Note 21—Fair Values of Assets and Liabilities

FASB ASC Topic 820, "Fair Value Measurements and Disclosures" requires disclosures for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). All non-financial assets are included either as a separate line item on the Consolidated Statements of Financial Condition or in the "Other assets" category of the Consolidated Statements of Financial Condition. Currently, First Commonwealth does not have any non-financial liabilities to disclose.

FASB ASC Topic 825, "Financial Instruments" permits entities to irrevocably elect to measure select financial instruments and certain other items at fair value. The unrealized gains and losses are required to be included in earnings each reporting period for the items that fair value measurement is elected. First Commonwealth has elected not to measure any existing financial instruments at fair value under FASB ASC Topic 825; however, in the future we may elect to adopt this guidance for select financial instruments.

In accordance with FASB ASC Topic 820, First Commonwealth groups financial assets and financial liabilities measured at fair value in three levels, based on the principal markets in which the assets and liabilities are transacted and the observability of the data points used to determine fair value. These levels are:

•

Level 1—Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange ("NYSE"). Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities. Level 1 securities include equity holdings comprised of publicly traded bank stocks which were priced using quoted market prices.

•

Level 2—Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained for identical or comparable assets or liabilities from alternative pricing sources with reasonable levels of price transparency. Level 2 includes Obligations of U.S. Government securities issued by Agencies and Sponsored Enterprises, Obligations of States and Political Subdivisions, certain corporate securities, certain equity securities, FHLB stock, interest rate derivatives that include interest rate swaps and risk participation agreements, certain other real estate owned and certain impaired loans.

Level 2 investment securities are valued by a recognized third party pricing service using observable inputs. The model used by the pricing service varies by asset class and incorporates available market, trade and bid information as well as cash flow information when applicable. Because many fixed-income investment securities do not trade on a daily basis, the model uses available information such as benchmark yield curves, benchmarking of like investment securities, sector groupings and matrix pricing. The model will also use processes such as an option adjusted spread to assess the impact of interest rates and to develop prepayment estimates. Market inputs normally used in the pricing model include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including market research publications.

Management validates the market values provided by the third party service by having another recognized pricing service price a random sample of securities each quarter, monthly monitoring of variances from prior period pricing and on a monthly basis evaluating pricing changes compared to expectations based on changes in the financial markets.

The equity investments included in Level 2 are based on broker prices and are included in Level 2 because they are not traded on an active exchange market.

Other Investments is comprised of FHLB stock whose estimated fair value is based on its par value. Additional information on FHLB stock is provided in Note 10 "Other investments."

Interest rate derivatives are reported at estimated fair value utilizing Level 2 inputs and are included in Other assets and Other liabilities. First Commonwealth values its interest rate swap positions using a yield curve by taking market prices/rates for an appropriate set of instruments. The set of instruments currently used to determine the U.S. Dollar yield curve includes cash LIBOR rates from overnight to three months, Eurodollar futures contracts and swap rates from three years to thirty years. These yield curves determine the valuations of interest rate swaps. Interest rate derivatives are further described in Note 7 "Derivatives."

For purposes of potential valuation adjustments to our derivative positions, First Commonwealth evaluates the credit risk of its counterparties as well as our own credit risk. Accordingly, we have considered factors such as the likelihood of default, expected loss given default, net exposures and remaining contractual life, among other things, in determining if any estimated fair value adjustments related to credit risk are required. We review our counterparty exposure quarterly, and when necessary, appropriate adjustments are made to reflect the exposure.

We also utilize this approach to estimate our own credit risk on derivative liability positions. In 2011, we recognized $4.4 million in credit losses related to two interest rate swaps which were terminated due to deterioration in the credit quality of the counterparty.

The estimated fair value for other real estate owned included in Level 2 is determined by either an independent market based appraisal less costs to sell or an executed sales agreement.

•

Level 3—Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer or broker traded transactions. If the inputs used to provide the valuation are unobservable and/or there is very little, if any, market activity for the security or similar securities, the securities would be considered Level 3 securities. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities. The assets included in Level 3 are select Obligations of States and Political Subdivisions, corporate securities, pooled trust preferred collateralized debt obligations, non-marketable equity investments, certain impaired loans and loans held for sale.

The estimated fair values for the Obligations of States and Political Subdivisions included in Level 3 and corporate securities, which include our single issue trust preferred securities, were obtained from pricing sources with reasonable pricing transparency, taking into account other unobservable inputs related to the risks for each issuer. These valuations were classified as Level 3 due to the inactivity in the respective markets.

Our pooled trust preferred collateralized debt obligations are collateralized by the trust preferred securities of individual banks, thrifts and bank holding companies in the U.S. There has been little or no active trading in these securities for approximately twenty-four months; therefore it was more appropriate to determine estimated fair value using a discounted cash flow analysis. The fair values of the pooled trust preferred collateralized debt obligations are determined by a specialized third party valuation service. Detail on the process for determining appropriate cash flows for this analysis is provided in Note 11 "Impairment of Investment Securities." The discount rate applied to the cash flows is determined by evaluating the current market yields for comparable corporate and structured credit products along with an evaluation of the risks associated with the cash flows of the comparable security. Due to the fact that there is no active market for the pooled trust preferred collateralized debt obligations, one key reference point is the market yield for the single issue trust preferred securities issued by banks and thrifts for which there is more activity than for the pooled securities. Adjustments are then made to reflect the credit and structural differences between these two security types.

Management validates the fair value of the pooled trust preferred collateralized debt obligations by monitoring the performance of the underlying collateral, discussing the discount rate, cash flow assumptions and general market trends with the specialized third party and by confirming changes in the underlying collateral to the trustee and underwriter reports. Management's monitoring of the underlying collateral includes deferrals of interest payments, payment defaults, cures of previously deferred interest payments, any regulatory filings or actions and general news related to the underlying collateral. Management also evaluates fair value changes compared to expectations based on changes in the interest rates used in determining the discount rate and general financial markets.

The estimated fair value of the non-marketable equity investments included in level 3 is based on par value.

Loans held for sale are carried at the lower of cost or fair value with the fair value being the expected sales price of the loan. The estimated fair value of the loans currently held for sale was determined by calculating the discounted expected future cash flows of the loan. The discount rate applied to the future cash flows was determined based on a risk based expected return and capital structure of potential buyers.

The tables below present the balances of assets and liabilities measured at fair value on a recurring basis at December 31:


	2011
	Level 1		Level 2		Level 3		Total
	(dollars in thousands)
Obligations of U.S. Government Agencies:
Mortgage-Backed Securities—Residential	$	0	$	36,194	$	0	$	36,194
Obligations of U.S. Government-Sponsored Enterprises:
Mortgage-Backed Securities—Residential		0		801,031		0		801,031
Mortgage-Backed Securities—Commercial		0		193		0		193
Other Government-Sponsored Enterprises		0		268,648		0		268,648
Obligations of States and Political Subdivisions		0		459		0		459
Corporate Securities		0		11,411		0		11,411
Pooled Trust Preferred Collateralized Debt Obligations		0		0		22,980		22,980

Total Debt Securities		0		1,117,936		22,980		1,140,916
Equities		440		0		1,420		1,860

Total Securities Available for Sale		440		1,117,936		24,400		1,142,776
Other Investments		0		39,796		0		39,796
Loans Held for Sale		0		0		13,412		13,412
Other Assets (a)		0		16,064		0		16,064

Total Assets	$	440	$	1,173,796	$	37,812	$	1,212,048

Other Liabilities (a)	$	0	$	18,986	$	0	$	18,986

Total Liabilities	$	0	$	18,986	$	0	$	18,986

(a)	Non-hedging interest rate derivatives


	2010
	Level 1		Level 2		Level 3		Total
	(dollars in thousands)
Obligations of U.S. Government Agencies:
Mortgage-Backed Securities—Residential	$	0	$	40,593	$	0	$	40,593
Obligations of U.S. Government-Sponsored Enterprises:
Mortgage-Backed Securities—Residential		0		641,981		0		641,981
Mortgage-Backed Securities—Commercial		0		233		0		233
Other Government-Sponsored Enterprises		0		183,887		0		183,887
Obligations of States and Political Subdivisions		0		47,476		343		47,819
Corporate Securities		0		0		21,376		21,376
Pooled Trust Preferred Collateralized Debt Obligations		0		0		26,352		26,352

Total Debt Securities		0		914,170		48,071		962,241
Equities		1,462		2,442		1,570		5,474

Total Securities Available for Sale		1,462		916,612		49,641		967,715
Other Investments		0		48,859		0		48,859
Other Assets (a)		0		15,939		0		15,939

Total Assets	$	1,462	$	981,410	$	49,641	$	1,032,513

Other Liabilities (a)	$	0	$	16,663	$	0	$	16,663

Total Liabilities	$	0	$	16,663	$	0	$	16,663

(a)	Non-hedging interest rate derivatives

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows at for the year ended December 31, 2011:


	Obligations of States and Political Subdivisions			Corporate Securities			Pooled Trust Preferred Collateralized Debt Obligations			Equities			Loans Held for Sale		Other Assets			Total
	(dollars in thousands)
Balance, beginning of year	$	343		$	21,376		$	26,352		$	1,570		$	0	$	0		$	49,641
Total gains or losses
Included in earnings		4			387			0			(150	)		0		(4,449	)		(4,208	)
Included in other comprehensive income		(20	)		(98	)		1,284			0			0		0			1,166
Purchases, issuances, sales, and settlements
Purchases		0			0			0			0			0		0			0
Issuances		0			0			0			0			0		0			0
Sales		(327	)		(6,700	)		0			0			0		0			(7,027	)
Settlements		0			(3,000	)		(4,656	)		0			0		(71	)		(7,727	)
Transfers from Level 3		0			(11,965	)		0			0			0		0			(11,965	)
Transfers into Level 3		0			0			0			0			13,412		4,520			17,932

Balance, end of year	$	0		$	0		$	22,980		$	1,420		$	13,412	$	0		$	37,812

There are no gains or losses included in earnings for the period that are attributable to the change in realized gains (losses) relating to assets held at December 31, 2011.

During 2011, securities totaling $12.0 million transferred from Level 3 to Level 2. There were no transfers between Level 1 and Level 2 securities. The primary reason for the transfer out of Level 3 in 2011 was due to an increase in activity in the market that resulted in observable market activity or comparable trades that could be used to establish a benchmark for valuation for this group of securities.

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows for the year ended December 31, 2010:


	Obligations of States and Political Subdivisions			Corporate Securities		Pooled Trust Preferred Collateralized Debt Obligations			Equities		Other Assets		Total
	(dollars in thousands)
Balance, beginning of year	$	3,600		$	18,830	$	29,730		$	1,570	$	0	$	53,730
Total gains or losses
Included in earnings		0			0		(8,688	)		0		0		(8,688	)
Included in other comprehensive income		(2,316	)		2,546		6,833			0		0		7,063
Purchases, issuances, sales, and settlements
Purchases		0			0		0			0		0		0
Issuances		0			0		0			0		0		0
Sales		(941	)		0		0			0		0		(941	)
Settlements		0			0		(1,523	)		0		0		(1,523	)
Transfers from Level 3		0			0		0			0		0		0
Transfers into Level 3		0			0		0			0		0		0

Balance, end of year	$	343		$	21,376	$	26,352		$	1,570	$	0	$	49,641

During 2010, there were no transfers between Level 1, Level 2 and Level 3 securities.

Losses of $6.8 million included in earnings for the year ended December 31, 2010 are attributable to the change in realized losses relating to assets held at December 31, 2010 and are reported in the lines "Net impairment losses" and "Net securities gains (losses)" in the Consolidated Statement of Operations.

Certain financial assets and financial liabilities 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).

The tables below present the balances of assets measured at fair value on a nonrecurring basis at December 31, and total gains and losses realized on these assets during the year ended December 31:


	2011
	Level 1		Level 2		Level 3		Total		Total Gains (Losses)
	(dollars in thousands)
Impaired loans	$	0	$	73,783	$	26,349	$	100,132	$	(24,636	)
Other real estate owned		0		31,232		438		31,670		(8,643	)

Total Assets	$	0	$	105,015	$	26,787	$	131,802	$	(33,279	)


	2010
	Level 1		Level 2		Level 3		Total		Total Gains (Losses)
	(dollars in thousands)
Impaired loans	$	0	$	78,967	$	26,715	$	105,682	$	(50,953	)
Other real estate owned		0		24,871		10		24,881		(2,309	)

Total Assets	$	0	$	103,838	$	26,725	$	130,563	$	(53,262	)

Impaired loans over $100 thousand are individually reviewed to determine the amount of each loan considered to be at risk of noncollection. The impaired loans are collateral based and the fair value is determined by reviewing real property appraisals, equipment valuations, accounts receivable listings and other financial information. First Commonwealth's loan policy requires updated appraisals be obtained at least every twelve months on all impaired loans with balances of $250 thousand and over.

Fair value for other real estate owned is determined by an independent market based appraisal less costs to sell and is classified as level 2. Other real estate owned has a current carrying value of $30.0 million as of December 31, 2011 and consisted primarily of a Pennsylvania based manufacturing plant with related real estate, an office building in western Pennsylvania and a multi-family construction project in eastern Pennsylvania. We review whether events and circumstances subsequent to a transfer to other real estate owned have occurred that indicate the balance of those assets may not be recoverable. If events and circumstances indicate further impairment, we will record a charge to the extent that the carrying value of the assets exceed their fair values, less cost to sell, as determined by valuation techniques appropriate in the circumstances.

Certain other assets and liabilities, including goodwill and core deposit intangibles, 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 only in certain circumstances. A goodwill impairment test for First Commonwealth was completed as of December 31, 2011. Based on this analysis, the fair value of First Commonwealth exceeded its book value. Additional information related to this measurement is provided in Note 16 "Goodwill and Other Amortizing Intangible Assets." There were no other assets or liabilities measured at fair value on a nonrecurring basis during 2011.

FASB ASC Topic 825, "Financial Instruments" 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 nonrecurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or nonrecurring basis are as discussed above. The methodologies for other financial assets and financial liabilities are discussed below.

Cash and short-term instruments: The carrying amounts for cash and short-term instruments approximate the estimated fair values of such assets.

Securities: Fair values for securities available for sale and securities held to maturity are based on quoted market prices, if available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Pooled trust preferred collateralized debt obligations values are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer or broker traded transactions. These valuations incorporate certain assumptions and projections in determining the fair value assigned to each instrument. The carrying value of nonmarketable equity securities, such as FHLB stock, is considered a reasonable estimate of fair value.

Loans held for sale: The fair value of loans held for sale are estimated utilizing a present value of future discounted cash flows of the loan utilizing a risk based expected return to discount the value.

Loans: The fair values of all loans are estimated by discounting the estimated future cash flows using interest rates currently offered for loans with similar terms to borrowers of similar credit quality adjusted for past due and nonperforming loans which is not an exit price under FASB ASC Topic 820, "Fair Value Measurements and Disclosures." At December 31, 2011, the Company completed a Step 2 goodwill impairment analysis which incorporated an exit price for loans under FASB ASC Topic 820 of $3.8 billion.

Off-balance sheet instruments: Many of First Commonwealth's off-balance sheet instruments, primarily loan commitments and standby letters of credit, are expected to expire without being drawn upon; therefore, the commitment amounts do not necessarily represent future cash requirements. Management has determined that due to the uncertainties of cash flows and difficulty in predicting the timing of cash flows for loan commitments, fair values were not estimated for either period. FASB ASC Topic 460, "Guarantees" clarified that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The carrying amount and estimated fair value for standby letters of credit was $0.1 million at December 31, 2011 and 2010. See Note 14 "Commitments and Letters of Credit," for additional information.

Deposit liabilities: Management estimates the fair value of deposits based on a market valuation of similar deposits. The carrying value of variable rate time deposit accounts and certificates of deposit approximate their fair values at the report date. Also, fair values of fixed rate time deposits for both periods are estimated by discounting the future cash flows using interest rates currently being offered and a schedule of aggregated expected maturities.

Short-term borrowings: The fair values of borrowings from the Federal Home Loan Bank were estimated based on the estimated incremental borrowing rate for similar types of borrowings. The carrying amounts of other short-term borrowings such as federal funds purchased, securities sold under agreement to repurchase and treasury, tax and loan notes were used to approximate fair value.

Long-term debt and subordinated debt: The fair value of long-term debt and subordinated debt is estimated by discounting the future cash flows using First Commonwealth's estimated incremental borrowing rate for similar types of borrowing arrangements.

The following table presents carrying amounts and estimated fair values of First Commonwealth's financial instruments at December 31:


	2011				2010
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
	(dollars in thousands)
Financial assets
Cash and due from banks	$	74,967	$	74,967	$	69,854	$	69,854
Interest-bearing deposits		3,511		3,511		4		4
Securities available for sale		1,142,776		1,142,776		967,715		967,715
Other investments		39,796		39,796		48,859		48,859
Loans held for sale		13,412		13,412		0		0
Loans		4,043,643		4,113,525		4,218,083		4,213,293
Financial liabilities
Deposits		4,504,684		4,452,235		4,617,852		4,560,070
Short-term borrowings		312,777		312,777		187,861		182,931
Long-term debt		101,664		103,749		98,748		102,038
Subordinated debt		105,750		75,310		105,750		86,870