NOTE 6 – FAIR VALUE MEASUREMENTS

Fair Value Hierarchy

ASC 820-10, “Fair Value Measurements and Disclosures,” provides a framework for measuring fair value under generally accepted accounting principles. The guidance allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis.

In accordance with ASC 820-10, the Company groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the observability and reliability of the assumptions used to determine fair value.

Level 1 - Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2 - Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

Level 3 - Level 3 inputs are unobservable inputs for the asset or liability.

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.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets and financial liabilities to determine fair value as of September 30, 2012 (unaudited) and December 31, 2011.

Cash Instruments

The Company’s cash instruments are generally classified within level 1 or level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. There were no significant transfers between level 1 and 2 of the fair value hierarchy for the nine months ended September 30, 2012 (unaudited) and the year ended December 31, 2011.

Investment Securities

The Company’s investment in mortgage-backed securities and other debt securities is generally classified within level 2 of the fair value hierarchy. For these securities, the Company obtains fair value measurements from independent pricing services. The fair value measurements consider observable data that may include reported trades, dealer quotes, market spreads, cash flows, the U.S. treasury yield curve, trading levels, market consensus prepayment speeds, credit information and the instrument’s terms and conditions.

Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. Subsequent to inception, management only changes level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalization and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows.

Loans Held for Sale

The Company elects to account for new originations of loans held for sale and transfers from held for investment to loans held for sale at the lower of cost or fair value. Fair value is measured using quoted market prices when available. If quoted market prices are not available, comparable market values or discounted cash flow analysis may be utilized. These assets are typically categorized as Level 3.

Impaired Loans

The Company’s impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using level 2 inputs based upon appraisals that utilize sales and estimated values of similar properties, obtained from a third party. The inputs used in the appraisals of the collateral are not always observable, and therefore the loans may be categorized as Level 3 within the fair value hierarchy.

Other Real Estate Owned

The fair values are estimated based upon recent valuations of the property less costs to sell the property. Certain inputs used in valuations are not always observable, and therefore Other Real Estate Owned may be categorized as Level 3 within the fair value hierarchy. When inputs in valuations are observable, they are classified as Level 2.

Fair Value Measurements

The following summarizes assets measured at fair value as of September 30, 2012 (unaudited) and December 31, 2011 (in thousands). Assets measured at fair value on a recurring basis at September 30, 2012 (unaudited) include investments in available-for-sale securities. Assets measured at fair value on a non-recurring basis include loans held for sale and other real estate owned.

Assets above for which fair value is only disclosed

a - Carrying value approximates fair value.

b - The fair values presented are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments and/or discounted cash flow analyses.

c - Fair value is estimated by discounting estimated future cash flows.

d - Fair value was determined by discounting anticipated future cash payments using rates currently available for instruments with similar remaining maturities.

Certain impaired loans were adjusted to the fair value, less the costs to sell, of the underlying collateral securing these loans resulting in losses. The loss is either recorded directly as an adjustment to current earnings through a partial charge off or is recorded as a component in determining the allowance for loan losses. Fair value was measured using appraised values of collateral and adjusted as necessary by management based on unobservable inputs for specific properties. However, the choice of observable data is subject to significant judgment, and there are often adjustments based on judgment in order to make observable data comparable and to consider the impact of time, the condition of properties, interest rates, and other market factors on current values. Additionally, commercial real estate appraisals frequently involve discounting of projected cash flows, which relies inherently on unobservable data. Therefore, real estate collateral related nonrecurring fair value measurement adjustments have generally been classified as Level 3. Estimates of fair value used for other collateral supporting commercial loans generally are based on assumptions not observable in the marketplace and therefore such valuations have been classified as Level 3.

There were no transfers between Level 1 and Level 2 assets and liabilities for the nine months ended September 30, 2012 (unaudited) and the year ended December 31, 2011.