18. Fair Value

Fair value 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 using quoted market prices. However, in many instances, quoted market prices are not available. In such instances, fair values are determined using various valuation techniques. Various assumptions and observable inputs must be relied upon in applying these techniques. GAAP establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

GAAP permits an entity to choose to measure eligible financial instruments and other items at fair value. At March 31, 2012, the Company elected the fair value option for its loans held for sale. Electing the fair value option for loans held for sale enables the Company's financial position to more clearly align with the economic value of the actively traded asset.

The fair value hierarchy for valuation of an asset or liability is as follows:

Level 1:

Valuation is based upon unadjusted quoted prices in active markets for identical assets and liabilities that the entity has the ability to access as of the measurement date.

Level 2:

Valuation is determined from quoted prices for similar assets or liabilities in active markets, from quoted prices for identical or similar instruments in markets that are not active or by model-based techniques in which all significant inputs are observable in the market.

Level 3:

Valuation is derived from model-based and other techniques in which at least one significant input is unobservable and which may be based on the Company's own estimates about the assumptions that market participants would use to value the asset or liability.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon model-based techniques incorporating various assumptions including interest rates, prepayment speeds and credit losses. Assets and liabilities valued using model-based techniques are classified as either Level 2 or Level 3, depending on the lowest level classification of an input that is considered significant to the overall valuation. A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Financial Instruments Recorded at Fair Value on a Recurring Basis

Securities Available for Sale: The fair value of debt securities available for sale is reported utilizing prices provided by an independent pricing service based on recent trading activity and other observable information including, but not limited to, dealer quotes, market spreads, cash flows, market interest rate curves, market consensus prepayment speeds, credit information, and the bond's terms and conditions. The fair value of equity securities available for sale was calculated using a discounted cash flow analysis using observable information including, but not limited to, cash flows, risk-adjusted discount rates and market spreads. The fair values of debt and equity securities are classified as Level 2.

Trading Account Assets: Trading account assets are invested in mutual funds and classified as Level 1 based upon quoted prices.

Loans Held for Sale: Effective March 31, 2012, the fair value of loans held for sale is determined using quoted secondary market prices or executed sales agreements and classified as Level 2.

Derivatives: The fair value of interest rate swaps is determined using inputs that are observable in the market place obtained from third parties including yield curves, publicly available volatilities, and floating indexes and, accordingly, are classified as Level 2 inputs. The credit value adjustments associated with derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. As of December 31, 2012 and December 31, 2011, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives due to collateral postings.

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of December 31, 2012 and December 31, 2011, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

	Readily Available Market Prices (Level 1)		Observable Market Data (Level 2)		Company Determined Fair Value (Level 3)		Total
At December 31, 2012
Financial Assets:
Available for sale debt securities:
Obligations of states and political subdivisions	$	-	$	33,040	$	-	$	33,040
Mortgage-backed securities issued or guaranteed by U.S. government sponsored enterprises		-		358,148		-		358,148
Collateralized mortgage obligations issued or guaranteed by U.S. government sponsored enterprises		-		381,688		-		381,688
Private issue collateralized mortgage obligations		-		8,174		-		8,174
Trading account assets		2,300		-		-		2,300
Customer interest rate swap agreement		-		496		-		496
Financial Liabilities:
Interest rate swap agreements		-		11,580		-		11,580
At December 31, 2011
Financial Assets:
Available for sale debt securities:
Obligations of U.S. government sponsored enterprises	$	-	$	30,107	$	-	$	30,107
Obligations of states and political subdivisions		-		39,758		-		39,758
Mortgage-backed securities issued or guaranteed by U.S. government sponsored enterprises		-		376,934		-		376,934
Collateralized mortgage obligations issued or guaranteed by U.S. government sponsored enterprises		-		128,450		-		128,450
Private issue collateralized mortgage obligations		-		10,641		-		10,641
Equity securities		-		4,146		-		4,146
Trading account assets		2,244		-		-		2,244
Customer interest rate swap agreement		-		211		-		211
Financial Liabilities:
Interest rate swap agreements		-		11,387		-		11,387

The Company did not have any transfers between Level 1 and Level 2 of the fair value hierarchy during 2012. The Company's policy for determining transfers between levels occurs at the end of the reporting period when circumstances in the underlying valuation criteria change and result in transfer between levels.

Financial Instruments Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain financial assets and financial liabilities at fair value on a nonrecurring basis in accordance with GAAP. These include assets that are measured at the lower of cost or market value that were recognized at fair value below cost at the end of the period.

Collateral-Dependent Impaired Loans: Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, the Company measures impairment in accordance with GAAP. Impaired loans are measured using one of three methods: the present value of expected future cash flows discounted at the loan's effective interest rate; the loan's observable market price; or the fair value of the collateral if the loan is collateral dependent. If the measure is less than an impaired loan's recorded investment, an impairment loss is recognized as part of the ALL. Accordingly, certain impaired loans may be subject to measurement at fair value on a non-recurring basis. Management has estimated the fair values of these assets using Level 2 inputs, such as the fair value of collateral based on independent third-party market approach appraisals for collateral-dependent loans, and level 3 inputs where circumstances warrant an adjustment to the appraised value based on the age of the appraisal and/or comparable sales, condition of the collateral, and market conditions.

Mortgage Servicing Rights: The Company accounts for mortgage servicing assets at cost, subject to impairment testing. When the carrying value exceeds fair value, a valuation allowance is established to reduce the carrying cost to fair value. Fair value is based on a valuation model that calculates the present value of estimated net servicing income. The Company obtains a third-party valuation based upon loan level data including note rate, type and term of the underlying loans. The model utilizes a variety of observable inputs for its assumptions, the most significant of which are loan prepayment assumptions and the discount rate used to discount future cash flows. Other assumptions include delinquency rates, servicing cost inflation and annual unit loan cost. Mortgage servicing rights are classified within Level 2 of the fair value hierarchy.

Non-Financial Assets and Non-Financial Liabilities Recorded at Fair Value

The Company has no non-financial assets or non-financial liabilities measured at fair value on a recurring basis. Non-financial assets measured at fair value on a non-recurring basis consist of OREO and goodwill.

OREO: OREO properties acquired through foreclosure or deed in lieu of foreclosure are recorded at the fair value of the real estate, less costs to sell. Any write-down of the recorded investment in the related loan is charged to the allowance for loan losses upon transfer to OREO. Upon acquisition of a property, a current appraisal or a broker's opinion is used to substantiate fair value for the property. After foreclosure, management periodically obtains updated valuations of the OREO assets and, if additional impairments are deemed necessary, the subsequent write-downs for declines in value are recorded through a valuation allowance and a provision for losses charged to other non-interest expense. Certain assets require assumptions, such as expected future cash flows, that are not observable in an active market in determination of fair value and are classified as Level 3.

Goodwill: Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. The fair value of goodwill is estimated by utilizing several standard valuation techniques, including discounted cash flow analyses, bank merger multiples, and an estimation of the impact of business conditions and investor activities on the long-term value of the goodwill.

Assets measured at fair value on a non-recurring basis as of December 31, 2012 and December 31, 2011 are included below:

	Readily Available Market Prices (Level 1)		Observable Market Data (Level 2)		Company Determined Fair Value (Level 3)		Total
At December 31, 2012
Assets:
Collateral-dependent impaired loans	$	-	$	-	$	9,183	$	9,183
Other real estate owned		-		-		1,313		1,313
Mortgage servicing rights		-		879		-		879
At December 31, 2011
Assets:
Impaired loans	$	-	$	-	$	18,183	$	18,183
Goodwill		-		-		276		276
Other real estate owned		-		-		1,682		1,682
Mortgage servicing rights		-		1,138		-		1,138

The December 31, 2011, non-recurring fair value table includes all impaired loans with a related allowance. The Company refined its process for identifying impaired loans for purposes of fair value disclosures; accordingly, the December 31, 2012, fair value table only includes those impaired loans for which the related allowance results in a fair value measure, as described above.

The following table presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a non-recurring basis at December 31, 2012:

	Fair Value		Valuation Methodology		Unobservable input		Discount Range
Collateral-dependent impaired loans:⁽¹⁾
Partially charged-off	$	3,524		Market approach appraisal of collateral		Management adjustment of appraisal		10 - 30	%
Specifically reserved	$	5,659		Market approach appraisal of collateral		Management adjustment of appraisal		-	⁽²⁾
Other real estate owned	$	1,313		Market approach appraisal of collateral		Management adjustment of appraisal		10 - 30	%
						Estimated selling cost		6 - 10	%

(1)

Does not include impaired loans that are measured by the present value of expected future cash flows discounted at the loan's effective interest rate.

(2)

The specific reserve for collateral-dependent impaired loans is determined by any deficit of 75% of collateral value below the recorded investment.

GAAP requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above. The following methods and assumptions were used by the Company in estimating the fair values of its other financial instruments.

Cash and Due from Banks: The carrying amounts reported in the Statement of Condition approximate fair value.

FHLB and Federal Reserve Bank Stock and Investments in CCTA AND UBCT: The carrying amounts reported in the Statement of Condition approximate fair value.

Loans: For variable rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. The fair value of other loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Interest Receivable and Payable: The carrying amounts reported in the Statement of Condition approximate fair value.

Deposits: The fair value of deposits with no stated maturity is equal to the carrying amount. The fair value of certificates of deposit is estimated using a discounted cash flow calculation that applies interest rates and remaining maturities for currently offered certificates of deposit.

Borrowings: The carrying amounts of short-term borrowings from the FHLB, securities sold under repurchase agreements, notes payable and other short-term borrowings approximate fair value. The fair values of long-term borrowings and commercial repurchase agreements are based on the discounted cash flows using current rates for advances of similar remaining maturities.

Junior Subordinated Debentures: The carrying amounts reported in the Statement of Condition approximate fair value.

The following table presents the carrying amounts and estimated fair value for financial instrument assets and liabilities at December 31, 2012:

					Fair Value Measurement at December 31, 2012
	Carrying Amount		Fair Value		Readily Available Market Prices (Level 1)		Observable Market Prices (Level 2)		Company Determined Market Prices (Level 3)
Financial assets:
Cash and due from banks	$	58,290	$	58,290	$	58,290	$	-	$	-
Securities available for sale		781,050		781,050		-		781,050		-
FHLB and Federal Reserve Bank stock		21,034		21,034		21,034		-		-
Trading account assets		2,300		2,300		2,300		-		-
Loans receivable, net of allowance		1,540,822		1,557,320		-		-		1,557,320
Mortgage servicing rights		542		879		-		879		-
Interest receivable		6,215		6,215		-		6,215		-
Investment in CCTA and UBCT		1,331		1,331		-		-		1,331
Customer interest rate swap agreement		496		496		-		496		-

					Fair Value Measurement at December 31, 2012
	Carrying Amount		Fair Value		Readily Available Market Prices (Level 1)		Observable Market Prices (Level 2)		Company Determined Market Prices (Level 3)
Financial liabilities:
Deposits		1,929,469		1,936,446		1,339,290		597,156		-
FHLB advances		56,404		60,813		-		60,813		-
Commercial repurchase agreements		66,187		69,067		-		69,067		-
Other borrowed funds		193,753		193,753		193,753		-		-
Junior subordinated debentures		43,819		43,819		-		43,819		-
Interest payable		905		905		905		-		-
Interest rate swap agreements		11,580		11,580		-		11,580		-

The following table presents the carrying amounts and estimated fair value for financial instrument assets and liabilities at December 31, 2011:

	December 31, 2011
	Carrying Amount		Fair Value
Financial assets:
Cash and due from banks	$	39,325	$	39,325
Securities available for sale		590,036		590,036
FHLB and Federal Reserve Bank stock		21,962		21,962
Trading account assets		2,244		2,244
Loans held for sale		6,061		6,268
Loans receivable, net of allowance		1,491,017		1,510,277
Mortgage servicing rights		768		1,138
Interest receivable		6,431		6,431
Investment in CCTA and UBCT		1,331		1,331
Customer interest rate swap agreement		211		211
Financial liabilities:
Deposits		1,591,366		1,600,222
FHLB advances		136,860		143,642
Commercial repurchase agreements		71,243		75,342
Other borrowed funds		204,413		204,413
Junior subordinated debentures		43,717		43,717
Interest payable		1,093		1,093
Interest rate swap agreements		11,387		11,387