NOTE 12 – FAIR VALUE

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. A description of the valuation methodologies used for assets and liabilities recorded at fair value, and for estimating fair value for financial and non-financial instruments not recorded at fair value, is set forth below:

Cash and cash equivalents—The carrying amounts for cash and due from banks and federal funds sold approximate fair value because of the short maturities of those investments. The Company does not record these assets at fair value on a recurring basis. These assets are classified as Level 1 within the fair value hierarchy.

Available for sale and held to maturity securities—Where quoted prices are available in an active market, the securities are classified within Level 1 of the valuation hierarchy. Examples of such instruments include mutual funds. If quoted prices are not available, then fair values are estimated by using pricing models (i.e., matrix pricing) or quoted prices of securities with similar characteristics and the securities are classified within Level 2 of the valuation hierarchy. Examples of such instruments include U.S. government agency bonds, U.S. government agency mortgage-backed securities and private label collateralized mortgage obligations. On the auction rate trust preferred securities, the Company determined the fair value of these investments based on the current market price of the underlying collateral preferred shares and therefore classified these investments as Level 2 in the fair value hierarchy. Securities classified within Level 3 of the valuation hierarchy are securities for which significant unobservable inputs are utilized. Available for sale securities are recorded at fair value on a recurring basis and held to maturity securities are only disclosed at fair value.

Loans held for sale—The carrying amounts of these assets approximate fair value because these loans, are generally sold through forward sales (either already contracted or soon to be executed at the recording date). The Company does not record these assets at fair value on a recurring basis. These assets are classified as Level 2 within the fair value hierarchy.

Loans receivable—For variable rate loans that reprice frequently and have no significant change in credit risk, carrying values are a reasonable estimate of fair values, adjusted for credit losses inherent in the loan portfolio. The fair value of fixed rate loans is estimated by discounting the future cash flows using estimated period end market rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, adjusted for credit losses inherent in the loan portfolio. The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for credit losses is established. The specific reserves for collateral dependent impaired loans are based on the fair value of collateral less estimated costs to sell. The fair value of collateral is determined based on appraisals. In some cases, adjustments are made to the appraised values due to various factors including age of the appraisal, age of comparables included in the appraisal, and known changes in the market and in the collateral. When significant adjustments are based on unobservable inputs, the resulting fair value measurement is categorized as a Level 3 measurement.

Accrued interest receivable—The carrying amount approximates fair value. The Company does not record these assets at fair value on a recurring basis. These assets are classified as Level 1 within the fair value hierarchy.

Mortgage servicing assets—The fair value is based on market prices for comparable servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The Company does not record these assets at fair value on a recurring basis. Servicing assets are classified as Level 2 within the fair value hierarchy.

Federal Home Loan Bank stock —The Bank is a member of the Federal Home Loan Bank (“FHLB”) of Boston and is required to maintain an investment in capital stock of the FHLB. The carrying amount is a reasonable estimate of fair value. The Company does not record this asset at fair value on a recurring basis. Based on redemption provisions, the stock of the FHLB has no quoted market value and is carried at cost. FHLB stock is classified as Level 3 within the fair value hierarchy.

Foreclosed real estate— Foreclosed real estate represents real estate acquired through or in lieu of foreclosure and which are recorded at fair value on a nonrecurring basis. Fair value is based upon appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company classifies the fair value measurement as Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company classifies the fair value measurement as Level 3. The Company classified these assets as Level 3 within the fair value hierarchy.

Deposit liabilities—The fair value of demand deposits, savings and money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated using a discounted cash flow calculation that applies interest rates currently being offered by market participants for deposits of similar remaining maturities, estimated using local market data, to a schedule of aggregated expected maturities of such deposits. The Company does not record deposits at fair value on a recurring basis. Demand deposits, savings and money market deposits are classified as Level 1 within the fair value hierarchy. Certificates of deposit are classified as Level 2 within the fair value hierarchy.

Borrowed funds—The fair value of FHLB advances and other borrowed funds (repurchase agreements) are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. The Company does not record this liability at fair value on a recurring basis. FHLB advances and other borrowings are classified as Level 2 within the fair value hierarchy.

Accrued interest payable—The carrying amounts approximates fair value. The Company does not record the liability at fair value on a recurring basis. This liability is classified as Level 1 within the fair value hierarchy.

Mortgagors’ escrow accounts—The carrying amount approximates fair value. The Company does not record this liability at fair value on a recurring basis. This liability is classified as Level 2 within the fair value hierarchy.

The following is a summary of the carrying values and estimated fair values of the Company’s significant financial instruments as of September 30, 2013 and December 31, 2012:

			September 30, 2013			December 31, 2012
	Fair Value		Carrying		Fair		Carrying		Fair
(In thousands)	Hierarchy Level		Value		Value		Value		Value
Financial Assets
Cash and cash equivalents	Level 1	$	26,442	$	26,442	$	23,229	$	23,229
Investment securities, available-for-sale:
Mutual fund - mortgage-backed securities	Level 1		506		506		-		-
Other	Level 2		27,480		27,480		23,484		23,484
Investment securities, held-to-maturity	Level 2		19,257		19,356		25,519		26,107
Loans held for sale	Level 2		653		653		2,761		2,761
Loans receivable, net:
Performing	Level 2		364,889		372,348		386,904		405,977
Impaired	Level 3		16,085		16,085		30,709		30,709
Accrued interest receivable	Level 1		1,473		1,473		1,761		1,761
Mortgage servicing assets	Level 3		1,121		1,560		1,039		1,633
FHLB Stock	Level 3		5,444		5,444		5,917		5,917
Financial Liabilities
Demand deposits, savings, Now and
money market deposits	Level 1		232,685		234,057		226,524		228,851
Time deposits	Level 2		155,313		157,354		176,378		179,125
FHLB advances	Level 2		29,031		29,933		41,476		42,453
Borrowed funds	Level 2		5,025		5,025		6,394		6,398
Mortgagors' escrow accounts	Level 2		2,349		2,349		4,628		4,628
Accrued interest payable	Level 1		60		60		99		99

The Company discloses fair value information about financial instruments, whether or not recognized in the statement of financial condition, for which it is practicable to estimate that value. Certain financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

The estimated fair value amounts as of September 30, 2013 and December 31, 2012 have been measured as of their respective period-ends and have not been reevaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than amounts reported at such dates.

The information presented should not be interpreted as an estimate of the fair value of the Company as a whole since a fair value calculation is only required for a limited portion of the Company’s assets and liabilities. Due to the wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful.

The Company uses fair value measurements to record available-for sale investment securities and residential loans held for sale at fair value on a recurring basis. Additionally, the Company uses fair value measurements to measure the reported amounts of impaired loans, foreclosed real estate and mortgage-servicing rights at fair value on a nonrecurring basis. These nonrecurring fair value adjustments typically involve the application of lower-of-cost-or market value accounting or write-downs of individual assets.

Unrecognized financial instruments—Loan commitments on which the committed interest rate is less than the current market rate were insignificant at September 30, 2013 and December 31, 2012.

The following table represents a further breakdown of investment securities and other financial instruments measured at fair value on a recurring basis.

	Fair Value At September 30, 2013
(In thousands)	Level 1		Level 2		Level 3		Total
Assets measured at fair value on a recurring basis:
Available-for-sale investment securities:
U.S. Government and agency obligations	$	-	$	6,634	$	-	$	6,634
U.S. Government agency mortgage-backed obligations		-		10,499		-		10,499
U.S. Government agency collateralized mortgage obligations		-		3,907		-		3,907
Private label collateralized mortgage obligations		-		269		-		269
Auction-rate trust preferred securities		-		6,171		-		6,171
Mutual fund - mortgage-backed securities		506		-				506

	Fair Value At December 31, 2012
(In thousands)	Level 1		Level 2		Level 3		Total
Assets measured at fair value on a recurring basis:
Available-for-sale investment securities:
U.S. Government and agency obligations	$	-	$	1,029	$	-	$	1,029
U.S. Government agency mortgage-backed obligations		-		13,960		-		13,960
U.S. Government agency collateralized mortgage obligations		-		985		-		985
Private label collateralized mortgage obligations		-		294		-		294
Auction-rate trust preferred securities		-		7,216		-		7,216

The following table represents assets measured at fair value on a non-recurring basis.

	Fair Value At September 30, 2013
(In thousands)	Level 1		Level 2		Level 3		Total
Assets measured at fair value on a non-recurring basis:
Impaired loans	$	-	$	-		16,085	$	16,085
Foreclosed real estate		-		-		887		887
Mortgage servicing rights		-		-		1,560		1,560

	Fair Value At December 31, 2012
(In thousands)	Level 1		Level 2		Level 3		Total
Assets measured at fair value on a non-recurring basis:
Impaired loans	$	-	$	-		30,709	$	30,709
Foreclosed real estate		-		-		735		735
Mortgage servicing rights		-		-		1,633		1,633

During the nine months ended September 30, 2013, the following fair values of those reflected in the above table were remeasured:

⋅ $ 8.1 million in collateral dependent impaired loans,

⋅ $887,000 in foreclosed real estate, and

⋅ $1.6 million in mortgage servicing rights.

During 2012, the Company modified its methodology for determining the fair value of its investment in auction-rate preferred securities, which were previously valued using a discounted cash flow model and classified as Level 3 in the fair value hierarchy. At December 31, 2012, the Company determined the fair value of these investments based on the current market prices of the underlying collateral preferred shares, and classified these investments as Level 2 in the fair value hierarchy.

Because broadly traded markets do not exist for most of the Company’s financial instruments, the fair value calculations attempt to incorporate the effect of current market conditions at a specific time. These determinations are subjective in nature, involve uncertainties and matters of significant judgment and do not include tax ramifications; therefore, the results cannot be determined with precision, substantiated by comparison to independent markets and may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results. For all of these reasons, the aggregation of the fair value calculations presented herein do not represent, and should not be construed to represent, the underlying value of the Company.

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent management believes necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment.

Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and by investing in securities with terms that mitigate the Company’s overall interest rate risk.