Fair Value of Financial Instruments

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 in active exchange markets for identical assets or liabilities; also includes certain U.S. Treasury and other U.S. government and agency securities actively traded in over-the-counter markets.

Level 2: Observable inputs other than Level 1 including quoted prices for similar assets or liabilities, quoted prices in less active markets, or other observable inputs that can be corroborated by observable market data; also includes derivative contracts whose value is determined using a pricing model with observable market inputs or can be derived principally from or corroborated by observable market data. This category generally includes certain U.S. government and agency securities, corporate debt securities, derivative instruments, and residential mortgage loans held for sale.

Level 3: Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation; also includes observable inputs for single dealer nonbinding quotes not corroborated by observable market data. This category generally includes certain private equity investments, retained interests from securitizations, and certain collateralized debt obligations.

Assets measured at fair value on a recurring basis comprised the following at June 30, 2011:



			Fair Value Measurements at Reporting Date Using
(Dollars in thousands)			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
June 30, 2011
Obligations of:
U.S. Treasury and government agencies	$	36	$	—	$	36	$	—
U.S. government sponsored agencies	12,321		—		12,321		—
States and political subdivisions	38,091		—		38,091		—
Residential mortgage-backed securities	540,931		—		540,931		—
Commercial mortgage-backed securities	35,288		—		35,288		—
Bank-issued trust preferred securities	13,385		—		13,385		—
Equity securities	3,546		3,425		121		—
Total available-for-sale securities	$	643,598	$	3,425	$	640,173	$	—
December 31, 2010
Obligations of:
U.S. Treasury and government agencies	$	39	$	—	$	39	$	—
U.S. government sponsored agencies	12,262		—		12,262		—
States and political subdivisions	47,379		—		47,379		—
Residential mortgage-backed securities	507,534		18,179		489,355		—
Commercial mortgage-backed securities	30,700		3,545		27,155		—
Bank-issued trust preferred securities	12,984		—		12,984		—
Equity securities	3,088		2,960		128		—
Total available-for-sale securities	$	613,986	$	24,684	$	589,302	$	—

The fair values used by Peoples are obtained from an independent pricing service and represent either quoted market prices for the identical securities (Level 1 inputs) or fair values determined by pricing models using a market approach that considers observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems (Level 2). The fair values of the residential and commercial mortgage-backed securities measured at fair value using Level 1 inputs at December 31, 2010 represented the purchase price of the securities since they were acquired near year-end 2010. At June 30, 2011, these securities were classified as Level 2 as a pricing model was used to value the securities, which was consistent with the rest of the classification for the sector.

Certain financial assets and financial liabilities are measured at fair value on a non-recurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Financial assets measured at fair value on a non-recurring basis included the following:

Impaired Loans: Impaired loans are measured and reported at fair value when management believes collection of contractual interest and principal payments is doubtful. Management’s determination of the fair value for these loans uses a market approach representing the estimated net proceeds to be received from the sale of the collateral based on observable market prices and market value provided by independent, licensed or certified appraisers (Level 2 inputs). At June 30, 2011, impaired loans with an aggregate outstanding principal balance of $20.6 million were measured and reported at a fair value of $13.4 million. For the three and six months ended June 30, 2011, Peoples recognized losses on impaired loans of $3.0 million and $7.2 million, respectively, through the allowance for loan losses.

Other Real Estate Owned: Other real estate owned ("OREO") is measured and reported at fair value when the current book value exceeds the estimated fair value of the property. Management's determination of the fair value for these loans uses a market approach representing the estimated net proceeds to be received from the sale of the property based on observable market prices and market value provided by independent, licensed or certified appraisers (Level 2 Inputs). At June 30, 2011, Peoples had $3.5 million of OREO which was measured and reported at a fair value of $2.2 million. As a result, Peoples recorded losses of $1.3 million through earnings for the three and six months ended June 30, 2011.

The following table presents the fair values of financial assets and liabilities carried on Peoples’ consolidated balance sheet, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis:



	June 30, 2011				December 31, 2010
(Dollars in thousands)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Cash and cash equivalents	$	37,649	$	37,649	$	74,644	$	74,644
Investment securities	670,920		670,909		641,307		641,296
Loans	916,461		824,929		938,707		825,547
Financial liabilities:
Deposits	$	1,358,826	$	1,372,923	$	1,361,600	$	1,380,336
Short-term borrowings	39,254		39,254		51,509		51,509
Long-term borrowings	151,703		160,716		157,703		164,075
Junior subordinated notes held by subsidiary trust	22,583		23,811		22,565		23,861

The methodologies for estimating the fair value of financial assets and liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above. For certain financial assets and liabilities, carrying value approximates fair value due to the nature of the financial instrument. These instruments include cash and cash equivalents, demand and other non-maturity deposits and overnight borrowings. Peoples used the following methods and assumptions in estimating the fair value of the following financial instruments:

Loans: The fair value of portfolio loans assumes sale of the notes to a third-party financial investor. Accordingly, this value is not necessarily the value to Peoples if the notes were held to maturity. Peoples considered interest rate, credit and market factors in estimating the fair value of loans. In the current whole loan market, financial investors are generally requiring a much higher rate of return than the return inherent in loans if held to maturity given the lack of market liquidity. This divergence accounts for the majority of the difference in carrying amount over fair value.

Deposits: The fair value of fixed maturity certificates of deposit is estimated using a discounted cash flow calculation based on current rates offered for deposits of similar remaining maturities.

Long-term Borrowings: The fair value of long-term borrowings is estimated using discounted cash flow analysis based on rates currently available to Peoples for borrowings with similar terms.

Junior Subordinated Notes Held by Subsidiary Trust: The fair value of the junior subordinated notes held by subsidiary trust is estimated using discounted cash flow analysis based on current market rates of securities with similar risk and remaining maturity.

Bank premises and equipment, customer relationships, deposit base, banking center networks, and other information required to compute Peoples’ aggregate fair value are not included in the above information. Accordingly, the above fair values are not intended to represent the aggregate fair value of Peoples.