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Fair Value Measurements

9 Months Ended

Sep. 30, 2011

Note 5. Fair Value Measurements

The estimated carrying and fair values of the Company’s financial instruments are as follows (in thousands):

	September 30, 2011				December 31, 2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(In thousands)
Financial assets:
Cash and due from banks	$	21,014	$	21,014	$	11,357	$	11,357
Interest-earning deposits in other banks	76,268		76,268		89,042		89,042
Federal funds sold	791		791		600		600
Available-for-sale investment securities	262,050		262,050		191,325		191,325
Loans, net	414,735		409,219		420,583		405,876
Bank owned life insurance	11,563		11,563		11,390		11,390
Federal Home Loan Bank stock	2,893		2,893		3,050		3,050
Accrued interest receivable	3,711		3,711		3,467		3,467

Financial liabilities:
Deposits	$	706,291	$	755,703	$	650,495	$	651,668
Short-term borrowings	—		—		10,000		10,000
Long-term debt	4,000		4,197		4,000		4,256
Junior subordinated deferrable interest debentures	5,155		2, 062		5,155		2,320
Accrued interest payable	216		216		475		475

These estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.

These estimates are made at a specific point in time based on relevant market data and information about the financial instruments. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding 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 fair values presented.

The following methods and assumptions were used to estimate the fair value of financial instruments. For cash and due from banks, interest-earning deposits in other banks, Federal funds sold, variable-rate loans, bank owned life insurance, accrued interest receivable and payable, FHLB stock, demand deposits and short-term borrowings, the carrying amount is estimated to be fair value. For investment securities, fair values are based on quoted market prices, quoted market prices for similar securities and indications of value provided by brokers. The fair values for fixed-rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered at each reporting date for loans with similar terms to borrowers of comparable creditworthiness. Fair values for fixed-rate certificates of deposit are estimated using discounted cash flow analyses using interest rates offered at each reporting date by the Company for certificates with similar remaining maturities. The fair value of long-term debt and subordinated debentures was determined based on the current market for like-kind instruments of a similar maturity and structure. The fair values of commitments are estimated using the fees currently charged to enter into similar agreements and are not significant and, therefore, not included in the above table.

Fair Value Hierarchy

In accordance with applicable guidance, the Company groups its assets and liabilities measured 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. Valuations within these levels are based upon:

Level 1 — Quoted market prices for identical instruments traded in active exchange markets.

Level 2 — 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 or can be corroborated by observable market data.

Level 3 — Model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect the Company’s estimates of assumptions that market participants would use on pricing the asset or liability. Valuation techniques include management judgment and estimation which may be significant.

Management monitors the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another. In such instances, we report the transfer at the beginning of the reporting period.

Management evaluates the significance of transfers between levels based upon the nature of the financial instrument and size of the transfer relative to total assets, total liabilities or total earnings. During the nine months ended September 30, 2011, no transfers between levels occurred.

Assets Recorded at Fair Value

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of September 30, 2011:

Recurring Basis

The Company is required or permitted to record the following assets at fair value on a recurring basis under other accounting pronouncements as of September 30, 2011 (in thousands).

Description	Fair Value		Level 1		Level 2		Level 3

Available-for-sale securities
Debt Securities:
U.S. Government agencies	$	161	$	—	$	161	$	—
Obligations of states and political subdivisions	94,161		—		94,161		—
U.S. Government agencies collateralized by mortgage obligations	148,282		—		148,282		—
Other collateralized mortgage obligations	11,498		—		11,498		—
Other equity securities	7,948		7,948		—		—
Total assets and liabilities measured at fair value	$	262,050	$	7,948	$	254,102	$	—

Securities in Level 1 are mutual funds and fair values are based on quoted market prices for identical instruments traded in active markets. Fair values for available-for-sale investment securities in Level 2 are based on quoted market prices for similar securities.

The balance of Level 3 assets measured at fair value on a recurring basis was zero for the year ended December 31, 2010. No changes occurred in the first three quarters of 2011.

There were no liabilities measured at fair value on a recurring basis at September 30, 2011.

Non-recurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a non-recurring basis. These include assets that are measured at the lower of cost or fair value that were recognized at fair value which was below cost at September 30, 2011 (in thousands).

Description	Fair Value		Level 1		Level 2		Level 3		Total Gains (Losses) in the Period
Impaired loans:
Commercial:
Commercial and industrial	$	2,468	$	—	$	—	$	2,468	$	267
Agricultural production	—		—		—		—		—
Total commercial	2,468		—		—		2,468		267
Real estate:
Owner occupied	1,026		—		—		1,026		203
Real estate-construction and other land loans	4,871		—		—		4,871		(312		)
Commercial real estate	2,169		—		—		2,169		627
Agricultural real estate	—		—		—		—		—
Other	1,681		—		—		1,681		(420		)
Total real estate	9,747		—		—		9,747		98
Consumer:
Equity loans and lines of credit	379		—		—		379		298
Consumer and installment	—		—		—		—		—
Total consumer	379		—		—		379		298
Lease financing receivable	—		—		—		—		—
Total impaired loans	12,594		—		—		12,594		663
Other real estate owned	270		—		—		270		—
Total assets measured at fair value on a non-recurring basis	$	12,864	$	—	$	—	$	12,864	$	663

The fair value of impaired loans and other real estate owned is based on the fair value of the collateral for all collateral dependent loans and for other impaired loans is estimated using a discounted cash flow model. Impaired loans and other real estate owned were determined to be collateral dependent and categorized as Level 3 due to ongoing real estate market conditions resulting in inactive market data, which in turn required the use of unobservable inputs and assumptions in fair value measurements. There were no changes in valuation techniques used during the nine months ended September 30, 2011 or the year ended December 31, 2010.

Impaired loans with a carrying value of $14,908,000 were written down to their fair value of $12,594,000, resulting in a related valuation allowance of $2,314,000 at September 30, 2011. The valuation allowance represents specific allocations of the allowance for credit losses for impaired loans.

There were no liabilities measured at fair value on a non-recurring basis at September 30, 2011.

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring and nonrecurring basis as of December 31, 2010:

Recurring Basis

The Company is required or permitted to record the following assets at fair value on a recurring basis under other accounting pronouncements (in thousands).

Description	Fair Value		Level 1		Level 2		Level 3

Available-for-sale securities
Debt Securities:
U.S. Government agencies	$	195	$	—	$	195	$	—
Obligations of states and political subdivisions	75,050		—		75,050		—
U.S. Government agencies collateralized by mortgage obligations	90,077		—		90,077		—
Other collateralized mortgage obligations	17,838		—		17,838		—
Corporate debt securities	504		—		504		—
Other equity securities	7,661		7,661		—		—
Total assets measured at fair value	$	191,325	$	7,661	$	183,664	$	—

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows for the year ended December 31, 2010 (in thousands).

	Balance, beginning of year		Net income		Other comprehensive income		Purchases, sales, and principal payments			Transfers into Level 3		Transfers out of Level 3			Balance, end of year

Available-for-sale securities
Other collateralized mortgage obligations	$	5,724	$	13	$	93	$	(2,752	)	$	—	$	(3,078	)	$	—
Corporate debt securities	785		235		—		(1,020		)	—		—			—
Other equity securities	7,588		—		—		—			—		(7,588		)	—
Total assets and liabilities measured at fair value	$	14,097	$	248	$	93	$	(3,772	)	$	—	$	(10,666	)	$	—

Gains and losses (realized and unrealized) included in earnings (or changes in net assets) for the year ended December 31, 2010 totaled $248,000 and were included in non-interest income.

There were no liabilities measured at fair value on a recurring basis at December 31, 2010.

Non-recurring Basis

Description	Fair Value		Level 1		Level 2		Level 3		Total Losses in the Year
Impaired loans:
Commercial and industrial	$	980	$	—	$	—	$	980	$	(248	)
Real estate:
Owner occupied	1,016		—		—		1,016		(261		)
Real estate-construction and other land loans	4,773		—		—		4,773		(1,170		)
Commercial real estate	679		—		—		679		(47		)
Other real estate	1,865		—		—		1,865		(420		)
Total impaired loans	9,313		—		—		9,313		(2,146		)
Other real estate owned	1,325		—		—		1,325		(309		)
Other	98		—		—		98		—
Total assets measured at fair value on a non-recurring basis	$	10,736	$	—	$	—	$	10,736	$	(2,455	)

In accordance with the provisions of ASC 360-10, impaired loans with a carrying value of $11,436,000 were written down to their fair value of $9,313,000, resulting in a valuation allowance of $2,124,000. The valuation allowance represents specific allocations for the allowance for credit losses for impaired loans.

The fair value of real estate is based on property appraisals at the time of transfer and as appropriate thereafter, less estimated costs to sell. Other real estate owned is periodically reviewed to determine whether the property continues to be carried at the lower of its recorded book value or estimated fair value, net of estimated selling costs. In 2010, other real estate properties were written down $309,000 to their estimated fair values of $1,325,000. In 2010, other repossessed assets were recorded at their estimated realizable value of $98,000.

There were no liabilities measured at fair value on a non-recurring basis at December 31, 2010.