8. Fair Value Measurements and Disclosures:

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Available for sale securities are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record other assets at fair value on a non-recurring basis, such as impaired loans and ORE. These non-recurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. Additionally, the Company is required to disclose, but not record, the fair value of other financial instruments.

Fair Value Hierarchy

The Company groups assets and liabilities 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. These levels are:

Level 1—Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2—Valuation is based upon quoted market 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 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 the use of option pricing models, discounted cash flow models and similar techniques.

Following is a description of valuation methodologies used to determine the fair value of financial assets and liabilities.

Cash and Due from Banks

The carrying amount shown as cash and due from banks approximates fair value.

Available for Sale Securities

The fair value of available for sale securities is based on quoted market prices. The Company’s available for sale securities are reported at their estimated fair value, which is determined utilizing several sources. The primary source is Interactive Data Corporation, which utilizes pricing models that vary based on asset class and include available trade, bid and other market information and whose methodology includes broker quotes, proprietary models and vast descriptive databases. The other source for determining fair value is matrix pricing, which is a mathematical technique used widely 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 securities. All of the Company’s available for sale securities are Level 2 assets.

Held to Maturity Securities

The fair value of held to maturity securities is based on quoted market prices.

Other Investments

The carrying amount shown as other investments approximates fair value.

Federal Home Loan Bank Stock

The carrying amount shown as Federal Home Loan Bank Stock approximates fair value.

Loans

The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings for the remaining maturities. The cash flows considered in computing the fair value of such loans are segmented into categories relating to the nature of the contract and collateral based on contractual principal maturities. Appropriate adjustments are made to reflect probable credit losses. Cash flows have not been adjusted for such factors as prepayment risk or the effect of the maturity of balloon notes. The fair value of floating rate loans is estimated to be its carrying value. At each reporting period, the Company determines which loans are impaired. Accordingly, the Company’s impaired loans are reported at their estimated fair value on a non-recurring basis. An allowance for each impaired loan, which are generally collateral-dependent, is calculated based on the fair value of its collateral. The fair value of the collateral is based on appraisals performed by third-party valuation specialists. Factors including the assumptions and techniques utilized by the appraiser are considered by Management. If the recorded investment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses. When the fair value of the collateral is based on an observable market price, the Company records the impaired loan as a non-recurring Level 2 asset. When an appraised value is not available or Management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as a non-recurring Level 3 asset.

Other Real Estate

In the course of lending operations, Management may determine that it is necessary to foreclose on the related collateral. Other real estate acquired through foreclosure is carried at fair value, less estimated costs to sell. The fair value of the collateral is based on appraisals performed by third-party valuation specialists. Factors including the assumptions and techniques utilized by the appraiser are considered by Management. If the current appraisal is more than one year old and/or the loan balance is more than $200,000, a new appraisal is obtained. Otherwise, the Bank’s in-house property evaluator and Management will determine the fair value of the collateral, based on comparable sales, market conditions, Management’s plans for disposition and other estimates of fair value obtained from principally independent sources, adjusted for estimated selling costs. When the fair value of the property is based on observable market price, the Company records the other real estate as a non-recurring Level 2 asset. When an appraised value is not available or Management determines the fair value of the other real estate is further impaired below the appraised value and there is no observable market price, the Company records the other real estate as a non-recurring Level 3 asset.

Cash Surrender Value of Life Insurance

The carrying amount of cash surrender value of bank-owned life insurance approximates fair value.

Deposits

The fair value of non-interest bearing demand and interest bearing savings and demand deposits is the amount reported in the financial statements. The fair value of time deposits is estimated by discounting the cash flows using current rates of time deposits with similar remaining maturities. The cash flows considered in computing the fair value of such deposits are based on contractual maturities, since approximately 98% of time deposits provide for automatic renewal at current interest rates.

Federal Funds Purchased and Securities Sold under Agreements to Repurchase

The carrying amount shown as federal funds purchased and securities sold under agreements to repurchase approximates fair value.

Borrowings from Federal Home Loan Bank

The fair value of FHLB fixed rate borrowings is estimated using discounted cash flows based on current incremental borrowing rates for similar types of borrowing arrangements. The Company has no FHLB variable rate borrowings.

Commitments to Extend Credit and Standby Letters of Credit

Because commitments to extend credit and standby letters of credit are generally short-term and at variable rates, the contract value and estimated value associated with these instruments are immaterial.

The balances of available for sale securities, which are the only assets measured at fair value on a recurring basis, by level within the fair value hierarchy and by investment type, as of June 30, 2013 and December 31, 2012 are as follows (in thousands):


			Fair Value Measurements Using
	Total		Level 1	Level 2		Level 3
June 30, 2013:
U.S. Treasuries	$	43,106	$	$	43,106	$
U.S. Government agencies		160,167			160,167
Mortgage-backed securities		41,865			41,865
States and political subdivisions		36,530			36,530
Equity securities		650			650

Total	$	282,318	$	$	282,318	$

December 31, 2012:
U.S. Treasuries	$	54,096	$	$	54,096	$
U.S. Government agencies		149,098			149,098
Mortgage-backed securities		17,441			17,441
States and political subdivisions		37,591			37,591
Equity securities		650			650

Total	$	258,876	$	$	258,876	$

Impaired loans, which are measured at fair value on a non-recurring basis, by level within the fair value hierarchy as of June 30, 2013 and December 31, 2012 are as follows (in thousands):


			Fair Value Measurements Using
	Total		Level 1	Level 2	Level 3
June 30, 2013	$	26,791	$	$	$	26,791
December 31, 2012		16,030				16,030

The following table presents a summary of changes in the fair value of impaired loans which are measured using level 3 inputs (in thousands):


	For the six			For the Year
	Months Ended			Ended
	June 30, 2013			December 31, 2012
Balance, beginning of period	$	16,030		$	14,770
Additions to impaired loans and troubled debt restructurings		15,904			2,960
Principal payments, charge-offs and transfers to other real estate		(1,614	)		(1,654	)
Change in allowance for loan losses on impaired loans		(3,529	)		(46	)

Balance, end of period	$	26,791		$	16,030

Other real estate, which is measured at fair value on a non-recurring basis, by level within the fair value hierarchy as of June 30, 2013 and December 31, 2012 are as follows (in thousands):


			Fair Value Measurements Using
	Total		Level 1	Level 2	Level 3
June 30, 2013	$	6,825	$	$	$	6,825
December 31, 2012		7,008				7,008

The following table presents a summary of changes in the fair value of other real estate which is measured using level 3 inputs (in thousands):


	For the Six			For the Year
	Months Ended			Ended
	June 30, 2013			December 31, 2012
Balance, beginning of period	$	7,008		$	6,153
Loans transferred to ORE		416			2,576
Sales		(520	)		(1,568	)
Writedowns		(22	)		(153	)
Insurance proceeds for casualty loss		(57	)

Balance, end of period	$	6,825		$	7,008

The carrying value and estimated fair value of assets and liabilities, by level within the fair value hierarchy, at June 30, 2013 and December 31, 2012, are as follows (in thousands):


	Carrying		Fair Value Measurements Using
	Amount		Level 1		Level 2		Level 3		Total
June 30, 2013:
Financial Assets:
Cash and due from banks	$	52,338	$	52,338	$		$		$	52,338
Available for sale securities		282,318				282,318				282,318
Held to maturity securities		9,732				9,278				9,278
Other investments		3,229		3,229						3,229
Federal Home Loan Bank stock		651				651				651
Loans, net		390,948						397,561		397,561
Other real estate		6,825						6,825		6,825
Cash surrender value of life insurance		17,163						17,163		17,163
Financial Liabilities:
Deposits:
Non-interest bearing		120,365		120,365						120,365
Interest bearing		360,240						362,902		362,902
Federal funds purchased and securities sold under agreements to repurchase		191,371		191,371						191,371
Borrowings from Federal Home Loan Bank		7,799				9,725				9,725
December 31, 2012:
Financial Assets:
Cash and due from banks	$	54,020	$	54,020	$		$		$	54,020
Available for sale securities		258,876				258,876				258,876
Held to maturity securities		7,125				7,225				7,225
Other investments		3,450		3,450						3,450
Federal Home Loan Bank stock		2,380				2,380				2,380
Loans, net		422,226						425,627		425,627
Other real estate		7,008						7,008		7,008
Cash surrender value of life insurance		16,861						16,861		16,861
Financial Liabilities:
Deposits:
Non-interest bearing		102,609		102,609						102,609
Interest bearing		373,110						376,209		376,209
Federal funds purchased and securities sold under agreements to repurchase		194,234		194,234						194,234
Borrowings from Federal Home Loan Bank		7,912				10,271				10,271