Fair Value of Financial Instruments

3 Months Ended

Mar. 31, 2013

Fair Value Disclosures [Text Block]

NOTE 10. 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 flows 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 March 31, 2013				As of December 31, 2012
(in thousands)	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets
Cash and cash equivalents	$	129,300	$	129,300	$	117,451	$	117,451
Securities available for sale		314,597		314,597		253,798		253,798
Securities held to maturity		14,869		16,942		15,555		17,867
Nonmarketable securities		19,245		19,245		20,914		20,914
Total loans, net		2,428,715		2,471,335		2,451,145		2,502,376
Loans held for sale		33,752		33,752		55,201		55,201
FDIC indemnification asset		58,917		58,917		80,268		80,268
Other repossessed assets acquired1		16,310		16,310		18,338		18,338
Residential mortgage servicing rights1		15,297		15,297		13,910		13,910
Accrued interest receivable1		8,675		8,675		8,564		8,564
Derivative financial instruments1		2,140		2,140		2,561		2,561
Liabilities
Deposits		2,600,520		2,612,531		2,595,333		2,608,927
Advances from FHLB		233,000		258,517		233,000		260,409
Long-term debt		47,204		47,016		47,204		46,749
FDIC true-up liability2		2,396		2,396		3,658		3,658
Accrued interest payable2		5,792		5,792		6,114		6,114

¹ Included as part of other assets in the Consolidated Balance Sheets.

² Included as part of other liabilities in the Consolidated Balance Sheets.

     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 from the year ended December 31, 2012.

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 March 31, 2013
(in thousands)	Level 1			Level 2			Level 3			Total
Obligations of US government agencies and corporations		$	1,019		$	225		$	---		$	1,244
State and municipal obligations			---			13,263			---			13,263
Collateralized debt obligations			---			---			3,504			3,504
Mortgage-backed securities			---			145,308			---			145,308
Collateralized mortgage obligations			---			144,507			---			144,507
Other securities			2,147			2,987			1,637			6,771
Securities available for sale			3,166			306,290			5,141			314,597
Residential mortgage servicing rights			---			---			15,297			15,297
Derivative financial instruments			2,140			---			---			2,140
Total assets at fair value		$	5,306		$	306,290		$	20,438		$	332,034

	As of December 31, 2012
(in thousands)	Level 1			Level 2			Level 3			Total
Obligations of US government agencies and corporations		$	---		$	1,278		$	---		$	1,278
State and municipal obligations			---			13,483			---			13,483
Collateralized debt obligations			---			---			3,332			3,332
Mortgage-backed securities			---			74,304			---			74,304
Collateralized mortgage obligations			---			154,883			---			154,883
Other securities			1,929			2,999			1,590			6,518
Securities available for sale			1,929			246,947			4,922			253,798
Residential mortgage servicing rights			---			---			13,910			13,910
Derivative financial instruments			2,561			---			---			2,561
Total assets at fair value		$	4,490		$	246,947		$	18,832		$	270,269

Securities Available for Sale

     Securities available for sale include obligations of the US government agencies and corporations, state and municipal obligations, CDOs, mortgage-backed securities, CMOs and other securities. For securities classified as 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, such as cash flow models, for which all significant assumptions are observable in the market.

     To determine the fair value of securities available for sale that are classified as level 2, cash flow models provided by a third-party pricing service and other observable inputs are utilized. The cash flow models incorporate market participant data and knowledge of the structures of each 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 security-specific credit premium.

     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. A cash flow analysis is performed on each security in the CMO portfolio, regardless of the credit rating, to determine if the security has any OTTI.

     The fair value of securities available for sale that are classified as level 3 primarily include 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. 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. If a security is rated below investment grade by a credit agency, a stress test is performed to determine OTTI.

     With respect to third party pricing services used to value both level 2 and level 3 securities, valuations are reviewed by management noting the extent to which the pricing service is gathering observable market information as opposed to using unobservable inputs. Review and oversight procedures are performed to ensure that securities available for sale are properly classified in the fair value hierarchy.

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.

     With respect to third party pricing services used to value MSRs, valuations are reviewed by management noting the extent to which the pricing service is gathering observable market information as opposed to using unobservable inputs. Review and oversight procedures are performed to ensure that MSRs are properly classified in the fair value hierarchy.

Derivative financial instruments

     The fair values of derivative financial instruments are determined based on quoted market prices, dealer quotes and internal pricing models that are primarily sensitive to market observable data.

     The following table presents quantitative information regarding the assumptions used for valuing level 3 assets.

(dollars in thousands)	Fair Value as of March 31, 20131		Valuation	Unobservable Input	Range	Minimum	Maximum	(Weighted Average)
Collateralized debt obligations	$	3,504	Discounted cash flow	Discount margin to LIBOR		10.50%	16.80%	12.19%
				Constant default rate		0.25%	0.84%	0.39%
				Default percentage		8.06%	48.92%	31.26%
MSRs	$	15,297	Discounted cash flow	Constant prepayment rate	14.60%
				Discount rate	10.43%
				Delinquency percentage	1.63%

¹ Other level 3 securities totaling $1.6 million are valued based on data provided by the issuer

Changes in Fair Value Measurement Levels

     The table below includes changes in level 3 fair 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.

	Quarter Ended March 31, 2013					Quarter Ended March 31, 2012
(in thousands)	Securities Available For Sale		Residential Mortgage Servicing Rights			Securities Available For Sale			Residential Mortgage Servicing Rights
Balance, beginning of period	$	4,922	$	13,910		$	57,028		$	10,663
Total net losses for the year included in
Other-than-temporary impairment losses on investment securities		---		---			(69	)		---
Mortgage and other loan income		---		(431	)		---			(538	)
Other comprehensive income, gross		172		---			274			---
Purchases		47		---			215			---
Servicing assets that resulted from transfers of financial assets		---		1,818			---			1,773
Paydowns		---		---			(3,424	)		---
Balance, end of period	$	5,141	$	15,297		$	54,024		$	11,898

Financial Instruments 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 March 31,2013		Level 1		Level 2		Level 3		Year to Date Losses
Assets
Loans held for sale	$	33,752	$	---	$	33,752	$	---	$	---
Impaired loans, net of specific allowance		33,502		---		---		33,502		3,752
Other repossessed assets acquired		16,310		---		---		16,310		408
Total	$	83,564	$	---	$	33,752	$	49,812	$	4,160

(in thousands)	As of December 31, 2012		Level 1		Level 2		Level 3		Year to Date Losses
Assets
Loans held for sale	$	55,201	$	---	$	55,201	$	---	$	---
Impaired loans, net of specific allowance		24,632		---		---		24,632		3,511
Other repossessed assets acquired		18,338		---		---		18,338		1,138
Total	$	98,171	$	---	$	55,201	$	42,970	$	4,649

Loans held for sale

     Loans held for sale is comprised of residential mortgage loans originated for sale in the secondary market. 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.

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 $1.3 million and $1.0 million at March 31, 2013 and December 31, 2012, respectively.

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. The following table presents the financial instruments not recorded at fair value categorized by the level of inputs.

	As of March 31, 2013
(in thousands)	Level 1		Level 2		Level 3		Total
Assets
Cash and cash equivalents	$	129,300	$	---	$	---	$	129,300
Securities held to maturity		---		16,942		---		16,942
Nonmarketable securities		---		---		19,245		19,245
Total loans, net1		---		---		2,437,833		2,437,833
FDIC indemnification asset		---		---		58,917		58,917
Accrued interest receivable2		8,675		---		---		8,675
Liabilities
Deposits		---		---		2,612,531		2,612,531
Advances from FHLB		---		---		258,517		258,517
Long term debt		---		---		47,016		47,016
FDIC true-up liability3		2,396		---		---		2,396
Accrued interest payable3		5,792		---		---		5,792

	As of December 31, 2012
(in thousands)	Level 1		Level 2		Level 3		Total
Assets
Cash and cash equivalents	$	117,451	$	---	$	---	$	117,451
Securities held to maturity		---		17,867		---		17,867
Nonmarketable securities		---		---		20,914		20,914
Total loans, net 1		---		---		2,477,744		2,477,744
FDIC indemnification asset		---		---		80,268		80,268
Accrued interest receivable2		8,564		---		---		8,564
Liabilities
Deposits		---		---		2,608,927		2,608,927
Advances from FHLB		---		---		260,409		260,409
Long term debt		---		---		46,749		46,749
FDIC true-up liability3		3,658		---		---		3,658
Accrued interest payable3		6,114		---		---		6,114

¹ Excludes impaired loans

² Included as part of other assets in the Consolidated Balance Sheets.

³ Included as part of other liabilities in the Consolidated Balance Sheets.

     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, and 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

     The carrying amount of FHLB and Federal Reserve stock is used to approximate the fair value of these securities as they are not readily marketable, are recorded at cost (par value) and are 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 investments in FHLB and Federal Reserve stock are ultimately recoverable at par.

Total loans, net

     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 receivable approximates fair value.

FDIC indemnification asset

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

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 payable 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.

FDIC true-up liability

     The fair value of the FDIC true-up liability is determined by the projected cash flows based on expected payments for recoveries in accordance with the Plantation loss share agreement with the FDIC. Cash flows are discounted to reflect the timing and payment of recoveries due to the FDIC.