State Bancorp 10-Q 2010
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: MARCH 31, 2010
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission File No. 001-14783
(Exact name of registrant as specified in its charter)
TWO JERICHO PLAZA, JERICHO, NEW YORK 11753
(Address of principal executive offices) (Zip Code)
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
As of April 23, 2010, there were 16,623,389 shares of registrant’s Common Stock outstanding.
STATE BANCORP, INC.
For the Quarterly Period Ended March 31, 2010
Table of Contents>
ITEM 1. - FINANCIAL STATEMENTS>
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS>
1. FINANCIAL STATEMENT PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
The unaudited condensed consolidated financial statements include the accounts of State Bancorp, Inc. and its wholly owned subsidiary, State Bank of Long Island (the “Bank”). The Bank’s consolidated financial statements include the accounts of its wholly owned subsidiaries, SB Portfolio Management Corp. (“SB Portfolio”), SB ORE Corp., and New Hyde Park Leasing Corporation and its subsidiaries, P.W.B. Realty, L.L.C. and State Title Agency, LLC. SB Portfolio is a fixed income portfolio management subsidiary that currently has no assets under management. State Bancorp, Inc. and subsidiaries are collectively referred to hereafter as the “Company.” All intercompany accounts and transactions have been eliminated.
In addition to the foregoing, the Company has two other subsidiaries, State Bancorp Capital Trust I and State Bancorp Capital Trust II, neither of which is consolidated with the Company for reporting purposes. State Bancorp Capital Trust I and State Bancorp Capital Trust II were formed in 2002 and 2003, respectively, for the purpose of issuing trust preferred securities, the proceeds of which were used to acquire junior subordinated debentures issued by the Company. The Company has fully and unconditionally guaranteed all obligations of State Bancorp Capital Trust I and State Bancorp Capital Trust II under the trust agreements relating to the respective trust preferred securities. (See Note 8 of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” of the Company’s 2009 Annual Report on Form 10-K.)
In the opinion of the Company’s management, the preceding unaudited condensed consolidated financial statements contain all adjustments, consisting of normal accruals, necessary for a fair presentation of its condensed consolidated balance sheets as of March 31, 2010 and December 31, 2009, its condensed consolidated statements of operations for the three months ended March 31, 2010 and 2009, its condensed consolidated statements of cash flows for the three months ended March 31, 2010 and 2009 and its condensed consolidated statements of stockholders’ equity and comprehensive income (loss) for the three months ended March 31, 2010 and 2009, in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The results of operations for the three months ended March 31, 2010 are not necessarily indicative of the results of operations to be expected for the remainder of the year. For further information, please refer to the audited consolidated financial statements and footnotes thereto included in the Company’s 2009 Annual Report on Form 10-K.
Accounting for Derivative Financial Instruments
From time to time, the Bank may execute customer interest rate swap transactions together with offsetting interest rate swap transactions with institutional dealers. Each swap is mutually exclusive, and the swaps are marked to market with changes in fair value recognized as other income, with the fair value for each individual swap largely offsetting the corresponding other. The customer swap program provides a customer financing option that can result in longer maturity terms without incurring the associated interest rate risk. The Company does not currently hold any derivative financial instruments for trading purposes.
For the three months ended March 31, 2010, a net credit valuation adjustment (“CVA”) of $16 thousand was recorded as a reduction to other income. The CVA represents the consideration of credit risk of the counterparties to a transaction and the effect of any credit enhancements related to the transaction. For the three months ended March 31, 2009, a net loss of $206 thousand was recorded as several customer interest rate swap transactions were no longer offset by an institutional dealer due to the event of default under the swap agreements the Bank had with Lehman Special Financing. (See Note 14 of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” of the Company’s 2009 Annual Report on Form 10-K.) As all customer interest rate swap transactions are now offset by swap transactions with institutional dealers, we expect that their future impact on the Company’s financial statements will be immaterial. At each of March 31, 2010 and December 31, 2009, the total gross notional amount of swap transactions outstanding was $37 million.
Information on the Company’s derivative financial instruments at March 31, 2010 and December 31, 2009 may be found below.
Accounting for Bank Owned Life Insurance
The Bank is the beneficiary of a policy that insures the lives of certain current and former senior officers of the Bank and its subsidiaries. The Company has recognized the cash surrender value, or the amount that can be realized under the insurance policy, as an asset in the consolidated balance sheets. Changes in the cash surrender value are recorded in other income.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance when management believes that the collectibility of the principal is unlikely, while recoveries of previously charged-off loans are credited to the allowance. The balance in the allowance for loan losses is maintained at a level that, in the opinion of management, is sufficient to absorb probable inherent losses. To determine that level, management evaluates problem loans based on the financial condition of the borrower, the value of collateral and/or guarantor support. Based upon the resultant risk categories assigned to each loan and the procedures regarding impairment described below, an appropriate allowance level is determined. Management also evaluates the quality of, and changes in, the portfolio, while taking into consideration the Bank’s historical loss experience, the existing economic climate of the service area in which the Bank operates, examinations by regulatory authorities, internal reviews and other evaluations in determining the appropriate allowance balance. Management utilizes all available information to estimate the adequacy of the allowance for loan losses. However, the ultimate collectibility of a substantial portion of the loan portfolio and the need for future additions to the allowance will be based upon changes in economic conditions and other relevant factors.
Commercial loans and commercial real estate loans are considered impaired when, based on current information and events, it is probable that the Company will not be able to collect all of the principal and interest due under the contractual terms of the loan. Management considers all non-accrual loans in excess of $250 thousand for impairment. Those with balances less than $250 thousand as well as other groups of smaller-balance homogeneous loans, such as consumer and residential mortgages, are collectively evaluated for impairment. Loans, for which the terms have been modified, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.
The allowance for loan losses related to loans that are impaired includes reserves which are based upon the expected future cash flows, discounted at the effective interest rate, or the fair value of the underlying collateral for collateral-dependent loans, or the observable market price. This evaluation is inherently subjective as it requires material estimates, including the amount and timing of future cash flows expected to be received on impaired loans, which may be susceptible to significant change.
Other-Than-Temporary Impairment (“OTTI”) of Investment Securities
Accounting guidance requires an entity to assess whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of these criteria is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to other factors, which is recognized in other comprehensive income and 2) OTTI related to credit loss, which must be recognized in the statement of operations. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.
Management evaluates securities for OTTI on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. In estimating OTTI, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. In analyzing an issuer’s financial condition, the Company’s management considers whether the securities are issued by the U.S. Government or its agencies, whether downgrades by bond rating agencies have occurred, industry analysts’ reports and the issuer’s financial statements and related disclosures.
Adoption of New Accounting Guidance
In January 2010, the Financial Accounting Standards Board (“FASB”) amended existing guidance to improve disclosure requirements related to fair value measurements. New disclosures are required for significant transfers in and out of Level 1 and Level 2 fair value measurements and the reasons for the transfers. In addition, the FASB clarified guidance related to disclosures for each class of assets and liabilities as well as disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements that fall in either Level 2 or Level 3. The impact of adoption on January 1, 2010 was not material as it required only disclosures which are included in the Fair Value footnote.
In June 2009, the FASB amended existing guidance to improve the relevance and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. This amended guidance addresses (1) practices that are not consistent with the intent and key requirements of the original guidance and (2) concerns of financial statement users that many of the financial assets (and related obligations) that have been derecognized should continue to be reported in the financial statements of transferors. The impact of adoption on January 1, 2010 was not material.
In June 2009, the FASB amended guidance for consolidation of variable interest entities by replacing the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity. The new approach focuses on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. Additional disclosures about an enterprise’s involvement in variable interest entities are also required. The impact of adoption on January 1, 2010 was not material.
Newly Issued But Not Yet Effective Accounting Guidance
In January 2010, the FASB amended existing guidance related to fair value measurements requiring new disclosures for activity in Level 3 fair value measurements. In the reconciliation for fair value measurements using significant unobservable inputs (Level 3), a reporting entity should present separately information about purchases, sales, issuances, and settlements (that is, on a gross basis rather than as one net number). These disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The impact of adoption is not expected to be material and relates to disclosure only.
2. STOCKHOLDERS’ EQUITY
The Company has 250,000 shares of preferred stock authorized. In December 2008, the U.S. Department of the Treasury (the “Treasury”) purchased 36,842 shares of the Company’s fixed-rate cumulative perpetual Series A Preferred Stock par value $0.01 per share and liquidation preference $1,000 per share, with a redemption and liquidation value of $37 million and an initial annual dividend of 5% for five years and 9% thereafter. Pursuant to the American Recovery and Reinvestment Act of 2009 (“ARRA”), subject to approval by the Treasury and the Company’s primary federal regulator, the Company may redeem the preferred stock without regard to whether the Company has replaced such funds from any other source or to any waiting period.
Stock held in treasury by the Company is reported as a reduction to total stockholders’ equity. During the first three months of 2010, the Company did not repurchase any of its common shares. In March of 2010, the Company reissued 142,665 shares of common stock previously held in treasury to be used for contributions under the Company’s Employee Stock Ownership Plan.
3. EARNINGS PER COMMON SHARE
Basic earnings per common share is computed based on the weighted-average number of shares outstanding. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options, restricted stock grants and common stock warrants. For periods in which a loss is reported, the impact of stock options, restricted stock grants and common stock warrants is not considered as the result would be antidilutive.
The computation of earnings per common share for the three months ended March 31, 2010 and 2009 is shown below.
4. INVESTMENT SECURITIES
At the time of purchase of a security, the Company designates the security as either available for sale or held to maturity, depending upon investment objectives, liquidity needs and intent. Securities held to maturity are stated at cost, adjusted for premium amortized or discount accreted, if any. The Company has the positive intent and ability to hold such securities to maturity. Securities available for sale are stated at estimated fair value. Unrealized gains and losses are excluded from income and reported net of tax as accumulated other comprehensive income (loss) as a separate component of stockholders’ equity until realized. Interest earned on investment securities is included in interest income. Realized gains and losses on the sale of securities are reported in the consolidated statements of operations and determined using the adjusted cost of the specific security sold.
At March 31, 2010 and December 31, 2009, the Company had no securities designated as held to maturity. The amortized cost, gross unrealized gains and losses and estimated fair value of securities available for sale at March 31, 2010 and December 31, 2009 are as below. The March 31, 2010 amounts include $7 million and $5 million in commitments to purchase mortgage-backed and Government Agency securities, respectively.
The amortized cost and estimated fair value of securities available for sale at March 31, 2010 are shown below by expected maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
The proceeds from sales of securities available for sale and the associated recognized gross gains, gross losses and taxes are shown below:
Information pertaining to securities with gross unrealized losses at March 31, 2010 and December 31, 2009, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
Unrealized losses on securities available for sale have not been recognized in the statements of operations because the issuers’ bonds are of high credit quality, management does not intend to sell and it is not more likely than not that management would be required to sell the securities prior to recovery, and the decline in fair value is largely due to interest rates.
In the case of adjustable rate securities, the coupon rate resets periodically and is typically comprised of a base market index rate plus a spread. The market value on these securities is primarily influenced by the length of time remaining before the coupon rate resets to market levels. As an adjustable rate security approaches that reset date, it is likely that an unrealized loss position would diminish.
The market value for fixed rate securities changes inversely with changes in interest rates. When interest rates are falling, the market value of fixed rate securities will appreciate, whereas in a rising interest rate environment, the market value of fixed rate securities will depreciate. The market value of fixed rate securities is also affected with the passage of time. As a fixed rate security approaches its maturity date, the market value of the security typically approaches its par value.
The Company’s loan portfolio is concentrated primarily in commercial and industrial loans and commercial mortgage loans.
Impaired loans, excluding loans held for sale, before related specifically allocated allowance for loan loss were $3 million and $5 million at March 31, 2010 and December 31, 2009, respectively. Impaired loans net of related specifically allocated allowance for loan loss were $3 million and $4 million at March 31, 2010 and December 31, 2009, respectively. No interest income was recognized on impaired loans for the three months ended March 31, 2010 and 2009. The recorded investment in loans that are considered to be impaired, as of March 31, 2010 and December 31, 2009, is summarized below:
Activity in the allowance for loan losses for the three months ended March 31, 2010 and 2009 is as follows:
The aggregate amount of loans, excluding loans held for sale, classified as special mention ($43 million), substandard ($69 million), doubtful ($298 thousand) or loss ($385 thousand) by the Company's loan grading process has decreased to $113 million at March 31, 2010 from $123 million at December 31, 2009. At March 31, 2010 and December 31, 2009, loans with unpaid principal balances on which the Bank is no longer accruing interest income were $6 million and $7 million, respectively. Of the total non-accrual loans at March 31, 2010 and December 31, 2009, $370 thousand and $670 thousand, respectively, were categorized as held for sale. The decrease in non-accrual loans at March 31, 2010 compared to December 31, 2009 was primarily due to net payments, sales and settlements. At March 31, 2010 there were no loans 90 days or more past due and still accruing interest. Such loans totaled $4 million at December 31, 2009.
6. LEGAL PROCEEDINGS
The Company and the Bank are subject to legal proceedings and claims that arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability, if any, with respect to such matters will not materially affect future operations and will not have a material impact on the Company’s financial statements.
7. REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under the capital adequacy guidelines, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and the Bank’s classification are also subject to qualitative judgments by the federal banking regulators about components of capital, risk weightings of assets and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total capital and Tier I capital, as defined in the federal banking regulations, to risk-weighted assets and of Tier I capital to average assets as shown in the following table. Each of the Company’s and the Bank’s capital ratios exceeds applicable regulatory capital requirements and the Bank meets the requisite capital ratios to be well-capitalized as of March 31, 2010 and December 31, 2009. There are no subsequent conditions or events that management believes have changed the Company’s or the Bank’s capital adequacy. The Company’s and the Bank’s capital amounts (in thousands) and ratios are as follows:
State banking regulations limit, absent regulatory approval, the Bank’s dividends to the Company to the lesser of the Bank’s undivided profits and the Bank’s retained net income for the current year plus its retained net income for the preceding two years (less any required transfers to capital surplus) up to the date of any dividend declaration in the current calendar year. As of March 31, 2010, no dividends were available to the Company from the Bank according to these limitations without seeking regulatory approval.
The preferred stock, purchased by the Treasury in December 2008, qualifies as Tier I capital for regulatory reporting purposes. The Treasury also received a warrant to purchase 465,569 shares of the Company’s common stock with an exercise price of $11.87 per share representing an aggregate market price of $6 million or 15% of the preferred stock investment. The warrant is immediately exercisable and expires in ten years. The Company allocated $1 million of the proceeds from the issuance of the preferred stock to the value of the warrant representing an unamortized discount on preferred stock. The discount is being amortized to preferred stock using an effective yield method over a five-year period. Through March 31, 2010, $288 thousand of the discount has been accreted to preferred stock.
The proceeds from the issuance to the U.S. Treasury were allocated based on the relative fair value of the warrant as compared to the fair value of the preferred stock. The fair value of the warrant was determined using a Black-Scholes valuation model. The assumptions used in the warrant valuation were a dividend yield of 3.8%, stock price volatility of 34% and a risk-free interest rate of 2.7%. The fair value of the preferred stock was determined using a discounted cash flow analysis based on assumptions regarding the market rate for preferred stock, which was estimated to be approximately 9% at the date of issuance.
8. STOCK-BASED COMPENSATION
Incentive Stock Options
Under the terms of the Company’s incentive stock option plans adopted in February 1999 and February 2002, options have been granted to certain key personnel that entitle each holder to purchase shares of the Company’s common stock. The option price is the higher of the fair market value or the book value of the shares at the date of grant. Such options were exercisable commencing one year from the date of grant, at the rate of 25% per year, and expire within ten years from the date of grant. Any optionee-owned stock may be used as full or partial payment of the exercise price and shall be valued at the fair market value of the stock on the date of exercise of the option.
At March 31, 2010, incentive stock options for the purchase of 239,313 shares were outstanding and exercisable. No options were exercised during the three months ended March 31, 2010 and 2009. The options outstanding and exercisable at March 31, 2010 have no intrinsic value. A summary of stock option activity follows:
The following summarizes shares subject to purchase from incentive stock options outstanding and exercisable as of March 31, 2010:
Restricted Stock Awards
Under the Company’s 2006 Equity Compensation Plan (the “2006 Plan”), the Company can award options, stock appreciation rights (“SARs”), restricted stock, performance units and unrestricted stock. The 2006 Plan also allows the Company to make awards conditional upon attainment of vesting conditions and performance targets. During the first three months of 2010, the Company awarded 27,777 shares of restricted stock to its President and CEO (“CEO”) representing incentive compensation taken in the form of restricted stock in lieu of cash.
The restricted stock awards currently outstanding primarily vest one-third on each of the third through fifth anniversaries of the award date. Based on an estimated forfeiture rate, of the 215,718 shares currently outstanding, 209,000 shares are expected to vest over the remaining vesting life. The Company recognizes compensation expense over the vesting period at the fair market value of the shares on the award date. If a participant’s service terminates for any reason other than death or disability, then the participant shall forfeit to the Company any shares acquired by the participant pursuant to the restricted stock award which remain subject to vesting conditions. The total remaining unrecognized compensation cost related to nonvested shares of restricted stock is $1.6 million at March 31, 2010 and is expected to be expensed over the weighted average remaining vesting life of 2.3 years. For the three months ended March 31, 2010 and 2009, $319 thousand and $89 thousand, respectively, were recognized as compensation expense, net of estimated forfeitures. The Company recognized tax benefits resulting from the compensation expense for the three months ended March 31, 2010 and 2009 of $109 thousand and $29 thousand, respectively.
A summary of restricted stock activity follows:
At March 31, 2010, 322,037 shares were reserved for possible issuance of awards of options, SARs, restricted stock, performance units and unrestricted stock.
Non-Plan Stock-Based Compensation
In November 2006, the Company granted non-qualified stock options and restricted stock awards to the CEO, pursuant to the terms of his employment agreement. The non-qualified stock options to purchase 164,745 shares have an exercise price of $17.84 and will vest 20% per year over five years. The estimated fair value of the options was $5.42 per share and was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used: (1) dividend yield 3.32%; (2) expected volatility 35%; (3) risk-free interest rate 4.57%; and (4) expected life of options 7.3 years. At March 31, 2010, 98,847 of these options were exercisable, but none have been exercised. The options outstanding and those exercisable at March 31, 2010 have no intrinsic value.
The restricted stock awarded totals 83,612 shares and was awarded at an average price of $17.94 to vest in 20 equal quarterly installments over five years. The fair value of restricted stock awards vested during the three months ended March 31, 2010 and 2009 was $33 thousand and $30 thousand, respectively. A summary of restricted stock activity follows:
The total remaining unrecognized compensation cost related to nonvested options and shares of restricted stock awarded to the CEO is $736 thousand at March 31, 2010 and will be expensed over the weighted average remaining vesting life of 1.0 years. For the three months ended March 31, 2010 and 2009, $142 thousand and $120 thousand, respectively, were recognized as compensation expense. The non-qualified stock options and the restricted stock awards were not issued as part of any of the Company’s registered stock-based compensation plans.
The Bank may use a secured line of credit with the Federal Home Loan Bank of New York (“FHLB”) for overnight funding or on a term basis to fund assets. The amount of this line of credit will fluctuate based upon the amount of pledged collateral in the form of real estate mortgage loans and investment securities. At March 31, 2010, the Bank had approximately $263 million of real estate mortgage loan collateral pledged at the FHLB. Based on this collateral, the Bank had approximately $162 million available to borrow overnight or on a term basis. There were no investment securities pledged. The FHLB line is renewed annually.
The following table provides information on the Bank’s FHLB lines at and for the quarter ended March 31, 2010 and year ended December 31, 2009.
At March 31, 2010 and December 31, 2009, the Bank had $3 million outstanding in securities sold under agreements to repurchase at a weighted-average interest rate of 1.88%.
On March 31, 2009, the Bank issued $29 million in senior unsecured debt due March 30, 2012 guaranteed by the Federal Deposit Insurance Corporation (“FDIC”) under the FDIC’s Temporary Liquidity Guarantee Program (“TLGP”). Interest at 2.625% per year is payable semi-annually in arrears on the 30th day of each March and September.
10. FAIR VALUE
A fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Three levels of inputs may be used to measure fair value.
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other 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.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
For the Company’s securities available for sale, the estimated fair value equals quoted market price, if available (Level 1 inputs). If a quoted market price is not available, fair value is estimated using a quoted market price for similar securities (Level 2 inputs). Our derivative instruments consist of interest rate swap transactions with customers on loans. As such, significant fair value inputs can generally be verified and do not typically involve significant management judgments (Level 2 inputs). The market value adjustment of the derivatives considers the credit risk of the counterparties to the transaction and the effect of any credit enhancements related to the transaction. The fair value of loans held for sale and impaired loans with specific allocations of the allowance for loan losses are 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. Unobservable inputs are typically significant and result in a Level 3 classification for determining fair value of loans held for sale and impaired loans.
Assets and Liabilities Measured on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are summarized below: