Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) 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 values:

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 company's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

When possible, the Company looks to active and observable markets to price identical assets or liabilities. When identical assets and liabilities are not traded in active markets, the Company looks to observable market data for similar assets and liabilities. However, certain assets and liabilities are not traded in observable markets and the Company must use other valuation methods to develop a fair value.

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument measured on a recurring basis:

Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

Assets and Liabilities Measured on a Recurring Basis

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

			Fair Value Measurements at December 31, 2011 Using:
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale
Mortgage-backed securities
U. S. agency MBS - residential	$	40,255	$	-	$	40,255	$	-
U. S. agency CMO's		205,738		-		205,738		-
Total mortgage-backed securities of government sponsored agencies		245,993		-		245,993		-
U. S. government sponsored agency securities		18,141		-		18,141		-
Obligations of states and political subdivisions		9,650		-		9,510		140
Other securities		4,695		-		4,695		-
Total available for sale	$	278,479	$	-	$	278,339	$	140

			Fair Value Measurements at December 31, 2010 Using:
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale
Mortgage-backed securities
U. S. agency MBS - residential	$	38,720	$	-	$	38,720	$	-
U. S. agency CMO's		148,784		-		148,784		-
Total mortgage-backed securities of government sponsored agencies		187,504		-		187,504		-
U. S. government sponsored agency securities		52,427		-		52,427		-
Obligations of states and political subdivisions		10,306		-		10,166		140
Other securities		6,283		-		6,283		-
Total available for sale	$	256,520	$	-	$	256,380	$	140

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

	Securities Available-for-sale
	Year Ended Dec. 31, 2011		Year Ended Dec. 31, 2010
Balance of recurring Level 3 assets at beginning of period	$	140	$	140
Total gains or losses (realized/unrealized):
Included in earnings – realized		-		-
Included in earnings – unrealized		-		-
Included in other comprehensive income		-		-
Purchases, sales, issuances and settlements, net		-		-
Transfers in and/or out of Level 3		-		-
Balance of recurring Level 3 assets at year-end	$	140	$	140

The carrying amount and estimated fair values of financial instruments at year end were as follows:

	2011						2010
	Carrying Amount			Fair Value			Carrying Amount			Fair Value
Financial assets
Cash and due from banks	$	72,056		$	72,056		$	98,650		$	98,650
Federal funds sold		10,832			10,832			23,598			23,598
Securities available for sale		278,479			278,479			256,520			256,520
Loans held for sale		70			70			1,477			1,477
Loans, net		681,128			675,616			716,099			715,992
Federal Home Loan Bank and Federal Reserve Bank stock		5,216			n/a			7,096			n/a
Interest receivable		3,497			3,497			3,742			3,742

Financial liabilities
Deposits	$	(925,078	)	$	(929,796	)	$	(985,291	)	$	(986,261	)
Securities sold under agreements to repurchase		(23,205	)		(23,205	)		(29,637	)		(29,637	)
Federal Home Loan Bank advances		(10,083	)		(10,141	)		(12,896	)		(13,045	)
Other borrowed funds		(18,130	)		(18,101	)		(20,178	)		(20,148	)
Interest payable		(712	)		(712	)		(899	)		(899	)

Carrying amount is the estimated fair value for cash and due from banks, Federal funds sold, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. It was not practicable to determine the fair value of Federal Home Loan Bank and Federal Reserve Bank stock due to the restrictions placed on its transferability. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of debt is based on current rates for similar financing. The fair value of commitments to extend credit and standby letters of credit is not material.

Assets and Liabilities Measured on a Non-Recurring Basis

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument measured on a non-recurring basis:

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 appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

Other real estate owned (OREO): The fair value of OREO is based on appraisals less cost to sell at the date of foreclosure. 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 appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Valuations are periodically performed by management and the assets are carried at fair value, less cost to sell.

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

			Fair Value Measurements at December 31 2011 Using
	Dec 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:
Residential Real Estate	$	4,297	$	-	$	-	$	4,297
Commercial Real Estate
Owner Occupied		1,168		-		-		1,168
Non-owner Occupied		1,269		-		-		1,269
Commercial and Industrial		1,038		-		-		1,038
All Other		4,386		-		-		4,389
Total impaired loans		12,158	$	-	$	-	$	12,158

Other real estate owned:
Residential Real Estate	$	1,608	$	-	$	-	$	1,608
Commercial Real Estate
Owner Occupied		701		-		-		701
Non-owner Occupied		2,931		-		-		2,931
Commercial and Industrial		55		-		-		55
All Other		8,788		-		-		8,788
Total OREO	$	14,083	$	-	$	-	$	14,083

			Fair Value Measurements at December 31, 2010 Using
	Dec 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:
Residential Real Estate	$	149	$	-	$	-	$	149
Commercial Real Estate
Owner Occupied		2,892		-		-		2,892
Non-owner Occupied		6,496		-		-		6,496
Commercial and Industrial		3,318		-		-		3,318
Consumer		20		-		-		20
All Other		2,000		-		-		2,000
Total impaired loans	$	14,875	$	-	$	-	$	14,875

Other real estate owned
Residential Real Estate	$	818	$	-	$	-	$	818
Multifamily Real Estate		3,385		-		-		3,385
Commercial Real Estate
Owner Occupied		352		-		-		352
Non-owner Occupied		2,778		-		-		2,778
Commercial and Industrial		66		-		-		66
All Other		3,850		-		-		3,850
Total OREO	$	11,249	$	-	$	-	$	11,249

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $15,205 at December 31, 2011 with a valuation allowance of $3,047 and a carrying amount of $17,397 at December 31, 2010 with a valuation allowance of $2,522, resulting in a provision for loan losses of $525 for the year ended December 31, 2011, compared to a $1,243 provision for loan losses for the year ended December 31, 2010.

Other real estate owned measured at fair value less costs to sell, had a net carrying amount of $14,083, which is made up of the outstanding balance of $15,288, net of a valuation allowance of $1,205 at December 31, 2011, resulting in write downs of $795 for the year ended December 31, 2011. At December 31, 2010, other real estate owned had a net carrying amount of $11,249, made up of the outstanding balance of $11,659 net of a $410 valuation allowance.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

+ References

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