Fair Value of Financial Instruments

12 Months Ended

Sep. 30, 2011

Fair Value Disclosures [Text Block]

NOTE 17. 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 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 September 30, 2011				As of September 30, 2010
(in thousands)	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets
Cash and cash equivalents	$	85,937	$	85,937	$	55,274	$	55,274
Securities available for sale		412,108		412,108		407,976		407,976
Securities held to maturity		21,671		24,162		22,529		24,878
Nonmarketable securites - FHLB stock		35,782		35,782		42,867		42,867
Net loans		2,300,947		2,379,886		2,477,477		2,550,329
Loans held for sale		94,872		94,872		28,400		28,400
Other repossessed assets acquired1		26,212		26,212		11,940		11,950
FDIC indemnification asset, net		50,465		50,465		67,583		67,583
Residential mortgage servicing rights1		10,572		10,572		10,200		10,200
Accrued interest receivable1		8,928		8,928		9,765		9,765
Derivative financial instruments1		1,816		1,816		2,205		2,205
Liabilities
Deposits		2,302,857		2,318,531		2,415,063		2,436,024
Advances from FHLB		558,000		597,021		508,235		546,056
Long-term debt		47,204		43,356		47,204		40,710
Accrued interest payable2		8,369		8,369		11,358		11,358
1 Included as part of other assets in the Consolidated Balance Sheets as of September 30, 2011 and 2010, respectively.
2 Included as part of other liabilities in the Consolidated Balance Sheets as of September 30, 2011 and 2010, respectively.

          The methods and assumptions used to estimate the fair value of financial instruments are set forth below. There were no changes in the valuation methods used to estimate fair value during fiscal 2010.

Assets Recorded at Fair Value on a Recurring Basis

          The following tables present the financial instruments measured at fair value on a recurring basis.

	As of September 30, 2011
(in thousands)	Level 1		Level 2		Level 3		Total
Obligations of the U.S. government agencies and corporations	$	---	$	1,863	$	---	$	1,863
State and municipal obligations		---		481		---		481
Collateralized debt obligations		---		---		3,074		3,074
Mortgage-backed securities		---		80,919		8,038		88,957
Collateralized mortgage obligations		---		63,079		249,434		312,513
Other securities		1,000		1,499		2,721		5,220
Securities available for sale		1,000		147,841		263,267		412,108
Residential mortgage servicing rights		---		---		10,572		10,572
Derivative financial instruments		1,816		---		---		1,816
Total assets at fair value	$	2,816	$	147,841	$	273,839	$	424,496

	As of September 30, 2010
(in thousands)	Level 1		Level 2		Level 3		Total
Obligations of the U.S. government agencies and corporations	$	---	$	2,049	$	---	$	2,049
State and municipal obligations		---		466		---		466
Collateralized debt obligations		---		---		3,417		3,417
Mortgage-backed securities		---		70,760		12,388		83,148
Collateralized mortgage obligations		---		5,437		306,660		312,097
Other securities		1,000		1,595		4,204		6,799
Securities available for sale		1,000		80,307		326,669		407,976
Residential mortgage servicing rights		---		---		10,200		10,200
Derivative financial instruments		2,205		---		---		2,205
Total assets at fair value	$	3,205	$	80,307	$	336,869	$	420,381

     For the year ended September 30, 2011, certain securities classified as Level 3 had $879 thousand 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 September 30, 2011, management reviewed the loss severity and duration of the Level 3 securities and determined it had the ability and intent to hold these securities until the unrealized loss is recovered.

Securities available for sale

     The fair value of securities available for sale 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 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 provided by a third-party pricing service are utilized. For trust preferred CDOs, 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. For private-label CMOs, the pricing model estimates each security’s cash flows and adjusted price based on coupon, constant prepayment rate, default rate, and required yields or spreads. If a security is rated below investment grade by a credit agency, a stress test is performed to determine OTTI.

Residential mortgage servicing rights

     The estimated fair value of residential 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 derivative instruments is based on quoted market prices.

Changes in Fair Value Measurement Levels

     The table below includes changes in Level 3fair value measurements based on the hierarchy levels previously discussed. The gains (losses) 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 year ended September 30, 2011.

	Year Ended September 30, 2011
(in thousands)	Securities Available For Sale			Residential Mortgage Servicing Rights
Balance at beginning of period	$	326,668		$	10,200
Total net gains (losses) for the year included in Income		540			(3,610	)
Other comprehensive loss, gross		(4,027	)		---
Purchases		15,973			---
Sales 1		---			---
Servicing assets that resulted from transfers of financial assets		---			3,982
Paydowns		(75,887	)		---
Balance at end of period	$	263,267		$	10,572
1 Level 3 impaired security with a cost basis of less than $100 thousand was sold during fiscal year 2011 with again in the amount of $1.4 million was recognized in earnings.

Assets Recorded at Fair Value on a Nonrecurring Basis

     The table below 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 September 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	$	94,872	$	---	$	40,785	$	54,087	$	---
Impaired loans, net of specific allowance		24,139		---		---		24,139		(2,875	)
FDIC indemnification asset, net		50,465		---		---		50,465		---
Other repossessed assets acquired		26,212		---		---		26,212		(3,058	)
Total nonrecurring basis measured assets	$	195,688	$	---	$	40,785	$	154,903	$	(5,933	)

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.

Impaired loans, net of specific allowance

     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. Certain assumptions and unobservable inputs are currently being used by appraisers, therefore qualifying these assets as Level 3. Specific reserves for impaired loans were $1.5 million at September 30, 2011.

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.

Other repossessed assets acquired

     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. Certain assumptions and unobservable inputs are currently being used by appraisers, therefore qualifying these assets as Level 3.

Assets Not Recorded at Fair Value

     Additionally, accounting standards require the disclosure of the estimated fair value of financial instruments that are not recorded at fair value. A financial instrument is defined as cash, evidence of an ownership interest in an entity or a contract that creates a contractual obligation or right to deliver or receive cash or another financial instrument from a second entity. For the financial instruments that First Financial does not record at fair value, estimates of fair value are calculated based on the value of one trading unit without regard to any premium or discount that may result from concentrations of ownership of a financial instrument, possible tax ramifications, estimated transaction costs that may result from bulk sales or the relationship between various financial instruments. No readily available market exists for a significant portion of First Financial’s financial instruments. Fair value estimates for these instruments are based on current economic conditions, currency and interest rate characteristics, loss experience and other factors. Many of these estimates involve uncertainties and matters of significant judgment and cannot be determined with precision. Therefore, the calculated fair value estimates in many instances cannot be sustained by comparison to independent markets, in many cases, may not be realizable in a current sale of the instrument. In addition, changes in assumptions could significantly affect these fair value estimates. The following methods and assumptions were used by First Financial in estimating the fair value of these financial instruments.

Cash and cash equivalents

     For these short-term instruments, the carrying amounts are a reasonable estimate of their fair values.

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 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. The carrying amount of accrued interest approximates fair value.

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. The carrying amount of accrued interest approximates fair value.

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.