Note 12. Fair Value of Financial Instruments

The Company is required to disclose fair values for its financial instruments. Fair values are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Also, it is the Company’s general practice and intention to hold most of its financial instruments to maturity and not to engage in trading or sales activities. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These fair values are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions can significantly affect the fair values.

Fair values have been determined by the Company using historical data and an estimation methodology suitable for each category of financial instruments. The Company’s fair values, methods, and assumptions are set forth below for the Company’s other financial instruments.

As certain assets and liabilities, such as deferred tax assets, premises and equipment, and many other operational elements of the Company, are not considered financial instruments but have value, this fair value of financial instruments would not represent the full market value of the Company.

The fair values of the Company’s financial instruments are as follows at June 30, 2013 and December 31, 2012:

					Fair Value Measurements at June 30, 2013
					Quoted Prices in
					Active Markets for		Significant Other		Significant
	Carrying		Fair		Identical Assets		Observable Inputs		Unobservable Inputs
(In Thousands)	Value		Value		(Level I)		(Level II)		(Level III)
Financial assets:
Cash and cash equivalents	$	28,439	$	28,439	$	28,439	$	—	$	—
Investment securities:
Available for sale	311,289		311,289		12,060		299,229		—
Loans held for sale	5,409		5,409		5,409		—		—
Loans, net	777,557		774,344		—		—		774,344
Bank-owned life insurance	25,022		25,022		25,022		—		—
Accrued interest receivable	4,999		4,999		4,999		—		—

Financial liabilities:
Interest-bearing deposits	$	744,265	$	723,925	$	484,783	$	—	$	239,142
Noninterest-bearing deposits	211,096		211,096		211,096		—		—
Short-term borrowings	39,000		39,000		39,000		—		—
Long-term borrowings, FHLB	70,750		73,067		—		—		73,067
Accrued interest payable	442		442		442		—		—

					Fair Value Measurements at December 31, 2012
					Quoted Prices in
					Active Markets for		Significant Other		Significant
	Carrying		Fair		Identical Assets		Observable Inputs		Unobservable Inputs
(In Thousands)	Value		Value		(Level I)		(Level II)		(Level III)
Financial assets:
Cash and cash equivalents	$	15,142	$	15,142	$	15,142	$	—	$	—
Investment securities:
Available for sale	289,316		289,316		11,653		277,663		—
Loans held for sale	3,774		3,774		3,774		—		—
Loans, net	504,615		506,406		—		—		506,406
Bank-owned life insurance	16,362		16,362		16,362		—		—
Accrued interest receivable	4,099		4,099		4,099		—		—

Financial liabilities:
Interest-bearing deposits	$	527,073	$	530,485	$	359,979	$	—	$	170,506
Noninterest-bearing deposits	114,953		114,953		114,953		—		—
Short-term borrowings	33,204		33,204		33,204		—		—
Long-term borrowings, FHLB	76,278		80,772		—		—		80,772
Accrued interest payable	366		366		366		—		—

Cash and Cash Equivalents, Loans Held for Sale, Accrued Interest Receivable, Short-term Borrowings, and Accrued Interest Payable:

The fair value is equal to the carrying value.

Investment Securities:

The fair value of investment securities available for sale and held to maturity is equal to the available quoted market price. If no quoted market price is available, fair value is estimated using the quoted market price for similar securities. Regulatory stocks’ fair value is equal to the carrying value.

Loans:

Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial and agricultural, commercial real estate, residential real estate, construction real estate, and installment loans to individuals. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories.

The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company’s historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions.

Fair value for significant nonperforming loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discounted rates are judgmentally determined using available market information and specific borrower information.

Bank-Owned Life Insurance:

The fair value is equal to the cash surrender value of the life insurance policies.

Deposits:

The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, NOW, and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows.

The fair value estimates above do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible.

Long Term Borrowings:

The fair value of long term borrowings is based on the discounted value of contractual cash flows.

Commitments to Extend Credit, Standby Letters of Credit, and Financial Guarantees Written:

There is no material difference between the notional amount and the estimated fair value of off-balance sheet items. The contractual amounts of unfunded commitments and letters of credit are presented in Note 10 (Off Balance Sheet Risk).