Fair Value

9 Months Ended

Sep. 30, 2012

Fair Value [Abstract]

FAIR VALUE

3. FAIR VALUE

Fair Value Option

Management elected to adopt the fair value option for its investment in certain securities that are traded frequently and do not meet the criteria to be classified as available for sale or held to maturity. With limited exceptions, these securities are common stocks or mutual funds that are classified as Level 1 in the fair value hierarchy.

Fair value changes attributable to unrealized gains that were included in earnings for the three and nine months ended September 30, 2012 were $213 and $237, respectively. Fair value changes attributable to unrealized losses that were included in earnings for the three and nine months ended September 30, 2011 were ($313) and ($226), respectively. Realized gains on the sale of securities for which the fair value option was elected were $62 and $218 during the three and nine months ended September 30, 2012. Realized gains on the sale of securities for which the fair value option was elected were $0 and $10 during the three and nine months ended September 30, 2011.

Dividend income is recorded based on cash dividends and comprises the “Dividends” line item in the accompanying consolidated statement of income. Dividend income was $16 and $47 for the three and nine months ended September 30, 2012 and $8 and $23 for the three and nine months ended September 30, 2011.

Fair Value Measurement

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an 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. A fair value hierarchy has also been established which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The following three levels of inputs are used to measure fair value:

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 fair values of most trading securities and securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or 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 relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). The fair value of one corporate bond held by the Corporation has been determined by using Level 3 inputs. The Corporation has engaged a valuation expert to price this security using a proprietary model, which incorporates assumptions about certain factors that market participants would use in pricing the securities, including bid/ask spreads and liquidity and credit premiums.

Trust preferred securities which are issued by financial institutions and insurance companies are priced using Level 3 inputs. The decline in the level of observable inputs and market activity in this class of investments by the measurement date has been significant and resulted in unreliable external pricing. Broker pricing and bid/ask spreads, when available, vary widely, and the once-active market has become comparatively inactive. The Corporation engaged a third party consultant who has developed a model for pricing these securities. Information such as historical and current performance of the underlying collateral, deferral and default rates, collateral coverage ratios, break in yield calculations, cash flow projections, liquidity and credit premiums required by a market participant, and financial trend analysis with respect to the individual issuing financial institutions and insurance companies are utilized in determining individual security valuations. Due to the current market conditions as well as the limited trading activity of these securities, the market value of the securities is highly sensitive to assumption changes and market volatility.

The Corporation’s derivative instrument is an interest rate swap that is similar to those that trade in liquid markets. As such, significant fair value inputs can generally be verified and do not typically involve significant management judgments (Level 2 inputs).

The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals prepared by third-parties. These 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. Management also adjusts appraised values based on the length of time that has passed since the appraisal date and other factors. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Assets and liabilities measured at fair value on a recurring basis are as follows at September 30, 2012 and December 31, 2011:

				Fair Value Measurements at September 30, 2012 Using
Description	Total			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Assets:
Securities Available For Sale:
U.S. Treasury	$	5,050		$	0	$	5,050		$	0
U.S. Government sponsored entities		119,753			0		119,753			0
States and political subdivisions		172,238			0		172,238			0
Residential mortgage and asset backed		357,804			3,560		354,244			0
Commercial mortgage and asset backed		1,947			0		1,947			0
Corporate notes and bonds		14,519			0		12,534			1,985
Pooled trust preferred		360			0		0			360
Pooled SBA		46,061			46,061		0			0
Other securities		1,552			1,552		0			0
Total Securities Available For Sale	$	719,284		$	51,173	$	665,766		$	2,345
Trading Securities:
Equity securities – financial services	$	555		$	555	$	0		$	0
Equity securities – industrials		541			541		0			0
Equity securities – health care		433			433		0			0
Certificates of deposit		407			407		0			0
Equity securities – energy		317			317		0			0
International mutual funds		267			267		0			0
Equity securities – materials		184			184		0			0
Large cap growth mutual funds		157			157		0			0
Equity securities – consumer staples		132			132		0			0
Large cap value mutual funds		106			106		0			0
Corporate notes and bonds		102			0		102			0
Money market mutual funds		96			96		0			0
Equity securities – technology		92			92		0			0
Real estate investment trust mutual funds		66			66		0			0
U.S. Government sponsored entities		58			0		58			0
Equity securities – consumer discretionary		54			54		0			0
Small cap mutual funds		27			27		0			0
Mid cap mutual funds		26			26		0			0
Total Trading Securities	$	3,620		$	3,460	$	160		$	0
Liabilities:
Interest rate swaps
	$	(1,848	)	$	0	$	(1,848	)	$	0

				Fair Value Measurements at December 31, 2011 Using
Description	Total			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Assets:
Securities Available For Sale:
U.S. Treasury	$	8,130		$	0	$	8,130		$	0
U.S. Government sponsored entities		107,492			2,000		105,492			0
States and political subdivisions		158,437			4,655		153,782			0
Residential mortgage and asset backed		300,126			8,577		291,549			0
Commercial mortgage and asset backed		2,122			0		2,122			0
Corporate notes and bonds		13,860			0		11,800			2,060
Pooled trust preferred		340			0		0			340
Pooled SBA		46,056			46,056		0			0
Other securities		1,544			1,544		0			0
Total Securities Available For Sale	$	638,107		$	62,832	$	572,875		$	2,400
Trading Securities:
Equity securities – financial services	$	779		$	779	$	0		$	0
Equity securities – industrials		324			324		0			0
International mutual funds		257			257		0			0
Certificates of deposit		255			255		0			0
Money market mutual funds		241			241		0			0
Equity securities – health care		204			204		0			0
Equity securities - utilities		197			197		0			0
Large cap growth mutual funds		145			145		0			0
Equity securities – consumer staples		145			145		0			0
Equity securities – consumer discretionary		126			126		0			0
Large cap value mutual funds		105			105		0			0
Corporate notes and bonds		100			0		100			0
Equity securities – technology		75			75		0			0
Equity securities – energy		72			72		0			0
Real estate investment trust mutual funds		68			68		0			0
U.S. Government sponsored entities		55			0		55			0
Equity securities – materials		37			37		0			0
Small cap mutual funds		25			25		0			0
Mid cap mutual funds		23			23		0			0
Total Trading Securities	$	3,233		$	3,078	$	155		$	0
Liabilities:
Interest rate swaps	$	(1,669	)	$	0	$	(1,669	)	$	0

The table below presents a reconciliation and income statement classification of gains and losses for all securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended September 30, 2012:

	Corporate notes and bonds			Pooled trust preferred
Balance, July 1, 2012	$	2,071		$	360
Total gains or (losses):
Included in other comprehensive income (unrealized)		(86	)		0
Balance, September 30, 2012	$	1,985		$	360

The table below presents a reconciliation and income statement classification of gains and losses for all securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2012:

	Corporate notes and Bonds			Pooled trust preferred
Balance, January 1, 2012	$	2,060		$	340
Total gains or (losses):
Included in other comprehensive income (unrealized)		(75	)		20
Balance, September 30, 2012	$	1,985		$	360

The table below presents a reconciliation and income statement classification of gains and losses for all securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended September 30, 2011:

	Residential mortgage and asset backed			Corporate notes and bonds		Pooled trust preferred
Balance, July 1, 2011	$	3,988		$	1,860	$	1,362
Transfers out of Level 3 (a) (b)		(3,988	)		0		0
Total gains or losses:
included in other comprehensive income (unrealized)		0			0		(130	)
Purchases, issuances, sales and settlements		0			0		(5	)
Balance, September 30, 2011	$	0		$	1,860	$	1,227

(a) Transferred from Level 3 to Level 2 since observable market data became available to value the security.

(b) The Corporation’s policy is to recognize transfers in and transfers out as of the actual date of the event or change in circumstances that caused the transfer.

The table below presents a reconciliation and income statement classification of gains and losses for all securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2011:

	Residential mortgage and asset backed			Corporate notes and bonds		U.S. Gov’t Sponsored Entities			Pooled trust preferred
Balance, January 1, 2011	$	2,269		$	1,240	$	2,000		$	1,292
Transfers out of Level 3 (a)(b)		(3,988	)		0		(2,000	)		0
Total gains or losses:
Included in earnings (realized)		0			0		0			(398	)
Included in other comprehensive income (unrealized)		0			620		0			338
Purchases, issuances, sales, and settlements:
Purchases		1,917			0		0			0
Settlements		(198	)		0		0			(5	)
Balance, September 30, 2011	$	0		$	1,860	$	0		$	1,227

(c) Transferred from Level 3 to Level 2 since observable market data became available to value the security.

(d) The Corporation’s policy is to recognize transfers in and transfers out as of the actual date of the event or change in circumstances that caused the transfer.

The unrealized losses reported in earnings for the nine months ended September 30, 2011 for Level 3 assets that are still held at the balance sheet date relate to pooled trust preferred securities deemed to be other-than-temporarily impaired.

The following table presents quantitative information about Level 3 fair value measurements at September 30, 2012:

	Fair value		Valuation Technique	Unobservable Inputs	Input Utilized
Corporate notes and bonds	$	1,985	Discounted cash flow	Constant prepayment rate Probability of default Discount rate	0% 0% 9.6%
Pooled trust preferred	$	360	Discounted cash flow	Collateral default rate Discount rate Recovery probability	2% annually for 2 years; 0.36% thereafter 17% 10%, lagged 2 years

The significant unobservable inputs used in the fair value measurement of the Corporation’s corporate notes and bonds are prepayment rates, probability of default, and discount rate. Significant increases/(decreases) in any of those inputs in isolation would result in a significantly reduced/increased fair value measurement. The significant unobservable inputs used in the fair value measurement of the Corporation’s pooled trust preferred securities are collateral default rate, discount rate, and recovery probability. Prepayment rates are also estimated for pooled trust preferred securities and vary depending on the asset size of the company that issued the security and whether the issue is fixed rate or variable rate; however, the overall effect of prepayment rates on fair value is not material. Significant increases in specific-issuer default assumptions or decreases in specific-issuer recovery assumptions would result in a significantly lower fair value measurement. Conversely, decreases in specific-issuer default assumptions or increases in specific-issuer recovery assumptions would result in a higher fair value measurement.

During the three months ended September 30, 2012 residential mortgage and asset backed securities totaling $3,148 that were reported as Level 1 securities as of the beginning of the period were transferred to the Level 2 category. There were no transfers of securities from Level 1 to Level 2 during the three months ended September 30, 2011.

During the nine months ended September 30, 2012 and 2011, the following available for sale securities reported as Level 1 securities as of the beginning of the period were transferred to the Level 2 category:

	2012		2011
U.S. Government sponsored entities	$	2,000	$	2,000
States and political subdivisions		4,655		4,750
Residential mortgage and asset backed		8,577		20,405
Total	$	15,232	$	27,155

These securities were transferred from the Level 1 category to the Level 2 category since there were no longer quoted prices for identical assets in active markets that the Corporation had the ability to access. During the nine months ended September 30, 2011, two pooled SBA securities that were classified as Level 2 securities at December 31, 2010 were transferred to the Level 1 category. The fair value on the date of transfer was $3,437. There were no transfers of securities from the Level 2 category to the Level 1 category during the three months ended September 30, 2011. There were no transfers of securities from the Level 2 category to the Level 1 category during the three and nine months ended September 30, 2012. The Corporation’s policy for determining when a transfer between the Level 1 and Level 2 categories has occurred is to monitor and report such transfers as of each quarterly reporting period.

Assets and liabilities measured at fair value on a non-recurring basis are as follows at September 30, 2012 and December 31, 2011:

			Fair Value Measurements at September 30, 2012 Using
Description	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans:
Commercial mortgages	$	8,327	$	0	$	0	$	8,327
Commercial, industrial, and agricultural		3,945		0		0		3,945
Residential real estate		419		0		0		419

			Fair Value Measurements at December 31, 2011 Using
Description	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans:
Commercial mortgages	$	7,219	$	0	$	0	$	7,219
Commercial, industrial, and agricultural		3,190		0		0		3,190
Residential real estate		105		0		0		105

Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a principal balance of $14,678 with a valuation allowance of $1,987 as of September 30, 2012, resulting in an additional provision for loan losses of $756 and $1,544 for the corresponding three and nine months then ended. Impaired loans had a principal balance of $22,384 with a valuation allowance of $1,493 as of December 31, 2011, and an additional provision for loan losses of $530 and $782 was recorded for the three and nine months ended September 30, 2011.

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2012:

	Fair value		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
Impaired loans – commercial mortgages	$	8,327	Sales comparison approach	Negative adjustment for changes in market conditions since appraisal	0% - 65% (17%)
Impaired loans – commercial, industrial, and agricultural		3,945	Income approach	Negative adjustment for changes in net operating income expectations since appraisal	14% - 65% (21%)
Impaired loans – residential real estate		419	Sales comparison approach	Negative adjustment for changes in market conditions since appraisal	10% -15% (11%)

Fair Value of Financial Instruments

The following table presents the carrying amount and fair value of financial instruments at September 30, 2012:

	Carrying			Fair Value Measurement Using:									Total
	Amount			Level 1			Level 2			Level 3			Fair Value
ASSETS
Cash and cash equivalents	$	32,946		$	32,946		$	0		$	0		$	32,946
Interest bearing time deposits with other banks		225			0			225			0			225
Securities available for sale		719,284			51,173			665,766			2,345			719,284
Trading securities		3,620			3,460			160			0			3,620
Loans held for sale		3,847			0			3,938			0			3,938
Net loans		896,568			0			0			922,833			922,833
FHLB and other equity interests		6,755			N/A			N/A			N/A			N/A
Accrued interest receivable		7,357			288			3,753			3,316			7,357
LIABILITIES
Deposits	$	(1,480,270	)	$	(1,259,828	)	$	(223,935	)	$	0		$	(1,483,763	)
FHLB and other borrowings		(74,336	)		0			(77,364	)		0			(77,364	)
Subordinated debentures		(20,620	)		0			0			(11,049	)		(11,049	)
Interest rate swaps		(1,848	)		0			(1,848	)		0			(1,848	)
Accrued interest payable		(1,041	)		(291	)		(732	)		(18	)		(1,041	)

The following table presents the carrying amount and fair value of financial instruments at December 31, 2011:

	Carrying Amount			Fair Value
ASSETS
Cash and cash equivalents	$	39,703		$	39,703
Interest bearing time deposits with other banks		224			229
Securities available for sale		638,107			638,107
Trading securities		3,233			3,233
Loans held for sale		1,442			1,470
Net loans		837,268			862,389
FHLB and other equity interests		6,537			N/A
Accrued interest receivable		6,567			6,567
LIABILITIES
Deposits	$	(1,353,851	)	$	(1,357,415	)
FHLB and other borrowings		(74,456	)		(83,042	)
Subordinated debentures		(20,620	)		(10,906	)
Interest rate swaps		(1,669	)		(1,669	)
Accrued interest payable		(1,308	)		(1,308	)

The methods and assumptions, not otherwise presented, used to estimate fair values are described as follows:

Cash and cash equivalents: The carrying amounts of cash and cash equivalents approximate fair values and are classified as Level 1.

Interest bearing time deposits with other banks: The fair value of interest bearing time deposits with other banks is estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of aggregated expected monthly maturities, resulting in a Level 2 classification.

Loans held for sale: The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

Loans: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values, resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality, resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

FHLB and other equity interests: It is not practical to determine the fair value of Federal Home Loan Bank stock and other equity interests due to restrictions placed on the transferability of these instruments.

Accrued interest receivable: The carrying amount of accrued interest receivable approximates fair value resulting in a classification that is consistent with the asset with which it is associated.

Deposits: The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (i.e. their carrying amount), resulting in a Level 1 classification. Fair values for time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits, resulting in a Level 2 classification.

FHLB and other borrowings: The fair values of the Corporation’s FHLB and other borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements, resulting in a Level 2 classification.

Subordinated debentures: The fair value of the Corporation’s subordinated debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of arrangements, resulting in a Level 3 classification.

Accrued interest payable: The carrying amount of accrued interest payable approximates fair value resulting in a classification that is consistent with the liability with which it is associated.

While estimates of fair value are based on management’s judgment of the most appropriate factors as of the balance sheet date, there is no assurance that the estimated fair values would have been realized if the assets had been disposed of or the liabilities settled at that date, since market values may differ depending on various circumstances. The estimated fair values would also not apply to subsequent dates.

In addition, other assets and liabilities that are not financial instruments, such as premises and equipment, are not included in the disclosures. Also, non-financial assets such as, among other things, the estimated earnings power of core deposits, the earnings potential of trust accounts, the trained workforce, and customer goodwill, which typically are not recognized on the balance sheet, may have value but are not included in the fair value disclosures.