Note 14 – Fair Value

Certain assets and liabilities are recorded at fair value to provide additional insight into the Company's quality of earnings. Some of these assets and liabilities are measured on a recurring basis while others are measured on a nonrecurring basis, with the determination based upon applicable existing accounting pronouncements. For example, securities available for sale are recorded at fair value on a recurring basis. Other assets, such as, mortgage servicing rights, loans held for sale, and impaired loans, are recorded at fair value on a nonrecurring basis using the lower of cost or market methodology to determine impairment of individual assets. The Company groups assets and liabilities which are recorded at fair value in 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. A financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement (with level 1 considered highest and level 3 considered lowest). A brief description of each level follows.

Level 1 – Valuation is based upon quoted prices for identical instruments in active markets.

Level 2 – Valuation is based upon 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 in the market.

Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates that market participants would use in pricing the asset or liability. Valuation includes use of discounted cash flow models and similar techniques.

The most significant instruments that the Company records at fair value include securities which fall into Level 2 in the fair value hierarchy. The securities in the available for sale portfolio are priced by independent providers. In obtaining such valuation information from third parties, the Company has evaluated their valuation methodologies used to develop the fair values in order to determine whether the valuations are representative of an exit price in the Company's principal markets. The Company's principal markets for its securities portfolios are the secondary institutional markets, with an exit price that is predominantly reflective of bid level pricing in those markets.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

Securities Available for Sale. Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices for similar assets, if available. If quoted prices are not available, fair values are measured using matrix pricing models, or other model-based valuation techniques requiring observable

inputs other than quoted prices such as yield curves, prepayment speeds, and default rates. Recurring Level 1 securities would include U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets. Recurring Level 2 securities include federal agency securities, mortgage-backed securities, collateralized mortgage obligations, municipal bonds and corporate debt securities.

The following table presents the balances of assets and liabilities that were measured at fair value on a recurring basis as of September 30, 2012, December 31, 2011 and September 30, 2011.

	At September 30, 2012
	Level 1		Level 2		Level 3		Total
Securities available for sale
Mortgage-backed securities	$	-	$	189,437,000	$	-	$	189,437,000
State and political subdivisions		-		108,955,000		-		108,955,000
Corporate securities		-		-		-		-
Other equity securities		-		1,508,000		-		1,508,000
Total assets	$	-	$	299,900,000	$	-	$	299,900,000

	At December 31, 2011
	Level 1		Level 2		Level 3		Total
Securities available for sale
Mortgage-backed securities	$	-	$	198,232,000	$	-	$	198,232,000
State and political subdivisions		-		85,726,000		-		85,726,000
Corporate securities		-		811,000		-		811,000
Other equity securities		-		1,433,000		-		1,433,000
Total assets	$	-	$	286,202,000	$	-	$	286,202,000

	At September 30, 2011
	Level 1		Level 2		Level 3		Total
Securities available for sale
U.S. Treasury and agency	$	-	$	16,494,000	$	-	$	16,494,000
Mortgage-backed securities		-		235,038,000		-		235,038,000
State and political subdivisions		-		74,039,000		-		74,039,000
Corporate securities		-		779,000		-		779,000
Other equity securities		-		432,000		-		432,000
Total assets	$	-	$	326,782,000	$	-	$	326,782,000

Assets and Liabilities Recorded at Fair Value on a Non-Recurring Basis

Mortgage Servicing Rights. Mortgage servicing rights represent the value associated with servicing residential mortgage loans. Servicing assets and servicing liabilities are reported using the amortization method. In evaluating the carrying values of mortgage servicing rights, the Company obtains third party valuations based on loan level data including note rate, type and term of the underlying loans and observable inputs for its assumptions. As such, the Company classifies mortgage servicing rights as nonrecurring Level 2.

Loans Held for Sale. Mortgage loans held for sale are recorded at the lower of carrying value or fair value. The fair value of mortgage loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies mortgage loans held for sale as nonrecurring Level 2.

Other Real Estate Owned. Real estate acquired through foreclosure is initially recorded at fair value. The fair value of other real estate owned is based on property appraisals and an analysis of similar properties currently available. As such, the Company records other real estate owned as nonrecurring Level 2.

Impaired Loans. A loan is considered to be impaired when it is probable that all of the principal and interest due under the original underwriting terms of the loan may not be collected. Impairment is measured based on the fair value of the underlying collateral or present value of expected cash flows. As such, the Company records impaired loans as nonrecurring Level 2.

The following tables include assets measured at fair value on a nonrecurring basis that have had a fair value adjustment since their initial recognition. Mortgage servicing rights are presented at fair value. Other real estate owned is presented net of an allowance of $479,000, $436,000 and $602,000 at September 30, 2012, December 31, 2011, and September 30, 2011, respectively. Impaired loans measured at fair value only include impaired loans with a related specific allowance for loan losses and are presented net of specific allowances of $5,062,000, $2,058,000 and $1,627,000 at September 30, 2012, December 31, 2011, and September 30, 2011, respectively.

	At September 30, 2012
	Level 1		Level 2		Level 3		Total
Mortgage servicing rights	$	-	$	1,129,000	$	-	$	1,129,000
Loans held for sale		-		-		-		-
Other real estate owned		-		5,471,000		-		5,471,000
Impaired loans		-		16,991,000		-		16,991,000
Total assets	$	-	$	23,591,000	$	-	$	23,591,000

	At December 31, 2011
	Level 1		Level 2		Level 3		Total
Mortgage servicing rights	$	-	$	1,581,000	$	-	$	1,581,000
Loans held for sale		-		-		-		-
Other real estate owned		-		4,094,000		-		4,094,000
Impaired loans		-		12,165,000		-		12,165,000
Total assets	$	-	$	17,840,000	$	-	$	17,840,000

	At September 30, 2011
	Level 1		Level 2		Level 3		Total
Mortgage servicing rights	$	-	$	1,541,000	$	-	$	1,541,000
Loans held for sale		-		230,000		-		230,000
Other real estate owned		-		6,310,000		-		6,310,000
Impaired loans		-		8,206,000		-		8,206,000
Total assets	$	-	$	16,287,000	$	-	$	16,287,000

Fair Value of Financial Instruments

FASB ASC Topic 825 "Financial Instruments", requires disclosures of fair value information about financial instruments, whether or not recognized in the balance sheet, if the fair values can be reasonably determined. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques using observable inputs when available. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Topic 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. The estimated fair values for financial instruments as of September 30, 2012 were as follows:

	Carrying		Estimated
	value		fair value		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents	$	14,904,000	$	14,904,000	$	14,904,000	$	-	$	-
Interest bearing deposits in other banks		681,000		681,000		681,000		-		-
Securities available for sale		299,900,000		299,900,000		-		299,900,000		-
Securities to be held to maturity		154,256,000		162,382,000		-		162,382,000		-
Restricted equity securities		14,448,000		14,448,000		-		14,448,000		-
Loans held for sale		-		-		-		-		-
Loans (net of allowance for loan losses)
Commercial
Real estate		250,063,000		249,660,000		-		5,000,000		244,660,000
Construction		20,702,000		20,669,000		-		1,255,000		19,414,000
Other		80,714,000		81,077,000		-		1,333,000		79,744,000
Municipal		16,428,000		18,140,000		-		-		18,140,000
Residential
Term		367,425,000		381,809,000		-		9,572,000		372,237,000
Construction		6,512,000		6,496,000		-		-		6,496,000
Home equity line of credit		99,202,000		99,938,000		-		273,000		99,665,000
Consumer		14,086,000		14,511,000		-		-		14,511,000
Total loans		855,132,000		872,300,000		-		17,433,000		854,867,000
Mortgage servicing rights		868,000		1,129,000		-		1,129,000		-
Accrued interest receivable		5,425,000		5,425,000		-		5,425,000		-
Financial liabilities
Demand deposits	$	89,500,000	$	91,729,000	$	-	$	91,729,000	$	-
NOW deposits		136,472,000		132,566,000		-		132,566,000		-
Money market deposits		74,805,000		67,105,000		-		67,105,000		-
Savings deposits		130,354,000		122,897,000		-		122,897,000		-
Local certificates of deposit		211,578,000		217,180,000		-		217,180,000		-
National certificates of deposit		301,838,000		306,061,000		-		306,061,000		-
Total deposits		944,547,000		937,538,000		-		937,538,000		-
Repurchase agreements		114,817,000		114,817,000		-		114,817,000		-
Federal Home Loan Bank advances		189,932,000		198,704,000		-		198,704,000		-
Total borrowed funds		304,749,000		313,521,000		-		313,521,000		-
Accrued interest payable		618,000		618,000		-		618,000		-

The estimated fair values for financial instruments as of December 31, 2011 and September 30, 2011 were as follows:

	December 31, 2011				September 30, 2011
	Carrying		Estimated		Carrying		Estimated
	amount		fair value		amount		fair value
Financial assets
Cash and cash equivalents	$	14,115,000	$	14,115,000	$	16,563,000	$	16,563,000
Interest-bearing deposits in other banks		-		-		100,000		100,000
Securities available for sale		286,202,000		286,202,000		326,782,000		326,782,000
Securities to be held to maturity		122,661,000		130,677,000		129,699,000		137,227,000
Restricted equity securities		15,443,000		15,443,000		15,443,000		15,443,000
Loans held for sale		-		-		230,000		230,000
Loans (net of allowance for loan losses)		851,988,000		866,442,000		853,254,000		869,209,000
Mortgage servicing rights		1,201,000		1,581,000		1,195,000		1,541,000
Accrued interest receivable		4,835,000		4,835,000		5,018,000		5,018,000
Financial liabilities
Deposits	$	941,333,000	$	921,388,000	$	1,004,894,000	$	981,577,000
Borrowed funds		265,663,000		273,568,000		255,616,000		265,118,000
Accrued interest payable		734,000		734,000		702,000		702,000

The fair value estimates, methods, and assumptions for the Company's financial instruments are set forth below.

Cash and Cash Equivalents and Due from Banks

The carrying values of cash and cash equivalents and due from banks approximate their relative fair values. As such, the Company classifies cash and cash equivalents as Level 1.

Investment Securities

The fair values of investment securities are estimated by independent providers. In obtaining such valuation information from third parties, the Company has evaluated their valuation methodologies used to develop the fair values in order to determine whether the valuations are representative of an exit price in the Company's principal markets. The Company's principal markets for its securities portfolios are the secondary institutional markets, with an exit price that is predominantly reflective of bid level pricing in those markets. Fair values are calculated based on the value of one unit without regard to any premium or discount that may result from concentrations of ownership of a financial instrument, possible tax ramifications, or estimated transaction costs. If these considerations had been incorporated into the fair value estimates, the aggregate fair value could have been changed. The carrying values of restricted equity securities approximate fair values. As such, the Company classifies investment securities as Level 2.

Loans Held for Sale.

Loans held for sale are recorded at the lower of carrying value or market value. The fair value of mortgage loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies mortgage loans held for sale as nonrecurring Level 2.

Loans

Fair values are estimated for portfolios of loans with similar financial characteristics. The fair values of performing loans are calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest risk inherent in the loan. The estimates of maturity are based on the Company's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions, and the effects of estimated prepayments. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information. Management has made estimates of fair value using discount rates that it believes to be reasonable. However, because there are significant Management assumptions and there is no active market for many of these financial instruments, Management has no basis to determine whether the fair value presented above would be indicative of the value negotiated in an actual sale. As such, the Company classifies loans as Level 3. Fair

values for impaired loans are based on estimated cash flows, discounted using a rate commensurate with the risk associated with the estimated cash flows, or, if collateral dependent, discounted to the appraised value of the collateral, less cost to sell. As such, the Company classifies impaired loans as Level 2.

Mortgage Servicing Rights.

Mortgage servicing rights represent the value associated with servicing residential mortgage loans. Servicing assets and servicing liabilities are reported using the amortization method. In evaluating the carrying values of mortgage servicing rights, the Company obtains third party valuations based on loan level data including note rate, type and term of the underlying loans and observable inputs for its assumptions. As such, the Company classifies mortgage servicing rights as nonrecurring Level 2.

Accrued Interest Receivable

The fair value estimate of this financial instrument approximates the carrying value as this financial instrument has a short maturity. It is the Company's policy to stop accruing interest on loans for which it is probable that the interest is not collectible. Therefore, this financial instrument has been adjusted for estimated credit loss. As such, the Company classifies accrued interest receivable as Level 2.

Deposits

The fair value of deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value estimates do not include the benefit that results from the low-cost funding provided by the deposits compared to the cost of borrowing funds in the market. If that value were considered, the fair value of the Company's net assets could increase. As such, the Company classifies deposits as Level 2.

Borrowed Funds

The fair value of borrowed funds is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently available for borrowings of similar remaining maturities. As such, the Company classifies borrowed funds as Level 2.

Accrued Interest Payable

The fair value estimate approximates the carrying amount as this financial instrument has a short maturity. As such, the Company classifies accrued interest payable as Level 2.

Off-Balance-Sheet Instruments

Off-balance-sheet instruments include loan commitments. Fair values for loan commitments have not been presented as the future revenue derived from such financial instruments is not significant.

Limitations

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These values do not reflect any premium or discount that could result from offering for sale at

one time the Company's entire holdings of a particular financial instrument. Because no market exists for a significant

portion of the Company's financial instruments, fair value estimates are based on Management's judgments regarding future expected loss experience, 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 estimates. Fair value estimates are based on existing on- and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial instruments include the deferred tax asset, premises and equipment, and other real estate owned. In addition, tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.