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Fair Value Measurements

3 Months Ended

Mar. 31, 2012

Note 8: Fair Value Measurements

The Company records fair value adjustments to certain assets and liabilities and determines fair value disclosures utilizing a definition of fair value of assets and liabilities that states that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Additional considerations come into play in determining the fair value of financial assets in markets that are not active.

The Company uses a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy based on these two types of inputs are as follows:

	Level 1 –		Valuation is based on quoted prices in active markets for identical assets and liabilities.
	Level 2 –		Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
	Level 3 –		Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:

Securities Available for Sale

Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). The carrying value of restricted Federal Reserve Bank and Federal Home Loan Bank stock approximates fair value based upon the redemption provisions of each entity and is therefore excluded from the following table.

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis:

			Fair Value Measurements at March 31, 2012 Using
Description	Balance as of March 31, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. Treasury	$	2,128	$	---	$	2,128	$	---
U.S. Government agencies and corporations		118,564		---		118,564		---
States and political subdivisions		48,819		---		48,819		---
Mortgage-backed securities		6,582		---		6,582		---
Corporate debt securities		18,438		---		18,438		---
Other securities		2,127		---		2,127		---
Total securities available for sale	$	196,658	$	---	$	196,658	$	---

			Fair Value Measurements at December 31, 2011 Using
Description	Balance as of December 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. Treasury	$	2,150	$	---	$	2,150	$	---
U.S. Government agencies and corporations		96,003		---		96,003		---
States and political subdivisions		49,122		---		49,122		---
Mortgage-backed securities		7,725		---		7,725		---
Corporate debt securities		16,077		---		16,077		---
Other securities		2,175		---		2,175		---
Total securities available for sale	$	173,252	$	---	$	173,252	$	---

Certain financial assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain financial assets recorded at fair value on a nonrecurring basis in the financial statements:

Loans Held for Sale

Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale at March 31, 2012 or December 31, 2011. Gains and losses on the sale of loans are recorded within income from mortgage banking on the Consolidated Statements of Income.

Impaired Loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that the Company will be unable to collect all the contractual interest and principal payments as scheduled in the loan agreement. Troubled debt restructurings are impaired loans. The measurement of loss associated with impaired loans may be based on either the observable market price of the loan, the present value of the expected cash flows or the fair value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction, if an appraisal of the real estate property is over 12 months old or if the real estate market is considered by management to be experiencing volatility, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal using observable market data, if the collateral is

deemed significant. If the collateral is not deemed significant, the value of business equipment is based on the net book value on the borrower’s financial statements. Likewise, values for inventory and accounts receivables collateral are based on the borrower’s financial statement balances or aging reports (Level 3). Estimated losses on impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

The following table summarizes the Company’s impaired loans that were measured at fair value on a nonrecurring basis at March 31, 2012 and at December 31, 2011.

					Carrying Value
Date	Description	Balance			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
	Assets:
March 31, 2012	Impaired loans net of valuation allowance		$	2,461		$	---		$	---		$	2,461
December 31, 2011	Impaired loans net of valuation allowance			5,968			---			---			5,968

The following table summarizes the activity in Company’s impaired loans that were valued using Level 3 inputs for the three months ended March 31, 2012.

	Carrying Value, December 31, 2011		Additions		Deletions due to Foreclosure			Change in Balance (1)			Impaired Loans Removed from Level 3 (2)			Carrying Value, March 31, 2012
Impaired loans
Principal balance	$	7,091	$	726	$	(423	)	$	(34	)	$	(4,306	)	$	3,054
Impairment allocation		1,123		120		(322	)		(87	)		(241	)		593
Net impaired loans	$	5,968	$	606	$	(101	)	$	53		$	(4,065	)	$	2,461

(1) The reported amounts represent changes in the balance due to principal payments by borrowers and reductions in impairment measurements as a result of current valuation procedures.

(2) The reported amount represents loans that were valued using Level 3 inputs as of December 31, 2011 that no longer have impairment allocations under Level 3 valuation.

Impaired loans are measured quarterly for impairment. The Company employs the most applicable valuation method for each loan based on current information at the time of valuation. The valuation procedures for the first quarter of 2012 resulted in changes to valuation method from collateral-based to the present value of cash flows for certain loans, and resulted in reduced allocations for certain loans. The impaired loans removed from Level 3 as well as the change in balance for impairment allocation summarized above reflect the change in valuation method and allocation for these loans.

Certain loans were removed from impaired Level 3 due to foreclosure. None of the foreclosures resulted in increases to the Company’s other real estate owned, as the loans were either unsecured or secured by properties that were purchased by third parties at auction.

The following table presents information about Level 3 Fair Value Measurements for March 31, 2012:

	Valuation Technique	Unobservable Input	Range (Weighted Average)
Impaired loans	Discounted appraised value	Selling cost	5% - 25% (14%)
Impaired loans	Discounted appraised value	Discount for lack of marketability and age of appraisal	0% - 50% (9%)
Impaired loans	Present value of cash flows	Discount rate	6.0% - 7.5% (6.2%)

Other Real Estate Owned

Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell.

The following table summarizes the Company’s other real estate owned that was measured at fair value on a nonrecurring basis at March 31, 2012 and at December 31, 2011.

					Carrying Value
Date	Description	Balance			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
	Assets:
March 31, 2012	Other real estate owned net of valuation allowance		$	940		$	---		$	---		$	940
December 31, 2011	Other real estate owned net of valuation allowance			1,489			---			---			1,489

The following table summarizes the activity in the Company’s other real estate owned that were valued using Level 3 inputs for the three months ended March 31, 2012

		Carrying Value, December 31, 2011				Additions				Sale of Property				Increase to Valuation Allowance				Carrying Value, March 31, 2012
Other real estate owned		$	1,489			$	---			$	(543	)		$	(6	)		$	940

The following table presents information about Level 3 Fair Value Measurements for March 31, 2012:

	Valuation Technique	Unobservable Input	Range (Weighted Average)
Other Real Estate Owned	Discounted appraised value	Selling cost	5% - 10% (6%)
Other Real Estate Owned	Discounted appraised value	Discount for lack of marketability and age of appraisal	0% - 22.57% (8.87%)

The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:

Cash and Due from Banks, Interest-Bearing Deposits, and Federal Funds Sold

The carrying amounts approximate fair value.

Securities

The fair value of securities, excluding restricted stock, is determined by quoted market prices or dealer quotes. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations, so fair value estimates are based on quoted market prices of similar instruments adjusted for differences between the quoted instruments and the instruments being valued. The carrying value of restricted securities approximates fair value based upon the redemption provisions of the applicable entities.

Loans Held for Sale

The fair value of loans held for sale is based on commitments on hand from investors or prevailing market prices.

Loans

Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, real estate – commercial, real estate – construction, real estate – mortgage, credit card and other consumer loans. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories.

The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan, as well as estimates for prepayments. The estimate of maturity is based on the Company’s historical experience with repayments for loan classification, modified, as required, by an estimate of the effect of economic conditions on lending.

Fair value for significant nonperforming loans is based on estimated cash flows which are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and discount rates are determined within management’s judgment, using available market information and specific borrower information.

Deposits

The fair value of demand and savings deposits is the amount payable on demand. The fair value of fixed maturity term deposits and certificates of deposit is estimated using the rates currently offered for deposits with similar remaining maturities.

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

Commitments to Extend Credit and Standby Letters of Credit

The only amounts recorded for commitments to extend credit, standby letters of credit and financial guarantees written are the deferred fees arising from these unrecognized financial instruments. These deferred fees are not deemed significant at March 31, 2012 and December 31, 2011, and, as such, the related fair values have not been estimated.

The estimated fair values, and related carrying amounts, of the Company’s financial instruments are as follows:

	March 31, 2012
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets Level 1		Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3		Total Estimated Fair Value
Financial assets:
Cash and due from banks	$	12,241	$	12,241					$	12,241
Interest-bearing deposits		101,301		101,301						101,301
Securities		337,713				345,855				345,855
Mortgage loans held for sale		1,371				1,371				1,371
Loans, net		576,501				570,495		2,461		572,956
Accrued interest receivable		6,175				6,175				6,175
BOLI		19,991				19,991				19,991
Financial liabilities:
Deposits	$	931,792			$	926,706			$	926,706
Accrued interest payable		191				191				191

	December 31, 2011
	Carrying Amount		Estimated Fair Value
Financial assets:
Cash and due from banks	$	11,897	$	11,897
Interest-bearing deposits		98,355		98,355
Securities		318,913		326,347
Mortgage loans held for sale		2,623		2,623
Loans, net		580,402		572,357
Accrued interest receivable		6,304		6,304
BOLI		19,812		19,812
Financial liabilities:
Deposits	$	919,333		913,882
Accrued interest payable		206		206

- Definition

This element represents the disclosure related to the fair value measurement of assets and liabilities which includes [financial] instruments measured at fair value that are classified in stockholders' equity. Such assets and liabilities may be measured on a recurring or nonrecurring basis. The disclosures which may be required or desired include: (1) for assets and liabilities measured on a recurring basis, disclosure may include: (a) the fair value measurements at the reporting date; (b) the level within the fair value hierarchy in which the fair value measurements in their entirety fall, segregating fair value measurements using quoted prices in active markets for identical assets or liabilities (Level 1), significant other observable inputs (Level 2), and significant unobservable inputs (Level 3); (c) for fair value measurements using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances, separately presenting changes during the period attributable to the following: (i) total gains or losses for the period (realized and unrealized), segregating those gains or losses included in earnings (or changes in net assets), and a description of where those gains or losses included in earnings (or changes in net assets) are reported in the statement of income (or activities); (ii) purchases, sales, issuances, and settlements (net); (iii) transfers in and transfers out of Level 3 (for example, transfers due to changes in the observability of significant inputs); (d) the amount of the total gains or losses for the period in subparagraph (c) (i) above included in earnings (or changes in net assets) that are attributable to the change in unrealized gains or losses relating to those assets and liabilities still held at the reporting date and a description of where those unrealized gains or losses are reported in the statement of income (or activities); (e) the valuation technique(s) used to measure fair value and a discussion of changes in valuation techniques, if any, during the period and (2) for assets and liabilities that are measured at fair value on a nonrecurring basis (for example, impaired assets) disclosure may include, in addition to (a) above: (a) the reasons for the fair value measurements recorded; (b) the same as (b) above; (c) for fair value measurements using significant unobservable inputs (Level 3), a description of the inputs and the information used to develop the inputs; and (d) the valuation technique(s) used to measure fair value and a discussion of changes, if any, in the valuation technique(s) used to measure similar assets and/or liabilities in prior periods.

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