Fair Value Measurement

6 Months Ended

Jun. 30, 2011

Fair Value Measurement [Abstract]

FAIR VALUE MEASUREMENT

NOTE 9. FAIR VALUE MEASUREMENT

The following table presents estimated fair values of the Company’s financial instruments as of June 30, 2011 and December 31, 2010, excluding financial instruments recorded at fair value on a recurring basis (summarized in a separate table), whether or not recognized or recorded at fair value in the consolidated balance sheets.

Non-financial assets and non-financial liabilities defined by the Codification (ASC 820-10-15-1A), such as Bank premises and equipment, deferred taxes and other liabilities, are excluded from the table. In addition, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements of the Financial Instruments Topic of the Codification (ASC 825-10-50-8), such as Bank-owned life insurance policies.

	June 30, 2011				December 31, 2010
	Carrying				Carrying
(Dollars in thousands)	Amounts		Fair Value		Amounts		Fair Value
Financial assets
Cash and cash equivalents	$	48,316	$	48,316	$	63,256	$	63,256
Portfolio loans, net		582,418		589,960		587,865		595,442
Mortgages loans held for sale		26,067		26,067		42,995		42,995
Interest receivable		3,555		3,555		3,845		3,845
Financial liabilities
Deposits		625,431		623,131		648,702		650,200
Securities sold under agreements to repurchase		15,353		14,233		13,548		12,425
Federal Home Loan Bank advances		91,000		90,951		141,000		140,963
Subordinated debenture		15,465		6,762		15,465		6,633
Interest payable		451		451		458		458
	Contract				Contract
Off balance sheet financial instruments:	Amount				Amount
Commitments to extend credit	$	138,551			$	146,915
Standby letters of credit	$	3,067			$	3,509
Guaranteed commitments outstanding	$	1,274			$	1,299

The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practical to estimate that value:

Cash and cash equivalents — The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents are a reasonable estimate of fair value. The carrying amount is a reasonable estimate of fair value because of the relatively short term between the origination of the instrument and its expected realization.

Portfolio loans, net — For variable-rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying values. For fixed rate loans projected cash flows are discounted back to their present value based on specific risk adjusted spreads to the U.S. Treasury Yield Curve, with the rate determined based on the timing of the cash flows. The ALL is considered to be a reasonable estimate of loan discount for credit quality concerns.

Mortgage loans held for sale — Mortgage loans held for sale are carried at the lower of cost or fair value. Cost generally approximates fair value, given the short duration of these assets.

Interest receivable and payable — The carrying amount of interest receivable and payable approximates its fair value.

Deposits — The fair value of deposits was derived by discounting the expected cash flows back to their present values based on the FHLB yield curve. The OTS decay rate assumptions for the timing of cash flows were used as a conservative proxy for non-maturity deposits.

Securities sold under agreements to repurchase — The fair value of securities sold under agreements to repurchase is estimated by discounting the contractual cash flows under outstanding borrowings at rates equal to the Company’s current offering rate, which approximate general market rates.

FHLB advances — The fair value of the FHLB advances is derived by discounting the cash flows of the fixed rate borrowings by the current FHLB offering rates of borrowings of similar terms, as of June 30, 2011. For variable rate FHLB borrowings, the carrying value approximates fair value.

Subordinated debentures — The fair value of the subordinated debenture is estimated by discounting the future cash flows using market rates at June 30, 2011, of which similar debentures would be issued with similar credit ratings as ours and similar remaining maturities. Future cash flows were discounted at 6.71%.

Commitments — Loan commitments and standby letters of credit generate ongoing fees, which are recognized over the term of the commitment period. In situations where the borrower’s credit quality has declined, we record a reserve for these off-balance sheet commitments. Given the uncertainty in the likelihood and timing of a commitment being drawn upon, a reasonable estimate of the fair value of these commitments is the carrying value of the related unamortized loan fees plus the reserve, which is not material. As such, no disclosures are made on the fair value of commitments.

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Available-for-sale securities, derivatives, and the earn out payable are recorded at fair value on a recurring basis. From time to time, the Company may be required to record at fair value other assets on a non recurring basis, such as collateral dependent impaired loans and certain other assets including OREO and goodwill. These nonrecurring fair value adjustments involve the application of lower of cost or fair value accounting or write downs of individual assets.

Fair Value Hierarchy

Level 1 valuations utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.

Level 2 valuations utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 valuations include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 valuations are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. Valuation is generated from model-based techniques that use significant assumptions 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 include the use of option pricing models, discounted cash flow models and similar techniques.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety.

The Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when developing fair value measurements. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of June 30, 2011 and December 31, 2010, respectively, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.

(Dollars in thousands)	Fair Value at June 30, 2011
Recurring basis	Total		Level 1		Level 2		Level 3
Available-for-sale securities
Obligations of states and political subdivisions	$	57,881	$	—	$	57,881	$	—
Corporate securities	$	23,432		—	$	23,432		—
Other investment securities (1)	$	80,871		—	$	80,871		—
Total assets measured at fair value	$	162,184	$	—	$	162,184	$	—
Earn out payable		596						596
Total liabilities measured at fair value	$	596	$	—	$	—	$	596

(1)  Principally represents U.S. Treasury and agencies or residential mortgage backed securities issued or guaranteed by governmental agencies.

(Dollars in thousands)	Fair Value at December 31, 2010
Recurring basis	Total		Level 1		Level 2		Level 3
Available-for-sale securities
Obligations of states and political subdivisions	$	64,151	$	—	$	64,151	$	—
Corporate securities		28,957		—		28,957		—
Other investment securities (1)		96,127		—		96,127		—
Derivatives		2,341		—		2,341		—
Total assets measured at fair value	$	191,576	$	—	$	191,576	$	—
Earn out payable		986		—		—		986
Total liabilities measured at fair value	$	986	$	—	$	—	$	986

(1) Principally represents U.S. Treasury and agencies or residential mortgage backed securities issued or guaranteed by governmental agencies.

The following table provides a reconciliation of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis for the three months and six months ended June 30, 2011, and 2010. The amount included in the “Transfer into Level 3” column represents the beginning balance of an item in the period (interim quarter) for which it was designated as a Level 3 fair value measure.

	Three months				Six months
	ended June 30,				ended June 30,
(Dollars in thousands)	2011		2010		2011			2010
Beginning balance — Earn out payable	$	596	$	965	$	986		$	965
Transfers into Level 3		—		—		—			—
Transfers out of Level 3		—		—		—			—
Total losses
Included in earnings (or changes in net liabilities)		—		11		(390	)		11
Included in other comprehensive income		—		—		—			—
Purchases, issuances, sales, and settlements
Purchases		—		—		—			—
Issuances		—		—		—			—
Sales		—		—		—			—
Settlements		—		—		—			—
Ending balance — Earn out payable	$	596	$	976	$	596		$	976

The available-for-sale securities amount above represents securities that have been adjusted to their fair value. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions among other things.

The derivative amount disclosed in the December 31, 2010 recurring fair value table above represent the fair value of the Company’s interest rate swaps, prior to termination. The valuation of the Company’s interest rate swaps was obtained from a third party pricing service. The fair values were determined by using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis was based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves. The Company has determined that the source of the derivative fair values fall with Level 2 of the fair value hierarchy.

The earn out payable amount above represents the fair value of the Company’s earn out incentive agreement with the non controlling interest of the Bank of Commerce Mortgage subsidiary. The non controlling interest of the mortgage subsidiary will earn certain cash payments from the Company, based on targeted results. The fair value of the earn out payable is estimated by using a discounted cash flow model whereby discounting the contractual cash flows expected to be paid out, under the assumption the mortgage subsidiary meets the target results. The expected contractual cash flows are discounted using the six month and two year treasury rates coinciding with their expected payment dates. As such, the Company has determined that the fair values fall with Level 3 of the fair value hierarchy.

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period.

Assets measured at fair value on a nonrecurring basis are included in the table below. No liabilities were measured at fair value on a nonrecurring basis at June 30, 2011 or December 31, 2010.

(Dollars in thousands)	Fair Value at June 30, 2011
Nonrecurring basis	Total		Level 1		Level 2		Level 3
Impaired loans	$	4,918	$	—	$	—	$	4,918
Other real estate owned		1,470		—		—		1,470
Total assets measured at fair value	$	6,388	$	—	$	—	$	6,388

(Dollars in thousands)	Fair Value at December 31, 2010
Nonrecurring basis	Total		Level 1		Level 2		Level 3
Impaired loans	$	12,982	$	—	$	—	$	12,982
Other real estate owned		1,994		—		—		1,994
Goodwill		3,695		—		—		3,695
Total assets measured at fair value	$	18,671	$	—	$	—	$	18,671

The following table presents the losses resulting from nonrecurring fair value adjustments for the three and six months ended June 30, 2011 and 2010:

	Three months ended				Six months ended
	June 30,				June 30,
(Dollars in thousands)	2011		2010		2011		2010
Impaired loans	$	2,243	$	332	$	3,145	$	1,415
Other real estate owned		370		1,064		557		1,245
Goodwill		—		32		—		32
Total assets measured at fair value	$	2,613	$	1,428	$	3,702	$	2,692

For the six months ended June 30, 2011:

• Collateral dependent impaired loans with a carrying amount of $8.0 million were written down to their fair value of $4.9 million resulting in a $3.1 million adjustment to the ALL.

• OREO with a carrying amount of $2.0 million was written down to fair value of $1.5 million resulting in a loss of $557 thousand which was included in earnings for the period.

The loan amounts above represent impaired, collateral dependent loans that have been adjusted to fair value. When we identify a collateral dependent loan as impaired, we measure the impairment using the current fair value of the collateral, less selling costs. Depending on the characteristics of a loan, the fair value of collateral is generally estimated by obtaining external appraisals. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we recognize this impairment and adjust the carrying value of the loan to fair value through the ALL.

The loss represents charge offs or impairments on collateral dependent loans for fair value adjustments based on the fair value of collateral. The carrying value of loans fully charged off is zero. When the fair value of the collateral is based on a current appraised value, 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 records the impaired loan as nonrecurring Level 3.

The OREO amount above represents impaired real estate that has been adjusted to fair value. OREO represents real estate which the Bank has taken control of in partial or full satisfaction of loans. At the time of foreclosure, OREO is recorded at the fair value less costs to sell, which becomes the property’s new basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the ALL. After foreclosure, management periodically performs valuations such that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Fair value adjustments on OREO are recognized within net loss on real estate owned. The loss represents impairments on OREO for fair value adjustments based on the fair value of the real estate. The Company records OREO as a nonrecurring Level 3.

The fair value of goodwill in the December 31, 2010 nonrecurring fair value table above represents goodwill that has been adjusted to fair value. The fair value of the mortgage subsidiary is estimated using a market and income approach, and is provided to the Company by a third party independent valuation consultant. Based on the fair value of the mortgage subsidiary, the Company makes a determination of goodwill impairment. An impairment review was performed during the three months ended June 30, 2011, and no fair value adjustment was deemed necessary. See Note 8 in the Company’s December 31, 2010 financial statements, incorporated in the annual December 31, 2010 10-K filing for further disclosure pertaining to the goodwill impairment analysis. The Company records goodwill as a nonrecurring Level 3 when impairment is recorded.

Limitations - Fair value estimates are made at a specific point in time, based on relevant market information and other information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument.

Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates 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 estimates.

Fair value estimates are based on current on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments.

Other significant assets and liabilities that are not considered financial assets or liabilities include deferred tax assets and liabilities, and property, plant and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.