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Fair Value of Financial Instruments
9 Months Ended
Jun. 30, 2011
Fair Value Disclosures [Text Block]

NOTE 7. Fair Value of Financial Instruments


          Fair value estimates are intended to represent the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Where there is no active market for a financial instrument, First Financial has made estimates using discounted cash flow or other valuation techniques. Inputs to these valuation methods are subjective in nature, involve uncertainties, and require significant judgment and therefore cannot be determined with precision. Accordingly, the derived fair value estimates presented below are not necessarily indicative of the amounts First Financial could realize in a current market exchange.


          Assets and liabilities are recorded at fair value according to a fair value hierarchy comprised of three levels. The levels are based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. The level of an asset or liability within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement (with Level 1 considered highest and Level 3 considered lowest). A brief description of each level follows.


 

 

Level 1 – Valuation is based on quoted prices for identical instruments in active markets.

Level 2 – Valuation is based on 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 that market participants would use in pricing the asset or liability. Valuation techniques include the use of discounted cash flow models and similar techniques.


          The following table presents the carrying value and fair value of the financial instruments.


 

 

 

 

 

 

 

 

 

 

 

 

 

 






 

 

 




 

 

 

As of June 30, 2011

 

As of September 30, 2010

 

 

 




 

(in thousands)

 

Carrying Value

 

Fair Value

 

Carrying Value

 

Fair Value

 










 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

64,999

 

$

64,999

 

$

55,274

 

$

55,274

 

Securities available for sale

 

 

418,967

 

 

418,967

 

 

407,976

 

 

407,976

 

Securities held to maturity

 

 

21,977

 

 

23,879

 

 

22,529

 

 

24,878

 

Nonmarketable securites - FHLB stock

 

 

37,626

 

 

37,626

 

 

42,867

 

 

42,867

 

Net loans

 

 

2,316,578

 

 

2,367,836

 

 

2,477,477

 

 

2,550,329

 

Loans held for sale

 

 

84,288

 

 

84,288

 

 

28,400

 

 

28,400

 

FDIC indemnification asset, net

 

 

58,926

 

 

58,926

 

 

67,583

 

 

67,583

 

Residential mortgage servicing rights1

 

 

12,403

 

 

12,403

 

 

10,200

 

 

10,200

 

Accrued interest receivable1

 

 

9,646

 

 

9,646

 

 

9,765

 

 

9,765

 

Derivative financial instruments1

 

 

969

 

 

969

 

 

2,205

 

 

2,205

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

2,315,745

 

 

2,324,770

 

 

2,415,063

 

 

2,436,024

 

Advances from FHLB

 

 

557,500

 

 

585,420

 

 

508,235

 

 

546,056

 

Long-term debt

 

 

47,204

 

 

43,936

 

 

47,204

 

 

40,710

 

Accrued interest payable2

 

 

8,667

 

 

8,667

 

 

11,358

 

 

11,358

 






 


 

 

1

Included as part of Other Assets in the Consolidated Balance Sheets as of June 30, 2011 and September 30, 2010.

 

 

2

Included as part of Other Liabilities in the Consolidated Balance Sheets as of June 30, 2011 and September 30, 2010.


          The carrying amount approximates fair value for cash and cash equivalents, accrued interest receivable and accrued interest payable. The methods and assumptions used to estimate the fair value for the other financial instruments are set forth below. There were no changes in the valuation methods used to estimate fair value since September 30, 2010.


Securities available for sale


          The fair value of available for sale securities that are classified as Level 3 include certain private-label mortgage-backed securities and trust preferred CDOs. In the absence of observable or corroborated market data, estimates that incorporate market-based assumptions are used when such information is available. These values take into account recent market activity as well as other market observable data such as interest rate, spread and prepayment information. When market observable data is not available, the valuation of the security is subjective and may involve substantial judgment. First Financial’s fair value models incorporate market participant data and knowledge of the structures of each individual security to develop cash flows specific to each security and apply appropriate discount rates. The discount rates are developed by determining credit spreads above a benchmark rate, such as LIBOR, and adding premiums for illiquidity based on a comparison of initial issuance spread to LIBOR versus a financial sector curve for recently issued debt to LIBOR. Specific securities that have increased uncertainty regarding the receipt of cash flows are discounted at higher rates due to the addition of a deal specific credit premium. Pricing is reviewed for reasonableness based on the direction of the specific markets and the general economic indicators. To determine the fair value, cash flow models for trust preferred CDOs provided by a third-party pricing service are utilized. The models estimate default vectors for the underlying issuers within each CDO security, estimate expected bank failures across the entire banking system to determine the impact on each CDO, and assign a risk rating to each individual issuer in the collateral pool. To determine the pricing valuation for private-label CMOs, First Financial obtains fair values for similar agency products from third party pricing brokers and determines an economic spread between agency and non-agency products. A pricing model is utilized to estimate each security’s cash flows and adjusted price based on coupon, constant prepayment rate, and required yields or spreads. If a private label security is rated below investment grade by a credit agency, a stress test is performed to determine OTTI.


Securities held to maturity


          The fair value of securities classified as held to maturity is based on quoted prices for similar assets.


Nonmarketable securities – FHLB stock


          The carrying amount of Federal Home Loan Bank (“FHLB”) stock is used to approximate the fair value as this security is not readily marketable, recorded at cost (par value), and evaluated for impairment based on the ultimate recoverability of the par value. First Financial considers positive and negative evidence, including the profitability and asset quality of the issuer, dividend payment history and recent redemption experience, when determining the ultimate recoverability of the par value. First Financial believes its investment in FHLB stock is ultimately recoverable at par.


Net loans


          The fair value of net loans is estimated based on discounted cash flows. The cash flows take into consideration current portfolio interest rates and repricing characteristics as well as assumptions relating to prepayment speeds. The discount rates take into consideration the current market interest rate environment, a credit risk component based on the credit characteristics of each loan portfolio, and a liquidity premium reflecting the liquidity or illiquidity of the market. Impaired loans are measured based on the fair value of the underlying collateral or discounted cash flow analyses, where applicable.


Loans held for sale


          Loans held for sale is comprised of residential mortgage loans originated for sale in the secondary market and certain nonperforming and performing loans identified to be sold in a bulk sale. The fair value of residential mortgage loans originated for sale in the secondary market is based on purchase commitments or quoted prices for the same or similar loans and classified as nonrecurring Level 2. The fair value of the nonperforming and performing loans identified to be sold in a bulk sale is based on market prices derived from indicative pricing and similar transactions recently completed in the distressed asset market. These loans are recorded at estimated fair value, net of transaction costs and are classified as nonrecurring Level 3.


FDIC indemnification asset, net


          The fair value is determined by the projected cash flows from the FDIC loss-share agreement based on expected reimbursements for losses at the applicable loss sharing percentages pursuant to the terms of the loss-share agreement. Cash flows are discounted to reflect the timing and receipt of the loss-sharing reimbursements from the FDIC.


Residential mortgage servicing rights


          The estimated fair value of residential mortgage servicing rights (“MSRs”) is obtained through an independent third party analysis of future cash flows. The evaluation utilizes assumptions market participants would use in determining fair value including market discount rates, prepayment speeds, servicing income, servicing costs, default rates and other market driven data, as well as the market’s perception of future interest rate movements. MSRs are classified as Level 3.


Derivative financial instruments


          Fair value of the derivative instruments is based on quoted market prices.


Deposits


          The fair value of core deposits, which include checking, savings and money market accounts, are, by definition, equal to the amount payable on demand as of the valuation date (i.e. their carrying amounts). Fair values for time deposits are based on the discounted value of contractual cash flows at current interest rates. The estimated fair value of deposits does not take into account the value of First Financial’s long-term relationships with depositors, commonly known as core deposit intangibles, which are separate intangible assets, and not considered financial instruments.


Advances from FHLB and Long-term debt


          The fair value of these financial instruments is estimated using observable market prices and by discounting future cash flows using current interest rates for similar financial instruments.


Assets Recorded at Fair Value on a Recurring Basis


          The following table presents the financial instruments measured at fair value on a recurring basis.


 

 

 

 

 

 

 

 

 

 

 

 

 

 




 

 

 

 

As of June 30, 2011

 

 

 


 

(in thousands)

 

Level 1

 

Level 2

 

Level 3

 

Total

 










 

Obligations of the U.S. government agencies and corporations

 

$

 

$

1,887

 

$

 

$

1,887

 

State and municipal obligations

 

 

 

 

466

 

 

 

 

466

 

Collateralized debt obligations

 

 

 

 

 

 

3,354

 

 

3,354

 

Mortgage-backed securities

 

 

 

 

84,308

 

 

9,157

 

 

93,465

 

Collateralized mortgage obligations

 

 

 

 

50,386

 

 

264,154

 

 

314,540

 

Other securities

 

 

1,000

 

 

1,594

 

 

2,661

 

 

5,255

 

 

 



 



 



 



 

Securities available for sale

 

 

1,000

 

 

138,641

 

 

279,326

 

 

418,967

 

 

 



 



 



 



 

Residential mortgage servicing rights

 

 

 

 

 

 

12,403

 

 

12,403

 

Derivative financial instruments

 

 

969

 

 

 

 

 

 

969

 

 

 



 



 



 



 

Total assets at fair value

 

$

1,969

 

$

138,641

 

$

291,729

 

$

432,339

 

 

 



 



 



 



 
















          For the three and nine months ended June 30, 2011, certain securities classified as Level 3 had $54 thousand and $710 thousand, respectively, in impairment losses which were considered OTTI. Some of the securities are currently paying interest but are not projected to completely repay principal. The anticipated loss of principal is based on cash flow projections which were modeled using a third party program. At June 30, 2011, management reviewed the loss severity and duration of the Level 3 securities and determined it has the ability and intent to hold these securities until the unrealized loss is recovered.


Changes in Fair Value Measurement Levels


          The following table includes changes in Level 3 fair value measurements based on the hierarchy levels previously discussed. The (losses) gains in the following table may include changes to fair value due in part to observable factors that may be part of the valuation methodology. There were no transfers in or out of the Level 3 category for the three and nine months ended June 30, 2011.


 

 

 

 

 

 

 

 

 

 

 

 

 

 






 

 

 

 

Three Months Ended
June 30, 2011

 

Nine Months Ended
June 30, 2011

 

 

 


 


 

(in thousands)

 

Securities
Available For
Sale

 

Residential
Mortgage
Servicing
Rights

 

Securities
Available For
Sale

 

Residential
Mortgage
Servicing
Rights

 






 




 

Balance, beginning of period

 

$

291,100

 

$

13,168

 

$

326,668

 

$

10,200

 

Total net (losses) gains for the year included in:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income

 

 

(54

)

 

(1,431

)

 

709

 

 

(912

)

Other comprehensive loss, gross

 

 

(1,930

)

 

 

 

(7,852

)

 

 

Purchases

 

 

8,811

 

 

 

 

15,860

 

 

 

Sales 1

 

 

 

 

 

 

 

 

 

Servicing rights

 

 

 

 

666

 

 

 

 

3,115

 

Paydowns

 

 

(18,601

)

 

 

 

(56,059

)

 

 

 

 



 



 



 



 

Balance, end of period

 

$

279,326

 

$

12,403

 

$

279,326

 

$

12,403

 

 

 



 



 



 



 


 

 


1

Level 3 impaired security with a cost basis of less that $100 thousand was sold during the quarter ended March 31, 2011. A gain in the amount of $1.4 million was recognized in earnings for the nine months ended June 30, 2011.


Assets Recorded at Fair Value on a Nonrecurring Basis


          The following table presents the assets measured at fair value on a nonrecurring basis categorized by the level of inputs used in the valuation of each asset and the corresponding realized loss.


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 












 

 

(in thousands)

 

As of
June 30,
2011

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

 

Significant Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Year
to Date
Losses

 












 

Loans held for sale

 

$

84,288

 

$

 

$

23,994

 

$

60,294

 

$

 

Impaired loans, net of specific allowance

 

 

22,739

 

 

 

 

 

 

22,739

 

 

(2,347

)

Other repossessed assets acquired

 

 

27,812

 

 

 

 

 

 

27,812

 

 

(4,821

)

 

 



 



 



 



 



 

Total nonrecurring basis measured assets

 

$

134,839

 

$

 

$

23,994

 

$

110,845

 

$

(7,168

)

 

 



 



 



 



 



 



















          Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or fair value. These loans are generally collateral dependent and their value is measured based on the value of the collateral securing these loans and are classified at Level 3 in the fair value hierarchy. Specific reserves for impaired loans were $2.4 million at June 30, 2011.


          Other repossessed assets acquired in settlement of loans are recorded at the lower of the principal balance of the loan or fair value of the property less estimated selling expenses. Fair value is generally based on appraisals of the real estate or market prices for similar non-real estate property and is considered to be Level 3 in the fair value hierarchy.