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 820, "Fair Value Measurement and Disclosures", the fair value of an 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 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 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 assets and 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 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). If no observable market data is available, valuations are based upon third party model based techniques (Level 3). FRB 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 following table.

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

	Fair Value Measurements at September 30, 2014 Using
	Balance as of September 30,			Quoted Prices in Active Markets for Identical Assets			Significant Other Observable Inputs			Significant Unobservable Inputs
Description	2014			Level 1			Level 2			Level 3
Assets:
Securities available for sale:
Federal agencies and GSEs		$	69,943		$	-		$	69,943		$	-
Mortgage-backed and CMOs			60,872			-			60,872			-
State and municipal			188,197			-			188,197			-
Corporate			8,409			-			8,409			-
Equity			1,113			-			-			1,113
Total		$	328,534		$	-		$	327,421		$	1,113

	Fair Value Measurements at December 31, 2013 Using
	Balance as of December 31,			Quoted Prices in Active Markets for Identical Assets			Significant Other Observable Inputs			Significant Unobservable Inputs
Description	2013			Level 1			Level 2			Level 3
Assets:
Securities available for sale:
Federal agencies and GSEs		$	65,881		$	-		$	65,881		$	-
Mortgage-backed and CMOs			69,608			-			69,608			-
State and municipal			198,733			-			198,733			-
Corporate			10,799			-			10,799			-
Equity			1,103			-			-			1,103
Total		$	346,124		$	-		$	345,021		$	1,103

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
			Total Realized / Unrealized Gains (Losses) Included in
	Balances as of January 1, 2014		Net Income		Other Comprehensive Income		Purchases, Sales, Issuances and Settlements, Net		Transfer In (Out) of Level 3		Balances as of September 30, 2014
Securities available for sale:

Equity	$	1,103	$	-	$	10	$	-	$	-	$	$1,113

Certain assets are measured at fair value on a nonrecurring basis in accordance with 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 nine month period ended September 30, 2014 or the year ended December 31, 2013. 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 agreements will not be collected. In addition, the impairment of a loan may be measured using a present value of future cash flows analysis (Level 3). Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the Company's collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal, of one year or less, conducted by an independent, licensed appraiser 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 property is more than one year old and not solely based on observable market comparables or management determines the fair value of the collateral is further impaired below the appraised value, then a Level 3 valuation is considered to measure the fair value. The value of business equipment is based upon an outside appraisal, of one year or less, 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: Measurement for fair values for other real estate owned are the same as real estate collateral discussed with impaired loans.

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

	Fair Value Measurements at September 30, 2014 Using
	Balance as of September 30,,			Quoted Prices in Active Markets for Identical Assets			Significant Other Observable Inputs			Significant Unobservable Inputs
Description	2014			Level 1			Level 2			Level 3
Assets:
Loans held for sale		$	811		$	-		$	811		$	-
Impaired loans, net of valuation allowance			2,158			-			-			2,158
Other real estate owned			2,364			-			-			2,364

	Fair Value Measurements at December 31, 2013 Using
	Balance as of December 31,			Quoted Prices in Active Markets for Identical Assets			Significant Other Observable Inputs			Significant Unobservable Inputs
Description	2013			Level 1			Level 2			Level 3
Assets:
Loans held for sale		$	2,760		$	-		$	2,760		$	-
Impaired loans, net of valuation allowance			3,193			-			-			3,193
Other real estate owned			3,422			-			-			3,422

Quantitative Information About Level 3 Fair Value Measurements for September 30, 2014

Assets	Valuation Technique	Unobservable Input	Weighted Rate

Securities available for sale	Third party model based techniques	Stock price in different rate environments	11%

Impaired loans	Discounted appraised value	Selling cost	6%
	Discounted cash flows	Market rate for borrower (discount rate)	6%

Other real estate owned	Discounted appraised value	Discount for lack of marketability and age of appraisal	6%

The carrying values and estimated fair values of the Company's financial instruments at September 30, 2014 are as follows (in thousands):

	Fair Value Measurements at September 30, 2014 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	$	80,977	$	-	$	80,977	$	-	$	80,977
Securities available for sale		328,534		-		327,421		1,113		328,534
Restricted stock		4,529		-		4,529		-		4,529
Loans held for sale		811		-		811		-		811
Loans, net of allowance		803,968		-		-		806,753		806,753
Bank owned life insurance		15,044		-		15,044		-		15,044
Accrued interest receivable		4,345		-		4,345		-		4,345

Financial Liabilities:
Deposits	$	1,051,060	$	-	$	691,869	$	361,059	$	1,052,928
Repurchase agreements		51,945		-		51,945		-		51,945
Other borrowings		9,930		-		-		10,447		10,447
Trust preferred capital notes		27,495		-		-		21,134		21,134
Accrued interest payable		581		-		581		-		581

The carrying values and estimated fair values of the Company's financial instruments at December 31, 2013 are as follows (in thousands):

	Fair Value Measurements at December 31, 2013 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	$	67,681	$	-	$	67,681	$	-	$	67,681
Securities available for sale		346,124		-		345,021		1,103		346,124
Restricted stock		4,889		-		4,889		-		4,889
Loans held for sale		2,760		-		2,760		-		2,760
Loans, net of allowance		782,071		-		-		783,825		783,825
Bank owned life insurance		14,746		-		14,746		-		14,746
Accrued interest receivable		4,741		-		4,741		-		4,741

Financial Liabilities:
Deposits	$	1,057,675	$	-	$	668,077	$	392,991	$	1,061,068
Repurchase agreements		39,478		-		39,478		-		39,478
Other borrowings		9,951		-		-		10,560		10,560
Trust preferred capital notes		27,419		-		-		18,162		18,162
Accrued interest payable		610		-		610		-		610

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 short-term borrowings. 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 September 30, 2014 and December 31, 2013, 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.