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Table of ContentsUNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q
For the quarterly period ended June 30, 2012 or
For the transition period from to Commission File Number: 001-31566 PROVIDENT FINANCIAL SERVICES, INC. (Exact Name of Registrant as Specified in Its Charter)
(732) 590-9200 (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 twelve 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. YES x NO ¨ 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 twelve months (or for such shorter period that the Registrant was required to submit and post such files). YES x NO ¨ 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 “large accelerated filer”, “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). YES ¨ NO x As of August 1, 2012 there were 83,209,293 shares issued and 60,141,128 shares outstanding of the Registrant’s Common Stock, par value $0.01 per share, including 420,083 shares held by the First Savings Bank Directors’ Deferred Fee Plan not otherwise considered outstanding under U.S. generally accepted accounting principles.
Table of ContentsPROVIDENT FINANCIAL SERVICES, INC.
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PROVIDENT FINANCIAL SERVICES, INC. AND SUBSIDIARY Consolidated Statements of Financial Condition June 30, 2012 (Unaudited) and December 31, 2011 (Dollars in Thousands)
See accompanying notes to unaudited consolidated financial statements.
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Table of ContentsPROVIDENT FINANCIAL SERVICES, INC. AND SUBSIDIARY Consolidated Statements of Income Three and six months ended June 30, 2012 and 2011 (Unaudited) (Dollars in thousands, except per share data)
See accompanying notes to unaudited consolidated financial statements.
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Table of ContentsPROVIDENT FINANCIAL SERVICES, INC. AND SUBSIDIARY Consolidated Statements of Comprehensive Income Three and six months ended June 30, 2012 and 2011 (Unaudited) (Dollars in thousands)
See accompanying notes to unaudited consolidated financial statements.
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Table of ContentsPROVIDENT FINANCIAL SERVICES, INC. AND SUBSIDIARY Consolidated Statements of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2012 and 2011 (Unaudited) (Dollars in thousands)
See accompanying notes to unaudited consolidated financial statements.
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Table of ContentsPROVIDENT FINANCIAL SERVICES, INC. AND SUBSIDIARY Consolidated Statements of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2012 and 2011 (Unaudited) (Continued) (Dollars in thousands)
See accompanying notes to unaudited consolidated financial statements.
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Table of ContentsPROVIDENT FINANCIAL SERVICES, INC. AND SUBSIDIARY Consolidated Statements of Cash Flows Six months ended June 30, 2012 and 2011 (Unaudited) (Dollars in thousands)
See accompanying notes to unaudited consolidated financial statements
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Table of ContentsPROVIDENT FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies A. Basis of Financial Statement Presentation The accompanying unaudited consolidated financial statements include the accounts of Provident Financial Services, Inc. and its wholly owned subsidiary, The Provident Bank (the “Bank,” together with Provident Financial Services, Inc., the “Company”). In preparing the interim unaudited consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statements of financial condition and the results of operations for the periods presented. Actual results could differ from these estimates. The allowance for loan losses is a material estimate that is particularly susceptible to near-term change. The current unstable economic environment has resulted in a heightened degree of uncertainty inherent in this material estimate. The interim unaudited consolidated financial statements reflect all normal and recurring adjustments, which are, in the opinion of management, considered necessary for a fair presentation of the financial condition and results of operations for the periods presented. The results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of the results of operations that may be expected for all of 2012. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission. These unaudited consolidated financial statements should be read in conjunction with the December 31, 2011 Annual Report to Stockholders on Form 10-K. B. Earnings Per Share The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share calculations:
Anti-dilutive stock options and awards totaling 3,962,816 shares at June 30, 2012, were excluded from the earnings per share calculations.
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Table of ContentsNote 2. Acquisition On August 11, 2011, the Company’s wholly owned subsidiary, The Provident Bank, completed its acquisition of Beacon Trust Company, a New Jersey limited purpose trust company, and Beacon Global Asset Management, Inc., an SEC-registered investment advisor incorporated in Delaware (“Beacon”). Pursuant to the terms of the Stock Purchase Agreement announced on May 19, 2011, Beacon’s former parent company, Beacon Financial Corporation may be paid cash consideration in an amount up to $10.5 million, based upon the acquired companies’ financial performance in the three years following the closing of the transaction. Subsequent to the acquisition, Beacon Global Asset Management was merged with and into Beacon Trust Company. The purpose of the Beacon acquisition was to significantly expand the Company’s wealth management business throughout the state of New Jersey. Beacon’s expertise in trust and wealth management services strategically positions the Company to increase market share and enhance the Company’s non-interest earnings growth. The purchase price was allocated to the acquired assets and liabilities of Beacon based on their fair value as of August 11, 2011. The allocation of the purchase price is presented in the following table.
In connection with the Beacon transaction, the Company recorded goodwill of $7.1 million, none of which was estimated to be deductible for income tax purposes. In addition, a core relationship intangible (“CRI”) of $2.4 million was recognized in connection with the Beacon acquisition and is being amortized on an accelerated basis over an estimated useful life of twelve years. Note 3. Investment Securities At June 30, 2012, the Company had $1.31 billion and $363.2 million in available for sale and held to maturity investment securities, respectively. Many factors, including lack of liquidity in the secondary market for certain securities, lack of reliable pricing information, regulatory actions, changes in the business environment or any changes in the competitive marketplace could have an adverse effect on the Company’s investment portfolio which could result in other-than-temporary impairment on certain investment securities in future periods. Included in the Company’s investment portfolio are private label mortgage-backed securities. These investments may pose a higher risk of future impairment charges as a result of the uncertain economic environment and the potential negative effect on future performance of these private label mortgage-backed securities. The total number of all held to maturity and available for sale securities in an unrealized loss position as of June 30, 2012 totaled 50, compared with 24 at December 31, 2011. This included four private label mortgage-backed securities at June 30, 2012, with an amortized cost of $13.0 million and unrealized losses totaling $804,000. Three of these private label mortgage-backed securities
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Table of Contentswere below investment grade at June 30, 2012. All securities with unrealized losses at June 30, 2012 were analyzed for other-than-temporary impairment. Based upon this analysis, no other-than-temporary impairment existed at June 30, 2012. Securities Available for Sale The following table presents the amortized cost, gross unrealized gains, gross unrealized losses and the estimated fair value for securities available for sale at June 30, 2012 and December 31, 2011 (in thousands):
The amortized cost and fair value of securities available for sale at June 30, 2012, by contractual maturity, are shown below (in thousands). Expected maturities may differ from contractual maturities due to prepayment or early call privileges of the issuer.
No securities were sold from the available for sale portfolio during the three months ended June 30, 2012, while proceeds from the sale of securities available for sale for the six months ended June 30, 2012 were $47,131,000, resulting in gross gains of $2,160,000 and no gross losses. During the three and six months ended June 30, 2011, no securities were sold from the available for sale portfolio. However, for the three and six months ended June 30, 2011, the Company recognized gains of $14,000 and $0, respectively, related to calls on certain securities in the available for sale portfolio, with proceeds from the calls totaling $514,000 for the three and six months ended June 30, 2011. The following table presents a roll-forward of the credit loss component of other-than-temporary impairment (“OTTI”) on debt securities for which a non-credit component of OTTI was recognized in other
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Table of Contentscomprehensive income. OTTI recognized in earnings after that date for credit-impaired debt securities is presented as an addition in two components, based upon whether the current period is the first time a debt security was credit-impaired (initial credit impairment) or is not the first time a debt security was credit impaired (subsequent credit impairment). Changes in the credit loss component of credit-impaired debt securities were as follows (in thousands):
The Company did not incur an other-than-temporary impairment charge on securities for the three and six months ended June 30, 2012. For the three and six months ended June 30, 2011, the Company recorded a net other-than-temporary impairment charge of $302,000. The following table represents the Company’s disclosure regarding securities available for sale with temporary impairment at June 30, 2012 and December 31, 2011 (in thousands):
The temporary loss position associated with debt securities is the result of changes in market interest rates relative to the coupon of the individual security and changes in credit spreads. In addition, there remains a lack of liquidity in certain sectors of the mortgage-backed securities market. Increases in delinquencies and foreclosures have resulted in limited trading activity and significant price declines, regardless of favorable movements in interest rates. The review of the portfolio for other-than-temporary impairment considers the percentage and length of time the market value of an investment is below book value, as well as general market conditions, changes in interest rates, credit risk, whether the Company has the intent to sell the securities and whether it is more likely than not that the Company would be required to sell the securities before the anticipated recovery. For each private-label mortgage-backed security, the Company estimates loss projections by stressing the individual loans collateralizing the security and applying a range of expected default rates, loss severities, and prepayment speeds in conjunction with the underlying credit enhancement for each security. Based on specific assumptions about collateral and vintage, a range of possible cash flows was identified to determine whether other-than-temporary impairment existed during the three and six months ended June 30, 2012
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Table of ContentsBased upon the review of the securities portfolio, the Company believes that as of June 30, 2012, securities with unrealized loss positions shown above do not represent impairments that are other-than-temporary, does not have the intent to sell the securities and it is more likely than not that the Company will not be required to sell the securities before the anticipated recovery. Investment Securities Held to Maturity The following table presents the amortized cost, gross unrealized gains, gross unrealized losses and the estimated fair value for investment securities held to maturity at June 30, 2012 and December 31, 2011 (in thousands):
The Company generally purchases securities for long-term investment purposes, and differences between amortized cost and fair values may fluctuate during the investment period. For the three and six months ended June 30, 2012, the Company recognized gains of $1,000 and $24,000, respectively, related to calls on certain securities in the held to maturity portfolio, with proceeds from the calls totaling $1,249,000 and $3,956,000, respectively. For the three and six months ended June 30, 2011, the Company recognized gains of $0 and $14,000, respectively, related to calls on certain securities in the held to maturity portfolio, with proceeds from the calls totaling $2,140,000 and $8,136,000 for the three and six months ended June 30, 2011, respectively. The amortized cost and fair value of investment securities at June 30, 2012 by contractual maturity are shown below (in thousands). Expected maturities may differ from contractual maturities due to prepayment or early call privileges of the issuer.
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Table of ContentsThe following table represents the Company’s disclosure on investment securities held to maturity with temporary impairment at June 30, 2012 and December 31, 2011 (in thousands):
The temporary loss position associated with held to maturity securities portfolio is the result of changes in market interest rates relative to the coupon of the individual security and changes in credit spreads. The review of the portfolio for other-than-temporary impairment considers the percentage and length of time the market value of an investment is below book value, as well as general market conditions, changes in interest rates, credit risks, whether the Company has the intent to sell the securities and whether it is more likely than not that the Company would be required to sell the securities before the anticipated recovery. Based upon the review of the held to maturity securities portfolio, the Company believes that as of June 30, 2012, securities with unrealized loss positions shown above do not represent impairments that are other-than-temporary, does not have the intent to sell the securities and it is more likely than not that the Company will not be required to sell the securities before the anticipated recovery.
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Table of ContentsNote 4. Loans Receivable and Allowance for Loan Losses Loans receivable at June 30, 2012 and December 31, 2011 are summarized as follows (in thousands):
The following table summarizes the aging of loans receivable by portfolio segment and class as follows (in thousands):
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Table of ContentsWithin the loans receivable are loans for which the accrual of interest income has been discontinued due to deterioration in the financial condition of the borrowers. The principal amounts of these non-accrual loans were $115.2 million and $122.5 million at June 30, 2012 and December 31, 2011, respectively. Included in non-accrual loans were $37.2 million and $45.6 million of loans which were less than 90 days past due at June 30, 2012 and December 31, 2011, respectively. There were no loans ninety days or greater past due and still accruing interest at June 30, 2012, or December 31, 2011. The Company defines an impaired loan as a non-homogenous loan greater than $1.0 million for which it is probable, based on current information, all amounts due under the contractual terms of the loan agreement will not be collected. Impaired loans also include all loans modified as troubled debt restructurings (“TDRs”). A loan is deemed to be a TDR when a loan modification resulting in a concession is made in an effort to mitigate potential loss arising from a borrower’s financial difficulty. Smaller balance homogeneous loans, including residential mortgages and other consumer loans, are evaluated collectively for impairment and are excluded from the definition of impaired loans, unless modified as TDRs. The Company separately calculates the reserve for loan losses on impaired loans. The Company may recognize impairment of a loan based upon (1) the present value of expected cash flows discounted at the effective interest rate; or (2) if a loan is collateral dependent, the fair value of collateral; or (3) the market price of the loan. Additionally, if impaired loans have risk characteristics in common, those loans may be aggregated and historical statistics may be used as a means of measuring those impaired loans. The Company uses third-party appraisals to determine the fair value of the underlying collateral in its analyses of collateral dependent impaired loans. A third party appraisal is generally ordered as soon as a loan is designated as a collateral dependent impaired loan and is updated annually or more frequently, if required. A specific allocation of the allowance for loan losses is established for each collateral dependent impaired loan with a carrying balance greater than the collateral’s fair value, less estimated costs to sell. Charge-offs are generally taken for the amount of the specific allocation when operations associated with the respective property cease and it is determined that collection of amounts due will be derived primarily from the disposition of the collateral. At each fiscal quarter end, if a loan is designated as a collateral dependent impaired loan and the third party appraisal has not yet been received, an evaluation of all available collateral is made using the best information available at the time, including rent rolls, borrower financial statements and tax returns, prior appraisals, management’s knowledge of the market and collateral, and internally prepared collateral valuations based upon market assumptions regarding vacancy and capitalization rates, each as and where applicable. Once the appraisal is received and reviewed, the specific reserves are adjusted to reflect the appraised value. The Company believes there have been no significant time lapses during the process described above. At June 30, 2012, there were 92 impaired loans totaling $115.5 million, of which 71 loans totaling $80.0 million were TDRs. Included in this total were 65 TDRs to 56 borrowers totaling $77.3 million that were performing in accordance with their restructured terms and which continued to accrue interest at June 30, 2012. At December 31, 2011, there were 65 impaired loans totaling $103.2 million, of which 48 loans totaling $63.1 million were TDRs. Included in this total were 38 TDRs to 36 borrowers totaling $38.9 million that were performing in accordance with their restructured terms and which continued to accrue interest at December 31, 2011.
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Table of ContentsLoans receivable summarized by portfolio segment and impairment method are as follows (in thousands):
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Table of ContentsThe allowance for loan losses is summarized by portfolio segment and impairment classification as follows (in thousands):
Loan modifications to borrowers experiencing financial difficulties that are considered TDRs primarily involve lowering the monthly payments on such loans through either a reduction in interest rate below a market rate, an extension of the term of the loan without a corresponding adjustment to the risk premium reflected in the interest rate, or a combination of these two methods. These modifications generally do not result in the forgiveness of principal or accrued interest. In addition, the Company attempts to obtain additional collateral or guarantor support when modifying such loans. If the borrower has demonstrated performance under the previous terms and our underwriting process shows the borrower has the capacity to continue to perform under the restructured terms, the loan will continue to accrue interest. Non-accruing restructured loans may be returned to accrual status when there has been a sustained period of repayment performance (generally six consecutive months of payments) and both principal and interest are deemed collectible. The following tables present the number of loans modified as TDRs during the three and six months ended June 30, 2012 and their balances immediately prior to the modification date and post-modification as of June 30, 2012.
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All TDRs are impaired loans, which are individually evaluated for impairment, as previously discussed. Estimated collateral values of collateral dependent impaired loans modified during the three and six months ended June 30, 2012 exceeded the carrying amounts of such loans. As a result, there were no charge-offs recorded on collateral dependent impaired loans presented in the preceding tables for the three and six months ended June 30, 2012. The allowance for loan losses associated with the TDRs presented in the preceding tables totaled $1.4 million at June 30, 2012, and was included in the allowance for loan losses for loans individually evaluated for impairment. The TDRs presented in the preceding tables had a weighted average modified interest rate of approximately 4.52 percent, compared to a rate of 5.08 percent prior to modification for the three months ended June 30, 2012, and 5.11 percent, compared to a rate of 5.93 percent prior to modification for the six months ended June 30, 2012. The following table presents loans modified as TDRs within the previous 12 months from June 30, 2012, and for which there was a payment default (90 days or more past due) during the quarter ended June 30, 2012:
TDRs that subsequently default are considered collateral dependent impaired loans and are evaluated for impairment based on the estimated fair value of the underlying collateral less expected selling costs.
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Table of ContentsThe activity in the allowance for loan losses by portfolio segment for the three and six months ended June 30, 2012 and 2011 is as follows (in thousands):
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Table of ContentsImpaired loans receivable by class are summarized as follows (in thousands):
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Table of ContentsSpecific allocations of the allowance for loan losses attributable to impaired loans totaled $8,578,000 and $9,326,000 at June 30, 2012 and December 31, 2011, respectively. At June 30, 2012 and December 31, 2011, impaired loans for which there was no related allowance for loan losses totaled $38,686,000 and $25,983,000, respectively. The average balances of impaired loans during the six months ended June 30, 2012 was $117,140,000. The Company utilizes an internal nine-point risk rating system to summarize its loan portfolio into categories with similar characteristics. Loans deemed to be “acceptable quality” (pass) are rated 1 through 4, with a rating of 1 established for loans with minimal risk. Loans that are deemed to be of “questionable quality” are rated 5 (watch) or 6 (special mention). Loans with adverse classifications (substandard, doubtful or loss) are rated 7, 8 or 9, respectively. Commercial mortgage, commercial, multi-family and construction loans are rated individually, and each lending officer is responsible for risk rating loans in their portfolio. These risk ratings are then reviewed by the department manager and/or the Chief Lending Officer and by Credit Administration. The risk ratings are also confirmed through periodic loan review examinations, which are currently performed by an independent third party. Reports concerning periodic loan review examinations by the independent third party are presented directly to both the Audit and Risk Committees of the Board of Directors. Loans receivable by credit quality risk rating indicator are as follows (in thousands):
Note 5. Deposits Deposits at June 30, 2012 and December 31, 2011 are summarized as follows (in thousands):
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Table of ContentsNote 6. Components of Net Periodic Benefit Cost The Bank has a noncontributory defined benefit pension plan (the “Plan”) covering its full-time employees who had attained age 21 with at least one year of service as of April 1, 2003. The Plan was frozen on April 1, 2003. All participants in the Plan are 100% vested. The Plan’s assets are invested in investment funds and group annuity contracts currently managed by the Principal Financial Group and Allmerica Financial. In addition to pension benefits, certain health care and life insurance benefits are currently made available to certain of the Bank’s retired employees. The costs of such benefits are accrued based on actuarial assumptions from the date of hire to the date the employee became fully eligible to receive the benefits. Effective January 1, 2003, eligibility for retiree health care benefits was frozen to new entrants and benefits were eliminated for employees with less than ten years of service as of December 31, 2002. Effective January 1, 2007, eligibility for retiree life insurance benefits was frozen to new entrants and retiree life insurance benefits were eliminated for employees with less than ten years of service as of December 31, 2006. Net periodic benefit (increase) cost for the three and six months ended June 30, 2012 and 2011 includes the following components (in thousands):
In its consolidated financial statements for the year ended December 31, 2011, the Company previously disclosed that it does not expect to contribute to the Plan in 2012. As of June 30, 2012, no contributions to the Plan have been made. The net periodic benefit (increase) cost for pension benefits and other post-retirement benefits for the three and six months ended June 30, 2012 were calculated using the actual January 1, 2012 pension valuation and the estimated results of the other post-retirement benefits January 1, 2012 valuations. Note 7. Impact of Recent Accounting Pronouncements Effective March 31, 2012, the Company adopted guidance regarding the presentation of comprehensive income. In June 2011, the Financial Accounting Standards Board (“FASB”) issued guidance providing an entity with the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both options, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. This guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. As originally issued, ASU 2011-5 requires entities to present reclassification adjustments out of accumulated other comprehensive income by component in the statement in which net income is presented and the statement in which other comprehensive income is presented (for both interim and annual financial statements). This requirement was deferred by ASU 2011-12,—Comprehensive Income (Topic 220)—Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards. ASU No. 2011-05 is effective for all interim and annual periods beginning on or after December 15, 2011
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Table of Contentswith early adoption permitted, and must be applied retrospectively. The Company presented comprehensive income in a separate consolidated statement of comprehensive income for the three and six months ended June 30, 2012 and 2011. In May 2011, the FASB issued guidance which results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with GAAP and International Financial Reporting Standards. This guidance is to be applied prospectively and is effective during interim and annual periods beginning after December 15, 2011. Early adoption was not permitted. The Company adopted this guidance effective March 31, 2012, and it did not have a material effect on the Company’s consolidated statement of condition or results of operations In April 2011, the FASB issued guidance to improve financial reporting of repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The amendments to this guidance remove from the assessment of effective control: (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. Other criteria applicable to the assessment of effective control are not changed by this new guidance. Those criteria indicate that the transferor is deemed to have maintained effective control over the financial assets transferred (and thus must account for the transaction as a secured borrowing) for agreements that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity if all of the following conditions are met: (1) the financial assets to be repurchased or redeemed are the same or substantially the same as those transferred; (2) the agreement is to repurchase or redeem them before maturity, at a fixed or determinable price; and (3) the agreement is entered into contemporaneously with, or in contemplation of, the transfer. This guidance became effective for the first interim or annual period beginning on or after December 15, 2011, and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption was not permitted. The adoption of this guidance did not have a material effect on the Company’s consolidated statement of condition or results of operations. Note 8. Fair Value Measurements The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The determination of fair values of financial instruments often requires the use of estimates. Where quoted market values in an active market are not readily available, the Company utilizes various valuation techniques to estimate fair value. Fair value is an estimate of the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. However, in many instances fair value estimates may not be substantiated by comparison to independent markets and may not be realized in an immediate sale of the financial instrument. GAAP establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of fair value hierarchy are as follows:
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Table of ContentsA financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The valuation techniques are based upon the unpaid principal balance only, and exclude any accrued interest or dividends at the measurement date. Interest income and expense and dividend income are recorded within the consolidated statements of income depending on the nature of the instrument using the effective interest method based on acquired discount or premium. Assets Measured at Fair Value on a Recurring Basis The valuation techniques described below were used to measure fair value of financial instruments in the table below on a recurring basis as of June 30, 2012 and December 31, 2011. Securities Available for Sale For securities available for sale, fair value was estimated using a market approach. The majority of the Company’s securities are fixed income instruments that are not quoted on an exchange, but are traded in active markets. Prices for these instruments are obtained through third party data service providers or dealer market participants with which the Company has historically transacted both purchases and sales of securities. Prices obtained from these sources include market quotations and matrix pricing. Matrix pricing, a Level 2 input, is a mathematical technique used principally to value certain securities to benchmark or to comparable securities. The Company evaluates the quality of Level 2 matrix pricing through comparison to similar assets with greater liquidity and evaluation of projected cash flows. As the Company is responsible for the determination of fair value, it performs quarterly analyses on the prices received from the pricing service to determine whether the prices are reasonable estimates of fair value. Specifically, the Company compares the prices received from the pricing service to a secondary pricing source. Additionally, the Company compares changes in the reported market values and returns to relevant market indices to test the reasonableness of the reported prices. The Company’s internal price verification procedures and review of fair value methodology documentation provided by independent pricing services has not historically resulted in adjustment in the prices obtained from the pricing service. The Company also may hold equity securities and debt instruments issued by the U.S. government and U.S. government-sponsored agencies that are traded in active markets with readily accessible quoted market prices that are considered Level 1 inputs. Assets Measured at Fair Value on a Non-Recurring Basis The valuation techniques described below were used to estimate fair value of financial instruments measured on a non-recurring basis as of June 30, 2012 and December 31, 2011. For loans measured for impairment based on the fair value of the underlying collateral, fair value was estimated using a market approach. The Company measures the fair value of collateral underlying impaired loans primarily through obtaining independent appraisals that rely upon quoted market prices for similar assets in active markets. These appraisals include adjustments, on an individual case basis, to comparable assets based on the appraisers’ market knowledge and experience, as well as adjustments for estimated costs to sell of up to 6%. The Company classifies these loans as Level 3 within the fair value hierarchy. Assets acquired through foreclosure or deed in lieu of foreclosure are carried at fair value, less estimated costs to sell of up to 6%. Fair value is generally based on independent appraisals that rely upon quoted market prices for similar assets in active markets. These appraisals include adjustments, on an individual case basis, to comparable assets based on the appraisers’ market knowledge and experience, and are classified as Level 3. When an asset is acquired, the excess of the loan balance over fair value, less estimated costs to sell, is charged to the allowance for loan losses. A reserve for foreclosed assets may be established to provide for possible write-downs and selling costs that occur subsequent to foreclosure.
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Table of ContentsForeclosed assets are carried net of the related reserve. Operating results from real estate owned, including rental income, operating expenses, and gains and losses realized from the sales of real estate owned, are recorded as incurred. There were no changes to the valuation techniques for fair value measurements as of June 30, 2012 and December 31, 2011. The following tables present the assets and liabilities reported on the consolidated statements of financial condition at their fair values as of June 30, 2012 and December 31, 2011, by level within the fair value hierarchy.
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