FAIR VALUE DISCLOSURES

12 Months Ended

Dec. 31, 2011

Notes to Financial Statements [Abstract]

NOTE 5 – FAIR VALUES OF FINANCIAL INSTRUMENTS

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (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. There are three levels of inputs that may be used to measure fair values:

Level 1		Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2		Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3		Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Securities: Securities available for sale are valued primarily by a third party pricing service. The fair values of securities available for sale are determined on a recurring basis by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or pricing models utilizing significant observable inputs such as matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). These models utilize the market approach with standard inputs that include, but are not limited to benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. For certain municipal securities that are not rated and observable inputs about the specific issuer are not available, fair values are estimated using observable data from other municipal securities presumed to be similar or other market data on other non-rated municipal securities (Level 3 inputs). There were no transfers from or into Level 1or Level 2 during 2011 and 2010 and there were no transfers from or into Level 3 during 2010.

Mortgage Banking Derivative: The fair values of derivatives are based on observable market data as of the measurement date (Level 2).

Impaired loans: Impaired loans with specific allocations of the allowance for loan losses are generally assessed against higher than normal discounted advance ratios of collateral as approved at the time of funding, with consideration given for any supplemental credit support from guarantors. Consideration is given for the type and nature of collateral, as well as the anticipated liquidation value to develop a discount for the advance ratios on each credit. Commercial real estate is generally discounted from its appraised value by 0-50% after various considerations including current net operating incomes being realized, general local market conditions, type of property, and potential buyer base. Appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments can be significant. Raw and finished inventory is discounted from its cost basis or book value by 35-65%, depending on the nature and marketability of the goods. Finished goods are generally discounted by 30-60%, depending on the ease of marketability, cost of transportation or application of the good. Work in process inventory is typically discounted by 50-100%, depending on the length of manufacturing time, components used in the process, and the breadth of the user base. Equipment is valued at a percentage of depreciated book value, or current appraised value if available, and is typically discounted at 30-70% after various considerations including age and condition of the equipment, marketability, breadth of use, and whether the equipment includes unique components or add-ons. Marketable securities are discounted by 10-30%, depending on the type of investment, age of valuation report and general market conditions. This methodology is based on a market approach and typically results in a Level 3 classification of the inputs for determining fair value.

Mortgage servicing rights: As of December 31, 2011, the fair value of the Company’s Level 3 servicing assets for residential mortgage loans was $2.1 million, some of which are not currently impaired and therefore carried at amortized cost. These residential mortgage loans have a weighted average interest rate of 4.93%, a weighted average maturity of 20 years and are secured by homes generally within the Company’s market area of Northern Indiana. A valuation model is used to estimate fair value, which is based on an income approach. The inputs used include estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, late fees, and float income. The most significant assumption used to value MSRs is prepayment rate. Prepayment rates are estimated based on published industry consensus prepayment rates. At December 31, 2011, the constant prepayment speed (PSA) used was 387 and the discount rate used was 9.2%. At December 31, 2010, the constant prepayment speed (PSA) used was 288 and the discount rate used was 9.5%.

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NOTE 5 – FAIR VALUES OF FINANCIAL INSTRUMENTS (continued)

Other real estate owned: Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

Real estate mortgage loans held for sale: Real estate mortgage loans held for sale are carried at the lower of cost or fair value, as determined by outstanding commitments, from third party investors.

The table below presents the balances of assets measured at fair value on a recurring basis:

	December 31, 2011
	Fair Value Measurements Using						Assets
	Level 1		Level 2		Level 3		at Fair Value
Assets			(in thousands)

U.S. Treasury securities	$	1,055	$	0	$	0	$	1,055
U.S. Government sponsored agencies		0		5,277		0		5,277
Mortgage-backed securities		0		350,102		0		350,102
Non-agency residential mortgage-backed securities		0		32,207		0		32,207
State and municipal securities		0		78,064		686		78,750
Total Securities		1,055		465,650		686		467,391

Mortgage banking derivative		0		406		0		406

Total assets	$	1,055	$	466,056	$	686	$	467,797

Liabilities

Mortgage banking derivative	$	0	$	81	$	0	$	81

	December 31, 2010
	Fair Value Measurements Using						Assets
	Level 1		Level 2		Level 3		at Fair Value
Assets			(in thousands)

U.S. Treasury securities	$	1,036	$	0	$	0	$	1,036
Mortgage-backed securities		0		308,851		0		308,851
Non-agency residential mortgage-backed securities		0		62,773		0		62,773
State and municipal securities		0		69,960		0		69,960
Total Securities		1,036		441,584		0		442,620

Mortgage banking derivative		0		378		0		378

Total assets	$	1,036	$	441,962	$	0	$	442,998

Liabilities

Mortgage banking derivative	$	0	$	21	$	0	$	21

There were no transfers from or into Level 1or Level 2 during 2011 and 2010 and there were no transfers from or into Level 3 during 2010.

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2011:

	State and
	Municipal
	Securities
	2011
	(in thousands)
Balance of recurring Level 3 assets at January 1	$	0
Transfers into Level 3		686
Balance of recurring Level 3 assets at December 31	$	686

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NOTE 5 – FAIR VALUES OF FINANCIAL INSTRUMENTS (continued)

The fair value of 3 state and municipal securities with a fair value of $686,000 as of December 31, 2011 were transferred out of Level 2 and into Level 3 because of a lack of observable market data for these investments. The Company’s policy is to recognize transfers as of the end of the reporting period. As a result, the fair value for these state and municipal securities was transferred on December 31, 2011.

The table below presents the balances of assets measured at fair value on a nonrecurring basis:

	December 31, 2011
	Fair Value Measurements Using						Assets
Assets	Level 1		Level 2		Level 3		at Fair Value
			(in thousands)
Impaired loans:
Commercial and industrial loans:
Working capital lines of credit loans	$	0	$	0	$	2,762	$	2,762
Non-working capital loans		0		0		11,885		11,885

Commercial real estate and multi-family residential loans:
Construction and land development loans		0		0		303		303
Owner occupied loans		0		0		3,515		3,515
Nonowner occupied loans		0		0		23,591		23,591
Multifamily loans		0		0		0		0

Agri-business and agricultural loans:
Loans secured by farmland		0		0		433		433
Loans for agricultural production		0		0		207		207

Other commercial loans		0		0		0		0

Consumer 1-4 family mortgage loans:
Closed end first mortgage loans		0		0		878		878
Open end and junior lien loans		0		0		406		406
Residential construction loans		0		0		0		0

Other consumer loans		0		0		0		0

Total impaired loans	$	0	$	0	$	43,980	$	43,980

Mortgage servicing rights		0		0		1,734		1,734
Other real estate owned		0		0		730		730

Total assets	$	0	$	0	$	46,444	$	46,444

	December 31, 2010
	Fair Value Measurements Using						Assets
Assets	Level 1		Level 2		Level 3		at Fair Value
			(in thousands)
Impaired loans:
Commercial and industrial loans:
Working capital lines of credit loans	$	0	$	0	$	2,708	$	2,708
Non-working capital loans		0		0		4,990		4,990

Commercial real estate and multi-family residential loans:
Construction and land development loans		0		0		1,207		1,207
Owner occupied loans		0		0		1,960		1,960
Nonowner occupied loans		0		0		14,666		14,666
Multifamily loans		0		0		0		0

Agri-business and agricultural loans:
Loans secured by farmland		0		0		322		322
Loans for agricultural production		0		0		635		635

Other commercial loans		0		0		7		7

Consumer 1-4 family mortgage loans:
Closed end first mortgage loans		0		0		815		815
Open end and junior lien loans		0		0		140		140
Residential construction loans		0		0		0		0

Other consumer loans		0		0		0		0

Total impaired loans	$	0	$	0	$	27,450	$	27,450

Mortgage servicing rights		0		0		11		11

Total assets	$	0	$	0	$	27,461	$	27,461

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NOTE 5 – FAIR VALUES OF FINANCIAL INSTRUMENTS (continued)

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a gross carrying amount of $62.2 million, with a valuation allowance of $18.2 million at December 31, 2011, resulting in an additional provision for loan losses of $6.9 million for the year ended December 31, 2011. At December 31, 2010, impaired loans had a carrying amount of $38.8 million, with a valuation allowance of $11.3 million, resulting in an additional provision for loans losses of $4.6 million for the year ending December 31, 2010.

Mortgage servicing rights, which are carried at the lower of cost or fair value, included a portion carried at their fair value of $1.7 million, which is made up of the outstanding balance of $1.8 million, net of a valuation allowance of $108,000 at December 31, 2011, resulting in a net increase in impairment of $86,000 for the year ended December 31, 2011. At December 31, 2010, mortgage servicing rights included a portion carried at their fair value of $11,000, which is made up of the outstanding balance of $33,000, net of a valuation allowance of $22,000 at December 31, 2010, resulting in a net recovery of $24,000 for the year ended December 31, 2010.

Other real estate owned measured at fair value less costs to sell, had a net carrying amount of $730,000, which is made up of the outstanding balance of $1.1 million, net of a valuation allowance of $340,000 at December 31, 2011, which was all written down during 2011.

The following table contains the estimated fair values and the related carrying values of the Company’s financial instruments at December 31, 2011 and 2010. Items which are not financial instruments are not included.

	2011						2010
	Carrying			Estimated			Carrying			Estimated
	Value			Fair Value			Value			Fair Value
	(in thousands)
Financial Assets:
Cash and cash equivalents	$	104,584		$	104,584		$	60,141		$	60,141
Securities available for sale		467,391			467,391			442,620			442,620
Real estate mortgages held for sale		2,953			2,998			5,606			5,661
Loans, net		2,180,309			2,141,459			2,044,952			2,041,812
Federal Home Loan Bank stock		7,313			N/A			8,511			N/A
Federal Reserve Bank stock		3,420			N/A			3,420			N/A
Accrued interest receivable		9,604			9,604			9,064			9,064
Financial Liabilities:
Certificates of deposit		(910,381	)		(925,619	)		(949,559	)		(962,456	)
All other deposits		(1,502,315	)		(1,502,315	)		(1,251,466	)		(1,251,466	)
Securities sold under agreements to repurchase		(131,990	)		(131,990	)		(142,015	)		(142,015	)
Other short-term borrowings		(10,000	)		(10,000	)		(32,037	)		(32,037	)
Long-term borrowings		(15,040	)		(16,079	)		(15,041	)		(15,991	)
Subordinated debentures		(30,928	)		(31,240	)		(30,928	)		(31,242	)
Standby letters of credit		(247	)		(247	)		(321	)		(321	)
Accrued interest payable		(5,574	)		(5,574	)		(4,978	)		(4,978	)

For purposes of the above disclosures of estimated fair value, the following assumptions were used as of December 31, 2011 and 2010. The estimated fair value for cash and cash equivalents, demand and savings deposits, variable rate loans, variable rate short term borrowings and accrued interest is considered to approximate cost. The fair value of FHLB and Federal Reserve Bank stock is not determinable as there are restrictions on its transferability. The estimated fair value for fixed rate loans, certificates of deposit and fixed rate borrowings is based on discounted cash flows using current market rates applied to the estimated life of the loan. Real estate mortgages held for sale are based upon the actual contracted price for those loans sold but not yet delivered or the current Federal Home Loan Mortgage Corporation price for normal delivery of mortgages with similar coupons and maturities at year-end. The fair value of subordinated debentures is based on the rates currently available to the Company with similar terms and remaining maturity and credit spread. The fair value of off-balance sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements. The estimated fair value of other financial instruments approximate cost and are not considered significant to this presentation.

- Definition

This element represents the disclosure related to the fair value measurement of assets and liabilities which includes [financial] instruments measured at fair value that are classified in stockholders' equity. Such assets and liabilities may be measured on a recurring or nonrecurring basis. The disclosures which may be required or desired include: (1) for assets and liabilities measured on a recurring basis, disclosure may include: (a) the fair value measurements at the reporting date; (b) the level within the fair value hierarchy in which the fair value measurements in their entirety fall, segregating fair value measurements using quoted prices in active markets for identical assets or liabilities (Level 1), significant other observable inputs (Level 2), and significant unobservable inputs (Level 3); (c) for fair value measurements using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances, separately presenting changes during the period attributable to the following: (i) total gains or losses for the period (realized and unrealized), segregating those gains or losses included in earnings (or changes in net assets), and a description of where those gains or losses included in earnings (or changes in net assets) are reported in the statement of income (or activities); (ii) purchases, sales, issuances, and settlements (net); (iii) transfers in and transfers out of Level 3 (for example, transfers due to changes in the observability of significant inputs); (d) the amount of the total gains or losses for the period in subparagraph (c) (i) above included in earnings (or changes in net assets) that are attributable to the change in unrealized gains or losses relating to those assets and liabilities still held at the reporting date and a description of where those unrealized gains or losses are reported in the statement of income (or activities); (e) the valuation technique(s) used to measure fair value and a discussion of changes in valuation techniques, if any, during the period and (2) for assets and liabilities that are measured at fair value on a nonrecurring basis (for example, impaired assets) disclosure may include, in addition to (a) above: (a) the reasons for the fair value measurements recorded; (b) the same as (b) above; (c) for fair value measurements using significant unobservable inputs (Level 3), a description of the inputs and the information used to develop the inputs; and (d) the valuation technique(s) used to measure fair value and a discussion of changes, if any, in the valuation technique(s) used to measure similar assets and/or liabilities in prior periods.

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