FAIR VALUE

6 Months Ended

Jun. 30, 2011

FAIR VALUE

FAIR VALUE

NOTE 8 — 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.

The fair value of impaired loans with specific allocations of the allowance for loan losses is generally 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 appraisers 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.

The fair value of servicing rights is based on a valuation model 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 Company is able to compare the valuation model inputs and results to widely available published industry data for reasonableness (Level 2 inputs).

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 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 (Level 3 inputs).

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 June 30, 2011 Using:
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
(Dollars in thousands)	Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets
Securities available-for sale
States and municipals	$	318,814			$	307,634	11,180
Mortgage-backed securities - residential	254,234				254,234
Collateralized mortgage obligations	253,446				253,446
Equity securities	4,405		3,655				750
Other securities	988		988
Total securities available-for-sale	$	831,887	$	4,643	$	815,314	$	11,930

			Fair Value Measurements at December 31, 2010 Using
	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
Securities available-for sale
States and municipals	$	300,144			$	300,144
Mortgage-backed securities - residential	312,831				312,831
Collateralized mortgage obligations	185,997				185,997
Equity securities	4,405		3,655				750
Other securities	2,694				824		1,870
Total securities available-for-sale	$	806,071	$	3,655	$	799,796	$	2,620

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 six month period ended June 30:

Six months ended June 30, 2011

	Available for sale securities
Beginning balance, January 1, 2011	$	2,620
Total gains or losses (realized / unrealized)
Included in earnings
Other changes in fair value	—
Gains (losses) on securities	—
Included in other comprehensive income	97
Purchases, issuances, and settlements	—
Transfers in and / or out of Level 3	9,213
Ending balance, June 30, 2011	$	11,930

The transfers out were securities that are being called by the issuer in the second quarter of 2011. The Company feels that the established call price is no longer indicative of a Level 3 value and thus transferred them to Level 1.  The transfers in were municipal securities that are no longer priced by our third party as of June 30, 2011 due to the smaller size lots of the issuers.  The Company continues to monitor these investments to insure there is no impairment.

Six months ended June 30, 2010

	Available for sale securities
Beginning balance, January 1, 2010	$	3,220
Total gains or losses (realized / unrealized)
Included in earnings
Other changes in fair value	—
Gains (losses) on securities	—
Included in other comprehensive income	261
Purchases, issuances, and settlements	—
Transfers in and / or out of Level 3	—
Ending balance, June 30, 2010	$	3,481

The table below summarizes changes in unrealized gains and losses recorded in earnings for the quarter ended June 30 for Level 3 assets and liabilities that are still held at June 30.

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 June 30, 2011 Using
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans
Construction and development	$	1,636			1,636
Commercial real estate	9,142				9,142
Hotel	5,389				5,389
Commercial and industrial loans	2,562				2,562
Other	333				333
Total impaired loans	19,062				19,062
Other real estate owned/assets held for sale	4,355				4,355

		Fair Value Measurements at December 31, 2010 Using
	Carrying Value	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	3,149			3,149
Farm	394			394
Hotel	11,452			11,452
Construction and development	14,503			14,503
Other	16,219			16,219
Total impaired loans	45,717			45,717
Servicing rights	5,498		5,498
Other real estate owned/assets held for sale	3,085			3,085

The following represent 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 gross carrying amount of $26,008, with a valuation allowance of $6,946 at June 30, 2011.  The Company recorded $1,412 of provision expense associated with these loans for the three months ended June 30, 2011 and $3,839 of provision expense associated with these loans for the six months ended June 30, 2011.  At December 31, 2010, impaired loans had a gross carrying amount of $56,041 with a valuation allowance of $10,324.  The Company recorded $7,877 of provision expense associated with these loans for the three month period ended June 30, 2010, and recorded $12,521 of provision expense for the six month period ended June 30, 2010. 

At December 31, 2010, servicing rights were carried at a fair value of $5,498, which is made up of the gross outstanding balance of $5,992, net of a valuation allowance of $494.  A $205 charge was included in the second quarter 2010 earnings and a $95 charge was included in the first six months 2010 earnings. 

Other real estate owned/assets held for sale is evaluated at the time a property is acquired through foreclosure or shortly thereafter.  Fair value is based on appraisals by qualified licensed appraisers.  At June 30, 2011, other real estate owned was carried at a fair value of $4,355, which is made up of the gross outstanding balance of $6,071, net of a valuation allowance of $1,716.  During the second quarter of 2011, these properties were written down by $228.  For the first six months of 2011, these properties were written down by $737.  No charges were taken in the three or six month periods ended June 30, 2010.

The following table presents the carrying amounts and estimated fair values of financial instruments at June 30, 2011 and December 31, 2010:

	June 30, 2011				December 31, 2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets
Cash and cash equivalents	$	151,208	$	151,208	$	60,123	$	60,123
Securities available-for-sale	831,887		831,887		806,071		806,071
Restricted stock	17,311		N/A		19,502		N/A
Loans, net including loans held for sale	1,559,502		1,533,338		1,598,494		1,584,631
Interest receivable	11,380		11,380		11,552		11,552
Financial liabilities
Deposits	2,243,646		2,247,212		2,211,564		2,214,778
Other borrowings	40,808		40,808		33,181		33,181
Subordinated debentures	50,192		26,605		50,117		26,565
FHLB advances	141,692		152,108		152,065		163,498
Interest payable	2,448		2,448		3,391		3,391

The difference between the loan balance included above and the amounts shown in Note 4 are the impaired loans discussed above.

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

Carrying amount is the estimated fair value of cash and cash equivalents, interest-bearing time deposits, accrued interest receivable and payable, demand and all other transactional deposits, short-term borrowings, variable rate notes payable, and variable rate loans or deposits that reprice frequently and fully.  For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair value of loans held for sale is based on market quotes. Fair value of FHLB advances and subordinated debentures is based on current rates for similar financing.  It is not practicable to determine the fair value of FHLB stock 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, and are not considered significant.