Fair Value Measurements

6 Months Ended

Jun. 30, 2011

Fair Value Measurements

Fair Value Measurements

(9.) FAIR VALUE MEASUREMENTS

Determination of Fair Value – Assets Measured at Fair Value on a Recurring and Nonrecurring Basis

Valuation Hierarchy

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability.  ASC Topic 820, "Fair Value Measurements and Disclosures," establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

• Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
• Level 2 - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.
• Level 3 - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity's own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the company's creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company's valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company's valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.  Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein. A more detailed description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Investment securities available for sale:Pooled trust preferred securities are reported at fair value utilizing Level 3 inputs.  Fair values for these securities are determined through the use of internal valuation methodologies appropriate for the specific asset, which may include the use of a discounted expected cash flow analysis or the use of broker quotes.Other securities classified as available for sale are reported at fair value utilizing Level 2 inputs. 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.

Loans held for sale: The fair value of loans held for sale is determined using quoted secondary market prices and investor commitments.  Loans held for sale are classified as Level 2 in the fair value hierarchy.

Collateral dependent impaired loans: 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 typically significant and result in a Level 3 classification of the inputs for determining fair value.

Other real estate owned (Foreclosed assets): Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned 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.

Mortgage servicing rights:  Mortgage servicing rights do not trade in an active market with readily observable market data. As a result, the Company estimates the fair value of mortgage servicing rights by using a discounted cash flow model to calculate the present value of estimated future net servicing income.  The assumptions used in the discounted cash flow model are those that we believe market participants would use in estimating future net servicing income, including estimates of loan prepayment rates, servicing costs, ancillary income, impound account balances, and discount rates.  Significant assumptions in the valuation of mortgage servicing rights include changes in interest rates, estimated loan repayment rates, and the timing of cash flows, among other factors. Mortgage servicing rights are classified as Level 3 measurements due to the use of significant unobservable inputs, as well as significant management judgment and estimation.

Assets Measured at Fair Value

The following table presents for each of the fair-value hierarchy levels the Company's assets that are measured at fair value on a recurring and non-recurring basis as of June 30, 2011 (in thousands).

	Level 1				Level 2				Level 3		Total
	Inputs				Inputs				Inputs		Fair Value
Measured on a recurring basis:
Securities available for sale:
U.S. Government agencies and government sponsored enterprises	$		-		$		115,116		$	-	$	115,116
State and political subdivisions			-				122,366			-		122,366
Mortgage-backed securities			-				462,452			-		462,452
Asset-backed securities:
Trust preferred securities			-				-			6,963		6,963
Other			-				61			-		61
	$		-		$		699,995		$	6,963	$	706,958
Measured on a nonrecurring basis:
Loans:
Loans held for sale		$		-		$		14,511	$	-	$	14,511
Collateral dependent impaired loans				-				-		2,032		2,032
Other assets:
Mortgage servicing rights				-				-		1,573		1,573
Other real estate owned				-				-		599		599
		$		-		$		14,511	$	4,204	$	18,715

The following table presents for each of the fair-value hierarchy levels the Company's assets that are measured at fair value on a recurring and non-recurring basis as of December 31, 2010 (in thousands).

	Level 1				Level 2				Level 3				Total
	Inputs				Inputs				Inputs				Fair Value
Measured on a recurring basis:
Securities available for sale:
U.S. Government agencies and government sponsored enterprises	$		-		$		140,784		$		-		$		140,784
State and political subdivisions			-				105,666				-				105,666
Mortgage-backed securities			-				419,281				-				419,281
Asset-backed securities:
Trust preferred securities			-				-				572				572
Other			-				65				-				65
	$		-		$		665,796		$		572		$		666,368
Measured on a nonrecurring basis:
Loans:
Loans held for sale		$		-		$		3,138		$		-		$	3,138
Collateral dependent impaired loans				-				-				2,457			2,457
Other assets:
Mortgage servicing rights				-				-				1,467			1,467
Other real estate owned				-				-				741			741
		$		-		$		3,138		$		4,665		$	7,803

There were no liabilities measured at fair value on a recurring or nonrecurring basis during the six month periods ended June 30, 2011 and 2010.

Changes in Level 3 Fair Value Measurements

The reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) is as follows for the periods indicated (in thousands):

	Three months ended				Six months ended
	June 30,				June 30,
	2011		2010		2011		2010
Securities available for sale (Level 3), beginning of period	$	567	$	661	$	572	$	1,015
Transfers into Level 3		-		-		-		-
Capitalized interest		111		114		221		200
Coupon payments applied to principal		(16)		(26)		(16)		(61)
Principal paydowns		(8)		-		(8)		-
Total gains/losses (realized/unrealized):
Included in earnings		-		-		-		(526)
Included in other comprehensive income		6,309		(103)		6,194		18
Securities available for sale (Level 3), end of period	$	6,963	$	646	$	6,963	$	646

Fair Value of Financial Instruments

The Fair Value of Financial Instruments Subsection of the ASC requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis.

The following discussion describes the valuation methodologies used for assets and liabilities measured or disclosed at fair value.  The techniques utilized in estimating the fair values of financial instruments are reliant on the assumptions used, including discount rates and estimates of the amount and timing of future cash flows.  Care should be exercised in deriving conclusions about our business, its value or financial position based on the fair value information of financial instruments presented below.

Fair value estimates are made at a specific point in time, based on available market information and judgments about the financial instrument, including estimates of timing, amount of expected future cash flows and the credit standing of the issuer.  Such estimates do not consider the tax impact of the realization of unrealized gains or losses. In some cases, the fair value estimates cannot be substantiated by comparison to independent markets.  In addition, the disclosed fair value may not be realized in the immediate settlement of the financial instrument.

The estimated fair value approximates carrying value for cash and cash equivalents, FHLB and FRB stock, company owned life insurance, accrued interest receivable, short-term borrowings and accrued interest payable. Fair value estimates for other financial instruments are discussed below.

Loans held for sale.  The fair value is based on estimates, quoted market prices and investor commitments.

Loans.  For variable rate loans that re-price frequently, fair value approximates carrying amount. The fair value for fixed rate loans is estimated through discounted cash flow analysis using interest rates currently being offered on loans with similar terms and credit quality.  For criticized and classified loans, fair value is estimated by discounting expected cash flows at a rate commensurate with the risk associated with the estimated cash flows, or estimates of fair value discounts based on observable market information.

Deposits.  The fair values for demand accounts, money market and savings deposits are equal to their carrying amounts. The fair values of certificates of deposit are estimated using a discounted cash flow approach that applies prevailing market interest rates for similar maturity instruments.

Long-term borrowings and junior subordinated debentures.The fair value for long-term borrowings and junior subordinated debentures are estimated using a discounted cash flow approach that applies prevailing market interest rates for similar maturity instruments.

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation.  Fair value is best determined based upon quoted market prices.  However, in many instances, there are no quoted market prices for the Company's various financial instruments.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.  Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.  Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.  The accounting guidelines exclude certain financial instruments and all non-financial instruments from its disclosure requirements.  Accordingly, the aggregate fair value amounts presented at June 30, 2011 and December 31, 2010 may not necessarily represent the underlying fair value of the Company.

The estimated fair values of financial instruments were as follows (in thousands):

		June 30, 2011				December 31, 2010
				Estimated				Estimated
		Carrying		Fair		Carrying		Fair
		Amount		Value		Amount		Value
Financial assets:
	Cash and cash equivalents	$	46,084	$	46,084	$	39,058	$	39,058
	Securities available for sale		706,958		706,958		666,368		666,368
	Securities held to maturity		24,091		24,797		28,162		28,849
	Loans held for sale		14,511		14,523		3,138		3,138
	Loans		1,347,420		1,417,663		1,325,524		1,388,787
	Accrued interest receivable		7,845		7,845		7,613		7,613
	FHLB and FRB stock		8,298		8,298		6,353		6,353
Financial liabilities:
	Demand, savings and money market deposits		1,173,053		1,173,053		1,143,136		1,143,136
	Certificate of deposit		699,186		700,234		739,754		740,440
	Short-term borrowings		132,395		132,395		77,110		77,110
	Long-term borrowings (excluding junior subordinated debentures)		10,000		10,010		10,065		10,244
	Junior subordinated debentures		16,702		10,550		16,702		10,564
	Accrued interest payable		7,299		7,299		7,620		7,620