Note 11:

Fair Value and Interest Rate Risk

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Fair value is 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. Fair value is best determined based upon quoted market prices. However, in certain instances, there are no quoted market prices for certain assets or liabilities. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. 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 asset or liability.

Fair value measurements focus on exit prices in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment.

The Company’s fair value measurements are classified into a fair value hierarchy based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. The three categories within the hierarchy are as follows:

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Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

•

Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

•

Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

The fair value measurement level of an asset or liability within the fair value hierarchy is based on the lower level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.

A description of the valuation methodologies used for assets and liabilities recorded at fair value, and for estimating fair value for financial and non-financial instruments not recorded at fair value, is set forth below.

Cash and due from banks, federal funds sold, short-term investments and accrued interest receivable and payable: The carrying amount is a reasonable estimate of fair value. These financial instruments are not recorded at fair value on a recurring basis.

Available-for-Sale Securities: These financial instruments are recorded at fair value in the financial statements. Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted prices are not available, then fair values are estimated by using pricing models (i.e., matrix pricing) or quoted prices of securities with similar characteristics and are classified within Level 2 of the valuation hierarchy. Examples of such instruments include U.S. government agency bonds and mortgage-backed securities and corporate bonds. The prices for these instruments are obtained through an independent pricing service or dealer market participants with whom the Company has historically transacted both purchases and sales of investment securities. Prices obtained from these sources include prices derived from market quotations and matrix pricings. The fair value measurements considered observable data may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Management reviews the data and assumptions used in pricing the securities by its third party provider to ensure the highest level of significant inputs are derived from market observable data. Level 3 securities are instruments for which significant unobservable input are utilized. Available-for-sale securities are recorded at fair value on a recurring basis.

Loans: For variable rate loans, which reprice frequently and have no significant change in credit risk, carrying values are a reasonable estimate of fair values, adjusted for credit losses inherent in the portfolios. The fair value of fixed rate loans is estimated by discounting the future cash flows using the period end rates, estimated by using local market data, at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, adjusted for credit losses inherent in the portfolios. The Company does not record loans at fair value on a recurring basis. However, from time to time, nonrecurring fair value adjustments to collateral-dependent impaired loans are recorded to reflect partial write-downs based on the observable market price or current appraised value of collateral. Fair values estimated in this manner do not fully incorporate an exit-price approach to fair value, but instead are based on a comparison to current market rates for comparable loans.

Other Real Estate Owned: The fair values of the Company’s other real estate owned (“OREO”) properties are based on the estimated current property valuations less estimated selling costs. When the fair value is based on current observable appraised values, OREO is classified within Level 2. The Company classifies OREO within Level 3 when unobservable adjustments are made to appraised values. The Company does not record other real estate owned at fair value on a recurring basis.

Deposits: The fair value of demand deposits, regular savings and certain money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit and other time deposits is estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities, estimated using local market data, to a schedule of aggregated expected maturities on such deposits. The Company does not record deposits at fair value on a recurring basis.

Short-term borrowings: The carrying amounts of borrowings under short-term repurchase agreements and other short-term borrowings maturing within 90 days approximate their fair values. The Company does not record short-term borrowings at fair value on a recurring basis.

Junior Subordinated Debt: Junior subordinated debt reprices quarterly and as a result the carrying amount is considered a reasonable estimate of fair value. The Company does not record junior subordinated debt at fair value on a recurring basis.

Federal Home Loan Bank Borrowings: The fair value of the advances is estimated using a discounted cash flow calculation that applies current Federal Home Loan Bank interest rates for advances of similar maturity to a schedule of maturities of such advances. The Company does not record these borrowings at fair value on a recurring basis.

Other Borrowings: The fair values of longer term borrowings and fixed rate repurchase agreements are estimated using a discounted cash flow calculation that applies current interest rates for transactions of similar maturity to a schedule of maturities of such transactions. The Company does not record these borrowings at fair value on a recurring basis.

Off-balance sheet instruments: Fair values for the Company’s off-balance-sheet instruments (lending commitments) are based on interest rate changes and fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The Company does not record its off-balance-sheet instruments at fair value on a recurring basis.

The following table details the financial assets measured at fair value on a recurring basis as of June 30, 2013 and December 31, 2012, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine fair value:


	Quoted Prices in		Significant		Significant
	Active Markets		Observable		Unobservable		Balance
	for Identical Assets		Inputs		Inputs		as of
June 30, 2013	(Level 1)		(Level 2)		(Level 3)		June 30, 2013
U.S. Government agency mortgage-backed securities	$	—	$	23,744,379	$	—	$	23,744,379
U.S. Government agency bonds		—		7,188,603		—		7,188,603
Corporate bonds		—		8,610,093		—		8,610,093

Securities available for sale	$	—	$	39,543,075	$	—	$	39,543,075


	Quoted Prices in		Significant		Significant
	Active Markets		Observable		Unobservable		Balance
	for Identical Assets		Inputs		Inputs		as of
December 31, 2012	(Level 1)		(Level 2)		(Level 3)		December 31, 2012
U.S. Government agency mortgage-backed securities	$	—	$	25,706,891	$	—	$	25,706,891
U.S. Government agency bonds				7,526,170		—		7,526,170
Corporate bonds		—		8,486,259		—		8,486,259

Securities available for sale	$	—	$	41,719,320	$	—	$	41,719,320

There were no transfers of assets between levels 1, 2 or 3 as of June 30, 2013 or December 31, 2012. Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

The following tables reflect financial assets measured at fair value on a non-recurring basis as of June 30, 2013 and December 31, 2012, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:


	Quoted Prices in		Significant		Significant
	Active Markets		Observable		Unobservable
	for Identical Assets		Inputs		Inputs
June 30, 2013	(Level 1)		(Level 2)		(Level 3)		Balance
Impaired Loans ⁽¹⁾	$	—	$	—	$	14,030,002	$	14,030,002

Other real estate owned ⁽²⁾	$	—	$	—	$	3,845,041	$	3,845,041

December 31, 2012
Impaired Loans ⁽¹⁾	$	—	$	—	$	8,424,786	$	8,424,786

Other real estate owned ⁽²⁾	$	—	$	—	$	4,873,844	$	4,873,844

⁽¹⁾	Represents carrying value for which adjustments are based on the appraised value of the collateral.

⁽²⁾	Represents carrying value for which adjustments are based on the appraised value of the property.

The Company discloses fair value information about financial instruments, whether or not recognized in the consolidated balance sheet, for which it is practicable to estimate that value. Certain financial instruments are excluded from disclosure requirements and, accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

The estimated fair value amounts have been measured as of June 30, 2013 and December 31, 2012 and have not been reevaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair value of these financial instruments subsequent to the respective reporting dates may be different than amounts reported on those dates.

The information presented should not be interpreted as an estimate of the fair value of the Company since a fair value calculation is only required for a limited portion of the Company’s assets and liabilities. Due to the wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other bank holding companies may not be meaningful.

The following is a summary of the carrying amounts and estimated fair values of the Company’s financial instruments not measured and not reported at fair value on the consolidated balance sheets at June 30, 2013 and December 31, 2012 (in thousands):


			June 30, 2013				December 31, 2012
	Fair Value		Carrying		Estimated		Carrying		Estimated
	Hierarchy		Amount		Fair Value		Amount		Fair Value
Financial Assets:
Cash and noninterest bearing balances due from banks		Level 1	$	3,866	$	3,866	$	2,736	$	2,736
Interest-bearing deposits due from banks		Level 1		20,509		20,509		67,567		67,567
Short-term investments		Level 1		711		711		711		711
Other investments		Level 2		3,500		3,500		3,500		3,500
Federal Reserve Bank stock		Level 1		1,634		1,634		1,730		1,730
Federal Home Loan Bank stock		Level 1		4,143		4,143		4,344		4,344
Loans receivable, net		Level 3		447,813		454,625		458,794		464,551
Accrued interest receivable		Level 1		1,711		1,711		1,894		1,894
Financial Liabilities:
Demand deposits		Level 1	$	63,869	$	63,869	$	65,176	$	65,176
Savings deposits		Level 1		94,601		94,601		77,761		77,761
Money market deposits		Level 1		36,494		36,494		42,401		42,401
NOW accounts		Level 1		33,706		33,706		30,191		30,191
Time deposits		Level 2		248,972		250,436		281,753		284,974
FHLB Borrowings		Level 2		35,000		35,691		50,000		52,448
Securities sold under repurchase agreements		Level 2		—		—		7,000		7,683
Subordinated debentures		Level 2		8,248		8,248		8,248		8,248
Accrued interest payable		Level 1		1,278		1,278		1,241		1,241

The following are the methods and assumptions that were used to estimate the fair value of other financial assets and liabilities in the table above:

Cash and due from banks and interest deposits with banks: The carrying amount is considered to be a reasonable estimate of fair value due to the short maturity of these items.

Short term investments: The carrying amount is considered to be a reasonable estimate of fair value due to the short maturity of these items.

Other Investments: The redeemable carrying amount of this security, with limited marketability, approximates its fair value.

Federal Reserve Bank and Federal Home Loan Bank stock: The redeemable carrying amount of these securities, with limited marketability, approximates their fair value.

Loans Receivable: The fair values of loans are estimated by discounting the projected future cash flows using market discount rates, primarily based on the Bank’s current offer rates on comparable products, which reflect credit and interest-rate risk inherent in the loan. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Fair values estimated in this manner do not fully incorporate an exit price approach to fair value, but instead are based on a comparison to current market rates for comparable loans.

Accrued interest receivable and payable: The carrying amounts of accrued interest approximate their fair value due to the short-term nature of these items.

Deposits: Current carrying amounts approximate estimated fair value of demand deposits, savings, money market and NOW accounts. The fair value of time deposits is based on the discounted value of contractual cash flows using the Bank’s current offer rates on comparable products of similar remaining maturities.

FHLB borrowings and securities sold under repurchase agreements: The fair values of the borrowings are estimated by discounting the estimated future cash flows using current market discount rates of financial instruments with similar characteristics, terms and remaining maturities.

Junior Subordinated Debt: There is no active market for the trust preferred securities issued by the Company’s capital trust. The carrying amount is considered to be a reasonable estimate of fair value because of the frequency they reprice to market rates.

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

Off-balance sheet instruments

Loan commitments on which the committed interest rate is less than the current market rate were insignificant at June 30, 2013 and December 31, 2012. The estimated fair value of fee income on letters of credit at June 30, 2013 and December 31, 2012 was insignificant.