Note 6. Disclosures About Fair Value of Assets and Liabilities

The Corporation has adopted fair value accounting guidance that defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This guidance 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 standard describes three levels of inputs that may be used to measure fair value:

Level 1 Quoted prices in active markets for identical assets or liabilities

Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in active markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities

Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or

Recurring Measurements

The following table presents the fair value measurements of assets and liabilities recognized in the Consolidated Condensed Balance Sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2012, and December 31, 2011.

				Fair Value Measurements Using
June 30, 2012	Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale securities:
U.S. Government-sponsored agency securities	$	4,933			$	4,933
State and municipal		145,597				126,059	$	19,538
U.S. Government-sponsored mortgage-backed securities		383,562				383,562
Corporate obligations		11,629				11,431		198
Marketable equity securities		1,830				1,826		4
Interest rate swap asset		5,552				5,552
Interest rate cap		243				243
Interest rate swap liability		(9,136	)			(9,136

				Fair Value Measurements Using
December 31, 2011	Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale securities:
U.S. Government-sponsored agency securities	$	17			$	17
State and municipal		147,353				126,712	$	20,641
U.S. Government-sponsored mortgage-backed securities		368,998				368,998
Corporate obligations		193						193
Marketable equity securities		1,830				1,826		4
Interest rate swap asset		5,241						5,241
Interest rate cap		424						424
Interest rate swap liability		(7,797	)					(7,797	)

Following is a description of the valuation methodologies and inputs used for instruments measured at fair value on a recurring basis and recognized in the accompanying Consolidated Condensed Balance Sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy. There have been no significant changes in the valuation techniques during the six months ended June 30, 2012.

Available for Sale Investment Securities

Where quoted, market prices are available in an active market and securities are classified within Level 1 of the valuation hierarchy. There are no securities classified within Level 1 of the hierarchy. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include agencies, mortgage backs, state and municipal, corporate obligations and equity securities. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy. Level 3 fair value, including corporate obligations, state and municipal and equity securities, was determined using a discounted cash flow model that incorporated market estimates of interest rates and volatility in markets that have not been active.

Third party vendors compile prices from various sources and may apply such techniques as matrix pricing to determine the value of identical or similar investment securities classified within Level 2. Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather relying on the investment securities’ relationship to other benchmark quoted investment securities. Any investment security not valued based upon the methods above are considered Level 3.

Pooled Trust Preferred Securities

Pooled trust preferred securities in the portfolio amount to $5.9 million in amortized cost, with a fair value of $168,000; all of which are classified as Level 3 inputs in the fair value hierarchy. These securities were rated A or better at inception, but at June 30, 2012, Moody’s ratings on these securities ranged from Ca to C. The issuers in these securities are primarily banks, but some of the pools do include a limited number of insurance companies. On a quarterly basis, the Corporation uses an other-than-temporary impairment (“OTTI”) evaluation process to compare the present value of expected cash flows to determine whether an adverse change in cash flows has occurred. The OTTI evaluation process considers the structure and term of the collateralized debt obligation (“CDO”), interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities. Assumptions used in the evaluation process include expected future default rates and prepayments as well as recovery assumptions on defaults and deferrals. In addition, the process is used to “stress” each CDO, or make assumptions more severe than expected activity, to determine the degree to which assumptions could deteriorate before the CDO could no longer fully support repayment of the Corporation’s note class. Upon completion of the June 30, 2012, quarterly evaluation process, the conclusion was no additional OTTI impairment for the three and six months ending June 30, 2012. The Corporation did not recognize any OTTI impairment for the three months ended June 30, 2011, but did recognize $400,000 of OTTI impairment for the six months ended June 30, 2011.

Level 3 Reconciliation

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the Consolidated Condensed Balance Sheets using significant unobservable (Level 3) inputs for the three and six months ended June 30, 2012, and 2011.

	Three Months Ended June 30, 2012						Six Months Ended June 30, 2012
	Available for Sale Securities			Interest Rate Swap Asset	Interest Rate Cap	Interest Rate Swap Liability	Available for Sale Securities			Interest Rate Swap Asset			Interest Rate Cap			Interest Rate Swap Liability
Balance at beginning of the period	$	19,878					$	20,838		$	5,241		$	424		$	(7,797	)
Total realized and unrealized gains and losses:
Included in net income (loss)											(860	)					863
Included in other comprehensive income		(238	)					(761	)		481			(15	)
Purchases, issuances and settlements
Transfers in/(out) of Level 3											(4,862	)		(409	)		6,934
Principal payments/additions		100						(337	)
Ending balance at June 30, 2012	$	19,740					$	19,740

	Three Months Ended June 30, 2011												Six Months Ended June 30, 2011
	Available for Sale Securities			Interest Rate Swap Asset			Interest Rate Cap			Interest Rate Swap Liability			Available for Sale Securities			Interest Rate Swap Asset			Interest Rate Cap			Interest Rate Swap Liability
Balance at beginning of the period	$	173		$	3,647		$	1,124		$	(3,379	)	$	186		$	4,002		$	1,109		$	(3,876	)
Total realized and unrealized gains and losses:
Included in net income (loss)					586						(607	)		(400	)		112						(110	)
Included in other comprehensive income		(82	)		(450	)		(170	)					240			(331	)		(155	)
Purchases, issuances and settlements
Transfers in/(out) of Level 3
Principal payments		89												154
Ending balance at June 30, 2011	$	180		$	3,783		$	954		$	(3,986	)	$	180		$	3,783		$	954		$	(3,986	)

There were no gains or losses for the period included in earnings that were attributable to the changes in unrealized gains or losses related to assets or liabilities held at June 30, 2012 or December 31, 2011.

Transfers Between Levels

Transfer between Levels 1, 2 and 3 and the reasons for those transfers are as follows:

	Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Transfers from Level:
Interest rate swap asset				$	4,862	The interest rate swap and cap instruments were transferred
Interest rate cap					409	from Level 3 to Level 2 as of March 31, 2012 due to the Corporation's additional analysis of valuation methodologies. These instruments are valued using widely accepted valuation techniques including discounted cash flow analysis using observable inputs such as contractual terms and Libor-based rate curves.
Interest rate swap liability					6,934
Total Transfers from Level				$	12,205

Transfers to Level:
Interest rate swap asset		$	4,862			The interest rate swap and cap instruments were transferred
Interest rate cap			409			from Level 3 to Level 2 as of March 31, 2012 due to the Corporation's additional analysis of valuation methodologies. These instruments are valued using widely accepted valuation techniques including discounted cash flow analysis using observable inputs such as contractual terms and Libor-based rate curves.
Interest rate swap liability			6,934
Total Transfers to Level		$	12,205

Nonrecurring Measurements

The following table presents the fair value measurement of assets and liabilities measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2012, and December 31, 2011.

			Fair Value Measurements Using
June 30, 2012	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Impaired loans	$	20,780			$	20,780
Other real estate owned (collateral dependent)	$	6,563			$	6,563

			Fair Value Measurements Using
December 31, 2011	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Impaired loans	$	22,885			$	22,885
Other real estate owned (collateral dependent)	$	7,882			$	7,882

Following is a description of valuation methodologies used for instruments measured at fair value on a nonrecurring basis and recognized in the Consolidated Condensed Balance Sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Nonrecurring Measurements continued

Impaired Loans (collateral dependent) and Other Real Estate Owned

Loan impairment is reported when substantial doubt about the collectability of scheduled payments exists. Impaired loans are carried at the present value of estimated future cash flows using the loan’s existing rate, or the fair value of collateral if the loan is collateral dependent. A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance. If these allocations cause the allowance for loan losses to increase, such increase is reported as a component of the provision for loan losses. Loan losses are charged against the allowance when management believes the uncollectability of the loan is confirmed. During the first six months of 2012, certain impaired loans were partially charged-off or re-evaluated. The valuation would be considered Level 3, consisting of appraisals of underlying collateral and discounted cash flow analysis.

The fair value for impaired loans and other real estate owned is measured based on the value of the collateral securing those loans or real estate and is determined using several methods. The fair value of real estate is generally determined based on appraisals by qualified licensed appraisers. The appraisers typically determine the value of the real estate by utilizing an income or market valuation approach. If an appraisal is not available, the fair value may be determined by using a cash flow analysis. Fair value on other collateral such as business assets is typically calculated by using financial information such as financial statements and aging reports provided by the borrower and is discounted as considered appropriate.

Unobservable (Level 3) Inputs

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements, other than goodwill, at June 30, 2012.

	Fair Value		Valuation Technique	Unobservable Inputs	Range

State and municipal securities	$	19,538	Discounted cash flow	Maturity/Call date	1 month to 11 yrs
				Blend of US Muni BQ curve	A- to BBB-
				Discount rate	1% - 4	%

Corporate obligations/ Marketable equity securities	$	202	Discounted cash flow	Risk free rate	3 month libor
				plus Premium for illiquidity	plus 200bps

Impaired loans (collateral dependent)	$	20,780	Collateral based measurements	Discount to reflect current market conditions and ultimate collectabilty	0% - 50	%

Other real estate owned	$	6,563	Appraisals	Discount to reflect current market conditions	0% - 20	%

Sensitivity of Significant Unobservable Inputs

The following is a discussion of the sensitivity of significant unobservable inputs, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement and of how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.

State and Municipal Securities

The significant unobservable inputs used in the fair value measurement of the Corporation’s state and municipal securities are premiums for unrated securities and marketability discounts. Significant increases or decreases in either of those inputs in isolation would result in a significantly lower or higher fair value measurement. Generally, changes in either of those inputs will not affect the other input.

Corporate Obligations/Equity Securities

The significant unobservable inputs used in the fair value measurement of the Corporation’s corporate obligations/equity securities are premiums for unrated securities and marketability discounts. Significant increases or decreases in either of those inputs in isolation would result in a significantly lower or higher fair value measurement. Generally, changes in either of those inputs will not affect the other input.

Fair Value of Financial Instruments

The following table presents estimated fair values of the Corporation’s financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2012, and December 31, 2011.

	June 30, 2012
	(unaudited)
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Carrying Amount		(Level 1)		(Level 2)		(Level 3)
Assets:
Cash and due from banks	$	68,493	$	68,493
Interest-bearing time deposits		41,760		41,760
Investment securities available for sale		547,551			$	527,811	$	19,740
Investment securities held to maturity		396,770				400,173		13,074
Mortgage loans held for sale		15,278				15,278
Loans		2,727,491						2,756,565
Federal Reserve Bank and Federal Home Loan Bank stock		33,033				33,033
Interest rate swap asset		5,795				5,795
Interest receivable		16,506				16,506
Liabilities:
Deposits	$	3,288,898	$	2,343,492	$	946,039
Borrowings:
Federal funds purchased		652				652
Securities sold under repurchase agreements		160,127				160,728
Federal Home Loan Bank advances		96,847				100,031
Subordinated debentures, revolving credit lines and term loans		115,951				68,852
Interest rate swap liability		9,136				9,136
Interest payable		2,168				2,168

	December 31, 2011
	(unaudited)
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Carrying Amount		(Level 1)		(Level 2)		(Level 3)
Assets:
Cash and due from banks	$	73,312	$	73,312
Interest-bearing time deposits		52,851		52,851
Investment securities available for sale		518,491			$	497,653	$	20,838
Investment securities held to maturity		427,909				428,737		13,732
Mortgage loans held for sale		17,864				17,864
Loans		2,642,517						2,658,227
Federal Reserve Bank and Federal Home Loan Bank stock		31,270				31,270
Interest rate swap asset		5,665						5,665
Interest receivable		17,723				17,723
Liabilities:
Deposits	$	3,134,655	$	2,195,679	$	944,078
Borrowings:
Securities sold under repurchase agreements		156,305				157,342
Federal Home Loan Bank advances		138,095				141,693
Subordinated debentures, revolving credit lines and term loans		194,974				142,632
Interest rate swap liability		7,797						7,797
Interest payable		2,925				2,925

The following methods were used to estimate the fair value of all other financial instruments recognized in the Consolidated Condensed Balance Sheets at amounts other than fair value.

Cash and due from banks: The fair value of cash and cash equivalents approximates carrying value.

Interest-bearing time deposits: The fair value of interest-bearing time deposits approximates carrying value.

Investment securities: Fair value is based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Mortgage Loans Held For Sale: The carrying amount approximates fair value due to the insignificant time between origination and date of sale.

Loans: The fair value for loans is estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. See Impaired Loans above.

Federal Reserve and Federal Home Loan Bank stock: The fair value of Federal Reserve Bank and Federal Home Loan Bank stock is based on the price which it may be resold to the Federal Reserve and Federal Home Loan Bank.

Derivative instruments: The fair value of the derivatives reflects the estimated amounts that would have been received to terminate these contracts at the reporting date based upon pricing or valuation models applied to current market information. Interest rate caps are valued using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates rose above the strike rate of the caps. The projected cash receipts on the caps are based on an expectation of future interest rates derived from observed market interest rate curves and volatilities.

Interest Receivable and Interest Payable: The carrying amount approximates fair value.

Deposits: The fair values of noninterest-bearing and interest-bearing demand accounts and savings deposits are equal to the amount payable on demand at the balance sheet date. The carrying amounts for variable rate, fixed-term certificates of deposit approximate their fair values at the balance sheet date. Fair values for fixed-rate certificates of deposit and other time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of aggregated expected monthly maturities on such time deposits.

Federal funds purchased: The carrying amount approximates fair value.

Borrowings: The fair value of borrowings is estimated using a discounted cash flow calculation, based on current rates for similar debt.