FAIR VALUE

12 Months Ended

Dec. 31, 2011

FAIR VALUE

6. FAIR VALUE

U.S. GAAP defines fair value as 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 and establishes a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:

Level 1:  Quoted prices (unadjusted) for identical assets or liabilities in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

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.

We used the following methods and significant assumptions to estimate the fair value of available-for-sale-securities.

Securities:  The fair values of some equity securities are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs). The fair values of most debt securities are determined by a 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 by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. For trust preferred securities, discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations. For other equity securities, discounted cash flows are calculated with available market information through processes using benchmark yields, market spreads sourced from new issues, dealer quotes and trade prices among other sources. Equity securities are carried at cost which approximates fair value.

Impaired Loans:  The fair value of impaired loans with specific allocations of the allowance for loan losses is generally 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 the 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.

Other Real Estate Owned:   The fair value of other real estate owned is generally based on recent real estate appraisals. These appraisals may use 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 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.

Loans Held For Sale:  Loans held for sale associated with a probable branch divestiture and probable loan sale are presented at the purchase discount and are classified within Level 2 of the valuation hierarchy. Loans held for sale December 31, 2011 include $35.1 million of loans that we expect to sell in a branch divestiture transaction and $10.7 million of loans which we expect to sell during 2012.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Assets measured at fair value on a recurring basis are summarized below: There were no significant transfers between Level 1 and Level 2 during the periods presented.

(Dollars in thousands)	December 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
U.S. Treasury and agencies	$	25,028	$	—	$	25,028	$	—
Government-sponsored mortgage-backed residential		264,691		—		264,691		—
State and municipal		23,794		—		23,794		—
Trust preferred securities		264		—		—		264
Total	$	313,777	$	—	$	313,513	$	264

(Dollars in thousands)	December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3
Assets:
U.S. Treasury and agencies	$	113,893	$	—	$	113,893	$	—
Government-sponsored mortgage-backed residential		59,170		—		59,170		—
Equity		293		2		—		291
State and municipal		22,618		—		22,618		—
Trust preferred securities		55		—		—		55
Total	$	196,029	$	2	$	195,681	$	346

Between June 2002 and July 2006, we invested in four available-for-sale and one held-to-maturity investment grade tranches of trust preferred collateralized debt obligation (“CDO”) securities. The securities were issued and are referred to as Preferred Term Securities Limited (“PreTSL”). The underlying collateral for the PreTSL is unguaranteed pooled trust preferred securities issued by banks, insurance companies and REITs geographically dispersed across the United States. We hold five PreTSL securities, none of which are currently investment grade. Prior to September 30, 2008, we determined the fair value of the trust preferred securities using a valuation technique based on Level 2 inputs. The Level 2 inputs included estimates of the market value for each security provided through our investment broker.

Since late 2007, the markets for collateralized debt obligations and trust preferred securities have become increasingly inactive. The inactivity began in late 2007 when new issues of similar securities were discounted in order to complete the offering. Beginning in the second quarter of 2008, the purchase and sale activity of these securities substantially decreased as investors elected to hold the securities instead of selling them at substantially depressed prices. Our brokers have indicated that little if any activity is occurring in this sector and that the PreTSL securities trades that are taking place are primarily distressed sales where the seller must liquidate as a result of insolvency, redemptions or closure of a fund holding the security, or other distressed conditions. As a result, the bid-ask spreads have widened significantly and the volume of trades decreased significantly compared to historical volumes.

During 2008, we concluded that the market for the trust preferred securities that we hold and for similar CDO securities (such as higher-rated tranches within the same CDO security) was also not active. That determination was made considering that there are few observable transactions for the trust preferred securities or similar CDO securities and the observable prices for those transactions have varied substantially over time. Consequently, we have considered those observable inputs and determined that our trust preferred securities are classified within Level 3 of the fair value hierarchy.

We have determined that an income approach valuation technique (using cash flows and present value techniques) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs is equally or more representative of fair value than relying on the estimation of market value technique used at prior measurement dates, which now has few observable inputs and relies on an inactive market with distressed sales conditions that would require significant adjustments.

We received valuation estimates on our trust preferred securities for December 31, 2011. Those valuation estimates were based on proprietary pricing models utilizing significant unobservable inputs in an inactive market with distressed sales, Level 3 inputs, rather than actual transactions in an active market. In accordance with current accounting guidance, we determined that a risk-adjusted discount rate appropriately reflects the reporting entity’s estimate of the assumptions that market participants would use in an active market to estimate the selling price of the asset at the measurement date.

We conduct a thorough review of fair value hierarchy classifications on a quarterly basis. Reclassification of certain financial instruments may occur when input observability changes.

The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods ended December 31, 2011 and 2010:

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) Year Ended December 31,
(Dollars in thousands)	2011			2010
Beginning balance	$	346		$	340
Total gains or losses:
Impairment charges on securities		(83	)		(998	)
Included in other comprehensive income		292			1,004
Sales of securities		(291	)		—
Transfers in and/or out of Level 3		—			—
Ending balance	$	264		$	346

The table below summarizes changes in unrealized gains and losses recorded in earnings for the year ended December 31 for Level 3 assets and liabilities that are still held at December 31.

	Changes in Unrealized Gains/Losses Relating to Assets Still Held at Reporting Date for the Year Ended December 31,
(Dollars in thousands)	2011		2010
Interest income on securities	$	—	$	—
Other changes in fair value		83		998
Total	$	83	$	998

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Assets measured at fair value on a nonrecurring basis are summarized below:

(Dollars in thousands)	December 31, 2011		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	$	2,643	$	—	$	—	$	2,643
Commercial Real Estate:
Land Development		7,929		—		—		7,929
Building Lots		1,517		—		—		1,517
Other		27,668		—		—		27,668
Real Estate Construction		—		—		—		—
Residential Mortgage		4,384		—		—		4,384
Consumer and Home Equity		937		—		—		937
Indirect Consumer		194		—		—		194
Real estate acquired through foreclosure:
Commercial		728		—		—		728
Commercial Real Estate:
Land Development		4,285		—		—		4,285
Building Lots		5,369		—		—		5,369
Other		6,300		—		—		6,300
Residential Mortgage		172		—		—		172
Trust preferred security held-to-maturity		24		—		—		24
Loans held for sale		45,829		—		45,829		—

(Dollars in thousands)	December 31, 2010		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	$	1,092	$	—	$	—	$	1,092
Commercial Real Estate:
Land Development		18,333		—		—		18,333
Building Lots		3,391		—		—		3,391
Other		49,505		—		—		49,505
Real Estate Construction		1,057		—		—		1,057
Residential Mortgage		4,821		—		—		4,821
Consumer and Home Equity		824		—		—		824
Indirect Consumer		171		—		—		171
Real estate acquired through foreclosure
Commercial		1,103		—		—		1,103
Commercial Real Estate:
Land Development		2,190		—		—		2,190
Building Lots		1,483		—		—		1,482
Other		3,375		—		—		3,375
Residential Mortgage		428		—		—		428
Trust preferred security held-to-maturity		22		—		—		22

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $49.0 million and $96.3 million, with a valuation allowance of $3.7 million and $13.3 million, resulting in an additional provision for loan losses of $14.1 million and $6.5 million for the 2011 and 2010 periods respectively. Values for collateral dependent loans are generally based on appraisals obtained from licensed real estate appraisals and in certain circumstances consideration of offers obtained to purchase properties prior to foreclosure. Appraisals for commercial real estate generally use three methods to derive value: cost, sales or market comparison and income approach. The cost method bases value on the estimated cost to replace the current property after considering adjustments for depreciation. Values of the market comparison approach evaluate the sales price of similar properties in the same market area. The income approach considers net operating income generated by the property and an investors required return. The final value is a reconciliation of these three approaches and takes into consideration any other factors management deems relevant to arrive at a representative fair value.

Real estate owned acquired through foreclosure is recorded at fair value less estimated selling costs at the date of foreclosure. Fair value is based on the appraised market value of the property based on sales of similar assets. The fair value may be subsequently reduced if the estimated fair value declines below the original appraised value. Fair value adjustments of $9.3 million and $2.3 million were made to real estate owned during the periods ended December 31, 2011 and 2010 respectively.

Trust preferred securities which are held-to-maturity are valued using an income approach valuation technique (using cash flows and present value techniques) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs. The income approach is equally or more representative of fair value than relying on the estimation of market value technique used at prior measurement dates, which now has few observable inputs and relies on an inactive market with distressed sales conditions that would require significant adjustments.

We received valuation estimates on our trust preferred security for December 31, 2011. Those valuation estimates were based on proprietary pricing models utilizing significant unobservable inputs in an inactive market with distressed sales, Level 3 inputs, rather than actual transactions in an active market.

Fair Value of Financial Instruments

The estimated fair value of financial instruments not previously presented is as follows:

	December 31, 2011				December 31, 2010
(Dollars in thousands)	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial assets:
Cash and due from banks	$	92,236	$	92,236	$	166,176	$	166,176
Securities held-to-maturity		—		—		102		104
Mortgage loans held for sale		10,187		10,326		6,388		6,472
Loans, net		628,800		643,797		782,672		792,486
Accrued interest receivable		3,168		3,168		3,807		3,807
FHLB stock		4,805		N1A		4,909		N1A
Financial liabilities:
Deposits		1,122,794		1,134,843		1,173,908		1,163,654
Advances from Federal Home Loan Bank		27,736		30,888		52,532		55,190
Subordinated debentures		18,000		12,448		18,000		12,743
Accrued interest payable		1,817		1,817		594		594

The methods and assumptions used in estimating fair value disclosures for financial instruments are presented below:

Carrying amount is the estimated fair value for cash and cash equivalents, interest bearing deposits, accrued interest receivable and payable, demand deposits, short-term debt and variable rate loans or deposits that re-price frequently and fully. Held-to-maturity securities fair values are based on market prices or dealer quotes and if no such information is available, on the rate and term of the security and information about the issuer. The value of mortgage loans held for sale is based on the underlying sale commitments. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent re-pricing or re-pricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life. Fair values of advances from Federal Home Loan Bank and subordinated debentures are based on current rates for similar financing. The fair value of off-balance-sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements and is not material. It is not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability.