held for sale are carried at the lower of cost or fair value, as determined by outstanding commitments, from third party investors.

Loans and Leases

Variable-rate loans reprice as the associated rate index changes. Therefore, the carrying value of these loans approximate fair value.   The fair value of our fixed-rate loans were calculated by discounting scheduled cash flows through the estimated maturity using credit adjusted quarter-end origination rates. Our estimate of maturity is based on the contractual cash flows adjusted for prepayment estimates based on current economic and lending conditions.

FHLB Stock

It is not practicable to estimate the fair value of FHLB stock due to restrictions placed on its transferability.

Accrued Interest Receivable

The carrying value of accrued interest receivable approximates fair value.

Deposits

The fair value of our deposits with no stated maturity, such as savings and checking, as well as mortgagors’ payments held in escrow, is equal to the amount payable on demand. The fair value of time deposits was estimated by discounting expected maturities at interest rates approximating those currently being offered.  The fair value of accrued interest approximates fair value.

Borrowings

The fair value of borrowings is estimated using discounted cash flows analysis to maturity.