FAIR VALUE MEASUREMENTS

The estimated carrying and fair values of the Company’s financial instruments are as follows:



	December 31, 2011				December 31, 2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(In thousands)
Financial assets:
Cash and due from banks	$	19,409	$	19,409	$	11,357	$	11,357
Interest-earning deposits in other banks	24,467		24,467		89,042		89,042
Federal funds sold	928		928		600		600
Available-for-sale investment securities	328,413		328,413		191,325		191,325
Loans, net	415,999		418,084		420,583		405,876
Federal Home Loan Bank stock	2,893		N/A		3,050		N/A
Accrued interest receivable	3,953		3,953		3,467		3,467
Financial liabilities:
Deposits	$	712,986	$	719,673	$	650,495	$	651,668
Short-term borrowings	—		—		10,000		10,000
Long-term debt	4,000		4,146		4,000		4,256
Junior subordinated deferrable interest debentures	5,155		2,706		5,155		2,320
Accrued interest payable	230		230		475		475

These estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.

These estimates are made at a specific point in time based on relevant market data and information about the financial instruments. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors. 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 fair values presented.

The following methods and assumptions were used to estimate the fair value of financial instruments. For cash and due from banks, interest-earning deposits in other banks, Federal funds sold, variable-rate loans, accrued interest receivable and payable, demand deposits and short-term borrowings, the carrying amount is estimated to be fair value. It was not practicable to determine the fair value of Federal Home Loan Bank (FHLB) stock due to restrictions placed on its transferability. For investment securities, fair values are based on quoted market prices, quoted market prices for similar securities and indications of value provided by brokers. The fair values for fixed-rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered at each reporting date for loans with similar terms to borrowers of comparable creditworthiness. Fair values for fixed-rate certificates of deposit are estimated using discounted cash flow analyses using interest rates offered at each reporting date by the Company for certificates with similar remaining maturities. The fair value of long-term debt and subordinated debentures was determined based on the current market for like-kind instruments of a similar maturity and structure. The fair values of commitments are estimated using the fees currently charged to enter into similar agreements and are not significant and, therefore, not included in the above table.

Fair Value Hierarchy

In accordance with applicable accounting guidance, the Company groups its assets and liabilities measured at fair value into three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. Valuations within these levels are based upon:

Level 1 — Quoted market prices (unadjusted) for identical instruments traded in active exchange markets that the Company has the ability to access as of the measurement date.

Level 2 — Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable or can be corroborated by observable market data.

Level 3 — Model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect the Company’s estimates of assumptions that market participants would use on pricing the asset or liability. Valuation techniques include management judgment and estimation which may be significant.

Management monitors the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another. In such instances, we report the transfer at the beginning of the reporting period.

Management evaluates the significance of transfers between levels based upon the nature of the financial instrument and size of the transfer relative to total assets, total liabilities or total earnings. During the year ended December 31, 2011, no transfers between levels occurred.

Assets Recorded at Fair Value

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring and nonrecurring basis as of December 31, 2011:

Recurring Basis

The Company is required or permitted to record the following assets at fair value on a recurring basis under other accounting pronouncements (in thousands).



Description	Fair Value		Level 1		Level 2		Level 3
Available-for-sale investment securities
Debt Securities:
U.S. Government sponsored entities and agencies	$	149	$	—	$	149	$	—
Obligations of states and political subdivisions	108,431		—		108,431		—
U.S. Government agencies collateralized by mortgage obligations	200,839		—		200,839		—
Other collateralized mortgage obligations	11,103		—		11,103		—
Other equity securities	7,891		7,891		—		—
Total assets and liabilities measured at fair value	$	328,413	$	7,891	$	320,522	$	—

Securities in Level 1 are mutual funds and fair values are based on quoted market prices for identical instruments traded in active markets. Fair values for available-for-sale investment securities in Level 2 are based on quoted market prices for similar securities.

The balance of Level 3 assets measured at fair value on a recurring basis was zero for the year ended December 31, 2011. There were no transfers between Levels 1, 2 or 3 for the year ended December 31, 2011.

There were no liabilities measured at fair value on a recurring basis at December 31, 2011.

Non-recurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a non-recurring basis. These include assets that are measured at the lower of cost or fair value that were recognized at fair value which was below cost at December 31, 2011 (in thousands).



Description	Fair Value		Level 1		Level 2		Level 3		Total Gains (Losses) in the Year
Impaired loans:
Commercial:
Commercial and industrial	$	2,312	$	—	$	—	$	2,312	$	(271	)
Total commercial	2,312		—		—		2,312		(271		)
Real estate:
Owner occupied	873		—		—		873		(65		)
Real estate-construction and other land loans	8,782		—		—		8,782		(996		)
Commercial real estate	1,487		—		—		1,487		(1,366		)
Total real estate	11,142		—		—		11,142		(2,427		)
Consumer:
Equity loans and lines of credit	2,003		—		—		2,003		4
Consumer and installment	51		—		—		51		(23		)
Total consumer	2,054		—		—		2,054		(19		)
Total impaired loans	15,508		—		—		15,508		(2,717		)
Total assets and liabilities measured at fair value on a non-recurring basis	$	15,508	$	—	$	—	$	15,508	$	(2,717	)

The fair value of impaired loans and other real estate owned is based on the fair value of the collateral for all collateral dependent loans and for other impaired loans is estimated using a discounted cash flow model. Impaired loans and other real estate owned were determined to be collateral dependent and categorized as Level 3 due to ongoing real estate market conditions resulting in inactive market data, which in turn required the use of unobservable inputs and assumptions in fair value measurements. There were no changes in valuation techniques used during the years ended December 31, 2011 and 2010.

In accordance with the provisions of ASC 360-10, impaired loans with a carrying value of $19,876,000 were written down to their fair value of $15,508,000. The valuation allowance represents specific allocations for the allowance for credit losses for impaired loans.

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring and nonrecurring basis as of December 31, 2010:

Recurring Basis

The Company is required or permitted to record the following assets at fair value on a recurring basis under other accounting pronouncements (in thousands).



Description	Fair Value		Level 1		Level 2		Level 3
Available-for-sale securities
Debt Securities:
U.S. Government sponsored entities and agencies	$	195	$	—	$	195	$	—
Obligations of states and political subdivisions	75,090		—		75,090		—
U.S. Government agencies collateralized by mortgage obligations	90,077		—		90,077		—
Other collateralized mortgage obligations	17,838		—		17,838		—
Corporate debt securities	504		—		504		—
Other equity securities	7,661		7,661		—		—
Total assets and liabilities measured at fair value	$	191,365	$	7,661	$	183,704	$	—

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows for the year ended December 31, 2010 (in thousands).



	Balance, beginning of year		Net income		Other comprehensive income		Purchases, sales, and principal payments			Transfers into Level 3		Transfers out of Level 3			Balance, end of year
Available-for-sale securities
Other collateralized mortgage obligations	$	5,724	$	13	$	93	$	(2,752	)	$	—	$	(3,078	)	$	—
Corporate debt securities	785		235		—		(1,020		)	—		—			—
Other equity securities	7,588		—		—		—			—		(7,588		)	—
Total assets and liabilities measured at fair value	$	14,097	$	248	$	93	$	(3,772	)	$	—	$	(10,666	)	$	—

Gains and losses (realized and unrealized) included in earnings (or changes in net assets) for the year ended December 31, 2010 totaled $248,000 and were included in non-interest income. During 2010, management transferred one CMO security totaling $3,078,000 from Level 3 to Level 2 and other equity securities totaling $7,588,000 from Level 3 to Level 1. The transfers occurred to correct immaterial misclassification errors in prior periods.

Non-recurring Basis



Description	Fair Value		Level 1		Level 2		Level 3		Total Losses in the Year
Impaired loans:
Commercial and industrial	$	838	$	—	$	—	$	838	$	(208	)
Total commercial	838						838		(208		)
Real estate:
Owner occupied	1,016		—		—		1,016		(261		)
Real estate-construction and other land loans	4,773		—		—		4,773		(1,170		)
Commercial real estate	679		—		—		679		(47		)
Total real estate	6,468		—		—		6,468		(1,478		)
Consumer
Equity loans and lines of credit	2,007		—		—		2,007		(460		)
Total consumer	2,007		—		—		2,007		(460		)

Total Impaired	9,313						9,313		(2,146		)
Other real estate owned	1,325		—		—		1,325		(309		)
Other repossessed assets	98		—		—		98		—
Total assets and liabilities measured at fair value on a non-recurring basis	$	10,736	$	—	$	—	$	10,736	$	(2,455	)

The fair value of impaired loans included above and other real estate owned is based on the fair value of the collateral. Impaired loans and other real estate owned were determined to be collateral dependent and categorized as Level 3 due to ongoing real estate market conditions resulting in inactive market data, which in turn required the use of unobservable inputs and assumptions in fair value measurements.

In accordance with the provision of ASC 360-10, impaired loans with a carrying value of $11,437,000 were written down to their fair value of $9,313,000 resulting in an impairment charge of $2,124,000. The valuation allowance represents specific allocation for the allowance for credit loans for impaired loans.

The fair value of other real estate owned is based on property appraisals at the time of transfer and as appropriate thereafter, less estimated costs to sell. Other real estate owned is periodically reviewed to determine whether the property continues to be carried at lower of it's recorded book value or estimated fair value, net of estimated selling costs. In 2010, other real estate properties were written down $309,000 to their estimated fair values of $1,325,000. In 2010, other repossessed assets were recorded at their estimated realizable value of $98,000.