Fair Value of Assets and Liabilities

9 Months Ended

Sep. 30, 2011

Fair Value of Assets and Liabilities [Abstract]

Fair Value of Assets and Liabilities

NOTE 8: Fair Value of Assets and Liabilities

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. U.S. GAAP requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. U.S. GAAP also establishes a fair value hierarchy which prioritizes the valuation inputs into three broad levels. Based on the underlying inputs, each fair value measurement in its entirety is reported in one of the three levels. These levels are:

• Level 1-Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 assets and liabilities include debt and equity securities traded in an active exchange market, as well as U.S. Treasury securities.

• Level 2-Valuation is based upon quoted 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 or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Valuations of other real estate owned are based upon appraisals by independent, licensed appraisers, general market conditions and recent sales of like properties.

• Level 3-Valuation is determined using model-based techniques with significant assumptions not observable in the market.

U.S. GAAP allows an entity the irrevocable option to elect fair value (the fair value option) for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Corporation has not made any fair value option elections as of September 30, 2011.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following tables present the balances of financial assets measured at fair value on a recurring basis.

(Dollars in thousands)	September 30, 2011
	Fair Value Measurements Using						Assets at Fair Value
	Level 1		Level 2		Level 3
Assets:
Securities available for sale
U.S. government agencies and corporations		-	$	11,056		-	$	11,056
Mortgage-backed securities		-		2,499		-		2,499
Obligations of states and political subdivisions		-		128,138		-		128,138
Preferred stock		-		100		-		100
Total securities available for sale		-	$	141,793		-	$	141,793
Liabilities:
Derivative payable		-	$	546		-	$	546
Total liabilities		-	$	546		-	$	546

	December 31, 2010
(Dollars in thousands)	Fair Value Measurements Using						Assets at Fair Value
	Level 1		Level 2		Level 3
Assets:
Securities available for sale
U.S. government agencies and corporations		-	$	13,656		-	$	13,656
Mortgage-backed securities		-		2,300		-		2,300
Obligations of states and political subdivisions		-		114,288		-		114,288
Preferred stock		-		31		-		31
Total securities available for sale		-	$	130,275		-	$	130,275
Liabilities:
Derivative payable		-	$	148		-	$	148
Total liabilities		-	$	148		-	$	148

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The Corporation is also required to measure and recognize certain other financial assets at fair value on a nonrecurring basis in the consolidated balance sheets. For assets measured at fair value on a nonrecurring basis and still held on the consolidated balance sheets, the following table provides the fair value measures by level of valuation assumptions used. Fair value adjustments for other real estate owned (OREO) are recorded in other noninterest expense and fair value adjustments for impaired loans are recorded in the provision for loan losses, in the consolidated statements of income.

	September 30, 2011
	Fair Value Measurements Using						Assets at  Fair Value
(Dollars in thousands)	Level 1		Level 2		Level 3
Impaired loans, net		-	$	13,516		-	$	13,516
OREO, net		-		6,442		-		6,442
Total		-	$	19,958		-	$	19,958
	December 31, 2010
	Fair Value Measurements Using						Assets at  Fair Value
(Dollars in thousands)	Level 1		Level 2		Level 3
Impaired loans, net		-	$	13,784		-	$	13,784
OREO, net		-		10,674		-		10,674
Total		-	$	24,458		-	$	24,458

Fair Value of Financial Instruments

The following reflects the fair value of financial instruments whether or not recognized on the consolidated balance sheets at fair value.

	September 30, 2011				December 31, 2010
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair  Value
(Dollars in thousands)
Financial assets:
Cash and short-term investments	$	23,634	$	23,634	$	9,680	$	9,680
Securities		141,793		141,793		130,275		130,275
Loans, net		622,921		626,035		606,744		607,264
Loans held for sale, net		36,377		37,768		67,153		67,314
Accrued interest receivable		5,150		5,150		5,073		5,073
Financial liabilities:
Demand deposits		325,122		325,122		315,448		315,448
Time deposits		312,244		316,770		309,686		315,009
Borrowings		159,424		156,258		164,140		160,398
Derivative payable		546		546		148		148
Accrued interest payable		1,120		1,120		1,160		1,160

The following describes the valuation techniques used by the Corporation to measure financial assets and financial liabilities at fair value as of September 30, 2011 and December 31, 2010.

Cash and short-term investments. The nature of these instruments and their relatively short maturities provide for the reporting of fair value equal to the historical cost.

Securities Available for Sale. Securities available for sale are recorded at fair value on a recurring basis.

Loans, net. The estimated fair value of the loan portfolio is based on present values using discount rates equal to the market rates currently charged on similar products.

Certain loans are accounted for under ASC Topic 310 - Receivables, including impaired loans measured at an observable market price (if available), or at the fair value of the loan's collateral (if the loan is collateral dependent). Collateral may be in the form of real estate or business assets including equipment, inventory and accounts receivable. A significant portion of the collateral securing the Corporation's impaired loans is real estate. The fair 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 Corporation using observable market data, which in some cases may be adjusted to reflect current trends, including sales prices, expenses, absorption periods and other current relevant factors (Level 2). The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business's financial statements, if not considered significant, using observable market data (Level 2). At September 30, 2011 and December 31, 2010, the Corporation's impaired loans were valued at $13.52 million and $13.78 million, respectively.

Loans Held for Sale. Loans held for sale are required to be measured at the lower of cost or fair value. These loans currently consist of 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 generally not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Corporation records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the three or nine months ended September 30, 2011.

Accrued interest receivable. The carrying amount of accrued interest receivable approximates fair value.

Deposits. The fair value of all demand deposit accounts is the amount payable at the report date. For all other deposits, the fair value is determined using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar products.

Borrowings. The fair value of borrowings is determined using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar products.

Derivative payable. The fair value of derivatives is determined using the discounted cash flow method.

Accrued interest payable. The carrying amount of accrued interest payable approximates fair value.

Letters of credit. The estimated fair value of letters of credit is based on estimated fees the Corporation would pay to have another entity assume its obligation under the outstanding arrangements. These fees are not considered material.

Unused portions of lines of credit. The estimated fair value of unused portions of lines of credit is based on estimated fees the Corporation would pay to have another entity assume its obligation under the outstanding arrangements. These fees are not considered material.

The Corporation assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Corporation's financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Corporation. Management attempts to match maturities of assets and liabilities to the extent believed necessary to balance minimizing interest rate risk and increasing net interest income in current market conditions. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors interest rates, maturities and repricing dates of assets and liabilities and attempts to manage interest rate risk by adjusting terms of new loans, deposits and borrowings and by investing in securities with terms that mitigate the Corporation's overall interest rate risk.