Fair Value of Assets and Liabilities

6 Months Ended

Jun. 30, 2011

Fair Value of Assets and Liabilities

Fair Value of Assets and Liabilities

Note 9.  Fair Value of Assets and Liabilities

The Company determines the fair market values of certain financial instruments based on the fair value hierarchy established in U.S. GAAP.  The fair value of a financial instrument is the amount at which the asset or obligation could be exchanged in a current transaction between willing parties, other than a forced or liquidation sale.  Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire holdings or a particular financial instrument. Pursuant to U.S. GAAP, the Company is required to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  Specifically, U.S. GAAP describes three levels of inputs that may be used to measure fair value, as outlined below:

Level 1 - Quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities may include debt and equity securities that are traded in an active exchange market and that are highly liquid and are actively traded in over the counter markets.

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. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

Fair Value Measurements

The following methods and assumptions were used by the Company in estimating fair values of financial instruments. Many of these estimates are subjective in nature, involve uncertainties and matters of judgment and, therefore, cannot be determined with precision.  Changes in assumptions could significantly affect these estimates.

Cash and Cash Equivalents

The carrying amounts reported in the balance sheet for cash and cash equivalents approximate the fair values of those assets due to the short-term nature of the assets.

Interest Bearing Deposits at Other Financial Institutions

The carrying amounts reported in the balance sheet for interest bearing deposits at other financial institutions approximates the fair value of these assets due to the short-term nature of the assets.

Investments Including Federal Home Loan Bank Stock and Mortgage-Backed Securities

Fair values are based upon quoted market prices, where available. If quoted market prices are not available, fair values are extrapolated from the quoted prices of similar instruments or through the use of other observable data supporting a valuation model.  Fair values for holdings of Federal Home Loan Bank stock is based on carrying amounts due to redemption provisions.

Loans, Loans Held for Sale, and Accrued Interest Receivable

For variable-rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying amounts.  The fair values for other loans (for example, fixed rate loans and loans that possess a rate variable other than daily) are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics.

The fair value of loans held for sale is determined, when possible, using quoted secondary market prices.  If no such quoted price exists, the fair value of the loan is determined using quoted prices for a similar asset or assets, adjusted for the specific attributes of that loan.  The carrying amount of accrued interest receivable approximates its fair value.

Impaired Loans

A loan is considered impaired when it is probable that payment of interest and principal will not be made in accordance with the original contractual terms of the loan agreement.  Impairment is measured based on the fair value of the underlying collateral or the discounted expected future cash flows.  The Company measures impairment on all non-accrual loans for which it has established specific reserves as part of the specific credit allocation component of the allowance for loan losses. As such, the Company records impaired loans as non-recurring Level 2 when the fair value of the underlying collateral is based on an observable market price or current appraised value.  When current market prices are not available or the Company determines that the fair value of the underlying collateral is further impaired below appraised values, the Company records impaired loans as non-recurring Level 3.  At June 30, 2011, a significant majority of the Company’s impaired loans were evaluated based on the fair value of their underlying collateral based upon the most recent appraisal available to Management.

Other Real Estate Owned and Foreclosed Collateral

Other real estate owned and foreclosed collateral are adjusted to fair value, less any estimated costs to sell, at the time the loans are transferred into this category.  The fair value of these assets is based on independent appraisals, observable market prices for similar assets, or Management’s estimation of value.  When the fair value is based on independent appraisals or observable market prices for similar assets, the Company records other real estate owned or foreclosed collateral as non-recurring Level 2 assets.  When appraised values are not available, there is no observable market price for similar assets, or Management determines the fair value of the asset is further impaired below appraised values or observable market prices, the Company records other real estate owned or foreclosed collateral as non-recurring Level 3 assets.

Bank Owned Life Insurance

Fair values are based on current cash surrender values at each reporting date provided by the underlying insurers.

Federal Home Loan Bank Advances

The fair value disclosed for FHLB advances is determined by discounting contractual cash flows at current market interest rates for similar instruments.

Non-Interest Bearing Deposits

The fair values disclosed for non-interest bearing deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts).

Interest Bearing Deposits and Accrued Interest Payable

The fair values disclosed for interest bearing deposits (for example, interest-bearing checking accounts and passbook accounts) are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The fair values for certificates of deposit are estimated using a discounted cash flow analysis that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits.  The carrying amount of accrued interest payable approximates its fair value.

Junior Subordinated Debentures

The fair value disclosed for junior subordinated debentures is based on contractual cash flows at current market interest rates for similar instruments.

Off-Balance Sheet Instruments

Fair values of commitments to extend credit and standby letters of credit are based upon fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreement and the counterparties’ credit standing.

The following table provides a summary of the financial instruments the Company measures at fair value on a recurring basis as of June 30, 2011 and December 31, 2010:

	Fair Value Measurements Using
	Quoted Prices in		Significant Other		Significant
	Active Markets for		Observable		Unobservable
(dollars in thousands)	Identical Assets		Inputs		Inputs		Assets At
As of June 30, 2011	(Level 1)		(Level 2)		(Level 3)		Fair Value
Assets
Obligations of U.S. government agencies	$	-	$	8,333	$	-	$	8,333
Mortgage backed securities
Agency	-		119,578		-		119,578
Non-agency	-		13,656		-		13,656
State and municipal securities	-		48,423		257		48,680
Corporate debt securities	-		28,183		-		28,183
Total assets measured on a recurring basis	$	-	$	218,173	$	257	$	218,430
As of December 31, 2010
Assets
Obligations of U.S. government agencies	$	-	$	6,436	$	-	$	6,436
Mortgage backed securities
Agency	-		160,617		-		160,617
Non-agency	-		9,059		-		9,059
State and municipal securities	-		47,462		283		47,745
Total assets measured on a recurring basis	$	-	$	223,574	$	283	$	223,857

The following table provides a summary of the changes in balance sheet carrying values associated with recurring Level 3 financial instruments during the three and six months ended June 30, 2011 and 2010:

						Purchases,
	Beginning		Gains			Issuances, and		Sales and		Ending
(dollars in thousands)	Balance		Included in OCI (1)			Settlements		Maturities		Balance
June 30, 2011
State and municipal securities	$	283	$	(26	)	$	-	$	-	$	257
June 30, 2010
State and municipal securities	$	737	$	18		$	-	$	-	$	755

(1) Realized or unrealized gains from the changes in values of Level 3 financial instruments represent gains from changes in values of financial instruments only for the period(s) in which the instruments were classified as Level 3.

The assets presented under Level 3 of the fair value hierarchy classified as obligations of state and municipal subdivisions represent available for sale investment securities in the form of certificates of participation, where an active market for such securities is not currently available.

The following table provides a summary of assets the Company measures at fair value on a non-recurring basis as of June 30, 2011 and December 31, 2010:

	Fair Value Measurements Using
	Quoted Prices in		Significant Other		Significant
	Active Markets for		Observable		Unobservable
(dollars in thousands)	Identical Assets		Inputs		Inputs		Assets At		Total
As of June 30, 2011	(Level 1)		(Level 2)		(Level 3)		Fair Value		Gains / (Losses)
Assets
Impaired loans
Residential 1 to 4 family	$	-	$	148	$	12	$	160	$	-
Home equity lines of credit	-		112		-		112		(88		)
Commercial real estate	-		4,752		4,161		8,914		(915		)
Commercial and industrial	-		647		901		1,548		(399		)
Agriculture	-		134		-		134		-
Land	-		63		2,297		2,360		(103		)
Loans held for sale	-		3,662		-		3,662		-
Other real estate owned	-		2,801		786		3,587		(240		)
Total assets measured on a non-recurring basis	$	-	$	12,319	$	8,157	$	20,476	$	(1,745	)
As of December 31, 2010
Assets
Impaired loans
Residential 1 to 4 family	$	-	$	748	$	-	$	748	$	(48	)
Home equity lines of credit	-		1,019		-		1,019		-
Commercial real estate	-		17,237		-		17,237		(1,556		)
Farmland	-		2,626		-		2,626		-
Commercial and industrial	-		5,397		-		5,397		(161		)
Agriculture	-		246		-		246		(117		)
Construction	-		2,564		-		2,564		(417		)
Land	-		3,136		-		3,136		(304		)
Installment loans to individuals	-		370		-		370		(88		)
Loans held for sale	-		11,008		-		11,008		-
Other real estate owned	-		6,668		-		6,668		(3,447		)
Total assets measured on a non-recurring basis	$	-	$	51,019	$	-	$	51,019	$	(6,138	)

Fair Value of Financial Instruments

The following table provides a summary of the estimated fair value of financial instruments at June 30, 2011 and December 31, 2010:

	June 30, 2011				December 31, 2010
	Carrying				Carrying
(dollars in thousands)	Amount		Fair Value		Amount		Fair Value
Assets
Cash and cash equivalents	$	39,811	$	39,811	$	22,951	$	22,951
Interest bearing deposits	99		99		119		119
Securities available for sale	218,430		218,430		224,966		224,966
Federal Home Loan Bank stock	4,761		4,761		5,180		5,180
Loans receivable, net of deferred fees and costs	663,164		665,599		675,690		678,916
Loans held for sale	3,662		3,662		11,008		11,008
Bank owned life insurance	14,103		14,103		13,843		13,843
Accrued interest receivable	3,788		3,788		3,986		3,986
Liabilities
Non-interest bearing deposits	213,251		213,251		182,658		182,658
Interest bearing deposits	589,259		590,263		615,548		617,296
Federal Home Loan Bank advances	29,000		29,453		45,000		45,025
Junior subordinated debentures	8,248		7,744		8,248		7,713
Accrued interest payable	449		449		423		423
	Notional		Cost to Cede		Notional		Cost to Cede
	Amount		or Assume		Amount		or Assume
Off-balance sheet instruments, commitments to extend credit and standby letters of credit	$	147,140	$	1,471	$	157,411	$	1,574