12.	FAIR VALUE MEASUREMENTS

The Company follows ASC 820 Fair Value Measurements and Disclosures ("ASC 820") to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. This section clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants.

ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions. The three levels of the fair value hierarchy under ASC 820 based on these two types of inputs are as follows:

 

		Level 1		Valuation is based on quoted prices in active markets for identical assets and liabilities.
		Level 2		Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the markets.
		Level 3		Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market. These unobservable inputs reflect the Company's assumptions about what market participants would use and information that is reasonably available under the circumstances without undue cost and effort.

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements.

Interest rate swap agreement used for interest rate risk management

Interest rate swaps are recorded at fair value on a recurring basis. The Company utilizes an interest rate swap agreement as part of the management of interest rate risk to modify the repricing characteristics of certain portions of the Company's interest-bearing assets and liabilities. The Company has contracted with a third party vendor to provide valuations for interest rate swaps using standard swap valuation techniques and therefore classifies such valuations as Level 2. Third party valuations are validated by the Company using Bloomberg's derivative pricing functions. The Company has considered counterparty credit risk in the valuation of its interest rate swap assets and has considered its own credit risk in the valuation of its interest rate swap liabilities.

 

Securities available for sale

Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data (Level 2). If the inputs used to provide the evaluation for certain securities are unobservable and/or there is little, if any, market activity then the security would fall to the lowest level of the hierarchy (Level 3).

The Company's investment portfolio is primarily valued using fair value measurements that are considered to be Level 2. The Company has contracted with a third party portfolio accounting service vendor for valuation of its securities portfolio. The vendor's primary source for security valuation is Interactive Data Corporation ("IDC"), which evaluates securities based on market data. IDC utilizes evaluated pricing models that vary by asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary modes, vast descriptive terms and conditions databases, as well as extensive quality control programs.

The vendor utilizes proprietary valuation matrices for valuing all municipals securities. The initial curves for determining the price, movement, and yield relationships within the municipal matrices are derived from industry benchmark curves or sourced from a municipal trading desk. The securities are further broken down according to issuer, credit support, state of issuance and rating to incorporate additional spreads to the industry benchmark curves.

The Company uses Bloomberg Valuation Service, an independent information source that draws on quantitative models and market data contributed from over thousands of participants, to validate third party valuations. Any material differences between valuation sources are researched by further analyzing the various inputs that are utilized by each pricing source. No material differences were identified during our validation as of March 31, 2012 and December 31, 2011.

The carrying value of restricted Federal Reserve Bank of Richmond and FHLB stock approximates fair value based on the redemption provisions of each entity and is therefore excluded from the following table.

 

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis at March 31, 2012 and December 31, 2011 (dollars in thousands):

 

		Fair Value Measurements at March 31, 2012 using
		Quoted Prices in Active Markets for Identical Assets				Significant Other Observable Inputs				Significant Unobservable Inputs
		Level 1				Level 2				Level 3				Balance
ASSETS
Interest rate swap - loans		$	—			$	44			$	—			$	44
Securities available for sale:
U.S. government and agency securities			—				3,754				—				3,754
Obligations of states and political subdivisions			—				201,260				—				201,260
Corporate and other bonds			—				11,908				—				11,908
Mortgage-backed securities			—				401,654				—				401,654
Other securities			—				3,175				—				3,175
Total		$	—			$	621,795			$	—			$	621,795
LIABILITIES
Interest rate swap - loans		$	—			$	44			$	—			$	44
Cash flow hedge - trust			—				4,096				—				4,096
Total		$	—			$	4,140			$	—			$	4,140

 

		Fair Value Measurements at December 31, 2011 using
		Quoted Prices in Active Markets for Identical Assets				Significant Other Observable Inputs				Significant Unobservable Inputs
		Level 1				Level 2				Level 3				Balance
ASSETS
Interest rate swap - loans		$	—			$	66			$	—			$	66
Securities available for sale:
U.S. government and agency securities			—				4,284				—				4,284
Obligations of states and political subdivisions			—				200,207				—				200,207
Corporate and other bonds			—				12,240				—				12,240
Mortgage-backed securities			—				400,318				—				400,318
Other securities			—				3,117				—				3,117
Total		$	—			$	620,232			$	—			$	620,232
LIABILITIES
Interest rate swap - loans		$	—			$	66			$	—			$	66
Cash flow hedge - trust			—				4,293				—				4,293
Total		$	—			$	4,359			$	—			$	4,359

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements.

Loans held for sale

Loans held for sale are carried at the lower of cost or market value. These loans currently consist of residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during March 31, 2012 and December 31, 2011. Gains and losses on the sale of loans are recorded within income from the mortgage segment on the Consolidated Statements of Income.

 

Impaired loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreements will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the Company's collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the property is more than two years old, then a Level 3 valuation is considered to measure the fair value. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business's financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Other real estate owned

Fair values of other real estate owned are carried at the lower of carrying value or fair value less selling costs. Fair value is based upon independent market prices, appraised values of the collateral or management's estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as Level 2 valuation. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as Level 3 valuation. Total valuation expenses related to OREO properties for March 31, 2012 and December 31, 2011 were $0 and $707,000, respectively.

The following table summarizes the Company's financial assets that were measured at fair value on a nonrecurring basis at March 31, 2012 and December 31, 2011 (dollars in thousands):

 

		Fair Value Measurements at March 31, 2012 using
		Quoted Prices in Active Markets for Identical Assets				Significant Other Observable Inputs				Significant Unobservable Inputs
		Level 1				Level 2				Level 3				Balance
ASSETS
Loans held for sale		$	—			$	73,575			$	—			$	73,575
Impaired loans			—				33,254				14,652				47,906
Other real estate owned			—				—				37,663				37,663
Total		$	—			$	106,829			$	52,315			$	159,144

 

		Fair Value Measurements at December 31, 2011 using
		Quoted Prices in Active Markets for Identical Assets				Significant Other Observable Inputs				Significant Unobservable Inputs
		Level 1				Level 2				Level 3				Balance
ASSETS
Loans held for sale		$	—			$	74,823			$	—			$	74,823
Impaired loans			—				28,525				34,898				63,423
Other real estate owned			—				—				32,263				32,263
Total		$	—			$	103,348			$	67,161			$	170,509

 

The changes in Level 3 assets measured at estimated fair value on a nonrecurring basis during the year ended March 31, 2012 were as follows:

 

		Fair Value Measurements at March 31, 2012
		Impaired Loans				Other Real Estate Owned
Balance - January 1, 2012		$	34,898			$	32,263
Total gains (losses) realized/unrealized:
Included in earnings			—				(27	)
Additions			13,890				6,912
Sales			—				(1,485	)
Net Payments			(25,603	)			—
Transfers from Level 2			—				—
Transfers to Level 2			(8,533	)			—
Balance - March 31, 2012		$	14,652			$	37,663

The following table displays quantitative information about Level 3 Fair Value Measurements for March 31, 2012 (dollars in thousands):

 

		Fair Value Measurements at March 31, 2012
		Fair Value				Valuation Technique(s)		Unobservable Inputs		Weighted Average
ASSETS
Commercial Construction		$	3,609			Market comparables		Discount applied to market comparables (1)			30	%
Commercial Real Estate - Owner Occupied			1,277			Market comparables		Discount applied to market comparables (1)			28	%
Raw Land and Lots			6,991			Market comparables		Discount applied to market comparables (1)			39	%
Commercial and Industrial			1,302			Market comparables		Discount applied to market comparables (1)			38	%
Other (2)			1,473			Market comparables		Discount applied to market comparables (1)			26	%
Total Impaired Loans			14,652
Other real estate owned			37,663			Market comparables		Discount applied to market comparables (1)			31	%
Total		$	52,315

 

(1)	A discount percentage is applied based on age of independent appraisals, current market conditions, and experience within the local market.

(2)	The "Other" category of the impaired loans section from the table above consists of Single Family Investment Real Estate, Mortgage, and Consumer Construction.

ASC 825, Financial Instruments requires disclosure about fair value of financial instruments for interim periods and excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

Cash and cash equivalents

For those short-term instruments, the carrying amount is a reasonable estimate of fair value.

Loans

The fair value of performing loans is estimated by discounting expected future cash flows using a yield curve that is constructed by adding a loan spread to a market yield curve. Loan spreads are based on spreads currently observed in the market for loans of similar type and structure.(Level 2). Fair value for impaired loans and their respective level within the fair value hierarchy, are described in the previous disclosure related to fair value measurements of assets that are measured on a nonrecurring basis.

Deposits

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposits is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities (Level 2).

 

Borrowings

The carrying value of the Company's repurchase agreements is a reasonable estimate of fair value. Other borrowings are discounted using the current yield curve for the same type of borrowing. For borrowings with embedded optionality, a third party source is used to value the instrument (Level 2). The Company validates all third party valuations for borrowings with optionality using Bloomberg's derivative pricing functions.

Accrued interest

The carrying amounts of accrued interest approximate fair value (Level 2).

Commitments to extend credit and standby letters of credit

The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. At March 31, 2012 and December 31, 2011, the fair value of loan commitments and standby letters of credit was immaterial.

The carrying values and estimated fair values of the Company's financial instruments as of March 31, 2012 and December 31, 2011 are as follows (dollars in thousands):

 

						Fair Value Measurements at March 31, 2012 using
						Quoted Prices in Active Markets for Identical Assets				Significant Other Observable Inputs				Significant Unobservable Inputs				Total Fair Value
		Carrying Value				Level 1				Level 2				Level 3				Balance
ASSETS
Cash and cash equivalents		$	111,183			$	111,183			$	—			$	—			$	111,183
Securities available for sale			621,751				—				621,751				—				621,751
Restricted stock			20,715				—				20,715				—				20,715
Loans held for sale			73,575				—				73,575				—				73,575
Net loans			2,801,554				—				2,803,515				14,652				2,818,167
Interest rate swap - loans			44				—				44				—				44
Accrued interest receivable			16,275				—				16,275				—				16,275
LIABILITIES
Deposits		$	3,215,707			$	—			$	3,230,517			$	—			$	3,230,517
Borrowings			268,856				—				268,821				—				268,821
Accrued interest payable			999				—				999				—				999
Cash flow hedge - trust			4,096				—				4,096				—				4,096
Interest rate swap - loans			44				—				44				—				44

 

						Fair Value Measurements at December 31, 2011 using
						Quoted Prices in Active Markets for Identical Assets				Significant Other Observable Inputs				Significant Unobservable Inputs				Total Fair Value
		Carrying Value				Level 1				Level 2				Level 3				Balance
ASSETS
Cash and cash equivalents		$	96,659			$	96,659			$	—			$	—			$	96,659
Securities available for sale			620,166				—				620,166				—				620,166
Restricted stock			20,661				—				20,661				—				20,661
Loans held for sale			74,823				—				74,823				—				74,823
Net loans			2,779,113				—				2,760,016				34,898				2,794,914
Interest rate swap - loans			66				—				66				—				66
Accrued interest receivable			16,626				—				16,626				—				16,626
LIABILITIES
Deposits		$	3,175,105			$	—			$	3,191,256			$	—			$	3,191,256
Borrowings			278,686				—				277,374				—				277,374
Accrued interest payable			1,865				—				1,865				—				1,865
Cash flow hedge - trust			4,293				—				4,293				—				4,293
Interest rate swap - loans			66				—				66				—				66

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company's financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company's overall interest rate risk.