NOTE 6 FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability 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 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 reporting entity's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Corporation used the following methods and significant assumptions to estimate fair value:

Investment Securities: The fair values of securities available for sale are usually determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs), or matrix pricing, which is a mathematical technique widely used 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).

The Corporation's investment in collateralized debt obligations consisting of pooled trust preferred securities which are issued by financial institutions were historically priced using Level 2 inputs. The lack of observable inputs and market activity in this class of investments has been significant and resulted in unreliable external pricing. Broker pricing and bid/ask spreads, when available, have varied widely. The once active market has become comparatively inactive. As a result, these investments are now priced using Level 3 inputs.

The Corporation utilizes an external model for pricing these securities. This is the same model used in determining OTTI as further described in Note 4. Information such as historical and current performance of the underlying collateral, deferral/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, are utilized in determining individual security valuations. Discount rates were utilized along with the cash flow projections in order to calculate an appropriate fair value. These discount rates were calculated based on industry index rates and adjusted for various credit and liquidity factors. Due to 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.

Trading Assets: Securities that are held to fund a deferred compensation plan are recorded at fair value with changes in fair value included in earnings. The fair values of trading assets are determined by quoted market prices (Level 1 inputs).

Impaired Loans: At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value have been partially charged-off or receive specific allocations as part of the allowance for loan loss accounting. For collateral dependent loans, fair value is commonly based on real estate appraisals. 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 independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, typically resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned: Assets acquired through or instead of loan foreclosures are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals. 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 independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Appraisals for both collateral-dependent impaired loans and other real estate owned (“OREO”) are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Corporation. Once received, appraisals are reviewed for reasonableness of assumptions, approaches utilized, Uniform Standards of Professional Appraisal Practice and other regulatory compliance, as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. Appraisals are generally completed within the previous 12-month period prior to a property being placed into OREO. On impaired loans, appraisal values are adjusted based on the age of the appraisal, the position of the lien, the type of the property and its condition.

Assets and liabilities measured at fair value on a recurring basis are summarized below:

			Fair Value Measurement at June 30, 2013 Using
Financial Assets:	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Obligations of U.S. Government and U.S. Government sponsored enterprises	$	144,450,370	$	31,526,000	$	112,924,370	$	-
Mortgage-backed securities, residential		22,979,392		-		22,979,392		-
Obligations of states and political subdivisions		37,003,563		-		37,003,563		-
Collateralized mortgage obligations		2,188,975		-		2,188,975		-
Corporate bonds and notes		7,515,573		-		7,515,573		-
SBA loan pools		1,591,911		-		1,591,911		-
Trust Preferred securities		2,515,706		-		2,001,406		514,300
Corporate stocks		7,116,462		6,473,329		643,133		-
Total available for sale securities	$	225,361,952	$	37,999,329	$	186,848,323	$	514,300

Trading assets	$	388,714	$	388,714	$	-	$	-

			Fair Value Measurement at December 31, 2012 Using
Financial Assets:	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Obligations of U.S. Government and U.S. Government sponsored enterprises	$	141,591,214	$	37,698,000	$	103,893,214	$	-
Mortgage-backed securities, residential		31,515,249		-		31,515,249		-
Obligations of states and political subdivisions		40,814,722		-		40,814,722		-
Collateralized mortgage obligations		3,543,360		-		3,543,360		-
Corporate bonds and notes		11,651,635		-		11,651,635		-
SBA loan pools		1,724,140		-		1,724,140		-
Trust Preferred securities		2,470,913		-		2,025,313		445,600
Corporate stocks		6,374,530		5,720,533		653,997		-
Total available for sale securities	$	239,685,763	$	43,418,533	$	195,821,630	$	445,600

Trading assets	$	348,241	$	348,241	$	-	$	-

There were no transfers between Level 1 and Level 2 during the six-month period ending June 30, 2013 or the year ending December, 31, 2012.

The significant unobservable inputs used in the fair value measurement of the Corporation’s collateralized debt obligations are probabilities of specific-issuer defaults and deferrals and specific-issuer recovery assumptions. 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. The Corporation treats all interest payment deferrals as defaults and assumes no recoveries on defaults.

The tables below present a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six-month periods ending June 30, 2013 and 2012:

	Fair Value Measurement for Six-Months Ended June 30, 2013 Using Significant Unobservable Inputs (Level 3)		Fair Value Measurement for Six-Months Ended June 30, 2012 Using Significant Unobservable Inputs (Level 3)
Trust Preferred Securities Available for Sale
Beginning balance	$	445,600	$	294,910
Total gains/losses (realized/unrealized):
Included in earnings:
Income on securities		-		-
Impairment charge on investment securities		-		-
Included in other comprehensive income		68,700		48,125
Transfers in and/or out of Level 3		-		-
Ending balance June 30	$	514,300	$	343,035

	Fair Value Measurement for Three-Months Ended June 30, 2013 Using Significant Unobservable Inputs (Level 3)		Fair Value Measurement for Three-Months Ended June 30, 2012 Using Significant Unobservable Inputs (Level 3)
Trust Preferred Securities Available for Sale
Beginning balance	$	496,825	$	346,210
Total gains/losses (realized/unrealized):
Included in earnings:
Income on securities		-		-
Impairment charge on investment securities		-		-
Included in other comprehensive income		17,475		(3,175)
Transfers in and/or out of Level 3		-		-
Ending balance March 31	$	514,300	$	343,035

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

			Fair Value Measurement at June 30, 2013 Using
Financial Assets:	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired Loans:
Commercial and agricultural:
Commercial &industrial	$	257,146	$	-	$	-	$	257,146
Commercial mortgages:				-		-
Other		680,723		-		-		680,723
Consumer loans:
Home equity lines & loans		53,856		-		-		53,856
Total Impaired Loans	$	991,725	$	-	$	-	$	991,725

Other real estate owned:
Commercial and agricultural:
Commercial and industrial	$	101,200	$	-	$	-	$	101,200
Commercial mortgages:
Other		257,702		-		-		257,702
Residential mortgages		161,950		-		-		161,950
Consumer loans:
Home equity lines & loans		66,959		-		-		66,959
Total Other real estate owned, net	$	587,811	$	-	$	-	$	587,811

			Fair Value Measurement at December 31, 2012 Using
Financial Assets:	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired Loans:
Commercial and agricultural:
Commercial & industrial	$	235,501	$	-	$	-	$	235,501
Commercial mortgages:				-		-
Other		305,222		-		-		305,222
Total Impaired Loans	$	540,723	$	-	$	-	$	540,723

Other real estate owned:
Commercial and agricultural:
Commercial and industrial	$	101,200	$	-	$	-	$	101,200
Commercial mortgages:
Other		257,702		-		-		257,702
Residential mortgages		201,679		-		-		201,679
Consumer loans:
Home equity lines & loans		4,000		-		-		4,000
Total Other real estate owned, net	$	564,581	$	-	$	-	$	564,581

The following table presents information related to Level 3 non-recurring fair value measurement at June 30, 2013 and December 31, 2012:

Description	Fair Value at June 30, 2013		Technique	Unobservable Inputs
Impaired loans	$	991,725	Third party real estate and a 100% discount of personal property	1	Management discount based on underlying collateral characteristics and market conditions

Other real estate owned	$	587,811	Third party appraisals	1	Estimated holding period
				2	Estimated closing costs

Description	Fair Value at December 31, 2012		Technique	Unobservable Inputs
Impaired loans	$	540,723	Third party real estate and a 100% discount of personal property	1	Management discount based on underlying collateral characteristics and market conditions

Other real estate owned	$	564,581	Third party appraisals	1	Estimated holding period
				2	Estimated closing costs

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal balance of $1,761,952 with a valuation allowance of $770,227 as of June 30, 2013, resulting in $494,350 and $577,589 of additional provision for loan losses for the three and six-month periods ended June 30, 2013, respectively. Impaired loans had a principal balance of $733,361, with a valuation allowance of $192,638 as of December 31, 2012, resulting in no additional provision for loan losses for the year ending December 31, 2012.

OREO, which is measured by the lower of carrying or fair value less costs to sell, had a net carrying amount of $587,811 at June 30, 2013. The net carrying amount reflects the outstanding balance of $780,178 net of a valuation allowance of $192,367 at June 30, 2013. There were no write downs for the three and six-month periods ending June 30, 2013. OREO had a net carrying amount of $564,581 at December 31, 2012. The net carrying amount reflects the outstanding balance of $756,948 net of a valuation allowance of $192,367 at December 31, 2012, which resulted in write downs of $116,840 for the year ending December 31, 2012.

The carrying amounts and estimated fair values of other financial instruments, at June 30, 2013 and December 31, 2012, are as follows (dollars in thousands):

	Fair Value Measurements at June 30, 2013 Using
Financial assets:	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)		Estimated Fair Value (1)
Cash and due from financial institutions	$	23,812	$	23,812	$	-	$	-	$	23,812
Interest-bearing deposits in other financial institutions		945		945		-		-		945
Trading assets		389		389		-		-		389
Securities available for sale		225,362		37,999		186,849		514		225,362
Securities held to maturity		6,570		-		7,064		-		7,064
Federal Home Loan and Federal Reserve Bank stock		4,579		-		-		-		N/A
Net loans		922,719		-		-		952,305		952,305
Loans held for sale		947		-		947		-		947
Accrued interest receivable		3,742		143		1,234		2,365		3,742
Financial liabilities:
Deposits:
Demand, savings, and insured money market accounts		830,003		830,003		-		-		830,003
Time deposits		224,965		-		226,038		-		226,038
Securities sold under agreements to repurchase		30,568		-		32,014		-		32,014
Federal Home Loan Bank advances		26,101		-		27,476		-		27,476
Accrued interest payable		405		16		224		165		405

		Fair Value Measurements at December 31, 2012
Financial Assets:		Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)			Estimated Fair Value (1)
Cash and due from financial institutions	$	29,239	$	29,239	$	-		-	$	29,239
Interest-bearing deposits in other financial institutions		11,002		8,645		2,357		-		11,002
Trading assets		348		348		-		-		348
Securities available for sale		239,686		43,419		195,822		445		239,686
Securities held to maturity		5,748		-		6,421		-		6,421
Federal Home Loan and Federal Reserve Bank stock		4,710		-		-		-		N/A
Net loans		883,084		-		-		916,289		916,289
Loans held for sale		1,057		-		1,057		-		1,057
Accrued interest receivable		3,788		175		1,257		2,356		3,788
Financial liabilities:
Deposits:
Demand, savings, and insured money market accounts	$	808,044	$	808,044	$	-	$	-	$	808,044
Time deposits		236,690		-		238,245		-		238,245
Securities sold under agreements to repurchase		32,711		-		35,260		-		35,260
Federal Home Loan Bank advances		27,225		-		29,688		-		29,688
Accrued interest payable		453		12		279		162		453
(1) Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

The methods and assumptions used to estimate fair value are described as follows:

Cash, Due From and Interest-Bearing Deposits in Other Financial Institutions

For those short-term instruments that generally mature in 90 days or less, the carrying value approximates fair value of which non interest-bearing deposits are classified as Level 1 and interest-bearing deposits with the Federal Home Loan Bank of New York (“FHLB”) and Federal Reserve Bank of New York (“FRB”) are classified as Level 1.

FHLB and FRB Stock

It is not practicable to determine the fair value of FHLB and FRB stock due to restrictions placed on its transferability.

Loans Receivable

For variable-rate loans that reprice frequently, fair values approximate carrying values. The fair values for other loans are estimated through discounted cash flow analysis using interest rates currently being offered for loans with similar terms and credit quality. Loans are classified as Level 3. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price. Loans held for sale are classified as Level 2.

Deposits

The fair values disclosed for demand deposits, savings accounts and money market accounts are, by definition, equal to the amounts payable on demand at the reporting date (i.e., their carrying values) and classified as Level 1.

The fair value of certificates of deposits is estimated using a discounted cash flow approach that applies interest rates currently being offered on certificates to a schedule of the weighted-average expected monthly maturities and classified as Level 2.

Securities Sold Under Agreements to Repurchase (Repurchase Agreements)

These instruments bear both variable and fixed rates of interest. Therefore, the carrying value approximates fair value for the variable rate instruments and the fair value of fixed rate instruments is based on discounted cash flows to maturity. These are classified as Level 2.

Federal Home Loan Bank Advances

These instruments bear a stated rate of interest to maturity and, therefore, the fair value is based on discounted cash flows to maturity and classified as Level 2.

Accrued Interest Receivable and Payable

For these short-term instruments, the carrying value approximates fair value resulting in a classification of Level 1, Level 2 or Level 3 depending upon the classification of the asset/liability they are associated with.