Fair Value Measurements

Fair Value Hierarchy

In accordance with applicable guidance, the Company groups its assets and liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. Valuations within these levels are based upon:

Level 1 — Quoted market prices (unadjusted) for identical instruments traded in active exchange markets that the Company has the ability to access as of the measurement date.

Level 2 — Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable or can be corroborated by observable market data.

Level 3 — Model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect the Company’s estimates of assumptions that market participants would use on pricing the asset or liability. Valuation techniques include management judgment and estimation which may be significant.

Management monitors the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another. In such instances, we report the transfer at the beginning of the reporting period.

The estimated carrying and fair values of the Company’s financial instruments are as follows (in thousands):



	September 30, 2012
	Carrying Amount		Fair Value
(In thousands)	Carrying Amount		Level 1		Level 2		Level 3		Total
Financial assets:
Cash and due from banks	$	21,124	$	21,124	$	—	$	—	$	21,124
Interest-earning deposits in other banks	55,074		55,074		—		—		55,074
Federal funds sold	721		721		—		—		721
Available-for-sale investment securities	364,808		8,040		356,768		—		364,808
Loans, net	388,922		—		—		392,854		392,854
Federal Home Loan Bank stock	3,850		N/A		N/A		N/A		N/A
Accrued interest receivable	3,778		29		1,903		1,846		3,778
Financial liabilities:
Deposits	737,286		—		758,806		—		758,806
Short-term borrowings	4,000		—		4,049		—		4,049
Junior subordinated deferrable interest debentures	5,155		—		—		2,990		2,990
Accrued interest payable	157		—		130		27		157



	December 31, 2011
(In thousands)	Carrying Amount		Fair Value
Financial assets:
Cash and due from banks	$	19,409	$	19,409
Interest-earning deposits in other banks	24,467		24,467
Federal funds sold	928		928
Available-for-sale investment securities	328,413		328,413
Loans, net	415,999		418,084
Federal Home Loan Bank stock	2,893		N/A
Accrued interest receivable	3,953		3,953
Financial liabilities:
Deposits	712,986		719,673
Long-term debt	4,000		4,146
Junior subordinated deferrable interest debentures	5,155		2,706
Accrued interest payable	230		230

These estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.

These estimates are made at a specific point in time based on relevant market data and information about the financial instruments. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the fair values presented.

The methods and assumptions used to estimate fair values are described as follows:

(a) Cash and Cash Equivalents

The carrying amounts of cash and due from banks, interest-earning deposits in other banks, and Federal funds sold approximate fair values and are classified as Level 1.

(b) Available-for-Sale Investment Securities

Available-for-sale investment securities in Level 1 are mutual funds and fair values are based on quoted market prices for identical instruments traded in active markets. Fair values for available-for-sale investment securities classified in Level 2 are based on quoted market prices for similar securities in active markets.

It is not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability.

(d) Loans

Fair values of loans are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are initially valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for loan losses. For collateral dependent loans, fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower's financial statements, or aging reports, adjusted or discounted based on management's historical knowledge, changes in market conditions from the time of the valuation, and management's expertise and knowledge of the client and client's business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

(e) Deposits

Fair value for fixed rate certificates of deposit are estimated using discounted cash flow analyses using interest rates offered at each reporting date by the Company for certificates with similar remaining maturities resulting in a Level 2 classification. Fair value of demand deposit, savings, and money market accounts are estimated using historical decay rates resulting in a Level 2 classification.

(f) Short-Term Borrowings

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.

(g) Other Borrowings

The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

The fair values of the Company’s Subordinated Debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

(h) Accrued Interest Receivable/Payable

The fair value of accrued interest receivable and payable is based on the fair value hierarchy of the related asset or liability.

(i) Off-Balance Sheet Instruments

Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.

Assets Recorded at Fair Value

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of September 30, 2012:

Recurring Basis

The Company is required or permitted to record the following assets at fair value on a recurring basis under other accounting pronouncements as of September 30, 2012 (in thousands).



Description	Fair Value		Level 1		Level 2		Level 3
Available-for-sale securities
Debt Securities:
U.S. Government agencies	$	2,318	$	—	$	2,318	$	—
Obligations of states and political subdivisions	137,637		—		137,637		—
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations	210,135		—		210,135		—
Private label residential mortgage backed securities	6,678		—		6,678		—
Other equity securities	8,040		8,040		—		—
Total assets measured at fair value on a recurring basis	$	364,808	$	8,040	$	356,768	$	—

Securities in Level 1 are mutual funds and fair values are based on quoted market prices for identical instruments traded in active markets. Fair values for available-for-sale investment securities in Level 2 are based on quoted market prices for similar securities in active markets.

Management evaluates the significance of transfers between levels based upon the nature of the financial instrument and size of the transfer relative to total assets, total liabilities or total earnings. During the nine months ended September 30, 2012, no transfers between levels occurred.

The were no Level 3 assets measured at fair value on a recurring basis at September 30, 2012.

There were no liabilities measured at fair value on a recurring basis at September 30, 2012.

Non-recurring Basis

The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a non-recurring basis. These include assets and liabilities that are measured at the lower of cost or fair value that were recognized at fair value which was below cost. There were no assets or liabilities measured at fair value on a non-recurring basis at September 30, 2012. The impaired loans measured at fair value at December 31, 2011 are no longer recorded at fair value due to the borrower payments reducing the carrying value of certain of these loans to less than fair value and due to other impaired loans now being evaluated under the discounted cash flow method versus the collateral method. The discounted cash flow method as prescribed by topic 310 is not a fair value measurement since the discount rate utilized is the loan's effective interest rate which is not a market rate. The discounted cash flow approach was determined to be the most appropriate impairment method to use for these impaired loans based on their significant payment history and the global cash flow analysis performed on each borrower.

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring and nonrecurring basis as of December 31, 2011:

Recurring Basis

The Company is required or permitted to record the following assets at fair value on a recurring basis under other accounting pronouncements (in thousands).



Description	Fair Value		Level 1		Level 2		Level 3
Available-for-sale securities
Debt Securities:
U.S. Government agencies	$	149	$	—	$	149	$	—
Obligations of states and political subdivisions	108,431		—		108,431		—
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations	204,544		—		204,544		—
Private label residential mortgage backed securities	7,398		—		7,398		—
Other equity securities	7,891		7,891		—		—
Total assets measured at fair value on a recurring basis	$	328,413	$	7,891	$	320,522	$	—

There were no Level 3 assets measured at fair value on a recurring basis at December 31, 2011.

There were no liabilities measured at fair value on a recurring basis at December 31, 2011.

Non-recurring Basis



Description	Fair Value		Level 1		Level 2		Level 3
Impaired loans:
Commercial:
Commercial and industrial	$	2,312	$	—	$	—	$	2,312
Total commercial	2,312		—		—		2,312
Real estate:
Owner occupied	873		—		—		873
Real estate-construction and other land loans	8,782		—		—		8,782
Commercial real estate	1,487		—		—		1,487
Total real estate	11,142		—		—		11,142
Consumer:
Equity loans and lines of credit	2,003		—		—		2,003
Consumer and installment	51		—		—		51
Total consumer	2,054		—		—		2,054
Total impaired loans	15,508		—		—		15,508
Total assets measured at fair value on a non-recurring basis	$	15,508	$	—	$	—	$	15,508

In accordance with the provisions of ASC 360-10, collateral dependent impaired loans with a carrying value of $19,876,000 were written down to their fair value of $15,508,000, resulting in a valuation allowance of $4,368,000. The valuation allowance represents specific allocations for the allowance for credit losses for impaired loans.

Impaired loans were determined to be collateral dependent and categorized as Level 3 due to ongoing real estate market conditions resulting in inactive market data, which in turn required the use of unobservable inputs and assumptions in fair value measurements. There were no changes in valuation techniques used during the year ended December 31, 2011.

There were no liabilities measured at fair value on a non-recurring basis at December 31, 2011.