Village Bank & Trust Financial Corp. - 10-Q filing on 2012-11-13

Fair Value

9 Months Ended

Sep. 30, 2012

Note 9 – Fair Value

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transaction involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are independent, knowledgeable, able to transact and willing to transact.

FASB Codification Topic 820: Fair Value Measurements and Disclosures establishes a hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair values hierarch is as follows:

Level 1 Inputs — Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2Inputs — Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 Inputs- Significant unobservable inputs that reflect a company's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods to determine the fair value of each type of financial instrument:

Securities: Fair values for securities available-for-sale are obtained from an independent pricing service. The prices are not adjusted. The independent pricing service uses industry-standard models to price U.S. Government agency obligations and mortgage backed securities that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Securities of obligations of state and political subdivisions are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate based on credit rating. Substantially all assumptions used by the independent pricing service are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace (Levels 1 and 2).

Impaired loans: The fair values of impaired loans are measured for impairment using the fair value of the collateral for collateral-dependent loans on a nonrecurring basis. Collateral may be in the form of real estate or business assets including equipment, inventory and accounts receivable. The vast majority of the Company's collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the property is more than two years old, then a Level 3 valuation is considered to measure the fair value. The value of business equipment is based upon an outside appraisal if deemed significant using observable market data. Likewise, values for inventory and account receivables collateral are based on financial statement balances or aging reports (Level 3). Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Real Estate Owned: Real estate owned assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, real estate owned assets are carried at net realizable value. Fair value is based upon independent market prices, appraised values of the collateral or management's estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring level 3.

Assets and liabilities measured at fair value under Topic 820 on a recurring and non-recurring basis are summarized below for the indicated dates:

	Fair Value Measurement
	at September 30, 2012 Using
	(In thousands)
			Quoted Prices
			in Active		Other		Significant
			Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets - Recurring
US Government Agencies	$	16,954	$	4,978	$	11,976	$	-
MBS		2,161		-		2,161		-
Municipals		11,304		1,736		9,568		-
US Treasury		2,997
Residential loans held for sale		22,527		-		22,527		-
						-
Financial Assets - Non-Recurring
Impaired loans		64,894		-		55,007		9,887
Real estate owned		20,576		-		18,132		2,444

	Fair Value Measurement
	at December 31, 2011 Using
	(in thousands)
			Quoted Prices
			in Active		Other		Significant
			Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets - Recurring
US Government Agencies	$	2,001	$	-	$	2,001	$	-
MBS		20,803		2,849		17,954		-
Small Business Administration		7,359		7,359		-		-
Residential loans held for sale		16,168		-		16,168		-

Financial Assets - Non-Recurring
Impaired loans		64,655		-		51,868		12,787
Real estate owned		9,177		-		874		8,303

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value at September 30, 2012:

					Range
	Fair Value		Valuation	Unobservable	(Weighted
	Estimate		Techniques	Input	Average)
	(In thousands)

Impaired Loans -Real Estate Secured	$	7,768	Appraisal (1) or Internal Valuation (2)	Appraisal Adjustments Liquidation Expenses (3)		10%-30	%
Impaired Loans - Non-Real Estate Secured	$	2,119	Appraisal (1) or Discounted Cash Flow	Appraisal Adjustments Liquidation Expenses (3)		10%-20	%
Real Estate Owned	$	2,444	Appraisal (1) or Internal Valuation (2)	Appraisal Adjustments Liquidation Expenses (3)		7%-30	%

(1) Fair Value is generally determined through independent appraisals of the underlying collateral, which generally
included various level 3 inputs which are not identifiable
(2) Internal valuations may be conducted to determine Fair Value for assets with nominal carrying balances
(3) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated
liquidation expenses

The following table presents the changes in the Level 3 fair value category for the nine months ended September 30, 2012.

	Impaired			Real Estate
	Loans			Owned			Total Assets
	(In thousands)

Balance at December 31, 2011	$	12,787		$	8,030		$	20,817
Total realized and unrealized gains (losses)
Included in earnings		-			(137	)		(137	)
Included in other comprehensive income		-			-			-
Net transfers in and/or out of Level 3		(2,900	)		(5,449	)		(8,349	)

Balance at September 30, 2012	$	9,887		$	2,444		$	12,331

	Impaired			Real Estate
	Loans			Owned			Total Assets
	(In thousands)

Balance at June 30, 2012	$	14,700		$	6,465		$	21,165
Total realized and unrealized gains (losses)
Included in earnings		-			(94	)		(94	)
Included in other comprehensive income		-			-			-
Net transfers in and/or out of Level 3		(4,813	)		(3,927	)		(8,740	)

Balance at September 30, 2012	$	9,887		$	2,444		$	12,331

In general, fair value of securities is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon market prices determined by an outside, independent entity that primarily uses as inputs, observable market-based parameters. Fair value of loans held for sale 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, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company 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. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company's monthly and or quarter valuation process.

Cash and cash equivalents – The carrying amount of cash and cash equivalents approximates fair value.

Investment securities – The fair value of investment securities available-for-sale is estimated based on bid quotations received from independent pricing services for similar assets. The carrying amount of other investments approximates fair value.

Loans – For variable rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. For all other loans, fair values are calculated by discounting the contractual cash flows using estimated market discount rates which reflect the credit and interest rate risk inherent in the loans, or by using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Deposits – The fair value of deposits with no stated maturity, such as demand, interest checking and money market, and savings accounts, is equal to the amount payable on demand at year-end. The fair value of certificates of deposit is based on the discounted value of contractual cash flows using the rates currently offered for deposits of similar remaining maturities.

Borrowings – The fair value of borrowings is based on the discounted value of contractual cash flows using the rates currently offered for borrowings of similar remaining maturities

Accrued interest – The carrying amounts of accrued interest receivable and payable approximate fair value.

The following table presents the estimated fair value of our financial instruments at the indicated dates:

		September 30,				December 31,
		2012				2011
	Level in Fair
	Value	Carrying		Estimated		Carrying		Estimated
	Hierarchy	Value		Fair Value		Value		Fair Value

Financial assets
Cash	Level 1	$	26,064,313	$	26,064,313	$	55,557,541	$	55,557,541
Cash equivalents	Level 2		154,012		154,012		7,228,475		7,228,475
Investment securities available for sale	Level 1		6,713,476		6,713,476		10,207,805		10,207,805
Investment securities available for sale	Level 2		26,702,475		26,702,475		19,955,487		19,955,487
Federal Home Loan Bank stock	Level 2		2,166,900		2,166,900		2,647,000		2,647,000
Loans held for sale	Level 2		22,526,733		22,526,733		16,168,405		16,168,405
Loans	Level 2		298,176,828		290,131,297		353,186,646		353,349,981
Impaired loans	Level 2		55,007,435		55,007,435		51,867,625		51,867,625
Impaired loans	Level 3		9,886,725		9,886,725		12,787,473		12,787,473
Other real estate owned	Level 2		18,132,086		18,132,086		874,246		874,246
Other real estate owned	Level 3		2,443,878		2,443,878		8,302,921		8,302,921
Bank owned life insurance	Level 3		6,525,838		6,525,838		6,065,305		6,065,305
Accrued interest receivable	Level 2		1,800,872		1,800,872		2,046,524		2,046,524

Financial liabilities
Deposits	Level 2		435,142,137		436,603,601		485,521,052		487,915,609
FHLB borrowings	Level 2		28,000,000		28,484,102		37,750,000		37,963,672
Trust preferred securities	Level 2		8,764,000		8,764,000		8,764,000		8,764,000
Other borrowings	Level 2		5,351,393		5,351,393		5,778,661		5,778,661
Accrued interest payable	Level 2		816,390		816,390		592,283		592,283