Note 13 - Fair Value Measurements

3 Months Ended

Mar. 31, 2013

Fair Value Disclosures [Text Block]

Note 13 - Fair Value Measurements

The Company is required to disclose the estimated fair value of financial instruments, both assets and liabilities on and off the balance sheet, for which it is practicable to estimate fair value. These fair value estimates are made at each balance sheet date, based on relevant market information and information about the financial instruments. Fair value estimates are intended to represent the price at which an asset could be sold or the price for which a liability could be settled in an orderly transaction between market participants at the measurement date. However, given there is no active market or observable market transactions for many of the Company’s financial instruments, the Company has made estimates of many of these fair values which are subjective in nature, involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimated values. The methodologies used for estimating the fair value of financial assets and financial liabilities are discussed below:

Cash and Cash Equivalents

Cash and cash equivalents, which are comprised of cash and due from banks, interest-bearing balances at banks and Federal funds sold, approximate their fair value.

Investment Securities

Fair value for investment securities is based on the quoted market price if such information is available. If a quoted market price is not available, fair values are based on quoted market prices of comparable instruments.

Nonmarketable Equity Securities

Cost is a reasonable estimate of fair value for nonmarketable equity securities because no quoted market prices are available and the securities are not readily marketable.  The carrying amount is adjusted for any permanent declines in value.

Loans, Net of Allowance and Loans Held for Sale

For certain homogenous categories of loans, such as residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Further adjustments are made to reflect current market conditions. There is no discount for liquidity included in the expected cash flow assumptions.

FDIC Indemnification Asset

The fair values for the FDIC indemnification asset are estimated based on discounted future cash flows using current discount rates.

Accrued Interest Receivable

The carrying amount is a reasonable estimate of fair value.

Deposits

The fair value of deposits that have no stated maturities, including demand deposits, savings, money market and NOW accounts, is the amount payable on demand at the reporting date. The fair value of deposits that have stated maturity dates, primarily time deposits, is estimated by discounting expected cash flows using the rates currently offered for instruments of similar remaining maturities.

Borrowings

The fair values of short-term and long-term borrowings are based on discounting expected cash flows at the interest rate for debt with the same or similar remaining maturities and collateral requirements.

Subordinated Debentures

The fair value of fixed rate subordinated debentures is estimated using a discounted cash flow calculation that applies the Company’s current borrowing rate.  The carrying amounts of variable rate borrowings are reasonable estimates of fair value because they can reprice frequently.

Contingent Payable

The carrying amount is a reasonable estimate of fair value.

Accrued Interest Payable

The carrying amount is a reasonable estimate of fair value.

Derivative Instruments

Derivative instruments, including interest rate swaps and swap fair value hedges, 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.

Financial Instruments with Off-Balance Sheet Risk

With regard to financial instruments with off-balance sheet risk, it is not practicable to estimate the fair value of future financing commitments.

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale and derivative instruments 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 on a nonrecurring basis. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

The Company groups assets and liabilities 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.

Level 1 Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2 Valuation is based upon 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 in the market.

Level 3 Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques may include the use of option pricing models, discounted cash flow models and similar techniques.

The carrying amounts and estimated fair values of the Company’s financial instruments, none of which are held for trading purposes, at March 31, 2013 and December 31, 2012 are as follows:

					Fair Value Measurements
	Carrying		Estimated		Quoted Prices in Active Markets for Identical Assets or Liabilities		Significant Other Observable Inputs		Significant Unobservable Inputs
(Dollars in thousands)	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
March 31, 2013:
Financial assets:
Cash and cash equivalents	$	122,265	$	122,265	$	122,265	$	-	$	-
Investment securities		299,073		299,073		-		298,658		415
Nonmarketable equity securities		5,913		5,913		-		5,913		-
Loans held for sale		11,659		11,659		-		11,659		-
Loans, net of allowance		1,319,000		1,303,061		-		8,852		1,294,209
FDIC indemnification asset		15,340		15,340		-		-		15,340
Accrued interest receivable		3,706		3,706		-		-		3,706
Financial liabilities:
Deposits with no stated maturity		990,424		990,424		-		990,424		-
Deposits with stated maturities		604,397		605,705		-		605,705		-
Swap fair value hedge		382		382		-		382		-
Borrowings		87,060		86,708		-		86,708		-
Contingent payable		3,003		3,003		-		3,003		-
Accrued interest payable		475		475		-		475		-
December 31, 2012:
Financial assets:
Cash and cash equivalents	$	184,142	$	184,142	$	184,142	$	-	$	-
Investment securities		245,571		245,571		-		245,156		415
Nonmarketable equity securities		7,422		7,422		-		7,422		-
Loans held for sale		14,147		14,147		-		14,147		-
Loans, net of allowance		1,346,116		1,332,683		-		11,390		1,321,293
FDIC indemnification asset		18,697		18,697		-		-		18,697
Accrued interest receivable		3,821		3,821				-		3,821
Financial liabilities:						-		-		-
Deposits with no stated maturity		1,002,258		1,002,258		-		1,002,258		-
Deposits with stated maturities		629,746		631,289		-		631,289		-
Swap fair value hedge		453		453		-		453		-
Borrowings		101,716		101,307		-		101,307		-
Contingent payable		3,003		3,003		-		3,003		-
Accrued interest payable		516		516		-		516		-

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value:

Investment Securities Available-for-Sale

Investment securities available-for-sale 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 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, municipal bonds and corporate debt securities that are valued using quoted prices for similar instruments in active markets. Securities classified as Level 3 include a corporate debt security in a less liquid market whose value is determined by reference to the going rate of a similar debt security if it were to enter the market at period end. The derived market value requires significant management judgment and is further substantiated by discounted cash flow methodologies.

Derivative Instruments

Derivative instruments held or issued by the Company for risk management purposes are traded in over-the-counter markets where quoted market prices are not readily available. For those derivatives, the Company uses a third party to measure the fair value on a recurring basis. The Company classifies derivative instruments held or issued for risk management purposes as Level 2. As of March 31, 2013 and December 31, 2012, the Company’s derivative instruments consist of swap fair value hedges.

Loans

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 it for the estimated impairment. The fair value of impaired loans is estimated using one of several methods, including collateral value, a loan’s observable market price and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value exceeds the recorded investments in such loans. Impaired loans where a specific allowance is established based on the fair value of collateral require classification in the fair value hierarchy. The Company records the impaired loans as nonrecurring Level 3.

At March 31, 2013 and December 31, 2012, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. The Company recorded the six loans involved in fair value hedges at fair market value on a recurring basis. The Company does not record other loans at fair value on a recurring basis.

Loans held for sale

Loans held for sale are adjusted to lower of cost or market upon transfer from the loan portfolio to loans held for sale. Subsequently, loans held for sale are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral, management’s estimation of the value of the collateral or commitments on hand from investors within the secondary market for loans with similar characteristics. The fair value adjustments for loans held for sale are recorded as recurring Level 2.

Other real estate owned

Other real estate owned (“OREO”) is adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair value less costs to sell. 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 the OREO as nonrecurring Level 3.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The table below presents, by level, the recorded amount of assets and liabilities at March 31, 2013 and December 31, 2012 measured at fair value on a recurring basis:

	Fair Value on a Recurring Basis
Description	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)		Assets/Liabilities at Fair Value
	(Dollars in thousands)
March 31, 2013
U.S. Government agencies	$	-	$	578		$	-	$	578
Municipal securities		-		17,676			-		17,676
Residential agency mortgage-backed securities		-		137,995			-		137,995
Commercial mortgage-backed securities		-		36,828			-		36,828
All other debt securities				105,581			415		105,996
Fair value loans		-		8,852			-		8,852
Swap fair value hedge		-		(382	)		-		(382	)
December 31, 2012
U.S. Government agencies	$	-	$	583		$	-	$	583
Municipal securities		-		17,986			-		17,986
Residential agency mortgage-backed securities		-		159,113			-		159,113
All other debt securities		-		67,474			415		67,889
Fair value loans		-		11,390			-		11,390
Swap fair value hedge		-		(453	)		-		(453	)

There were no transfers between valuation levels for any accounts.  If different valuation techniques are deemed necessary, the Company would consider those transfers to occur at the end of the period that the accounts are valued.

The following are reconciliations of the beginning and ending balances for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three months ended March 31, 2013 and 2012. The ending balances for Level 3 assets at March 31, 2013 remained unchanged from December 31, 2012 at $0.4 million.

Level 3 Assets Reconciliation

	Three Months Ended
	March
	2013		2012
	(dollars in thousands)
Corporate and Other Securities:
Balance, beginning of period	$	415	$	405
Decrease in unrealized loss		-		2
				-
Balance, end of period	$	415	$	407

Assets Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain other financial assets at fair value 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 impairment charges of individual assets.  Processes are in place for overseeing the valuation procedures for Level 3 measurements of OREO and impaired loans.  The assets are reviewed on a quarterly basis to determine the accuracy of the observable inputs, generally third party appraisals, auction values, values derived from trade publications and data submitted by the borrower, and the appropriateness of the unobservable inputs, generally discounts due to current market conditions and collection issues.  Discounts are based on asset type and valuation source; deviations from the standard are documented.  The discounts are periodically reviewed to determine they remain appropriate.  Consideration is given to current trends in market values for the asset categories and gain and losses on sales of similar assets.

Discounts range from 0% to 60% depending on the nature of the assets and source of value.  Real estate is valued based on appraisals or evaluations, discounted by 8% at a minimum with higher discounts for property in poor condition or property with characteristics that may make it more difficult to market.  Commercial loans secured by receivables or non-real estate collateral are generally valued using the discounted cash flow method.  Inputs are determined on a borrower-by-borrower basis.

Impaired loans and related write-downs are based on the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are reviewed quarterly and estimated using customized discounting criteria and appraisals.

Other real estate owned is based on the lower of the cost or fair value of the underlying collateral less expected selling costs.  Collateral values are estimated primarily using appraisals and reflect a market value approach.  Fair values are reviewed quarterly and new appraisals are obtained annually.

The table below presents the carrying value of assets at March 31, 2013 and December 31, 2012 measured at fair value on a nonrecurring basis:

Fair Value on a Nonrecurring Basis

Description	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Assets/ (Liabilities) at Fair Value
	(Dollars in thousands)
March 31, 2013
OREO	$	-	$	-	$	3,880	$	3,880
Impaired loans:
Commercial and industrial		-		-		364		364
CRE - investor income producing		-		-		3,419		3,419
Residential mortgage		-		-		751		751
Home equity lines of credit		-		-		113		113
December 31, 2012
OREO	$	-	$	-	$	25,390	$	25,390
Impaired loans:
Commercial and industrial		-		-		115		115
Residential mortgage		-		-		962		962
Home equity lines of credit		-		-		155		155

The table below presents the valuation methodology and unobservable inputs for Level 3 assets and liabilities measured at fair value on a nonrecurring basis at March 31, 2013.

(dollars in thousands)	Fair Value		Valuation Methodology	Unobservable Inputs	Range of Inputs
OREO	$	3,880	Appraisals	Discount to reflect current market conditions		0%	-	55%
Impaired loans		4,534	Discounted cash flows	Expected percent of total contractual cash flows not expected to be collected		0%	-	50%
		113	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability		0%	-	60%
	$	8,527

In accordance with accounting for foreclosed property, the carrying value of OREO is periodically reviewed and written down to fair value and any loss is included in earnings. During the three months ended March 31, 2013, OREO with a carrying value of $4.1 million was written down by $0.2 million to $3.9 million.  During the three months ended March 31, 2012, OREO with a carrying value of $1.8 million was written down by $0.2 million to $1.5 million.

There were no transfers between valuation levels for any accounts for the three months ended March 31, 2013 and 2012. If different valuation techniques are deemed necessary, we would consider those transfers to occur at the end of the period that the accounts are valued.