Fair Value

9 Months Ended

Sep. 30, 2011

Fair Value [Abstract]

Fair Value

Note 9.  Fair Value

The Company measures, monitors, and discloses certain of its assets and liabilities on a fair value basis. Fair value is defined as 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.

The Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. Fair value guidance establishes a fair value hierarchy that prioritizes the inputs used to measure fair value into three broad levels based on the reliability of the input assumptions. The hierarchy gives the highest priority to level 1 measurements and the lowest priority to level 3 measurements and the categorization of where an asset or liability falls within the hierarchy is based on the lowest level of input that is significant to the fair value measurement. The three levels of the fair value hierarchy are defined as follows:

Level 1 – Unadjusted quoted prices for identical assets or liabilities traded in active markets.

Level 2 – Observable inputs other than level 1 prices, such as quoted prices for similar instruments; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Securities

Available for Sale Securities. The fair value of securities available for sale is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs). If the securities could not be priced using quoted market prices, observable market activity or comparable trades, the financial market was considered not active and the assets were classified as Level 3.

Pooled Trust Preferred Collateralized Debt Obligations ("CDO"). The assets included in Level 3 are CDOs. Due to the decline in the level of observable inputs and market activity for trust preferred CDOs, the Company uses an internal other-than-temporary impairment ("OTTI") evaluation model to compare the present value of expected cash flows to the previous estimate to ensure there are no adverse changes in cash flows during the quarter. The OTTI model considers the structure and term of each CDO and the financial condition of the underlying issuers. Specifically, the model details interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment

deferrals or defaults of underlying trust-preferred securities. Assumptions used in the model include expected future default rates and prepayments.

We assume no recoveries on defaults and treat all interest payment deferrals as defaults.   In addition, we use the model to "stress" each CDO, or make assumptions more severe than expected activity, to determine the degree to which assumptions could deteriorate before the CDO could no longer fully support repayment of the Company's note class.

Each issuer in the tranche was analyzed using the Fitch ratings for the quarter and key financial data so that the issuer in each tranche can be divided between a pool of "performing" company and "under-performing" company.   A factor is applied to the under-performing company for each quarter to project additional defaults

and deferrals to be factored into the cash flow model. Three internal scenarios were developed that had different assumptions regarding the impact of the economic environment on additional defaults and deferrals for the upcoming quarters.  On average, the additional deferrals for a specific CDO that were factored in to our calculation ranged between 6% and 17% of the performing balance of the instrument between the three scenarios. All of the additional deferrals for the three scenarios are factored in to the cash flow for each tranche.  A discount factor to be added to the London Interbank Offered Rate ("LIBOR") was developed for each specific tranche and incorporated to arrive at the discount rate for the CDO.  The factor ranged from 200 basis points to 600 basis points based over LIBOR on the rating of the CDO and its gross-up factor for risk based capital.  These rates were applied to calculate the net present value of the cash flows.  The results of the three net present value calculations were weighted based on their likelihood of occurring. The scenarios were weighted 35%, 47% and 18%.  

Finally, an independent valuation of our portfolio was obtained. This was weighted as the final overall step to arrive at our valuation for September 30, 2011 using 55% for the internal weighting and 45% for the external one. Due to market conditions as well as the limited trading activity of these securities, the market value of the securities is highly sensitive to assumption changes and market volatility.

At September 30, 2011, the Company held five pooled trust preferred CDOs with an amortized cost of $8.1 million. These securities were rated high quality (A3 and above) at inception, but at September 30, 2011, these securities were rated as Ca, which are defined as highly speculative and/or default, with some recovery; and C, which is the lowest rating. The issuers in these securities are primarily banks, but some of the pools do include a limited number of insurance companies.

The Company performed an analysis including evaluation for OTTI for each of the five CDOs.  During the third quarter of 2011, our model indicated no OTTI was needed for credit impairment. Management has determined that the CDOs are deemed to be only temporarily impaired at quarter-end due to the projected cash flows adjusted for the possible further deterioration is sufficient to return the outstanding principal balance with interest at the stated rate. Specific ratings of our CDOs that have incurred OTTI during 2011 are listed below:

Issue	Tranche	Gross Amortized Cost	Fair Value	Gross Unrealized Gains/(Losses)	Ratings as of Sep 30, 2011 Moody's/S&P	Ratings as of Dec 31, 2010 Moody's/S&P
PreTSL XIII	B-3	385	244	(141)	Ca / NR	Ca / NR
PreTSL XVI	B	-	-	-	Ca / NR	Ca / NR
PreTSL XXIV	C-2	-	-	-	Ca / NR	Ca / NR
		$          385	$          244	$         (141)

Private Label CMOs. Private label CMOs were also evaluated using management's internal analysis process. These securities were rated high quality (A3 and above) at inception and are primarily supported by prime collateral, although the RAST Series security has some alt-a collateral support. During the third quarter of 2011, our model indicated no OTTI on these CMOs, with an aggregate cost basis of $1.8 million.

Single Issue Trust Preferred.  During the third quarter of 2010, the Company purchased $3.8 million of single-issue trust preferred securities that are classified as available for sale. With respect to these securities, the Company looks at rating agency actions, payment history, the capital levels of the banks and the financial performance as filed in regulatory reports.  During the quarter, $0.8 million of these securities were called, leaving the Company with an investment of $3.0 million.    

The Company's unrealized losses on other securities relate primarily to its investment in CDO securities. The decline in fair value is primarily attributable to temporary illiquidity and the financial crisis affecting these markets and not necessarily the expected cash flows of the individual securities. Due to the illiquidity in the market, it is unlikely that the Company would be able to recover its investment in these securities if the Company sold the securities at this time. The Company does not intend to sell these securities nor is it more likely than not the Company will be required to sell these securities before its anticipated recovery.

Other Real Estate Owned ("OREO")

Other real estate owned includes properties acquired in partial or total satisfaction of certain loans. Properties are initially recorded at fair value, which represents the estimated sales price of the properties on the date acquired less estimated selling costs, establishing a new cost basis. Any write-downs in the carrying value of a property at the time of acquisition are charged against the allowance for loan losses. Management periodically reviews the carrying value of other real estate owned. Any write-downs of the properties subsequent to acquisition, as well as gains or losses on disposition and income or expense from the operations of other real estate owned, are recognized in operating results in the period they are realized.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table summarizes, by measurement hierarchy, the various assets and liabilities of the Company that are measured at fair value on a recurring basis:

		Quoted Prices in	Significant	Significant
		Active Markets	Other	Unobservable
	Carrying	For Identical Assets	Observable Inputs	Inputs
	Amount	(Level 1)	(Level 2)	(Level 3)
September 30, 2011
U.S. government agencies	$                            3,285	$                            -	$                             3,285	$                          -
State and political subdivisions	21,361	-	21,361	-
U.S. government agency residential                                      mortgage-backed securities	179,098	-	179,098	-
Collateralized mortgage obligations:
Agency	16,823	-	16,823	-
Private Label	2,178	-	-	2,178
Equities	2,520	-	2,520	-
Collateralized debt obligations:
Single Issue	3,071	-	3,071	-
Pooled	5,763	-	-	5,763
Corporate	1,987	-	1,987	-
Available-for-sale securities	$                            236,086	$                            -	$                             228,145	$                  7,941

		Quoted Prices in	Significant	Significant
		Active Markets	Other	Unobservable
	Carrying	For Identical Assets	Observable Inputs	Inputs
	Amount	(Level 1)	(Level 2)	(Level 3)
December 31, 2010
U.S. government agencies	$                            7,085	$                            -	$                             7,085	$                          -
State and political subdivisions	28,348	-	28,348	-
U.S. government agency residential                                      mortgage-backed securities	147,846	-	147,846	-
Collateralized mortgage obligations:
Agency	20,735	-	20,735	-
Private Label	4,936	-	-	4,936
Equities	2,254	-	2,254	-
Collateralized debt obligations:
Single Issue	3,849	-	3,849	-
Pooled	4,422	-	-	4,422
Available-for-sale securities	$                            219,475	$                            -	$                             210,117	$                  9,358

Assets and Liabilities Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs

The following table reconciles the beginning and ending balances of the assets of the Company that are measured at fair value on a recurring basis using significant unobservable inputs. There currently are no liabilities of the Company that are measured at fair value on a recurring basis using significant unobservable inputs.

	Securities Available for Sale
	2011		2010
	CDOs	CMOs	CDOs	CMOs
Beginning balance, July 1	$          5,470	$          3,004	$          7,128	$          7,999
Transfers into Level 3	-	-	-	-
Total gains or losses (realized/unrealized) included in earnings
Security impairment	-	-	(498)	-
Capitalized interest/(payments received)	(1)	(955)	30	(1,393)
Discount/(premium) amortization	-	1	-	1
Included in other comprehensive income	294	128	(234)	105
Ending Balance, September 30	$          5,763	$          2,178	$          6,426	$          6,712

	Securities Available for Sale
	2011		2010
	CDOs	CMOs	CDOs	CMOs
Beginning balance, January 1	$          4,422	$          4,936	$          9,758	$        11,166
Transfers into Level 3	-	-	-	-
Total gains or losses (realized/unrealized) included in earnings
Security impairment	(499)	-	(3,883)	(139)
Capitalized interest/(payments received)	14	(3,117)	30	(4,442)
Discount/(premium) amortization	3	2	71	2
Included in other comprehensive income	1,823	357	450	125
Ending Balance, September 30	$          5,763	$          2,178	$          6,426	$          6,712

Assets Measured at Fair Value on a Non-Recurring Basis

The following table summarizes, by measurement hierarchy, financial assets of the Company that are measured at fair value on a non-recurring basis.

		Quoted Prices in	Significant	Significant
		Active Markets	Other	Unobservable
	Carrying	For Identical Assets	Observable Inputs	Inputs
	Amount	(Level 1)	(Level 2)	(Level 3)
September 30, 2011
Impaired loans
Commercial
Closed End	$                      746	$                       -	$                       -	$                      746
Line of Credit	984	-	-	984
Agricultural & AGRE	-	-	-	-
CRE - Construction, land & development	16,702	-	-	16,702
CRE – all other
Owner Occupied	10,819	-	-	10,819
Non-owner occupied	9,414	-	-	9,414
1-4 family residential
Senior lien	6,123	-	-	6,123
Junior lien & lines of credit	373	-	-	373
Consumer	-	-	-	-
OREO property
Commercial
Closed End	$                           -	$                       -	$                       -	$                           -
Line of Credit	-	-	-	-
Agricultural & AGRE	-	-	-	-
CRE - Construction, land & development	3,152	-	-	3,152
CRE – all other
Owner Occupied	3,034	-	-	3,034
Non-owner occupied	180	-	-	180
1-4 family residential
Senior lien	710	-	-	710
Junior lien & lines of credit	-	-	-	-
Consumer	-	-	-	-

		Quoted Prices in	Significant	Significant
		Active Markets	Other	Unobservable
	Carrying	For Identical Assets	Observable Inputs	Inputs
	Amount	(Level 1)	(Level 2)	(Level 3)
December 31, 2010
Impaired loans
Commercial	$                   1,715	$                       -	$                       -	$                   1,715
Agricultural & AGRE	4,120	-	-	4,120
Construction, land & development	31,666	-	-	31,666
Commercial RE	23,036	-	-	23,036
1-4 family residential	10,264	-	-	10,264
OREO property
Construction, land & development	9,317	-	-	9,317
Commercial RE	3,284	-	-	3,284
1-4 family residential	178	-	-	178

The fair value of impaired loans with specific loan loss allocations is generally based on the most recent real estate appraisals with discounts applied or discounted cash flows. Appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Judgments used to determine appraised values can be subjective, discounts applied can be significant, as the timing of expected cash flows can be fluid. All of these factors result in a Level 3 classification of the inputs for determining fair value. Impaired loans had a carrying amount of $55.6 million with specific loan loss allocations of $10.4 million in third quarter 2011, resulting in a decrease in specific related allowance for loan losses of $7.2 million when compared to December 31, 2010 and a decrease of $2.2 million compared to June 30, 2011.  At December 31, 2010, impaired loans had a carrying amount of $88.5 million with specific loan loss allocations of $17.7 million, which resulted in an increase in specific related allowance for loan losses of $9.1 million in 2010.  

At September 30, 2011, OREO properties had a net carrying value of $7.1 million, comprised of $14.2 million with a valuation allowance of $7.1 million. This resulted in a charge to earnings of $4.5 million for the third quarter 2011 and a charge of $5.8 million for the nine months ending September 30, 2011. At December 31, 2010, OREO properties had a net carrying value of $12.8 million, comprised of $17.9 million with a valuation allowance of $5.1 million.

The Methods and Assumptions Used to Estimate Fair Value

The carrying amount is the estimated fair value for cash and due from banks, federal funds sold, short-term borrowings, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully.  Security fair values are based on the methods described above.  

The carrying value and fair value of the subordinated debentures issued to capital trusts are estimated using market data for similarly risk weighted items to value them.   For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, the fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk.  Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values.  The fair value of loans held for sale is based on market quotes.  The fair value of debt and redeemable stock is based on current rates for similar financing. It was not practicable to determine the fair value of the restricted securities due to restrictions placed on its transferability.  The fair value of off-balance-sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements.

The estimated fair values of the Company's financial instruments at September 30, 2011 and December 31, 2010 are as follows:

	September 30,		December 31,
	2011		2010
	Carrying	Fair	Carrying	Fair
	Amount	Value	Amount	Value
Financial assets
Cash and cash equivalents	$         63,296	$         63,296	$         82,945	$         82,945
Securities	236,086	236,086	219,475	219,475
Restricted securities	9,150	N/A	10,470	N/A
Net loans	597,136	580,795	690,360	657,529
Accrued interest receivable	3,417	3,417	3,860	3,860
Financial liabilities
Deposits	862,117	863,885	931,105	935,371
Federal funds purchased and securities sold under agreements to repurchase	21,364	21,364	16,188	16,188
Federal Home Loan Bank advances	48,058	49,843	71,059	73,170
Notes payable	10,533	9,130	10,623	10,796
Subordinated debentures	20,620	13,777	20,620	9,865
Series B mandatory redeemable preferred stock	268	268	268	268
Accrued interest payable	3,832	3,832	3,962	3,962

Other assets and liabilities of the Company that are not defined as financial instruments are not included in the above disclosures, such as property and equipment. In addition, nonfinancial instruments typically not recognized in financial statements nevertheless may have value but are not included in the above disclosures. These include, among other items, the estimated earning potential of core deposit accounts, the earnings potential of loan servicing rights, customer goodwill and similar items.