Fair Value of Financial Instruments

6 Months Ended

Jun. 30, 2012

Fair Value of Financial Instruments [Abstract]

Fair Value of Financial Instruments

Note 14 - Fair Value of Financial Instruments

Determination of Fair Value

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the fair value measurements and disclosures topic of FASB ASC, the fair value of a financial instrument is 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. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The recent fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 -	Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2 -	Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3 -	Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:

Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).  Federal Reserve Bank of Richmond and FHLB stocks are carried at cost since no ready market exists and there is no quoted market value.  The Company is required to own stock in these entities as long as it is a member.  Therefore, they have been excluded from the table below.

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis during the period (in thousands):

			Fair Value Measurements at June 30, 2012 Using
	Balance as of June 30,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2012		Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Federal agencies and GSEs	$	37,177	$	-	$	37,177	$	-
Mortgage-backed and CMOs		96,882		-		96,882		-
State and municipal		192,022		-		192,022		-
Corporate		8,442		-		8,105		337
Total	$	334,523	$	-	$	334,186	$	337

			Fair Value Measurements at December 31, 2011 Using
	Balance as of December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2011		Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Federal agencies and GSEs	$	32,679	$	-	$	32,679	$	-
Mortgage-backed and CMOs		103,904		-		103,904		-
State and municipal		194,405		-		194,405		-
Corporate		2,378		-		2,054		324
Total	$	333,366	$	-	$	333,042	$	324

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
			Total Realized / Unrealized Gains
			(Losses) Included in
	Balances as of January 1, 2012		Net Income		Other Comprehensive Income		Purchases, Sales, Issuances and Settlements, Net	Transfer In (Out) of Level 3		Balances as of June 30, 2012
Securities available for sale:
Corporate	$	324	$	13	$	-	-	$	-	$	337
Total assets	$	324	$	13	$	-	-	$	-	$	337

         Certain assets are measured at fair value on a nonrecurring basis in accordance with U.S. GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:

Loans held for sale: Loans held for sale are carried at estimated fair value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the period ended June 30, 2012. Gains and losses on the sale of loans are recorded within income from mortgage banking on the Consolidated Statements of Income.

Impaired loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business's financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Other real estate owned ("OREO"):  Property acquired in satisfaction of loans is carried at the lower of cost or market value.  The value of real estate is determined utilizing an income or market valuation approach less cost to sell based on an appraisal conducted by an independent, licensed appraiser outside of the company using observable market data (Level 2).  However, if the real estate is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3.  OREO is measured at fair value on a nonrecurring basis.  Any initial fair value adjustment is charged against the allowance for loan loss.  Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense on the Consolidated Statements of Income.

The following table summarizes the Company's assets that were measured at fair value on a nonrecurring basis during the period (in thousands):

			Fair Value Measurements at June 30, 2012 Using
	Balance as of June 30,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2012		Level 1		Level 2		Level 3
Assets:
Loans held for sale	$	9,215	$	-	$	9,215	$	-
Impaired loans, net of valuation allowance		440		-		440		-
Other real estate owned		4,731		-		4,731		-

			Fair Value Measurements at December 31, 2011 Using
	Balance as of December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2011		Level 1		Level 2		Level 3
Assets:
Loans held for sale	$	6,330	$	-	$	6,330	$	-
Impaired loans, net of valuation allowance		1,142		-		1,142		-
Other real estate owned		5,353		-		5,353		-

The carrying values and estimated fair values of the Company's financial instruments as of June 30, 2012 are as follows (in thousands):

			Fair Value Measurements at June 30, 2012 using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs		Fair Value
	Carrying Value		Level 1		Level 2		Level 3		Balance
Financial Assets:
Cash and cash equivalents	$	28,909	$	28,909	$	-	$	-	$	28,909
Securities avaiable for sale		334,523		-		334,186		337		334,523
Loans held for sale		9,215		-		9,215		-		9,215
Loans, net of allowance		795,970		-		787,894		-		787,894
Bank owned life insurance		13,273		-		13,273		-		13,273
Accrued Iinterest receivable		5,106		-		5,106		-		5,106
Financial Liabilities:
Deposits	$	1,042,485	$	-	$	1,020,830	$	-	$	1,020,830
Repurchase agreements		46,113		-		46,113		-		46,113
Other borrowings		10,142		-		11,078		-		11,078
Trust preferred capital notes		27,267		-		23,032		-		23,032
Accrued interest payable		758		-		758		-		758

The Company has one Level 3 security, a trust preferred security issued by a community bank. It is a Level 3 security under the three-tier fair value hierarchy because of an absence of observable inputs for these and similar securities in the debt markets.  The Company acquired this security in connection with merger with MidCarolina and obtained an independent third party appraisal of the fair value at July 1, 2011. Because of the lack of observable inputs, the valuation was completed using a discounted cash flow computation, adjusted for an estimated default rate determined by reviewing industry statistics. The merger date initial fair value estimate of the security was 67.28% of its $500,000 par, or $336,000. Approximately $147,000 of this impairment was attributed to factors other than credit, and $17,000 was attributable to credit factors.

The carrying values and estimated fair values of the Company's financial instruments as of December 31, 2011 are as follows (in thousands):

			Fair Value Measurements at December 31, 2011 using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs		Fair Value
	Carrying Value		Level 1		Level 2		Level 3		Balance
Financial Assets:
Cash and cash equivalents	$	28,893	$	28,893	$	-	$	-	$	28,893
Securities avaiable for sale		333,366		-		333,042		324		333,366
Loans held for sale		6,330		-		6,330		-		6,330
Loans, net of allowance		814,229		-		811,573		-		811,573
Bank owned life insurance		13,058		-		13,058		-		13,058
Accrued Iinterest receivable		5,091		-		5,091		-		5,091
Financial Liabilities:
Deposits	$	1,058,754	$	-	$	1,066,448	$	-	$	1,066,448
Repurchase agreements		45,575		-		45,575		-		45,575
Other borrowings		13,206		-		13,064		-		13,064
Trust preferred capital notes		27,212		-		27,184		-		27,184
Accrued interest payable		857		-		857		-		857

The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:

Cash and cash equivalents.  The carrying amount is a reasonable estimate of fair value.

Securities.  Fair values are based on quoted market prices or dealer quotes.

Loans held for sale.  The carrying amount is a reasonable estimate of fair value.

Loans.  For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.  Fair values for fixed-rate loans are estimated based upon discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Bank owned life insurance. Bank owned life insurance represents insurance policies on officers, directors, and past directors of the Company.  The cash values of the policies are estimates using information provided by insurance carriers.  These policies are carried at their cash surrender value, which approximates the fair value.

Accrued interest receivable.  The carrying amount is a reasonable estimate of fair value.

Deposits.  The fair value of demand deposits, savings deposits, and money market deposits equals the carrying value. The fair value of fixed-rate certificates of deposit is estimated by discounting the future cash flows using the current rates at which similar deposit instruments would be offered to depositors for the same remaining maturities.

Repurchase agreements.  The carrying amount is a reasonable estimate of fair value.

Other borrowings.  The fair values of other borrowings are estimated using discounted cash flow analyses based on the interest rates for similar types of borrowing arrangements.

Trust preferred capital notes.  Fair value is calculated by discounting the future cash flows using the estimated current interest rates at which similar securities would be issued.

Accrued interest payable.  The carrying amount is a reasonable estimate of fair value.

Off-balance sheet instruments.  The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.  At June 30, 2012 and December 31, 2011, the fair value of off balance sheet instruments was deemed immaterial, and therefore was not included in the previous table.

The Company assumes interest rate risk (the risk that interest rates will change) in its normal operations.  As a result, the fair values of the Company's financial instruments will change when interest rates change and that change may be either favorable or unfavorable to the Company.