NOTE 7 — FAIR VALUE

ASC 820 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) for 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 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: 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 values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or using market data utilizing pricing models, primarily Interactive Data Corporation ("IDC"), that vary based upon asset class and include available trade, bid, and other market information. Matrix pricing is used for most municipals, 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. The grouping of securities is done according to insurer, credit support, state of issuance, and rating to incorporate additional spreads and municipal curves. For the general market municipals, the Thomson Municipal Market Data curve is used to determine the initial curve for determining the price, movement, and yield relationships with the municipal market (Level 2 inputs). Level 3 securities are largely comprised of small, local municipality issuances. Fair values are derived through consideration of funding type, maturity and other features of the issuance, and include reviewing financial statements, earnings forecasts, industry trends and the valuation of comparative issuers. In most cases, the book value of the security is used as the fair value as meaningful pricing data is not readily available. Twice a year, a sample of prices supplied by the pricing agent is validated by comparison to prices obtained from other third party sources.

The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals or industry accepted valuation methods and excludes loans evaluated under the present value of cash flows. In a limited number of situations, the Company's appraisal department is determining the value of appraisal. 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 loan officers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. These adjustments typically range from 0%-50%. Impaired loans are evaluated quarterly for additional impairment and take into account changing market conditions, specific information in the market the property is located, and the overall economic climate as well as overall changes in the credit. The Company's Appraisal Manager has the overall responsibility for all appraisals. The Company's loan officer responsible for the loan, the special assets officer, as well as the senior officers of the Company review the adjustments made to the appraisal for market and disposal costs on the loan.

The fair value of servicing rights is based on a valuation model from a 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. The inputs used include estimates of prepayment speeds, discount rate, cost to service, contractual servicing fee income, late fees, and float income. The most significant assumption used to value mortgage servicing rights is prepayment rate. Prepayment rates are estimated based on published industry consensus prepayment rates. The most significant unobservable assumption is the discount rate. At December 31, 2014 the constant prepayment speed (PSA) used was 190 and the discount rate was 10.0%. At December 31, 2013 the constant prepayment speed (PSA) used was 174 and the discount rate was 10.0%. The Company is able to compare the valuation model inputs and results to widely available published industry data for reasonableness (Level 3 inputs). On a quarterly basis, loan servicing rights are evaluated for impairment based upon the fair value of the rights as compared to carrying amount. If the carrying amount of an individual tranche exceeds fair value, impairment is recorded on that tranche so that the servicing asset is carried at fair value. Fair value is determined at a tranche level, based on market prices for comparable mortgage servicing contracts, when available, or alternatively based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model utilizes assumptions that market participants would use in estimating future net servicing income and that can be validated against available market data.

The fair value of other real estate owned is measured based on the value of the collateral securing those assets and is determined using several methods. The fair value of real estate is generally determined based on appraisals by qualified licensed (third party) appraisers. The appraisers typically determine the value of the real estate by utilizing an income or market valuation approach. If an appraisal is not available, the fair value may be determined by using a cash flow analysis. Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers whose qualifications and licenses have been reviewed and verified by the Company. Once received, a member of the Appraisal Department 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. Fair values are reviewed on at least an annual basis. The Company normally applies an internal discount to the value of appraisals used in the fair value evaluation of OREO. The deductions take into account changing business factors and market conditions. These deductions range from 0% to 50%. As noted in the impaired loans discussion above, the Company's Appraisal Manager has the overall responsibility for all appraisals. The Appraisal Manager reports to the Vice President of Credit Administration who reports to the Chief Credit Officer of the Company.

The fair value of mortgage banking derivatives are based on derivative valuation models using market data inputs as of the valuation date (Level 2). The mortgage banking derivative is classified as Interest receivable and other assets on the balance sheet.

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value under ASC 820 on a recurring basis, including financial assets and liabilities for which the Company has elected the fair value option, are summarized below:

			Fair Value Measurements at December 31, 2014 Using:
(Dollars in thousands)	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Financial Assets
Investment securities available-for-sale
U. S. government agency	$	661			$	661
States and municipal		334,298				321,488	$	12,810
Mortgage-backed securities — residential — Government Sponsored Entity		182,172				182,172
Collateralized mortgage obligations — Government Sponsored Entity		343,437				343,437
Equity securities		4,689	$	4,689
Other securities		2,503						2,503

Total investment securities available-for-sale	$	867,760	$	4,689	$	847,758	$	15,313


Mortgage banking derivatives	$	975			$	975

			Fair Value Measurements at December 31, 2013 Using:
(Dollars in thousands)	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Financial Assets
Investment securities available-for-sale
U. S. government agency	$	798			$	798
States and municipal		331,112				316,692	$	14,420
Mortgage-backed securities — residential — Government Sponsored Entity		185,429				185,429
Collateralized mortgage obligations — Government Sponsored Entity		365,309				365,309
Equity securities		4,939	$	4,689				250
Other securities		3,519				993		2,526

Total investment securities available-for-sale	$	891,106	$	4,689	$	869,221	$	17,196


Mortgage banking derivatives	$	525			$	525

There have been no transfers between Level 1 and 2 during the two years ending December 31, 2014 and 2013.

The tables below present 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 years ended December 31, 2014 and 2013:

States and municipal	2014			2013

Beginning balance, January 1	$	14,420		$	15,470
Total gains or losses (realized / unrealized)
Included in other comprehensive income		5			(99	)
Settlements		(1,615	)		(951	)

Ending balance, December 31	$	12,810		$	14,420

Equity securities	2014			2013

Beginning balance, January 1	$	250		$	250
Total gains or losses (realized / unrealized)
Settlements		(250	)		—

Ending balance, December 31	$	—		$	250

Other securities	2014			2013

Beginning balance, January 1	$	2,526		$	2,557
Total gains or losses (realized / unrealized)
Included in other comprehensive income		(23	)		(31	)

Ending balance, December 31	$	2,503		$	2,526

The Company's state and municipal security valuations were supported by analysis prepared by an independent third party. Fair values are derived through consideration of funding type, maturity and other features of the issuance, and include reviewing financial statements, earnings forecasts, industry trends and the valuation of comparative issuers.

The Company's equity security valuation was supported by an analysis prepared by the Company's Investments Manager. Fair value is derived through consideration of funding type, maturity and other features of the issuance, and includes reviewing financial statements, earnings forecasts, industry trends and the valuation of comparative issuers.

The Company's other security valuation was supported by analysis prepared by an independent third party. Fair values are derived through consideration of funding type, maturity and other features of the issuance, and include reviewing financial statements, earnings forecasts, industry trends and the valuation of comparative issuers.

Assets and Liabilities Measured on a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

			Fair Value Measurements at December 31, 2014 Using:
	December 31, 2014		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)

Assets:
Impaired loans
Commercial and industrial	$	—			$	—
Agricultural		—				—
Farm real estate		55				55
Other real estate		1,235				1,235

Total impaired loans	$	1,290			$	1,290
Impaired servicing rights	$	1,854			$	1,854
Other real estate owned
Construction and development	$	21			$	21
Other real estate		291				291
1-4 Family		150				150

	$	462			$	462

			Fair Value Measurements at December 31, 2013 Using:
	December 31, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)

Assets:
Impaired loans
Commercial and industrial	$	76			$	76
Farm real estate		375				375
Other real estate		5,112				5,112
1-4 Family		226				226

Total impaired loans	$	5,789			$	5,789
Impaired servicing rights	$	1,794			$	1,794
Other real estate owned
Construction and development	$	522			$	522
Other real estate		425				425
Home equity		67				67

	$	1,014			$	1,014

The following represents impairment charges recognized during the period:

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a recorded investment of $2,056, with a valuation allowance of $766, resulting in an additional provision for loan losses of $181 in 2014. A breakdown of these loans by portfolio class is as follows:

	Recorded Investment		Valuation Allowance		Net

Commercial and industrial	$	12	$	12	$	—
Agricultural		150		150		—
Farm real estate		76		21		55
Other real estate		1,818		583		1,235

Ending Balance	$	2,056	$	766	$	1,290

At December 31, 2013, impaired loans had a recorded investment of $6,879, with a valuation allowance of $1,090, resulting in an additional provision for loan losses of $432 for the year ending December 31, 2013.

Impaired tranches of servicing rights were carried at a fair value of $1,854, which is made up of the gross outstanding balance of $2,254, net of a valuation allowance of $400. A charge of $25 was included in 2014 earnings. In 2013, impaired servicing rights were written down to a fair value of $1,794, which was made up of the gross outstanding balance was $2,169, net of a valuation allowance of $375. A recovery of $750 was included in 2013 earnings.

Other real estate owned/assets held for sale is evaluated at the time a property is acquired through foreclosure or moved to held for sale or shortly thereafter. Fair value is based on appraisals by qualified licensed appraisers. At December 31, 2014, the fair value is made up of the gross outstanding balance of $697, net a valuation allowance of $235. At December 31, 2013, the fair value is made up of the gross outstanding balance of $1,362, net a valuation allowance of $348. During 2014, these properties were written down by $121 which was included in 2014 earnings. During 2013, these properties were written down by $175 which was included in 2013 earnings. A breakdown of these properties by portfolio class at December 31, 2014 is as follows:

	Gross Balance		Valuation Allowance		Net

Construction and development	$	30	$	9	$	21
Other real estate		466		175		291
1-4 Family		201		51		150

Ending Balance	$	697	$	235	$	462

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2014 and 2013. Impaired commercial, commercial real estate loans, and other real estate owned that are deemed collateral dependent are valued based on the fair value of the underlying collateral. These estimates are based on the most recently available appraisals with certain adjustments made based on the type of property, age of appraisal, current status of the property and other related factors to estimate the current value of the collateral.

December 31, 2014	Fair Value (in thousands)		Valuation Technique(s)	Unobservable Input(s)	Range/ Average

Impaired Loans:
Farm real estate	$	55	Sales comparison approach	Adjustment for differences between comparable sales	40% 40% Avg
Other		1,235	Sales comparison approach	Adjustment for differences between comparable sales, type of property, current status of property	20%-45% 36% Avg

	$	1,290
Other real estate owned:
Construction and development	$	21	Sales comparison approach	Adjustment for differences between comparable sales.	15% 15% Avg
Other and 1-4 Family		441	Sales comparison approach	Adjustment for differences between comparable sales.	10%-19% 11% Avg

	$	462
Mortgage servicing rights	$	1,854	Cash flow analysis	Discount rate	10%

December 31, 2013	Fair Value (in thousands)	Valuation Technique(s)	Unobservable Input(s)	Range/ Average

Impaired Loans:
Commercial & industrial	$ 76	Sales comparison approach	Adjustment for differences between comparable sales	0%-10% 10% Avg
Farm real estate	375	Sales comparison approach	Adjustment for differences between comparable sales	40% 40% Avg
Other/1-4 Family	5,338 $5,789	Sales comparison approach	Adjustment for differences between comparable sales, type of property, current status of property	0%-40% 25% Avg
Other real estate owned:
Construction and development	$ 522	Sales comparison approach	Adjustment for differences between comparable sales.	10% 10% Avg
Other and Home equity	492 $1,014	Sales comparison approach	Adjustment for differences between comparable sales.	10%-15% 10% Avg
Mortgage servicing rights	$1,794	Cash flow analysis	Discount rate	10%

Carrying amount and estimated fair values of financial instruments, not previously presented, at year end were as follows:

December 31, 2014	Carrying Amount			Level 1			Level 2			Level 3		Total

Assets
Cash and cash equivalents	$	62,485		$	60,662		$	1,823				$	62,485
Interest bearing time deposits		1,915						1,915					1,915
Loans including loans held for sale, net		1,941,507						8,514		$	1,946,843		1,955,357
FHLB and other stock		13,854											N/A
Interest receivable		10,064						4,459			5,605		10,064
Liabilities
Deposits		(2,468,321	)		(513,393	)		(1,952,833	)				(2,466,226	)
Other borrowings		(26,349	)					(26,349	)				(26,349	)
FHLB advances		(214,413	)					(219,050	)				(219,050	)
Interest payable		(599	)					(599	)				(599	)
Subordinated debentures		(41,239	)					(24,212	)				(24,212	)

December 31, 2013	Carrying Amount			Level 1			Level 2			Level 3		Total

Assets
Cash and cash equivalents	$	61,320		$	55,826		$	5,494				$	61,320
Loans including loans held for sale, net		1,644,527						6,158		$	1,657,199		1,663,357
FHLB and other stock		15,629											N/A
Interest receivable		9,706						4,573			5,133		9,706
Liabilities
Deposits		(2,200,628	)		(436,550	)		(1,764,719	)				(2,201,269	)
Other borrowings		(38,594	)					(38,594	)				(38,594	)
FHLB advances		(247,858	)					(252,402	)				(252,402	)
Interest payable		(799	)					(799	)				(799	)
Subordinated debentures		(46,394	)					(23,130	)				(23,130	)

The difference between the loan balance included above and the amounts shown in Note 5 are the impaired loans discussed above.

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

(a) Cash and Cash Equivalents

The carrying amounts of cash, short-term instruments, and interest bearing time deposits approximate fair values and are classified as either Level 1 or Level 2. Noninterest bearing deposits are Level 1 whereas interest bearing due from bank accounts and fed funds sold are Level 2.

(b) FHLB and other stock

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

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. Loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

(d) Deposits

The fair values disclosed for non-interest bearing deposits are equal to the amount payable on demand at the reporting date resulting in a Level 1 classification. The carrying amounts of variable rate interest bearing deposits approximate their fair values at the reporting date resulting in a Level 2 classification. Fair values for fixed rate interest bearing deposits are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

(e) Other Borrowings

The fair values of the Company's FHLB advances are estimated using discounted cash flow analyses based on the current borrowing rates 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 2 classification.

The fair values of the Company's Other borrowings are estimated using discounted cash flow analyses based on current borrowing rates resulting in a Level 2 classification.

(f) Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification based on the level of the asset or liability with which the accrual is associated.