Note 5. Fair Value

The estimated fair values of the Company’s financial instruments are as follows:


(In thousands)	June 30, 2012				December 31, 2011
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
*Financial assets*
Cash and due from banks	$	47,166	$	47,166	$	4,255	$	4,255
Interest-bearing deposits with banks		164		164		14,758		14,758
Federal funds sold		—		—		33,700		33,700
Securities, available for sale		82,552		82,552		57,105		57,105
Securities, held to maturity		12,824		13,500		12,950		13,662
Restricted equity securities		615		615		592		592
Total loans		119,924		122,683		130,158		132,837
Accrued interest receivable		827		827		824		824
Bank Owned Life Insurance		6,322		6,322		5,437		5,437

*Financial liabilities*
Deposits		246,437		248,768		232,411		234,816
Accrued interest payable		89		89		88		88
*Off-balance sheet assets (liabilities)*
Commitments to extend credit and standby letter of credit		—		14,030		—		11,912

Generally accepted accounting principles of the United States (“GAAP”) provides a framework for measuring and disclosing fair value of assets and liabilities recognized in the balance sheet, whether the measurements are made on a recurring basis (for example, available for sale investment securities) or on a nonrecurring basis (for example, impaired loans).

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. GAAP also 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 Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

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 the 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 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 for assets and liabilities recorded at fair value:

Investment Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Loans

The Company does not record loans at fair value on a recurring basis, however, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan are considered impaired. Once a loan is identified as individually impaired, management measures impairment. The fair value of impaired loans is estimated using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring a specific allowance represents loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observerable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. 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 loan as nonrecurring Level 3.

Foreclosed Assets

Foreclosed assets are adjusted for fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. 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 foreclosed asset at nonrecurring Level 3.

Assets and Liabilities Recorded as Fair Value on a Recurring Basis

The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis.


(In thousands)
June 30, 2012	Total		Level 1		Level 2		Level 3
Government sponsored enterprises	$	5,947	$	—	$	5,947	$	—
State and municipal securities		7,275		584		6,691		—
Mortgage-backed securities		67,228		—		67,228		—
Other securities		2,102		—		2,102		—

Total assets at fair value	$	82,552	$	584	$	81,968	$	—


(In thousands)
December 31, 2011	Total		Level 1		Level 2		Level 3
Government sponsored enterprises	$	1,952	$	—	$	1,952	$	—
State and municipal securities		5,493		355		5,138		—
Mortgage-backed securities		46,928		—		46,928		—
Other securities		2,732		—		2,732		—

Total assets at fair value	$	57,105	$	355	$	56,750	$	—

There were no liabilities measured at fair value on a recurring basis at June 30, 2012 and December 31, 2011.

Assets and Liabilities Recorded as Fair Value on a Nonrecurring Basis

The Company may be required from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below:


(In thousands)
June 30, 2012	Total		Level 1		Level 2		Level 3
Loans:
Commercial	$	—	$	—	$	—	$	—
Real Estate
Construction and land development		1,891		—		1,891		—
Residential, 1-4 families		—		—		—		—
Nonfarm, nonresidential		4,186		—		4,186		—

Impaired Loans		6,077		—		6,077		—
Foreclosed assets		3,517		—		3,517		—

Total assets at fair value	$	9,594	$	—	$	9,594	$	—


(In thousands)
December 31, 2011	Total		Level 1		Level 2		Level 3
Loans:
Real Estate
Construction and land development	$	2,613	$	—	$	2,613	$	—
Residential, 1-4 families		539		—		539		—
Nonfarm, nonresidential		4,372		—		4,372		—

Impaired Loans		7,524		—		7,524		—
Foreclosed assets		3,418		—		3,418		—

Total assets at fair value	$	10,942	$	—	$	10,942	$	—

There were no liabilities measured at fair value on a nonrecurring basis at June 30, 2012 and December 31, 2011.