Fair Value Option and Fair Value Measurements

6 Months Ended

Jun. 30, 2012

Fair Value Option and Fair Value Measurements

Fair Value Option and Fair Value Measurements

Note 12 – Fair Value Option and Fair Value Measurements

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an 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.  The fair value hierarchy established also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  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 Company has the ability to access as of the measurement date.

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

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

The Company uses the following methods and significant assumptions to estimate fair value:

·Securities available-for-sale are valued primarily by a third party pricing agent and both the market and income valuation approaches are implemented using the following types of inputs:

oU.S. treasuries are priced using the market approach and utilizing live data feeds from active market exchanges for identical securities.

oGovernment-sponsored agency debt securities are primarily priced using available market information through processes such as benchmark curves, market valuations of like securities, sector groupings and matrix pricing.

·Other government-sponsored agency securities, mortgage-backed securities and some of the actively traded REMICs and CMOs are primarily priced using available market information including benchmark yields, prepayment speeds, spreads and volatility of similar securities.

·Other inactive government-sponsored agency securities are primarily priced using consensus pricing and dealer quotes.

·State and political subdivisions are largely grouped by characteristics, i.e., geographical data and source of revenue in trade dissemination systems.  Because some securities are not traded daily and due to other grouping limitations, active market quotes are often obtained using benchmarking for like securities and could be valued with level 3 measurements.

·Collateralized debt obligations are collateralized by trust preferred security issuances of other financial institutions.  Uncertainty in the financial markets in the periods presented has resulted in reduced liquidity for these investment securities, which continued to affect market pricing in the period presented.  To reflect an appropriate fair value measurement, management included a risk premium adjustment to provide an estimate of the yield that a market participant would demand because of uncertainty in cash flows in the discounted cash flow analysis.  Management initially made that adjustment to Level 3 valuation at June 30, 2009, because the level of market activity for CDO securities is incomplete and sporadic, information on orderly sale transactions was not generally available.

·Asset-backed securities are priced using a single expected cash flow stream model.

·Marketable equity securities are priced using available market information.

·Residential mortgage loans eligible for sale in the secondary market are carried at fair market value.  The fair value of loans held for sale is determined using quoted secondary market prices.

·Lending related commitments to fund certain residential mortgage loans (interest rate locks) to be sold in the secondary market and forward commitments for the future delivery of mortgage loans to third party investors as well as forward commitments for future delivery of mortgage-backed securities are considered derivatives.  Fair values are estimated based on observable changes in mortgage interest rates including mortgage-backed securities prices from the date of the commitment and do not typically involve significant judgments by management.

·The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income.  The valuation model incorporates assumptions that market participants would use in estimating future net servicing income to derive the resultant value.  The Company is able to compare the valuation model inputs, such as the discount rate, prepayment speeds, weighted average delinquency and foreclosure/bankruptcy rates  to widely available published industry data for reasonableness.

·Interest rate swap positions, both assets and liabilities, are based on a valuation pricing model using an income approach based upon readily observable market parameters such as interest rate yield curves.

·Both the credit valuation reserve on current interest rate swap positions and on receivables related to unwound customer interest rate swap positions was determined based upon management’s estimate of the amount of credit risk exposure, including available collateral protection and/or by utilizing an estimate related to a probability of default as indicated in the Bank credit policy.  Such adjustments would result in a Level 3 classification.

·The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals.  These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.  Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available.  Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

·Other Real Estate Owned:  Nonrecurring adjustments to certain commercial and residential real estate properties classified as OREO are measured at the lower of carrying amount or fair value, less costs to sell.  Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification.  In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

Assets and Liabilities Measured at Fair Value on a Recurring Basis:

The tables below present the balance of assets and liabilities at June 30, 2012, and December 31, 2011, respectively, which are measured by the Company at fair value on a recurring basis:

	June 30, 2012
	Level 1			Level 2			Level 3		Total
Assets:
Investment securities available-for-sale
U.S. Treasury	$	1,515		$		-	$	-	$		1,515
U.S. government agencies	-			44,623			-		44,623
U.S. government agency mortgage-backed	-			95,208			-		95,208
States and political subdivisions	-			13,920			138		14,058
Corporate Bonds	-			35,267			-		35,267
Collateralized mortgage obligations	-			62,387			-		62,387
Asset-backed securities	51,752			84,922			-		136,674
Collateralized debt obligations	-			-			9,163		9,163
Loans held-for-sale	-			6,445			-		6,445
Mortgage servicing rights	-			-			3,531		3,531
Other assets (Interest rate swap agreements net of swap credit valuation)	-			2,606			(69)		2,537
Other assets (Forward MBS)	-			910			-		910
Total	$	53,267		$		346,288	$	12,763	$		412,318
Liabilities:
Other liabilities (Interest rate swap agreements)	$	-		$		2,606	$	-	$		2,606
Other liabilities (Interest rate lock commitments to borrowers)	-			16			-		16
Total	$	-		$		2,622	$	-	$		2,622
	December 31, 2011
	Level 1			Level 2			Level 3		Total
Assets:
Investment securities available-for-sale
U.S. Treasury	$		1,524	$	-		$	-	$	1,524
U.S. government agencies	-			43,398			-		43,398
U.S. government agency mortgage-backed	-			154,007			-		154,007
States and political subdivisions	-			13,671			138		13,809
Corporate Bonds	-			31,389			-		31,389
Collateralized mortgage obligations	-			25,122			-		25,122
Asset-backed securities				28,341			-		28,341
Collateralized debt obligations	-			-			9,974		9,974
Loans held-for-sale	-			12,806			-		12,806
Mortgage servicing rights	-			-			3,487		3,487
Other assets (Interest rate swap agreements net of swap credit valuation)	-			3,152			(80)		3,072
Other assets (Forward MBS)	-			107			-		107
Total	$		1,524	$	311,993		$	13,519	$	327,036
Liabilities:
Other liabilities (Interest rate swap agreements)	$		-	$	3,152		$	-	$	3,152
Other liabilities (Interest rate lock commitments to borrowers)	-			50			-		50
Total	$		-	$	3,202		$	-	$	3,202

At March 31, 2012, $3.3 million in asset-backed securities were reported in level 1 using their purchased price. Subsequently, these securities have been included in level 2 using a third party pricing service.  Similarly, at June 30, 2012 $51.8 million in asset–backed securities are reported in level 1 using their purchase price.

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows:

	Six months ended June 30, 2012
	Investment securities  available-for- sale
	Collateralized Debt Obligations			States and Political Subdivisons			Mortgage Servicing Rights			Interest Rate Swap Valuation
Beginning balance January 1, 2012	$	9,974		$		138	$	3,487		$		(80)
Transfers into Level 3	-			-			-			-
Transfers out of Level 3	-			-			-			-
Total gains or losses
Included in earnings (or changes in net assets)	80			-			(835)			11
Included in other comprehensive income	(829)			-			-			-
Purchases, issuances, sales, and settlements
Purchases	-			-			-			-
Issuances	-			-			879			-
Settlements	(62)			-			-			-
Expirations	-			-			-			-
Ending balance June 30, 2012	$	9,163		$		138	$	3,531		$		(69)
	Six months ended June 30, 2011
	Investment securities available-for- sale
	Equity Securities			Collateralized Debt Obligations			States and political subdivisions			Mortgage Servicing Rights			Interest Rate Swap Valuation		Risk Participation Agreement
Beginning balance January 1, 2011	$		6	$	11,073		$		3,000	$	3,897		$	(108)	$	(38)
Transfers into Level 3	-			-			-			-			-		-
Transfers out of Level 3	-			-			(3,000)			-			-		-
Total gains or losses
Included in earnings (or changes in net assets)	-			69			-			(500)			(43)		38
Included in other comprehensive income	2			617			-			-			-		-
Purchases, issuances, sales, and settlements
Purchases	-			-			-			-			-		-
Issuances	-			-			-			621			-		-
Settlements	-			(69)			-			-			-		-
Expirations	-			-			-			-			-		-
Ending balance June 30, 2011	$		8	$	11,690		$		-	$	4,018		$	(151)	$	-

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis:

The Company may be required, from time to time, to measure certain other assets at fair value on a nonrecurring basis in accordance with GAAP.  These assets consist of impaired loans and other real estate owned.  For assets measured at fair value on a nonrecurring basis on hand at June 30, 2012, and December 31, 2011, respectively, the following tables provide the level of valuation assumptions used to determine each valuation and the carrying value of the related assets:

	June 30, 2012
	Level 1		Level 2		Level 3		Total
Impaired loans1	$	-	$	-	$	39,392	$	39,392
Other real estate owned, net2	-		-		89,671		89,671
Total	$	-	$	-	$	129,063	$	129,063

1   Represents carrying value and related write-downs of loans for which adjustments are substantially based on the appraised value of collateral for collateral-dependent loans.  These loans had a carrying amount of $45.7 million, with a valuation allowance of $6.3 million, resulting in a decrease of specific allocations within the allowance for loan losses of $6.7 million for the six months ending June 30, 2012.

2 OREO, measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $89.7 million, which is made up of the outstanding balance of $117.1 million, net of a valuation allowance of $27.5 million, at June 30, 2012, resulting in a charge to expense of $7.6 million for the six months ended June 30, 2012.

	December 31, 2011
	Level 1		Level 2		Level 3		Total
Impaired loans1	$	-	$	-	$	51,075	$	51,075
Other real estate owned, net2	-		-		93,290		93,290
Total	$	-	$	-	$	144,365	$	144,365

1Represents carrying value and related write-downs of loans for which adjustments are substantially based on the appraised value of collateral for collateral-dependent loans. These loans had a carrying amount of $64.1 million, with a valuation allowance of $13.0 million, resulting in a decrease of specific allocations within the allowance for loan losses of $9.9 million for the year ending December 31, 2011.

2OREO is measured at the lower of carrying or fair value less costs to sell and had a net carrying amount of $93.3 million, which is made up of the outstanding balance of $116.8 million, net of a valuation allowance of $23.5 million, at December 31, 2011, resulting in a charge to expense of $15.1 million for the year ended December 31, 2011.