FAIR VALUE OF FINANCIAL INSTRUMENTS

9 Months Ended

Sep. 30, 2011

Fair Value Disclosures [Abstract]

FAIR VALUE

NOTE 2 – FAIR VALUE

The measurement of fair value under US GAAP uses a hierarchy intended to maximize the use of observable inputs and minimize the use of unobservable inputs.  This hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as follows:

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, and other inputs that are observable or can be corroborated by observable market data.

Level 3:  Significant, unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The following is a description of the Company’s valuation methodologies used to measure and disclose the fair values of its financial assets and liabilities on a recurring or nonrecurring basis:

Securities Available For Sale:  Securities classified as available for sale are reported at fair value utilizing Level 2 inputs.  For these securities, the Company obtains fair value measurements using pricing models that vary based on asset class and include available trade, bid and other market information.  Fair value of securities available for sale may also be determined by 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 quoted securities.

Impaired Loans:  Impaired loans with specific allocations of the allowance for loan losses are reported at the fair value of the underlying collateral adjusted for selling costs or the present value of estimated future cash flows using the loans’ effective rate at inception.  Collateral values are estimated using Level 3 inputs based on third party appraisals.

Mortgage Servicing Rights:  Fair value is based on market prices for comparable mortgage servicing contracts.

Other Real Estate Owned:  Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (“OREO”) are measured at fair value, less costs to sell. Fair

values are based on recent real estate appraisals. These appraisals may use 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 independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Assets and Liabilities Measured on a Recurring Basis

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

	Fair Value Measurements at September 30, 2011, Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable  Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
U.S. Treasury securities		----	$	14,533		----
U.S. Government sponsored entity securities		----		2,589		----
Obligations of states and political subdivisions		----		677		----
Agency mortgage-backed securities, residential		----		68,242		----

	Fair Value Measurements at December 31, 2010, Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable  Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
U.S. Treasury securities		----	$	17,079		----
U.S. Government sponsored entity securities		----		7,731		----
Agency mortgage-backed securities, residential		----		61,029		----

Assets and Liabilities Measured on a Nonrecurring Basis

Assets and liabilities measured at fair value on a nonrecurring basis are summarized below:

	Fair Value Measurements at September 30, 2011, Using
	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:
Commercial real estate-nonowner occupied		----		----	$	2,000
Mortgage servicing rights		----		----		408
Other real estate owned		----		----		3,734

	Fair Value Measurements at December 31, 2010, Using
	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:
Commercial real estate-owner occupied		----		----	$	3,606
Commercial real estate-nonowner occupied		----		----		2,187
Commercial and industrial		----		----		3,785
Residential real estate		----		----		414
Mortgage servicing rights		----		----		434

mpaired loans had a principal balance of $18,610 at September 30, 2011.  The portion of impaired loans with specific allocations of the allowance for loan losses had a carrying amount of $2,405 and was measured for impairment using the present value of estimated future cash flows.  This resulted in a valuation allowance of $405 at September 30, 2011, which contributed to a decrease of $32 in provision for loan loss expense during the nine months ended September 30, 2011.  This is compared to an increase of $2,164 in provision for loan loss expense during the nine months ended September 30, 2010.  At December 31, 2010, impaired loans had a principal balance of $23,106. The portion of impaired loans with specific allocations of the allowance for loan losses had a carrying amount of $15,222.  The loans were measured for impairment using fair value of the underlying collateral and the present value of estimated future cash flows.  This resulted in a valuation allowance of $5,230 at December 31, 2010.

Mortgage servicing rights, which are carried at lower of cost or fair value, were carried at their fair value of $408, which is made up of the outstanding balance of $583, net of a valuation allowance of $175 at September 30, 2011.  This is compared to a fair value of $434, made up of the outstanding balance of $609, net of a valuation allowance of $175 at December 31, 2010.

Other real estate owned is carried at the estimated fair value of the property less estimated selling costs. Costs incurred to carry other real estate are charged to expense. If fair value declines subsequent to foreclosure, a valuation allowance is recorded. Other real estate owned totaled $4,022 at September 30, 2011 as compared to $4,403 at December 31, 2010.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Cash Equivalents: For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Securities:  The Company obtains fair value measurements using pricing models that vary based on asset class and include available trade, bid and other market information. Fair value of securities may also be determined by 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 quoted securities.

Federal Home Loan Bank stock: It is not practical to determine the fair value of Federal Home Loan Bank stock due to restrictions placed on its transferability.

Loans: The fair value of fixed-rate loans is estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The fair value of loan commitments and standby letters of credit was not material at September 30, 2011 or December 31, 2010. The fair value for variable rate loans is estimated to be equal to carrying value. This fair value represents an entry price in accordance with ASC 825. While ASC 820 amended ASC 825 in several respects, this approach to fair value remains an acceptable approach under generally accepted accounting principles.

Deposit Liabilities: The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.

Borrowings: For other borrowed funds and subordinated debentures, rates currently available to the Bank for debt with similar terms and remaining maturities are used to estimate fair value. For securities sold under agreements to repurchase, carrying value is a reasonable estimate of fair value.

Accrued Interest Receivable and Payable: For accrued interest receivable and payable, the carrying amount is a reasonable estimate of fair value.

In addition, other assets and liabilities that are not defined as financial instruments were not included in the disclosures below, such as premises and equipment and life insurance contracts. The fair value of off-balance sheet items is not considered material (or is based on the current fees or cost that would be charged to enter into or terminate such arrangements).

The following table presents the fair values of financial assets and liabilities carried on the Company’s consolidated balance sheet at September 30, 2011 and December 31, 2010, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring or non-recurring basis:

	September 30, 2011				December 31, 2010
	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial Assets:
Cash and cash equivalents	$	59,289	$	59,289	$	59,751	$	59,751
Securities		107,175		107,054		108,017		107,037
Federal Home Loan Bank stock		6,281		N/A		6,281		N/A
Loans		608,390		618,529		631,936		637,986
Accrued interest receivable		2,508		2,508		2,704		2,704
Financial liabilities:
Deposits		706,502		709,416		694,781		698,199
Securities sold under agreements to repurchase		1,012		1,012		38,107		38,107
Other borrowed funds		21,466		21,682		27,743		26,968
Subordinated debentures		13,500		11,532		13,500		11,507
Accrued interest payable		1,970		1,970		2,600		2,600

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.