Fair Value Measurements

6 Months Ended

Jun. 30, 2011

NOTE 4: FAIR VALUE MEASUREMENTS

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In estimating fair value, Southwest utilizes valuation techniques that are consistent with the market approach, the income approach, and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability.

ASC 820, Fair Value Measurements and Disclosure, 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		Quoted prices in active markets for identical assets or liabilities: Level 1 assets and liabilities include debt and equity securities that are traded in an active exchange market, as well as certain U.S. Treasury securities that are highly liquid and are actively traded in over-the-counter markets.

Level 2		Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments. This category includes U.S. Government and agency securities, residential mortgage-backed debt securities, municipal obligation securities, loans held for sale, certain private equity investments, and other real estate.

Level 3		Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. This category includes certain impaired loans, certain other real estate, goodwill, and other intangible assets.

The estimated fair value amounts have been determined by Southwest using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amount Southwest could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

A description of the valuation methodologies used for assets measured at fair value on a recurring basis is as follows:

Loans held for sale — Real estate mortgage loans held for sale are carried at the lower of cost or market, which is determined on an individual loan basis. Guaranteed student loans held for sale are carried at the lower of cost or market, which is determined on an aggregate basis.

Available for sale securities — The fair value of U.S. Government and federal agency securities, equity securities, and residential mortgage-backed securities is estimated based on quoted market prices or dealer quotes. The fair value of other investments such as obligations of state and political subdivisions is estimated based on quoted market prices. The fair value of a certain private equity investment is estimated based on Southwest’s proportionate share of the net asset value, $1.4 million and $1.3 million as of June 30, 2011 and December 31, 2010, respectively. The investee invests in small and mid-sized U.S. financial institutions and other financial-related companies. This investment has a quarterly redemption with sixty-five days’ notice.

Derivative instrument — Southwest utilizes an interest rate swap agreement to convert one of its variable-rate subordinated debentures to a fixed rate (cash flow hedge). The fair value of the interest rate swap agreement is obtained from dealer quotes.

The following table summarizes financial assets measured at fair value on a recurring basis.


				Fair Value Measurement at Reporting Date Using
				Quoted Prices in					Significant
				Active Markets for		Significant Other			Unobservable
				Identical Assets		Observable Inputs			Inputs
(Dollars in thousands)	Total			(Level 1)		(Level 2)			(Level 3)

At June 30, 2011
Loans held for sale:
Student loans	$	5,600		$	—	$	5,600		$	—
One-to-four family residential		4,211			—		4,211			—
Government guaranteed commercial real estate		27,245			—		27,245			—
Government guaranteed commercial		148			—		148			—

Available for sale securities:
U.S. Government obligations		1,105			1,105		—			—
Federal agency securities		69,852			—		69,852			—
Obligations of state and political subdivisions		217			—		217			—
Residential mortgage-backed securities		180,049			—		180,049			—
Equity securities		1,511			94		1,417			—

Derivative instrument		(1,180	)		—		(1,180	)		—

Total	$	288,758		$	1,199	$	287,559		$	—


At December 31, 2010
Loans held for sale:
Student loans	$	5,843		$	—	$	5,843		$	—
One-to-four family residential		2,300			—		2,300			—
Government guaranteed commercial real estate		26,718			—		26,718			—
Government guaranteed commercial		333			—		333			—

Available for sale securities:
U.S. Government obligations		1,108			1,108		—			—
Federal agency securities		65,374			—		65,374			—
Obligations of state and political subdivisions		233			—		233			—
Residential mortgage-backed securities		180,017			—		180,017			—
Equity securities		1,489			222		1,267			—

Total	$	283,415		$	1,330	$	282,085		$	—

Certain financial assets are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). These assets are recorded at the lower of cost or fair value. Valuation methodologies for assets measured on a nonrecurring basis are as follows:

Impaired loans — Certain impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from collateral. Collateral values are estimated using Level 2 inputs based on third-party appraisals or Level 3 inputs based on customized discounting criteria. Certain other impaired loans are remeasured and reported through a specific valuation allowance allocation of the allowance for loan losses based upon the net present value of cash flows.

Other real estate — Other real estate fair value is based on third-party appraisals for significant properties less the estimated costs to sell the asset.

Goodwill — Fair value of goodwill is based on the fair value of each of Southwest’s reporting units to which goodwill is allocated compared with their respective carrying value. There has been no impairment during 2011 or 2010; therefore, no fair value adjustment was recorded through earnings.

Core deposit premiums — The fair value of core deposit premiums are based on third-party appraisals. There has been no impairment during 2011 or 2010; therefore, no fair value adjustment was recorded through earnings.

Mortgage loan servicing rights — There is no active trading market for loan servicing rights. The fair value of loan servicing rights is estimated by calculating the present value of net servicing revenue over the anticipated life of each loan. A cash flow model is used to determine fair value. Key assumptions and estimates, including projected prepayment speeds and assumed servicing costs, earnings on escrow deposits, ancillary income, and discount rates, used by this model are based on current market sources. A separate third party model is used to estimate prepayment speeds based on interest rates, housing turnover rates, estimated loan curtailment, anticipated defaults, and other relevant factors. The prepayment model is updated for changes in market conditions. There has been no impairment during 2011 or 2010; therefore, no fair value adjustment was recorded through earnings.

Assets measured at fair value on a nonrecurring basis are summarized below.


			Fair Value Measurements Using
			Quoted Prices in				Significant
			Active Markets for		Significant Other		Unobservable
	Fair Value		Identical Assets		Observable Inputs		Inputs		Total Gains
(Dollars in thousands)	Total		(Level 1)		(Level 2)		(Level 3)		(Losses)

At June 30, 2011
Noncovered impaired loans at fair value:
Commercial real estate	$	72,887	$	—	$	72,887	$	—	$	(3,953	)
One-to-four family residential		1,000		—		1,000		—		(48	)
Real estate construction		60,966		—		47,461		13,505		(10,676	)
Commercial		14,669		—		14,669		—		(5,219	)
Other consumer		153		—		153		—		(134	)

Noncovered other real estate		38,956		—		38,956		—		(1,126	)

Total	$	188,631	$	—	$	175,126	$	13,505	$	(21,156	)


At December 31, 2010
Noncovered impaired loans at fair value:
Commercial real estate	$	43,349	$	—	$	43,349	$	—	$	(5,003	)
One-to-four family residential		1,660		—		1,660		—		1,819
Real estate construction		42,577		—		29,072		13,505		(4,144	)
Commercial		9,727		—		9,727		—		(1,214	)
Other consumer		38		—		38		—		86

Noncovered other real estate		37,722		—		37,722		—		(360	)

Total	$	135,073	$	—	$	121,568	$	13,505	$	(8,816	)

Noncovered impaired loans measured at fair value with a carrying amount of $190.1 million were written down to a fair value of $149.7 million, resulting in a life-to-date impairment of $40.4 million, of which $20.0 million was included in the provision for loan losses for the six months ended June 30, 2011. As of December 31, 2010, noncovered impaired loans measured at fair value with a carrying amount of $125.2 million were written down to the fair value of $97.4 million at December 31, 2010, resulting in a life-to-date impairment charge of $27.9 million, of which $8.5 million was included in the provision for loan losses for the year ended December 31, 2010.

As of June 30, 2011, noncovered other real estate assets were written down to their respective fair values, resulting in impairment charges of $1.1 million, which was included in noninterest expense for the six months ended June 30, 2011. As of December 31, 2010, noncovered other real estate assets were written down to their respective fair values, resulting in impairment charges of $0.4 million, which was included in noninterest expense for the year ended December 31, 2010.

ASC 825, Financial Instruments, requires an entity to provide disclosures about fair value of financial instruments, including those that are not measured and reported at fair value on a recurring or nonrecurring basis. The methodologies used in estimating the fair value of financial instruments that are measured on a recurring or nonrecurring basis are discussed above. The methodologies for the other financial instruments are discussed below:

Cash and cash equivalents — For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value.

Investment securities — The investment securities held to maturity are carried at cost. The fair value of the held to maturity securities is estimated based on quoted market prices or dealer quotes.

Loans — Fair values are estimated for certain homogenous categories of loans adjusted for differences in loan characteristics. Southwest’s loans have been aggregated by categories consisting of commercial, real estate, student, and other consumer. The fair value of loans is estimated by discounting the cash flows using risks inherent in the loan category and interest rates currently offered for loans with similar terms and credit risks.

Accrued interest receivable — The carrying amount is a reasonable estimate of fair value for accrued interest receivable.

Other assets — The estimated fair value of other assets, which primarily consists of investments carried at cost, prepaids, and deferred taxes, approximates their carrying values.

Deposits — The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the statement of financial condition date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.

Other liabilities and accrued interest payable — The estimated fair value of other liabilities, which primarily includes trade accounts payable, and accrued interest payable approximates their carrying values.

Other borrowings — The fair value for fixed rate FHLB advances is based upon discounted cash flow analysis using interest rates currently being offered for similar instruments. The fair values of other borrowings are the amounts payable at the statement of financial condition date, as the carrying amount is a reasonable estimate of fair value due to the short-term maturity rates. Included in other borrowings are federal funds purchased, FHLB advances, securities sold under agreements to repurchase, and treasury tax and loan demand notes.

Subordinated debentures — Two subordinated debentures have floating rates that reset quarterly and the third subordinated debenture has a fixed rate. The fair value of the floating rate subordinated debentures approximates current book value. The fair value of the fixed rate subordinated debenture is based on market price.

The carrying values and estimated fair values of Southwest’s financial instruments follow:


	At June 30, 2011						At December 31, 2010
	Carrying			Fair			Carrying		Fair
(Dollars in thousands)	Values			Values			Values		Values

Cash and cash equivalents	$	68,101		$	68,101		$	67,496	$	67,496
Securities held to maturity		15,419			15,461			14,304		14,029
Securities available for sale		252,734			252,734			248,221		248,221
Total loans, net of allowance		2,184,878			2,086,455			2,354,886		2,279,605
Accrued interest receivable		7,973			7,973			8,590		8,590
Other assets		42,197			42,197			49,181		49,181
Deposits		2,094,236			2,021,369			2,252,728		2,119,840
Accrued interest payable		1,574			1,574			1,577		1,577
Other liabilities		10,290			10,290			8,981		8,981
Derivative instrument		(1,180	)		(1,180	)		—		—
Other borrowings		96,682			102,022			94,602		100,550
Subordinated debentures		81,963			83,702			81,963		84,654

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

+ References

Reference 1: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 820
-SubTopic 10
-Section 50
-Paragraph 5
-URI http://asc.fasb.org/extlink&oid=6925170&loc=d3e19296-110258

Reference 2: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 159
-Paragraph 17-22, 27, 28
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 3: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 825
-SubTopic 10
-Section 50
-Paragraph 10
-URI http://asc.fasb.org/extlink&oid=6947722&loc=d3e13433-108611

Reference 4: http://www.xbrl.org/2003/role/presentationRef
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-Number 107
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Reference 5: http://www.xbrl.org/2003/role/presentationRef
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-Topic 825
-SubTopic 10
-Section 50
-Paragraph 28
-URI http://asc.fasb.org/extlink&oid=6957238&loc=d3e14064-108612

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-Name Statement of Financial Accounting Standard (FAS)
-Number 107
-Paragraph 15A
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Reference 8: http://www.xbrl.org/2003/role/presentationRef
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-Topic 825
-SubTopic 10
-Section 50
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-Number 133
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Reference 10: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 820
-SubTopic 10
-Section 50
-Paragraph 2
-URI http://asc.fasb.org/extlink&oid=6925170&loc=d3e19207-110258

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-Number 107
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