12. Fair Value Disclosures

FASB ASC topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC topic 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 instruments include securities traded on active exchange markets, such as the New York Stock Exchange, as well as U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets.

Level 2: Valuation is based upon 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 in the market. Level 2 instruments include securities traded in less active dealer or broker markets.

Level 3: Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

We used the following methods and significant assumptions to estimate fair value:

Securities: Where quoted market prices are available in an active market, securities (trading or available for sale) are classified as Level 1 of the valuation hierarchy. Level 1 securities include certain preferred stocks included in our trading portfolio for which there are quoted prices in active markets. If quoted market prices are not available for the specific security, then fair values are estimated by (1) using quoted market prices of securities with similar characteristics, (2) matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for specific securities but rather by relying on the securities' relationship to other benchmark quoted prices, or (3) a discounted cash flow analysis whose significant fair value inputs can generally be verified and do not typically involve judgment by management. These securities are classified as Level 2 of the valuation hierarchy and include agency and private label residential mortgage-backed securities, municipal securities and trust preferred securities.

Loans held for sale: The fair value of mortgage loans held for sale is based on mortgage backed security pricing for comparable assets (recurring Level 2). The fair value of loans held for sale relating to branch sale is based on a discount provided for in the branch sale agreement (non-recurring Level 2).

Impaired loans with specific loss allocations based on collateral value: From time to time, certain loans are considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. We measure our investment in an impaired loan based on one of three methods: the loan's observable market price, the fair value of the collateral or the present value of expected future cash flows discounted at the loan's effective interest rate. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2012 and December 31, 2011, all of our total impaired loans were evaluated based on either the fair value of the collateral or the present value of expected future cash flows discounted at the loan's effective interest rate. When the fair value of the collateral is based on an appraised value or when an appraised value is not available we record the impaired loan as nonrecurring Level 3. 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 can be significant and thus will typically result in a Level 3 classification of the inputs for determining fair value.

Other real estate: At the time of acquisition, other real estate is recorded at fair value, less estimated costs to sell, which becomes the property's new basis. Subsequent write-downs to reflect declines in value since the time of acquisition may occur from time to time and are recorded in other expense in the Condensed Consolidated Statements of Operations. The fair value of the property used at and subsequent to the time of acquisition is typically determined by a third party appraisal of the property. 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 can be significant and typically result in a Level 3 classification of the inputs for determining fair value.

Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by us. Once received, an independent third party (for commercial properties over $0.25 million) or a member of our special assets group (for commercial properties under $0.25 million and retail properties) reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. On an annual basis, we compare the actual selling price of collateral that has been sold to the most recent appraised value to determine what additional adjustment, if any, should be made to the appraisal value to arrive at fair value. For commercial properties we typically do not discount an appraisal while for retail properties we generally discount the value by 5%. In addition, we will adjust the appraised values for expected liquidation costs including sales commissions and transfer taxes.

Capitalized mortgage loan servicing rights: The fair value of capitalized mortgage loan servicing rights is based on a valuation model used by an independent third party that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. Since the secondary servicing market has not been active since the later part of 2009, model assumptions are generally unobservable and are based upon the best information available including data relating to our own servicing portfolio, reviews of mortgage servicing assumption and valuation surveys and input from various mortgage servicers and, therefore, are recorded as nonrecurring Level 3. At September 30, 2012 these assumptions included a weighted average ("WA") discount rate of 11.0%, WA cost to service of $84, WA ancillary income of $44 and WA float rate of 0.76%. Management evaluates the third party valuation for reasonableness each quarter as part of our financial reporting control processes.

Derivatives: The fair value of interest rate swap agreements, in general, is determined using a discounted cash flow model whose significant fair value inputs can generally be verified and do not typically involve judgment by management (recurring Level 2). The fair value of the Amended Warrant at September 30, 2012 was estimated based on an internal update of an independent third party analysis that was performed at March 31, 2012 (the December 31, 2011 fair value was also based on an independent valuation performed at that date). Nearly all key variables remained consistent between March 31, 2012 (the last date a third party valuation was performed) and September 30, 2012. The internal update primarily focused on the change in our stock price during the second and third quarters of 2012, which was not significant. The third party valuation uses a simulation analysis which considers potential outcomes for a large number of independent scenarios regarding the future prices of our common stock. The simulation analysis relies on a binomial lattice model, a standard technique usually applied to the valuation of stock options. The binomial lattice maps out possible price paths of our common stock, the underlying asset of the Amended Warrant. The simulation is based on a 500-step lattice covering the term of the Amended Warrant. The binomial lattice requires specification of 14 variables, of which several are unobservable in the market including probability of a non-permitted capital raise (1.0% at September 30, 2012 and December 31, 2011), expected discount to stock price in an equity raise (10%), dollar amount of expected capital raise ($100 million) and expected time of equity raise (April, 2013 at September 30, 2012 and December 31, 2011). As a result of these unobservable inputs, the resulting fair value of the Amended Warrant is classified as Level 3 pricing. Changes in these variables would have an impact on the fair value of the Amended Warrant. If the probability of a non-permitted capital raise increased to 2.5%, 5.0% or 10.0%, the value of the Amended Warrant is estimated to increase to $0.43 million, $0.48 million and $0.61 million, respectively.

Property and equipment held for sale: The fair value of property and equipment held for sale relating to the branch sale was determined based upon a value agreed upon in the branch sale agreement (non-recurring Level 2) and property and equipment held for sale relating to our branch consolidation was based on recent offers (non-recurring Level 2) and appraisals (non-recurring Level 3).

Assets and liabilities measured at fair value, including financial assets for which we have elected the fair value option, were as follows:

			Fair Value Measurements Using
			Quoted
			Prices
			in Active
			Markets		Significant		Significant
			for		Other		Un-
	Fair Value		Identical		Observable		observable
	Measure-		Assets		Inputs		Inputs
	ments		(Level 1)		(Level 2)		(Level 3)
	(In thousands)
September 30, 2012:
Measured at Fair Value on a Recurring Basis:
Assets
Trading securities	$	38	$	38	$	-	$	-
Securities available for sale
U.S. agency		45,637		-		45,637		-
U.S. agency residential mortgage-backed		132,620		-		132,620		-
Private label residential mortgage-backed		8,302		-		8,302		-
Obligations of states and political subdivisions		40,361		-		40,361		-
Trust preferred		3,266		-		3,266		-
Loans held for sale		41,969		-		41,969		-
Derivatives (1)		2,787		-		2,787		-
Liabilities
Derivatives (2)		2,695		-		2,310		385

Measured at Fair Value on a Non-recurring basis:
Assets
Capitalized mortgage loan servicing rights (3)		8,855		-		-		8,855
Impaired loans (4)
Commercial
Income producing - real estate		4,862		-		-		4,862
Land, land development &construction-real estate		3,074		-		-		3,074
Commercial and industrial		7,622		-		-		7,622
Mortgage
1-4 Family		2,822		-		-		2,822
Resort Lending		239		-		-		239
Other real estate (5)
Commercial
Income producing - real estate		2,157		-		-		2,157
Land, land development &construction-real estate		5,193		-		-		5,193
Mortgage
1-4 Family		591		-		-		591
Resort Lending		4,636		-		-		4,636
Installment
Home equity installment - 1st lien		104		-		-		104
Loans held for sale relating to branch sale		52,280		-		52,280		-
Property and equipment held for sale		10,148		-		9,825		323

(1) Included in accrued income and other assets

(2) Included in accrued expenses and other liabilities

(3) Only includes servicing rights that are carried at fair value due to recognition of a valuation allowance.

(4) Only includes impaired loans with specific loss allocations based on collateral value.

(5) Only includes other real estate with subsequent write downs to fair value.

			Fair Value Measurements Using
			Quoted
			Prices
			in Active
			Markets		Significant		Significant
			for		Other		Un-
	Fair Value		Identical		Observable		observable
	Measure-		Assets		Inputs		Inputs
	ments		(Level 1)		(Level 2)		(Level 3)
	(In thousands)
December 31, 2011:
Measured at Fair Value on a Recurring Basis:
Assets
Trading securities	$	77	$	77	$	-	$	-
Securities available for sale
U.S. agency		25,017		-		25,017		-
U.S. agency residential mortgage-backed		94,206		-		94,206		-
Private label residential mortgage-backed		8,268		-		8,268		-
Obligations of states and political subdivisions		27,317		-		27,317		-
Trust preferred		2,636		-		2,636		-
Loans held for sale		44,801		-		44,801		-
Derivatives (1)		857		-		857		-
Liabilities
Derivatives (2)		1,883		-		1,709		174

Measured at Fair Value on a Non-recurring basis:
Assets
Capitalized mortgage loan servicing rights (3)		11,004		-		-		11,004
Impaired loans (4)
Commercial
Income producing - real estate		8,022		-		-		8,022
Land, land development &construction-real estate		5,702		-		-		5,702
Commercial and industrial		5,613		-		-		5,613
Mortgage
1-4 Family		3,263		-		-		3,263
Resort Lending		1,064		-		-		1,064
Other real estate (5)
Commercial
Income producing - real estate		1,388		-		-		1,388
Land, land development &construction-real estate		7,512		-		-		7,512
Commercial and industrial		497		-		-		497
Mortgage
1-4 Family		2,079		-		-		2,079
Resort Lending		5,297		-		-		5,297
Home equity line of credit - 1st lien		53		-		-		53
Installment
Home equity installment - 1st lien		100		-		-		100

(1) Included in accrued income and other assets

(2) Included in accrued expenses and other liabilities

(3) Only includes servicing rights that are carried at fair value due to recognition of a valuation allowance.

(4) Only includes impaired loans with specific loss allocations based on collateral value.

(5) Only includes other real estate with subsequent write downs to fair value.

There were no transfers between Level 1 and Level 2 during the nine months ended September 30, 2012 and 2011.

Changes in fair values for financial assets which we have elected the fair value option for the periods presented were as follows:

		Changes in Fair Values for the Nine-Month
		Periods Ended September 30 for Items Measured at
		Fair Value Pursuant to Election of the Fair Value Option
		2012								2011
							Total							Total
							Change							Change
							in Fair							in Fair
							Values							Values
							Included							Included
		Net Gains (Losses)					in Current			Net Gains (Losses)				in Current
		on Assets					Period			on Assets				Period
		Securities			Loans		Earnings			Securities		Loans		Earnings
		(In thousands)
Trading securities	$	(39	)	$	-	$	(39	)	$	67	$	-	$	67
Loans held for sale		-			587		587			-		807		807

For those items measured at fair value pursuant to our election of the fair value option, interest income is recorded within the Condensed Consolidated Statements of Operations based on the contractual amount of interest income earned on these financial assets and dividend income is recorded based on cash dividends.

The following represent impairment charges recognized during the three and nine month periods ended September 30, 2012 and 2011 relating to assets measured at fair value on a non-recurring basis:

Capitalized mortgage loan servicing rights, whose individual strata are measured at fair value, had a carrying amount of $8.9 million which is net of a valuation allowance of $7.2 million at September 30, 2012 and had a carrying amount of $11.0 million which is net of a valuation allowance of $6.5 million at December 31, 2011. A recovery (charge) of $(0.4) million and $(0.6) million was included in our results of operations for the three and nine month periods ended September 30, 2012, respectively and $(3.1) million and $(3.2) million during the same periods in 2011.

Loans which are measured for impairment using the fair value of collateral for collateral dependent loans, had a carrying amount of $26.4 million, with a valuation allowance of $7.8 million at September 30, 2012 and had a carrying amount of $33.9 million, with a valuation allowance of $10.3 million at December 31, 2011. An additional provision for loan losses relating to impaired loans of $0.3 million and $1.9 million was included in our results of operations for the three and nine month periods ended September 30, 2012, respectively and $2.7 million and $6.6 million during the same periods in 2011.

Other real estate, which is measured using the fair value of the property, had a carrying amount of $12.7 million which is net of a valuation allowance of $10.0 million at September 30, 2012 and a carrying amount of $16.9 million which is net of a valuation allowance of $14.7 million at December 31, 2011. An additional charge relating to ORE measured at fair value of $1.1 million and $1.5 million was included in our results of operations during the three and nine month periods ended September 30, 2012, respectively and $2.1 million and $4.1 million during the same periods in 2011.

Property and equipment held for sale, which is measured using the fair value of the assets, had a carrying amount of $10.1 million, which is net of a valuation allowance of $3.3 million at September 30, 2012. A charge relating to property and equipment measured at fair value of $0.9 million was included in our results of operations during the three and nine month periods ended September 30, 2012. There were no such balances at December 31, 2011 or charges during the three and nine month periods ended September 30, 2011.

A reconciliation for all liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30 follows:

	(Liability)
	Amended Warrant
	Three months ended						Nine months ended
	September 30,						September 30,
	2012			2011			2012			2011

Beginning balance	$	(353	)	$	(315	)	$	(174	)	$	(1,311	)
Total gains (losses) realized and unrealized:
Included in results of operations		(32	)		29			(211	)		1,025
Included in other comprehensive income		-			-			-			-
Purchases, issuances, settlements, maturities and calls		-			-			-			-
Transfers in and/or out of Level 3		-			-			-			-
Ending balance	$	(385	)	$	(286	)	$	(385	)	$	(286	)

Amount of total gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to assets and liabilities still held at September 30	$	(32	)	$	29		$	(211	)	$	1,025

During 2010, we entered into an amended and restated warrant with the UST that would allow them to purchase our common stock at a fixed price (see Note #15). Because of certain anti-dilution features included in the Amended Warrant, it is not considered to be indexed to our common stock and is therefore accounted for as a derivative instrument (see Note #7). Any change in value of this warrant is recorded in other income in our Condensed Consolidated Statements of Operations.

The following table reflects the difference between the aggregate fair value and the aggregate remaining contractual principal balance outstanding for loans held for sale for which the fair value option has been elected for the periods presented.

	Aggregate Fair Value		Difference		Contractual Principal
	(In thousands)
Loans held for sale
September 30, 2012	$	41,969	$	1,990	$	39,979
December 31, 2011		44,801		1,403		43,398