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FAIR VALUE
9 Months Ended
Sep. 30, 2011
FAIR VALUE
NOTE 4 – FAIR VALUE

ASC 820-10, formerly SFAS No. 157, defines fair value, establishes a framework for measuring fair value and expands disclosure of fair value measurements.

Fair Value Hierarchy

ASC 820-10 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. In accordance with ASC 820-10, these inputs are summarized in the three broad levels listed below:

 
¨
Level 1 – Quoted prices in active markets for identical securities

 
¨
Level 2 – Other significant observable inputs (including quoted prices in active markets for similar securities)

 
¨
Level 3 – Significant unobservable inputs (including the Company’s own assumptions in determining the fair value of investments)

In determining the appropriate levels, the Company performs a detailed analysis of the assets and liabilities that are subject to ASC 820-10.

The Company’s bond holdings in the investment securities portfolio are the only asset or liability subject to fair value measurements on a recurring basis.  No assets are valued under Level 1 inputs at September 30, 2011 or December 31, 2010.  The Company has assets measured by fair value measurements on a non-recurring basis during 2011.  At September 30, 2011, these assets include 22 loans classified as impaired, which include nonaccrual, past due 90 days or more and still accruing, or troubled debt restructuring, and a homogeneous pool of indirect loans all considered to be impaired loans, which are valued under Level 3 inputs and two properties classified as OREO valued under Level 2 inputs.

The changes in the assets subject to fair value measurements are summarized below by Level:

   
(Dollars in Thousands)
        
                     
Fair
  
   
  
Level 1
    
Level 2
    
Level 3
    
Value
  
December 31, 2010                        
Recurring:
                        
Investment securities available for sale (AFS)
   $ -     $ 87,268     $ -     $ 87,268  
                                 
Non-recurring:
                                
Maryland Financial Bank stock
     -       100       -       100  
Impaired loans
     -       -       9,476       9,476  
OREO
     -       215       -       215  
      -       87,583       9,476       97,059  
                                 
Activity:
                                
Investment securities AFS
                                
Purchases of investment securities
     -       31,715       -       31,715  
Sales, calls and maturities of investment securities
     -       (24,452 )     -       (24,452 )
Amortization/accretion of premium/discount
     -       (670 )     -       (670 )
Increase in market value
     -       4,199       -       4,199  
OTTI on investments
     -       (22 )     -       (22 )
                                 
Maryland Financial Bank stock
                                
OTTI on stock
     -       (70 )     -       (70 )
                                 
Loans
                                
New impaired loans
     -       -       1,054       1,054  
Payments and other loan reductions
     -       -       (1,090 )     (1,090 )
Change in total provision
     -       -       15       15  
Loans converted to OREO
     -       -       (1,307 )     (1,307 )
                                 
OREO
                                
Write-down to Sale Price
     -       (40 )     -       (40 )
OREO converted from loans
     -       1,307       -       1,307  
Sales of OREO
     -       (285 )     -       (285 )
                                 
September 30, 2011
                                
Recurring:
                                
Investment securities AFS
     -       98,038       -       98,038  
                                 
Non-recurring:
                                
Maryland Financial Bank stock
     -       30       -       30  
Impaired loans
     -       -       8,148       8,148  
OREO
     -       1,197       -       1,197  
    $ -     $ 99,265     $ 8,148     $ 107,413  

The estimated fair values of the Company’s financial instruments at September 30, 2011 and December 31, 2010 are summarized below. The fair values of a significant portion of these financial instruments are estimates derived using present value techniques and may not be indicative of the net realizable or liquidation values. Also, the calculation of estimated fair values is based on market conditions at a specific point in time and may not reflect current or future fair values.

   
September 30, 2011
    
December 31, 2010
  
(In Thousands)
  
Carrying
    
Fair
    
Carrying
    
Fair
  
   
Amount
    
Value
    
Amount
    
Value
  
Financial assets:
                        
Cash and due from banks
   $ 7,908     $ 7,908     $ 6,492     $ 6,492  
Interest-bearing deposits
     8,921       8,921       1,568       1,568  
Federal funds sold
     759       759       940       940  
Investment securities
     98,038       98,038       87,268       87,268  
Investments in restricted stock
     1,579       1,579       1,745       1,745  
Ground rents
     178       178       178       178  
Loans, net
     226,702       226,441       229,851       234,426  
Accrued interest receivable
     1,398       1,398       1,539       1,539  
                                 
Financial liabilities:
                                
Deposits
     309,701       291,985       294,444       269,480  
Short-term borrowings
     219       219       4,274       4,274  
Long-term borrowings
     20,000       21,207       20,000       19,611  
Dividends payable
     232       232       232       232  
Accrued interest payable
     77       77       55       55  
                                 
Off-balance sheet commitments
     22,821       22,821       21,762       21,762  

Fair values are based on quoted market prices for similar instruments or estimated using discounted cash flows. The discounts used are estimated using comparable market rates for similar types of instruments adjusted to be commensurate with the credit risk, overhead costs and optionality of such instruments.

The fair value of cash and due from banks, federal funds sold, investments in restricted stocks and accrued interest receivable are equal to the carrying amounts. The fair values of investment securities are determined using market quotations. The fair value of loans receivable is estimated using discounted cash flow analysis.

The fair value of non-interest bearing deposits, interest-bearing checking, savings, and money market deposit accounts, securities sold under agreements to repurchase, and accrued interest payable are equal to the carrying amounts. The fair value of fixed-maturity time deposits is estimated using discounted cash flow analysis.

The gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2011 are as follows:

Securities available for sale:
  
Less than 12 months
    
12 months or more
    
Total
  
(Dollars in Thousands)
                                    
   
Fair
    
Unrealized
    
Fair
    
Unrealized
    
Fair
    
Unrealized
  
   
Value
    
Loss
    
Value
    
Loss
    
Value
    
Loss
  
                                     
Obligations of U.S. Govt Agencies
   $ 0     $ 0     $ 0     $ 0     $ 0     $ 0  
State and Municipal
     1,301       5       1,839       72       3,140       77  
Corporate Trust Preferred
     0       0       332       301       332       301  
Mortgage Backed
     13,193       73       1,931       28       15,124       101  
    $ 14,494     $ 78     $ 4,102     $ 401     $ 18,596     $ 479  

At September 30, 2011, the company owned one pooled trust preferred security issued by Regional Diversified Funding, Senior Notes with a Fitch rating of C.  The market for these securities at September 30, 2011 was not active and markets for similar securities were also not active.  As a result, the Company had cash flow testing performed as of September 30, 2011 by an unrelated third party in order to measure the possible extent of other-than-temporary-impairment (“OTTI”).  This testing assumed future defaults on the currently performing financial institutions of 75 basis points applied annually with a 15% recovery after a two year lag on both current and future defaulting financial institutions.  As a result of this testing, a write-down of $22,000 was taken on this security in the first quarter of 2011.

Maryland Financial Bank stock was written down $70,000 in the second quarter of 2011 due to a prospectus that offered stock at a discount from par.

Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses.  In estimating other-than-temporary-impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability of the Company to retain it’s investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

As of September 30, 2011, management had the ability and intent to hold the securities classified as available for sale for a period of time sufficient for a recovery of cost.  On September 30, 2011 the Bank held 10 investment securities having continuous unrealized loss positions for more than 12 months.  Management has determined that all unrealized losses are either due to increases in market interest rates over the yields available at the time the underlying securities were purchased, current call features that are nearing, and the effect the sub-prime market has had on all mortgage-backed securities.  The Bank has no mortgage-backed securities collateralized by sub-prime mortgages.  The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline.  Management does not believe any of the securities are impaired due to reasons of credit quality.  Except as noted above, as of September 30, 2011, management believes the impairments detailed in the table above are temporary and no impairment loss has been realized in the Company’s consolidated income statement.

A rollforward of the cumulative other-than-temporary credit losses recognized in earnings for all debt securities for which a portion of an other-than-temporary loss is recognized in accumulated other comprehensive loss is as follows:

   
September 30,
    
December 31,
  
   
2011
    
2010
  
   
(Dollars in Thousands)
  
             
Estimated credit losses, beginning of year
   $ 3,155     $ 2,893  
Credit losses - no previous OTTI recognized
     -       -  
Credit losses - previous OTTI recognized
     22       262  
                 
Estimated credit losses, end of period
   $ 3,177     $ 3,155