9. Fair Value of Financial Instruments

Fair value is defined 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. GAAP established a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value and describes three levels of inputs that may be used to measure fair value:

Level 1		Quoted prices in active markets for identical assets or liabilities.

Level 2		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 for substantially the full term of the assets or liabilities.

Level 3		Unobservable inputs that are supported by little or no market activity and that are significant to the fair
		value of the assets or liabilities.

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying consolidated balance sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Securities Available for Sale

When quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Bond money market funds are included in Level 1. If quoted market prices are not available, then fair values are estimated by using pricing models and quoted prices of securities with similar characteristics. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond's terms and conditions. Level 2 securities include collateralized mortgage obligations, mortgage backed securities, corporate debt, agency and municipal bonds. In certain cases where Level 1 and Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and consist of equity securities.

The following table presents the fair value measurements of assets recognized in the accompanying consolidated balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2011 and December 31, 2010. (dollars in thousands)

		Fair Value Measurements Using
		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
		Level 1		Level 2		Level 3		Fair Value
June 30, 2011
Municipal bonds	$	-	$	58,108	$	-	$	58,108
Asset backed securities		-		7		-		7
Collateralized mortgage obligations issued by:
Agencies		-		50,300		-		50,300
Private label		-		83,732		-		83,732
Mortgage backed securities issued by agencies		-		45,689		-		45,689
Corporate debt		-		1,646		-		1,646
Bond money market funds		300		-		-		300
Equity securities		-		-		75		75
Securities available for sale	$	300	$	239,482	$	75	$	239,857

December 31, 2010
Municipal bonds	$	-	$	63,854	$	-	$	63,854
Asset backed securities		-		42		-		42
Collateralized mortgage obligations issued by:
Agencies		-		50,599		-		50,599
Private label		-		96,407		-		96,407
Mortgage backed securities issued by agencies		-		13,261		-		13,261
Corporate debt		-		1,459		-		1,459
Bond money market funds		768		-		-		768
Equity securities		-		-		75		75
Securities available for sale	$	768	$	225,622	$	75	$	226,465

The following table presents a reconciliation of the beginning and ending balances of recurring securities available for sale fair value measurements recognized in the accompanying consolidated balance sheets using significant unobservable (Level 3) inputs for the three months ended March 31, 2011 and 2010. (dollars in thousands)

Total Fair Value Measurements		Available for Sale Debt Securities
		Three Months Ended				Six Months Ended
		June 30,				June 30,
Level 3 Instruments Only		2011		2010		2011		2010
Beginning Balance	$	75	$	27,775	$	75	$	75
Purchases		-		40,284		-		88,978
Settlements		-		(67,984)		-		(88,978)
Ending Balance	$	75	$	75	$	75	$	75

There were no realized and unrealized gains and losses recognized in the accompanying consolidated statement of operations using significant unobservable (Level 3) inputs for the three and six months ended June 30, 2011 and 2010.

The following table presents the fair value measurements of assets recognized in the accompanying consolidated balance sheets measured at fair value on a non recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2011 and December 31, 2010. (dollars in thousands)

	Fair Value Measurements Using
	Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs	Significant Unobservable Inputs
	Level 1	Level 2	Level 3	Fair Value
June 30, 2011
Impaired loans	-	-	19,093	19,093
Other real estate owned	-	-	-	-

December 31, 2010
Impaired loans			33,170	33,170
Other real estate owned	-	-	1,602	1,602

At June 30, 2011, collateral dependent impaired loans which had an evaluation adjustment during 2011 had an aggregate cost of $21.3 million and had been written down to a fair value of $19.1 million measured using Level 3 inputs within the fair value hierarchy. At December 31, 2010, collateral dependent impaired loans which had an evaluation adjustment during 2010 had an aggregate cost of $36.3 million and had been written down to a fair value of $33.2 million measured using Level 3 inputs within the fair value hierarchy. Level 3 inputs for impaired loans included current and prior appraisals and discounting factors.

At June 30, 2011, there was no other real estate owned reported at fair value less cost to sell measured using Level 3 inputs within the fair value hierarchy. At December 31, 2010, other real estate owned was reported at fair value less cost to sell of $1.6 million measured using Level 3 inputs within the fair value hierarchy. Level 3 inputs for other real estate owned included third party appraisals adjusted for cost to sell.

The disclosure of the estimated fair value of financial instruments is as follows: (dollars in thousands)

		June 30, 2011				Dec. 31, 2010
		Carrying Value		Fair Value		Carrying Value		Fair Value
Assets:
Cash and cash equivalents	$	15,637	$	15,637	$	13,063	$	13,063
Securities available for sale		239,857		239,857		226,465		226,465
Loans held for sale		2,441		2,503		7,666		7,827
Loans, net		719,614		733,559		732,795		761,838
Accrued interest receivable		3,681		3,681		3,785		3,785
Federal Home Loan Bank stock		6,563		6,563		7,507		7,507

Liabilities:
Deposits		850,551		857,204		853,343		861,739
FHLB advances		53,657		55,112		53,284		55,028
Junior subordinated debt		15,464		11,864		15,464		9,281
Short-term borrowings		11,305		11,305		12,088		12,088
Advance payments by borrowers for taxes and insurance		290		290		272		272
Accrued interest payable		81		81		84		84

Cash, Accrued Interest Receivable, Advance Payments by Borrowers for Taxes and Insurance, Accrued Interest Payable and Short-term Borrowings

The carrying amount as reported in the Condensed Consolidated Balance Sheets is a reasonable estimate of fair value.

Securities Available for Sale

Fair values are based on quoted market prices and dealer quotes. If quoted market prices or dealer quotes are not available, fair value is determined based on quoted prices of similar instruments.

Loans Held for Sale and Loans, net

The fair value of loans is estimated by discounting the future cash flows using the current rates for loans of similar credit risk and maturities. The estimate of credit losses is equal to the allowance for loan losses. Loans held for sale are based on current market prices.

Federal Home Loan Bank Stock

The fair value is estimated to be the carrying value, which is par.

Deposits

The fair value of demand deposits, savings accounts and money market deposit accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated, by discounting future cash flows, using rates currently offered for deposits of similar remaining maturities.

FHLB Advances

The fair value is estimated by discounting future cash flows using rates currently available to the Company for advances of similar maturities.

Junior Subordinated Debt and Long Term Debt

Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate fair value of existing debt. Fair value of Junior Subordinated Debt is based on quoted market prices for similar liabilities when traded as an asset in an active market.

The fair value estimates presented herein are based on information available to management at June 30, 2011. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.