4. Fair Value

FASB ASC No. 820-10 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: Quoted prices (unadjusted) of identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level I 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: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The fair value of most 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).

For those securities that cannot be priced using quoted market prices or observable inputs a Level 3 valuation is determined. These securities are primarily trust preferred securities, which are priced using Level 3 due to current market illiquidity and certain investments in state and municipal securities. The fair value of the trust preferred securities is obtained from a third party provider without adjustment. As described previously, management obtains values from other pricing sources to validate the Standard & Poors pricing that they currently utilize. The fair value of state and municipal obligations are derived by comparing the securities to current market rates plus an appropriate credit spread to determine an estimated value. Illiquidity spreads are then considered. Credit reviews are performed on each of the issuers. The significant unobservable inputs used in the fair value measurement of the Corporation’s state and municipal obligations are credit spreads related to specific issuers. Significantly higher credit spread assumptions would result in significantly lower fair value measurement. Conversely, significantly lower credit spreads would result in a significantly higher fair value measurements.

The fair value of derivatives is based on valuation models using observable market data as of the measurement date (Level 2 inputs).

	June 30, 2013
	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
(Dollar amounts in thousands)	Level 1		Level 2		Level 3		Total
U.S. Government agencies	$	-	$	1,755	$	-	$	1,755
Mortgage Backed Securities-residential		-		227,690		-		227,690
Mortgage Backed Securities-commercial		-		4,638		-		4,638
Collateralized mortgage obligations		-		402,997		-		402,997
State and municipal		-		184,819		6,502		191,321
Collateralized debt obligations		-		-		8,176		8,176
Equities		470		-		-		470
TOTAL	$	470	$	821,899	$	14,678	$	837,047
Derivative Assets				1,401
Derivative Liabilities				(1,401)

	December 31, 2012
	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
(Dollar amounts in thousands)	Level 1		Level 2		Level 3		Total
U.S. Government agencies	$	-	$	1,886	$	-	$	1,886
Mortgage Backed Securities-residential		-		244,676		-		244,676
Mortgage Backed Securities-commercial		-		5,131		-		5,131
Collateralized mortgage obligations		-		233,320		-		233,320
State and municipal		-		189,574		9,911		199,485
Collateralized debt obligations		-		-		6,122		6,122
Equities		380		-		-		380
TOTAL	$	380	$	674,587	$	16,033	$	691,000
Derivative Assets				2,053
Derivative Liabilities				(2,053)

There were no transfers between Level 1 and Level 2 during 2013 and 2012.

The table below presents a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2013 and the year ended December 31, 2012.

	Fair Value Measurements Using SignificantUnobservable Inputs (Level 3)
	Three months ended June 30, 2013
	State and		Collateralized
	municipal		debt
	obligations		obligations		Total
Beginning balance, April 1	$	6,502	$	5,972	$	12,474
Total realized/unrealized gains or losses
Included in earnings		-		-		-
Included in other comprehensive income		-		2,408		2,408
Transfers & Purchases		-		-		-
Settlements		-		(204)		(204)
Ending balance, June 30	$	6,502	$	8,176	$	14,678

	Fair Value Measurements Using SignificantUnobservable Inputs (Level 3)
	Six months ended June 30, 2013
	State and		Collateralized
	municipal		debt
	obligations		obligations		Total
Beginning balance, January 1	$	9,911	$	6,122	$	16,033
Total realized/unrealized gains or losses
Included in earnings		-				-
Included in other comprehensive income		-		2,803		2,803
Transfers & Purchases		-		-		-
Settlements		(3,409)		(749)		(4,158)
Ending balance, June 31	$	6,502	$	8,176	$	14,678

	Fair Value Measurements Using SignificantUnobservable Inputs (Level 3)
	December 31, 2012
			State and		Collateralized
			municipal		debt
	Equities		obligations		obligations		Total
Beginning balance, January 1	$	1,711	$	9,525	$	4,771	$	16,007
Total realized/unrealized gains or losses
Included in earnings		(446)		-		(96)		(542)
Included in other comprehensive income		-		-		1,556		1,556
Transfers & Purchases		-		1,186		-		1,186
Settlements		(1,265)		(800)		(109)		(2,174)
Ending balance, December 31	$	-	$	9,911	$	6,122	$	16,033

The following table presents quantitative information about recurring and non-recurring Level 3 fair value measurements at June 30, 2013.

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range
			Discounted cash flow	Discount rate		3.05%-5.50%
State and municipal obligations	$	6,502		Probability of default		0%
Other real estate	$	9,336	Sales comparison/income approach	Discount rate for age of appraisal and market conditions		5.00%-20.00%
Impaired Loans		21,060	Sales comparison/income approach	Discount rate for age of appraisal and market conditions		0.00%-50.00%

All impaired loans disclosed in footnote 2 are valued at Level 3 and are carried at a fair value of $21.1 million, net of a valuation allowance of $6.2 million at June 30, 2013. At December 31, 2012 impaired loans valued at Level 3 were carried at a fair value of $26.0 million, net of a valuation allowance of $7.6 million. The impact to the provision for loan losses was $(0.6) and $ 2.4 million for the three and six months ended June 30, 201 3, and was $4.2 million for the year ended December 31, 2012. Other real estate owned is valued at Level 3. Other real estate owned at June 30, 2013, with a value of $9.3 million was reduced $232 thousand for fair value adjustment. Other real estate owned at December 31, 2012, with a value of $7.7 million was reduced $234 thousand for fair value adjustment.

Fair value is measured based on the value of the collateral securing those loans, and is determined using several methods. Generally the fair value of real estate is determined based on appraisals by qualified licensed appraisers. Appraisals for real estate generally use three methods to derive value: cost, sales or market comparison and income approach. The cost method bases value on the cost to replace current property. The market comparison evaluates the sales price of similar properties in the same market area. The income approach considers net operating income generated by the property and the investor’s required return. The final fair value is based on a reconciliation of these three approaches. If an appraisal is not available, the fair value may be determined by using a cash flow analysis, a broker’s opinion of value, the net present value of future cash flows, or an observable market price from an active market. Fair value of other real estate is based upon the current appraised values of the properties as determined by qualified licensed appraisers and the Company’s judgment of other relevant market conditions. Appraisals are obtained annually and reductions in value are recorded as a valuation through a charge to expense. The primary unobservable input used by management in estimating fair value are additional discounts to the appraised value to consider selling costs and the age of the appraisal, which are based on management’s past experience in resolving these types of properties. These discounts range from 5% to20% for costs to sell and marketability. Other real estate and impaired loans carried at fair value are primarily comprised of smaller balance properties. One impaired loan has an estimated fair value of $3.9 million. The collateral securing this loan is a hotel and was appraised based on income and sales comparison approaches. Given the current distressed market, it was difficult for the appraiser to identify recent and relevant comparable sales, therefore the value was based predominantly on the income method which applied a 9.5% capitalization rate to projected net operating income.

The following tables presents loans identified as impaired by class of loans as of June 30, 2013 and December 31, 2012, which are all considered Level 3.

	June 30, 2013
(Dollar amounts in thousands)	Carrying Value		Allowance for Loan Losses Allocated		Fair Value
Commercial
Commercial & Industrial	$	14,391	$	3,657	$	10,734
Farmland		-		-		-
Non Farm, Non Residential		8,373		1,507		6,866
Agriculture		-		-		-
All Other Commercial		4,189		993		3,196
Residential
First Liens		73		-		73
Home Equity		191		-		191
Junior Liens		-		-		-
Multifamily		-		-		-
All Other Residential		-		-		-
Consumer
Motor Vehicle		-		-		-
All Other Consumer		-		-		-
TOTAL	$	27,217	$	6,157	$	21,060

	December 31, 2012
(Dollar amounts in thousands)	Carrying Value		Allowance for Loan Losses Allocated		Fair Value
Commercial
Commercial & Industrial	$	17,098	$	3,153	$	13,945
Farmland		891		191		700
Non Farm, Non Residential		7,386		293		7,093
Agriculture		-		-
All Other Commercial		1,209		52		1,157
Residential
First Liens		1,254		126		1,128
Home Equity		179		-		179
Junior Liens		-		-		-
Multifamily		5,540		3,794		1,746
All Other Residential		-				-
Consumer
Motor Vehicle		-				-
All Other Consumer		-				-
TOTAL	$	33,557	$	7,609	$	25,948

The carrying amounts and estimated fair value of financial instruments at June 30, 2013 and December 31, 2012, are shown below. 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 were described previously. For fixed-rate, non-impaired loans or deposits, variable rate loans or deposits with infrequent repricing or repricing limits, and for longer-term borrowings, fair value is based on discounted cash flows using current market rates applied to the estimated life and considering credit risk. The valuation of impaired loans was described previously. Loan fair value estimates do not necessarily represent an exit price. Fair values of loans held for sale are based on market bids on the loans or similar loans. It was not practicable to determine the fair value of Federal Home Loan Bank stock due to restrictions placed on its transferability. For the FDIC indemnification asset the carrying value is the estimated fair value as it represents amounts to be received from the FDIC in the near term. Fair value of debt is based on current rates for similar financing. The fair value of off-balance sheet items is not considered material.

	June 30, 2013
	Carrying		Fair Value
(Dollar amounts in thousands)	Value		Level 1		Level 2		Level 3		Total

Cash and due from banks	$	73,720	$	17,946	$	55,774	$	-	$	73,720
Federal funds sold		10,215		-		10,215		-		10,215
Securities available—for—sale		837,047		470		821,898		14,679		837,047
Restricted stock		21,050		n/a		n/a		n/a		n/a
Loans, net		1,777,186		-				1,832,518		1,832,518
FDIC Indemnification Asset		1,515		-		1,515		-		1,515
Accrued interest receivable		11,046		-		3,171		7,875		11,046
Deposits		(2,279,505)		-		(2,282,242)		-		(2,282,242)
Short—term borrowings		(29,194)		-		(29,194)		-		(29,194)
Federal Home Loan Bank advances		(209,534)		-		(211,786)		-		(211,786)
Accrued interest payable		(924)		-		(924)		-		(924)

	December 31, 2012
	Carrying		Fair Value
(Dollar amounts in thousands)	Value		Level 1		Level 2		Level 3		Total
Cash and due from banks	$	87,230	$	21,333	$	65,897	$	-	$	87,230
Federal funds sold		20,800		-		20,800		-		20,800
Securities available—for—sale		691,000		380		674,587		16,033		691,000
Restricted stock		21,292		n/a		n/a		n/a		n/a
Loans, net		1,829,978		-		-		1,916,256		1,916,256
FDIC Indemnification Asset		2,632		-		2,632		-		2,632
Accrued interest receivable		12,024		-		2,980		9,044		12,024
Deposits		(2,276,134)		-		(2,280,910)		-		(2,280,910)
Short—term borrowings		(40,551)		-		(40,551)		-		(40,551)
Federal Home Loan Bank advances		(119,705)		-		(124,933)		-		(124,933)
Accrued interest payable		(1,163)		-		(1,163)		-		(1,163)