Investment securities at June 30, 2009 and December 31, 2008 consisted of the following (dollars in thousands):

 

		Amortized cost				Gross unrealized gains				Gross unrealized losses				Estimated fair value
6/30/2009
Available-for-sale
U.S. Agency mortgage-backed securities		$	90,565			$	1,215			$	334			$	91,446
U.S. Agency asset-backed securities			7,919				404				-				8,323
Obligations of state and political subdivisions			1,480				77				-				1,557
Mutual fund			432				11				-				443
		$	100,396			$	1,707			$	334			$	101,769
Held-to-maturity
Obligations of state and political subdivisions		$	2,010			$	98			$	-			$	2,108

 

7

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		Amortized cost				Gross unrealized gains				Gross unrealized losses				Estimated fair value
12/31/2008
Available-for-sale
U.S. Agency mortgage-backed securities		$	94,292			$	607			$	1,365			$	93,534
U.S. Government and agency securities			8,273				453				-				8,726
Obligations of state and political subdivisions			1,503				32				5				1,530
U.S. Agency asset-backed securities			3,193				67				-				3,260
Mutual fund			423				7				-				430
		$	107,684			$	1,166			$	1,370			$	107,480
Held-to-maturity
Obligations of state and political subdivisions		$	2,211			$	36			$	-			$	2,247

 

 

The following table presents only those securities with gross unrealized losses per 3rd party valuation reports.  Such securities are aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2009:

 

		Less than 12 months								12 months or more								Total
		Estimated fair value				Unrealized losses				Estimated fair value				Unrealized losses				Estimated fair value				Unrealized losses
U.S. Agency mortgage-
backed securities (MBS)		$	19,712			$	150			$	9,223			$	184			$	28,935			$	334

 

The unrealized losses on agency guaranteed MBS investments are primarily due to widening of interest rate spreads as compared to yields/spread relationships prevailing at the time specific investment securities were purchased.  Management expects the fair value of these investment securities to recover as market volatility lessens, and/or as securities approach their maturity dates.  Because the portfolio is mainly conventional agency MBS which carry US government guarantees as to principal and interest, management does not believe  securities are materially impaired due to issues of credit quality nor that the above gross unrealized losses on investment securities are other-than-temporary.  Accordingly no impairment adjustments have been recorded.

3.	Loans and Reserve for Credit Losses

The composition of the loan portfolio at June 30, 2009 and December 31, 2008 was as follows (dollars in thousands):

 

Loan portfolio		June 30, 2009				% of gross loans				December 31, 2008				% of gross loans				% Change Jun/Dec
Commercial		$	515,681				29	%		$	582,831				30	%			-11.5	%
Real Estate:
Construction/lot/land development			466,551				26	%			517,721				26	%			-9.9	%
Mortgage			98,030				5	%			96,248				5	%			1.9	%
Commercial			667,903				37	%			703,149				36	%			-5.0	%
Consumer			54,549				3	%			56,235				3	%			-3.0	%
Total loans			1,802,714				100	%			1,956,184				100	%			-7.8	%
Less reserve for loan losses			62,388								47,166								32.3	%
Total loans, net		$	1,740,326							$	1,909,018								-8.8	%

 

Total loans have been strategically reduced as compared to year end 2008 and prior quarter end as a result of select loan sales or participations,  non renewal of mainly transaction only loans where deposit relationship with customer was de minimus, as well as net charge-offs (particularly in the residential land development portfolio).

Mortgage real estate loans include mortgage loans held for sale of approximately $3.5 million at June 30, 2009 and approximately $1.4 million at December 31, 2008.  In addition, the above loans are net of deferred loan fees of approximately $3.8 million at June 30, 2009 and $4.7 million at December 31, 2008.

 

8

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Primarily because of the economic recession and real estate downturn, credit quality stress is currently concentrated in Cascade’s real estate related loan categories.  The table below presents the geographic distribution of the construction/lot loan category at June 30, 2009 and December 31, 2008 (dollars in thousands):

		June 30, 2009				% of category				% of Constr / lot portfolio				% of gross loans				December 31, 2009				% change Jun/Dec
Residential Land Development:
Raw Land		$	59,688				34	%			13	%			3	%		$	72,329				-17.5	%
Land Development			102,253				59	%			22	%			6	%			112,234				-8.9	%
Speculative Lots			11,715				7	%			3	%			1	%			14,855				-21.1	%
		$	173,656				100	%			37	%			10	%		$	199,418				-12.9	%
Geographic distribution by region:
Central Oregon		$	67,139				39	%			14	%			4	%		$	74,209				-9.5	%
Northwest Oregon			4,602				3	%			1	%			0	%			4,670				-1.5	%
Southern Oregon			9,472				5	%			2	%			1	%			12,722				-25.5	%
Total Oregon			81,213				47	%			17	%			5	%			91,601				-11.3	%
Idaho			92,443				53	%			20	%			5	%			107,817				-14.3	%
Grand total		$	173,656				100	%			37	%			10	%		$	199,418				-12.9	%
Residential Construction:
Pre sold		$	17,141				18	%			4	%			1	%		$	19,202				-10.7	%
Lots			15,198				16	%			3	%			1	%			17,331				-12.3	%
Speculative Construction			63,434				66	%			14	%			4	%			71,412				-11.2	%
		$	95,773				100	%			21	%			5	%		$	107,945				-11.3	%
Geographic distribution by region:
Central Oregon		$	43,863				46	%			9	%			2	%		$	43,593				0.6	%
Northwest Oregon			23,711				25	%			5	%			1	%			30,445				-22.1	%
Southern Oregon			5,217				5	%			1	%			0	%			5,799				-10.0	%
Total Oregon			72,791				76	%			16	%			3	%			79,837				-8.8	%
Idaho			22,982				24	%			5	%			2	%			28,109				-18.2	%
Grand total		$	95,773				100	%			21	%			5	%		$	107,945				-11.3	%
Commercial Construction:
Pre sold		$	27,161				14	%			6	%			2	%		$	27,826				-2.4	%
Lots			14,472				7	%			3	%			1	%			16,404				-11.8	%
Speculative			125,481				64	%			27	%			7	%			143,719				-12.7	%
Speculative Lots			30,008				15	%			6	%			2	%			22,409				33.9	%
		$	197,122				100	%			42	%			12	%		$	210,358				-6.3	%
Geographic distribution by region:
Central Oregon		$	35,647				19	%			8	%			2	%		$	49,817				-28.4	%
Northwest Oregon			101,266				47	%			22	%			6	%			83,720				21.0	%
Southern Oregon			28,836				15	%			6	%			2	%			33,837				-14.8	%
Total Oregon			165,749				81	%			36	%			10	%			167,375				-1.0	%
Idaho			31,373				20	%			7	%			2	%			42,984				-27.0	%
Grand total		$	197,122				101	%			42	%			12	%		$	210,358				-6.3	%

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Transactions in the reserve for loan losses and unfunded commitments for the six months ended June 30, 2009 and 2008 were as follows (dollars in thousands):

		Six months ended
		June 30,
Reserve for loan losses		2009				2008
Balance at beginning of period		$	47,166			$	33,875
Loan loss provision			63,000				22,864
Recoveries			1,001				705
Loans charged off			(48,779	)			(14,807	)
Balance at end of period		$	62,388			$	42,637
Reserve for unfunded commitments
Balance at beginning of period		$	1,039			$	3,163
Credit for unfunded commitments			(335	)			-
Balance at end of period		$	704			$	3,163
Reserve for credit losses
Reserve for loan losses		$	62,388			$	42,637
Reserve for unfunded commitments			704				3,163
Total reserve for credit losses		$	63,092			$	45,800

 

 

 

At June 30, 2009, the Bank had approximately $372.0 million in outstanding commitments to extend credit, compared to approximately $514.6 million at year-end 2008. The reduction is a function of completion of prior period construction draws as well as management of commitments to a lower level.  Reserve for unfunded commitments are classified as other liabilities and totaled approximately $.7 million at June 30, 2009 and $1.0 million at December 31, 2008.

4.	Non-Performing Assets

Risk of nonpayment exists with respect to all loans, which could result in the classification of such loans as non-performing. The increase in non-performing assets (NPA’s) is primarily due to the economic recession and real estate downturn which has impacted the Company’s loan portfolio. NPA balances were down modestly from the immediately preceding quarter, but up significantly compared to year-end 2008 primarily due to the continued effect of the adverse economy and real estate downturn on residential land development and construction loan portfolios.

 

The Company has a significant concentration in real estate lending, with many of the Company's loans to real estate developers and secured by real estate located in Oregon and Idaho.  Declining real estate values and a severe constriction in the availability of mortgage financing has negatively impacted real estate sales, which has resulted in customers' inability to repay loans. In addition, the value of collateral underlying such loans has decreased materially.  During the first half of 2009, the Company has continued to experience increases in non-performing assets relating to real estate lending, primarily in our residential real estate portfolio.

 

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The following table presents information with respect to non-performing assets at June 30, 2009, March 31, 2009 and December 31, 2008 (dollars in thousands):

		June 30,				March 31,				December 31,
		2009				2009				2008
Loans on non-accrual status		$	164,887			$	176,979			$	120,468
Loans past due 90 days or more
but not on non-accrual status			-				392				5
OREO - non-performing			39,226				39,956				38,952
Total NPA's		$	204,113			$	217,327			$	159,425
Operating commercial real estate OREO		$	12,825			$	13,775			$	13,775
OREO - non-performing			39,226				39,956				38,952
Total OREO		$	52,051			$	53,731			$	52,727
Selected ratios:
NPLs to total gross loans			9.15	%			9.17	%			6.16	%
NPAs to total gross loans and OREO			11.00	%			10.93	%			7.94	%
NPAs to total assets			8.50	%			9.39	%			7.00	%

 

The composition of non-performing assets as of June 30, 2009, March 31, 2009 and December 31, 2008 was as follows (dollars in thousands):

 

		June 30, 2009				% of total				March 31, 2009				% of total				December 31, 2008				% of total
Commercial		$	23,518				12	%		$	29,497				13	%		$	16,877				11	%
Real Estate:
Development/Construction/lot			161,143				79	%			170,570				74	%			128,053				80	%
Mortgage			1,697				1	%			1,884				1	%			2,252				1	%
Commercial			17,654				8	%			28,870				12	%			12,024				8	%
Consumer			101				0	%			281				0	%			219				0	%
Total non-performing assets		$	204,113				100	%		$	231,102				100	%		$	159,425				100	%

 

The following table presents non-performing assets as of June 30, 2009, March 31, 2009 and December 31, 2008 by region (dollars in thousands):

 

Region		June 30, 2009				% of total NPA's				March 31, 2009				% of total NPA's				December 31, 2008
Central Oregon		$	68,229				33	%		$	59,689				26	%		$	48,421
Northwest Oregon			19,667				10	%			38,826				17	%			4,093
Southern Oregon			21,294				10	%			22,753				10	%			20,680
Total Oregon			109,190				54	%			121,268				52	%			73,194
Idaho			94,923				46	%			109,834				48	%			86,231
Grand total		$	204,113				100	%		$	231,102				100	%		$	159,425

 

A loan is considered to be impaired (non-performing) when it is determined probable that the principal and/or interest amounts due will not be collected according to the contractual terms of the loan agreement. Impaired loans are generally carried at the lower of cost or fair value, which may be determined based upon recent independent appraisals which are further reduced for estimated selling costs or as a practical expedient basis by estimating the present value of expected future cash flows, discounted at the loan’s effective interest rate.  Certain large groups of smaller balance homogeneous loans, collectively measured for impairment, are excluded. Impaired loans are charged to the reserve when management believes after considering economic and business conditions, collection efforts and collateral position that the borrower’s financial condition is such that collection of principal is not probable. See “Footnote 10 – Fair Value Measurements” for additional information related to fair value measurement.

At June 30, 2009, impaired loans carried at fair value totaled approximately $164.9 and related specific valuation allowances were $0.2 million.  At December 31, 2008, impaired loans were approximately $120.5 million and related specific valuation allowances were $2.7 million.  Interest income recognized for cash payments received on impaired loans for the periods presented was insignificant. The average recorded investment in impaired loans was approximately $156.5 million and $69.5 million for the six months ended June 30, 2009 and 2008, respectively.

 

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The accrual of interest on a loan is discontinued when, in management’s judgment, the future collectability of principal or interest is in doubt.  Loans placed on non-accrual status may or may not be contractually past due at the time of such determination, and may or may not be secured.  When a loan is placed on non-accrual status, it is the Bank’s policy to reverse, and charge against current income, interest previously accrued but uncollected. Interest subsequently collected on such loans is credited to loan principal if, in the opinion of management, full collectability of principal is doubtful.  Interest income that was reversed and charged against income for the six months ended June 30, 2009 and 2008, was approximately $1.3 million.

5.	Mortgage Servicing Rights

At June 30, 2009 and December 31, 2008, the Bank retained servicing rights to mortgage loans with principal balances of approximately $547.7 million and $512.2 million, respectively.  Generally, loans which are sold with the servicing rights retained are sold to Fannie Mae, a U.S. government sponsored enterprise.  The Company also sells mortgage originations servicing-released in the normal course of business to other mortgage companies.  Sold loans are not included in loan balances in the accompanying condensed consolidated balance sheets. The sales of these mortgage loans are subject to specific underwriting documentation standards and requirements, which may result in repurchase risk.

Mortgage servicing rights (MSRs) included in other assets in the accompanying condensed consolidated balance sheets are accounted for at the lower of origination value less accumulated amortization, or current fair value.  The carrying value of MSRs was $4.1 million at June 30, 2009 and $3.6 million at December 31, 2008.  The fair value of MSRs was approximately $5.4 million at June 30, 2009 and $4.6 million at December 31, 2008.  Activity in MSRs for the six months ended June 30, 2009 and 2008 was as follows (dollars in thousands): (See MD&A – Non-Interest income).

		Six months ended
		June 30,
		2009				2008
Balance at beginning of period		$	3,605			$	3,756
Additions			1,416				664
Amortization			(884	)			(611	)
Balance at end of period		$	4,137			$	3,809

 

 

6.	Deferred Income Taxes

 

As of June 30, 2009 and December 31, 2008, the Company had recorded net deferred income tax assets (which are included in other assets in the accompanying condensed consolidated balance sheets) of approximately $34.3 million and $22.2 million, respectively. The determination of the amount of deferred income tax assets which are more likely than not to be realized is primarily dependent on projections of future earnings, which are subject to uncertainty and estimates that may change given economic conditions and other factors. The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the deferred tax asset will not be realized. “More likely than not” is defined as greater than a 50% chance. All available evidence, both positive and negative is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed.  Based upon management’s analysis of available evidence, it has determined that it is “more likely than not” that all of the Company’s deferred income tax assets as of June 30, 2009 and December 31, 2008 will be fully realized and therefore no valuation allowance was recorded. However, changes in the estimate about future taxable income could significantly affect the determination of the necessity for a valuation allowance for deferred income tax assets in future periods.

7.	Junior Subordinated Debentures

At June 30, 2009, the Company had four subsidiary grantor trusts for the purpose of issuing trust preferred securities (“TPS”) and common securities. The common securities were purchased by the Company, and the Company’s investment in the common securities of $2.1 million is included in accrued interest and other assets in the accompanying condensed consolidated balance sheets.  The weighted average interest rate of all TPS was 3.65% at June 30, 2009 and 4.19% at December 31, 2008.   The interest on TPS may be deferred at the sole determination of the issuer.  Under such circumstances the Company would continue to accrue interest but not make payments on the TPS.  On April 27, 2009 the Company’s board of directors (the Board) elected to defer payment of interest on TPS until such time as resumption is deemed appropriate.

 

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In accordance with industry practice, the Company’s liability for the common securities has been included with the Debentures in the accompanying condensed consolidated balance sheets. Management believes that at June 30, 2009, the TPS meet applicable regulatory guidelines to qualify as Tier I capital in the amount of $37.3 million and Tier 2 capital in the amount of $29.2 million.  At December 31, 2008, the TPS met applicable regulatory guidelines to qualify as Tier I capital and Tier 2 capital in the amounts of $43.5 million and  $23.0 million, respectively.

8.	Other Borrowings

At June 30, 2009 the Bank had a total of $208.3 million in long-term borrowings from Federal Home Loan Bank (FHLB) with maturities ranging from 2009 to 2025, bearing a weighted-average of 2.62%.  Also, the Bank had $41.0 million of senior unsecured debt issued in connection with the FDIC’s Temporary Liquidity Guarantee Program (TLGP) maturing February 12, 2012 bearing a weighted average rate of 2.24%, exclusive of net issuance costs and 1% per annum FDIC insurance assessment applicable to TLGP debt which are being amortized straight line over the term of the debt.  At year-end 2008, the Bank had a total of $128.5 million in long-term borrowings from FHLB with maturities from 2009 to 2025.  In addition, at December 31, 2008, the Bank had short-term borrowings with FRB of approximately $120.5 million.  (See MD&A “Liquidity and Sources of Funds” for further discussion).

9.	Basic and Diluted Earnings (loss) per Common Share

The Company’s basic earnings (loss) per common share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding during the period.  The Company’s diluted earnings per common share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding plus dilutive common shares related to stock options and nonvested restricted stock. For the six months and three months ended June 30, 2009, the Company’s diluted loss per common share is the same as the basic loss per common share due to the anti-dilutive effect of common stock equivalents.

The numerators and denominators used in computing basic and diluted earnings (loss) per common share for the six months and three months ended June 30, 2009 and 2008 can be reconciled as follows (dollars in thousands, except per share data):

 

		Six months ended								Three months ended
		June 30,								June 30,
		2009				2008				2009				2008
Net income (loss)		$	(31,984	)		$	2,647			$	(28,068	)		$	(3,393	)
Weighted-average shares outstanding - basic			27,972,968				27,920,072				27,984,815				27,928,937
Basic net income (loss) per common share		$	(1.14	)		$	0.09			$	(1.00	)		$	(0.12	)
Incremental shares arising from stock-based compensation			N/A				145,609				N/A				N/A
Weighted-average shares outstanding - diluted			27,972,968				28,065,681				27,984,815				27,928,937
Diluted net (loss) income per common share		$	(1.14	)		$	0.09			$	(1.00	)		$	(0.12	)
Common stock equivalent shares excluded due to antidilutive effect			114,054				-				114,054				-

 

10.	Stock-Based Compensation

The Company has historically maintained certain stock-based compensation plans, approved by the Company’s shareholders that are administered by the Board, or the Compensation Committee of the Board (the Compensation Committee).  In addition, on April 28, 2008, the shareholders of the Company approved the 2008 Cascade Bancorp Performance Incentive Plan (the 2008 Plan).  The 2008 Plan authorized the Board to issue up to an additional one million shares of common stock related to the grant or settlement of stock-based compensation awards, expanded the types of stock-based compensation awards that may be granted, and expanded the parties eligible to receive such awards.  Under the Company’s stock-based compensation plans, the Board (or the Compensation Committee) may grant stock options (including incentive stock options (ISOs) as defined in Section 422 of the Internal Revenue Code, non-qualified stock options (NSOs), restricted stock, restricted stock units, stock appreciation rights and other similar types of equity awards intended to qualify as “performance-based” compensation under applicable tax rules).  The stock-based compensation plans were established to allow for the granting of compensation awards to attract, motivate and retain employees, executive officers, non-employee directors and other service providers who contribute to the success and profitability of the Company and to give such persons a proprietary interest in the Company, thereby enhancing their personal interest in the Company’s success.

 

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The Board or the Compensation Committee may establish and prescribe grant guidelines including various terms and conditions for the granting of stock-based compensation and the total number of shares authorized for this purpose.  Under the 2008 Plan, for ISOs and NSOs, the option strike price must be no less than 100% of the stock price at the grant date. (Prior to the approval of the 2008 Plan, the option strike price for NSOs could be no less than 85% of the stock price at the grant date).  Generally, options become exercisable in varying amounts based on years of employee service and vesting schedules.  All options expire after a period of ten years from the date of grant.  Other permissible stock awards include restricted stock grants, restricted stock units, stock appreciation rights or other similar stock awards (including awards that do not require the grantee to pay any amount in connection with receiving the shares or that have a purchase price that is less than the grant date fair market value of the Company’s stock.)

During the six months ended June 30, 2009 the Company did not grant any stock options.  During the six months ended June 30, 2008 the Company granted 390,130 stock options with a calculated fair value of $2.35 per option.

The Company used the Black-Scholes option-pricing model with the following weighted-average assumptions to value options granted for the six and three months ended June 30, 2008:

Dividend yield		4.0%
Expected volatility		32.0%
Risk-free interest rate		3.0%
Expected option lives		7.2 years

The dividend yield is based on historical dividend information. The expected volatility is based on historical volatility of the Company’s common stock price. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the date of grant for periods corresponding with the expected lives of the options granted. The expected option lives represent the period of time that options are expected to be outstanding giving consideration to vesting schedules and historical exercise and forfeiture patterns.

The Black-Scholes option-pricing model was developed for use in estimating the fair value of publicly-traded options that have no vesting restrictions and are fully transferable.  Additionally, the model requires the input of highly subjective assumptions.  Because the Company’s stock options have characteristics significantly different from those of publicly-traded options, and because changes in the subjective input assumptions can materially affect the fair value estimates, in the opinion of the Company’s management, the Black-Scholes option-pricing model does not necessarily provide a reliable single measure of the fair value of the Company’s stock options.

 

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The following table presents the activity related to stock options under all plans for the six months ended June 30, 2009:

 

		Options				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term (Years)				Aggregate Intrinsic Value (000)
Options outstanding at December 31, 2008			1,089,091			$	12.05				4.2				271
Granted			-				-				N/A				N/A
Exercised			-				-				N/A				N/A
Cancelled			(62,190	)			9.86				N/A				N/A
Options outstanding at June 30, 2009			1,026,901			$	12.26				5.0			$	-
Options exercisable at June 30, 2009			538,160			$	10.01				8.6			$	-

 

Stock-based compensation expense related to stock options for the six months ended June 30, 2009 and 2008 was approximately $0.3 million and $0.2 million, respectively.  As of June 30, 2009, there was approximately $0.7 million of unrecognized compensation expense related to nonvested stock options, which will be recognized over the remaining vesting periods of the underlying stock options.

During the three months ended June 30, 2009, the Company granted 62,181 shares of immediately vested restricted stock and 8,840 shares of deferred restricted stock at a grant date fair value of $2.50 per share (approximately $177,000).

The following table presents the activity for nonvested and deferred restricted stock for the six months ended June 30, 2009:

 

		Number of Shares				Weighted- Average Grant  Date Fair Value Per Share				Weighted- Average Remaining Vesting Term (years)
Nonvested as of December 31, 2008			131,593			$	17.70				N/A
Granted			71,021				2.50				N/A
Vested			(88,560	)			2.81				N/A
Nonvested as of June 30, 2009			114,054			$	18.10				2.09

 

Total expense recognized by the Company for nonvested stock for the six months June 30, 2009 and 2008 was approximately $0.4 million and $0.5 million, respectively.  As of June 30, 2009, unrecognized compensation cost related to nonvested stock totaled approximately $0.8 million.  The nonvested stock is scheduled to vest over periods of three to four years from the grant date.  The unearned compensation on nonvested stock is being amortized to expense on a straight-line basis over the applicable vesting periods.

11.	Fair Value Measurements

SFAS No. 157’s hierarchy for determining fair value measurement, includes three levels and is based upon the valuation techniques used to measure assets and liabilities. The three levels are as follow:

·

Quoted prices in active markets for identical assets (Level 1): Inputs that are quoted unadjusted prices in active markets for identical assets that the Company has the ability to access at the measurement date. An active market for the asset is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.

·

Significant other observable inputs (Level 2): Inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity including quoted prices for similar assets or liabilities, quoted prices for securities in inactive markets and inputs derived principally from, or corroborated by, observable market data by correlation or other means.

·

Significant unobservable inputs (Level 3): Inputs that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

 

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A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets and financial liabilities carried at fair value effective January 1, 2008. In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally-developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the corporation’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the condensed consolidated balance sheet date may differ significantly from the amounts presented herein.

The following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to valuation methodology:

Investment securities: Where quoted prices are available in an active market, investment securities available-for-sale are classified within level 1 of the hierarchy. Level 1 includes investment securities available-for-sale that have quoted prices in an active market for identical assets. If quoted market prices for identical securities are not available then fair values are estimated by independent sources using pricing models and/or quoted prices of investment securities with similar characteristics or discounted cash flows. The Company has categorized most of its investment securities available-for-sale as level 2, since U.S Agency MBS are mainly priced in this latter manner.

Impaired loans: SFAS No. 157 applies to loans measured for impairment using the practical expedients permitted by SFAS No. 114, “Accounting by Creditors for Impairment of a Loan”, including impaired loans measured at an observable market price (if available) or at the fair value of the loan’s collateral (if collateral dependent). Fair value of the loan’s collateral is determined by appraisals or independent valuation which is then adjusted for the estimated costs related to liquidation of the collateral. Management’s ongoing review of appraisal information may result in additional discounts or adjustments to valuation based upon more recent market sales activity or more current appraisal information derived from properties of similar type and/or locale.  A significant portion of the Bank’s impaired loans are measured using the estimated fair market value of the collateral less the estimated costs to sell.  The Company has categorized its impaired loans as level 3.

OREO: The Company’s OREO is measured at estimated fair value less estimated costs to sell. Fair value was generally determined based on third-party appraisals of fair value in an orderly sale. Historically appraisals have considered comparable sales of like assets in reaching a conclusion as to fair value.  Many recent real estate sales could be termed distressed sales since a preponderance are short-sale or foreclosure related, this has directly impacted appraisal valuation estimates.  Estimated costs to sell OREO were based on standard market factors.  The valuation of OREO is subject to significant external and internal judgment. Management periodically reviews OREO to determine whether the property continues to be carried at the lower of its recorded book value or estimated fair value, net of estimated costs to sell. The Company has categorized its OREO as level 3.

 

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The table below presents assets and liabilities measured at fair value on a recurring basis at June 30, 2009 (dollars in thousands):

 

		Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets
Investment securities available - for - sale		$	-			$	101,769			$	-
Total recurring assets measured at fair value		$	-			$	101,769			$	-

 

Certain non-financial assets are also measured at fair value on a non-recurring basis.  These assets primarily consist of intangible assets and other non-financial long-lived assets which are measured at fair value for periodic impairment assessments.

Certain assets are measured at fair value on a nonrecurring basis (e.g., the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments when there is evidence of impairment). The following table represents the assets measured at fair value on a nonrecurring basis by the Company (dollars in thousands):

 

		Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets
Impaired loans with specific valuation allowances under SFAS No. 114		$	-			$	-			$	164,887
Other real estate owned							-				52,051
		$	-			$	-			$	216,938

 

The Company did not change the methodology used to determine fair value for any financial instruments during 2008.  Accordingly, for any given class of financial instruments, the Company did not have any transfers between level 1, level 2, or level 3 during the six month period ended June 30, 2009.

The following disclosures are made in accordance with the provisions of SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” which requires the disclosure of fair value information about financial instruments where it is practicable to estimate that value.

In cases where quoted market values are not available, the Company primarily uses present value techniques to estimate the fair value of its financial instruments.  Valuation methods require considerable judgment, and the resulting estimates of fair value can be significantly affected by the assumptions made and methods used.  Accordingly, the estimates provided herein do not necessarily indicate amounts which could be realized in a current market exchange.

In addition, as the Company normally intends to hold the majority of its financial instruments until maturity, it does not expect to realize many of the estimated amounts disclosed.  The disclosures also do not include estimated fair value amounts for items which are not defined as financial instruments but which may have significant value.  The Company does not believe that it would be practicable to estimate a representational fair value for these types of items as of June 30, 2009 and December 31, 2008.

Because SFAS No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements, any aggregation of the fair value amounts presented would not represent the underlying value of the Company.

The Company uses the following methods and assumptions to estimate the fair value of its financial instruments:

Cash and cash equivalents:  The carrying amount approximates the estimated fair value of these instruments.

 

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Investment securities:  See above description.

FHLB stock:  The carrying amount approximates the estimated fair value.

Loans:  The estimated fair value of loans is calculated by discounting the contractual cash flows of the loans using June 30, 2009 and December 31, 2008 origination rates. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated. Fair values for impaired loans are estimated using a discounted cash flow analysis or the underlying collateral values.

BOLI:  The carrying amount approximates the estimated fair value of these instruments.

OREO:  See above description.

Deposits:  The estimated fair value of demand deposits, consisting of checking, interest bearing demand and savings deposit accounts, is represented by the amounts payable on demand.  At the reporting date, the estimated fair value of time deposits is calculated by discounting the scheduled cash flows using the June 30, 2009 and December 31, 2008 rates offered on those instruments.

Junior subordinated debentures and other borrowings (including federal funds purchased):  The fair value of the Bank’s junior subordinated debentures and other borrowings (including federal funds purchased) are estimated using discounted cash flow analyses based on the Bank’s June 30, 2009 and December 31, 2008 incremental borrowing rates for similar types of borrowing arrangements.

Customer repurchase agreements: The carrying value approximates the estimated fair value.

Loan commitments and standby letters of credit:  The majority of the Bank’s commitments to extend credit have variable interest rates and “escape” clauses if the customer’s credit quality deteriorates. Therefore, the fair values of these items are not significant and are not included in the following table.

The estimated fair values of the Company’s significant on-balance sheet financial instruments at June 30, 2009 and December 31, 2008 were approximately as follows:

 

		June 30, 2009								December 31, 2008
		Carrying value				Estimated fair value				Carrying value				Estimated fair value
Financial assets:
Cash and cash equivalents		$	344,166			$	344,166			$	48,946			$	48,946
Investment securities:
Available-for-sale			101,769				101,769				107,480				107,480
Held-to-maturity			2,010				2,108				2,211				2,247
FHLB stock			10,472				10,472				10,472				10,472
Loans, net			1,740,326				1,743,321				1,909,018				1,950,602
BOLI			33,612				33,612				33,568				33,568
OREO			52,051				52,051				52,727				52,727
Financial liabilities:
Deposits			1,955,585				1,957,843				1,794,611				1,795,004
Junior subordinated debentures
and other borrowings			317,838				316,925				317,533				320,796
Customer repurchase agreements			275				275				9,871				9,867

 

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