Edgar Filing: CITIZENS & NORTHERN CORP

Unassociated Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______________ to _________________________.

Commission file number: 000-16084

CITIZENS & NORTHERN CORPORATION

(Exact name of Registrant as specified in its charter)

PENNSYLVANIA		23-2451943
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

90-92 MAIN STREET, WELLSBORO, PA 16901

(Address of principal executive offices) (Zip code)

570-724-3411

(Registrant's telephone number including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.

Common Stock ($1.00 par value)

12,142,757 Shares Outstanding on November 5, 2010

CITIZENS & NORTHERN CORPORATION

Index

Part I. Financial Information

Item 1. Financial Statements	Page 3

Consolidated Balance Sheet – September 30, 2010 and December 31, 2009	Page 3

Consolidated Statement of Operations - Three Months and Nine Months Ended September 30, 2010 and 2009	Page 4

Consolidated Statement of Cash Flows - Nine Months Ended September 30, 2010 and 2009	Page 5

Consolidated Statement of Changes in Stockholders’ Equity- Nine Months Ended September 30, 2010 and 2009	Page 6 - 7

Notes to Consolidated Financial Statements	Pages 8 - 24

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	Pages 24 - 43

Item 3. Quantitative and Qualitative Disclosures About Market Risk	Pages 43 - 46

Item 4. Controls and Procedures	Page 46

Part II. Other Information	Pages 47 - 49

Signatures	Page 50

Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification - Chief Executive Officer	Page 51

Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification - Chief Financial Officer	Page 52

Exhibit 32. Section 1350 Certifications	Page 53

PART 1 - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Consolidated Balance Sheet	September 30,			December 31,
(In Thousands Except Share Data)	2010			2009
	(Unaudited)			(Note)
ASSETS
Cash and due from banks:
Noninterest-bearing	$	16,501		$	18,247
Interest-bearing		36,724			73,818
Total cash and cash equivalents		53,225			92,065
Trading securities		0			1,045
Available-for-sale securities		433,392			396,288
Held-to-maturity securities		0			300
Loans, net of allowance for loan losses of$8,602,000 at September 30, 2010 and $8,265,000 at December 31, 2009		718,087			713,338
Bank-owned life insurance		21,708			22,798
Accrued interest receivable		5,303			5,613
Bank premises and equipment, net		23,076			24,316
Foreclosed assets held for sale		530			873
Deferred tax asset, net		13,096			22,037
Intangible asset - Core deposit intangibles		370			502
Intangible asset - Goodwill		11,942			11,942
Other assets		27,379			30,678
TOTAL ASSETS	$	1,308,108		$	1,321,795

LIABILITIES
Deposits:
Noninterest-bearing	$	151,703		$	137,470
Interest-bearing		831,813			789,319
Total deposits		983,516			926,789
Dividends payable		0			169
Short-term borrowings		18,402			39,229
Long-term borrowings		158,654			196,242
Accrued interest and other liabilities		6,454			6,956
TOTAL LIABILITIES		1,167,026			1,169,385

STOCKHOLDERS' EQUITY
Preferred stock, $1,000 par value; authorized 30,000 shares; $1,000 liquidation preference per share; no shares issued at September 30, 2010 and 26,440 shares issued at December 31, 2009		0			25,749
Common stock, par value $1.00 per share; authorized 20,000,000 shares in 2010 and 2009; 12,397,335 shares issued at September 30, 2010 and 12,374,481 shares issued at December 31, 2009		12,397			12,374
Paid-in capital		66,614			66,833
Retained earnings		62,480			53,027
Unamortized stock compensation		(140	)		(107	)
Treasury stock, at cost; 254,578 shares at September 30, 2010 and 262,780 shares at December 31, 2009		(4,431	)		(4,575	)
Sub-total		136,920			153,301
Accumulated other comprehensive income (loss):
Unrealized gains (losses) on available-for-sale securities		4,393			(522	)
Defined benefit plans		(231	)		(369	)
Total accumulated other comprehensive income (loss)		4,162			(891	)
TOTAL STOCKHOLDERS' EQUITY		141,082			152,410
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY	$	1,308,108		$	1,321,795

The accompanying notes are an integral part of these consolidated financial statements.Note: The balance sheet at December 31, 2009 has been derived from the audited financial statements at that date but does not include all the information and notes required by U.S. generally accepted accounting principles for complete financial statements.

CONSOLIDATED STATEMENT OF OPERATIONS

(In Thousands, Except Per Share Data) (Unaudited)

	3 Months Ended					Fiscal Year To Date
	Sept. 30		Sept. 30,			9 Months Ended Sept. 30,
	2010		2009			2010			2009
	(Current)		(Prior Year)			(Current)			(Prior Year)
INTEREST INCOME
Interest and fees on loans	$	11,153	$	11,314		$	33,112		$	34,027
Interest on balances with depository institutions		26		24			102			28
Interest on loans to political subdivisions		395		436			1,192			1,244
Interest on federal funds sold		0		0			0			15
Interest on trading securities		0		2			1			33
Income from available-for-sale and held-to-maturity securities:
Taxable		2,641		3,726			8,425			12,648
Tax-exempt		1,223		1,186			3,588			3,246
Dividends		57		120			194			479
Total interest and dividend income		15,495		16,808			46,614			51,720
INTEREST EXPENSE
Interest on deposits		2,916		3,578			9,131			11,258
Interest on short-term borrowings		15		121			166			431
Interest on long-term borrowings		1,708		2,317			5,638			7,097
Total interest expense		4,639		6,016			14,935			18,786
Net interest income		10,856		10,792			31,679			32,934
Provision for loan losses		189		634			472			554
Net interest income after provision for loan losses		10,667		10,158			31,207			32,380

OTHER INCOME
Trust and financial management revenue		876		757			2,605			2,396
Service charges on deposit accounts		1,166		1,317			3,449			3,514
Service charges and fees		191		198			594			615
Insurance commissions, fees and premiums		65		69			186			226
Increase in cash surrender value of life insurance		121		107			352			384
Other operating income		1,030		834			2,894			1,967
Sub-total		3,449		3,282			10,080			9,102
Total other-than-temporary impairment losses on available-for-sale securities		0		(38,679	)		(381	)		(81,634	)
Portion of (gain) recognized in other comprehensive loss (before taxes)		0		(9,268	)		(52	)		(2,773	)
Net impairment losses recognized in earnings		0		(47,947	)		(433	)		(84,407	)
Realized gains on available-for-sale securities, net		388		99			1,198			885
Net impairment losses recognized in earnings and realized gains on available-for-sale securities		388		(47,848	)		765			(83,522	)
Total other income (loss)		3,837		(44,566	)		10,845			(74,420	)
OTHER EXPENSES
Salaries and wages		3,354		3,334			9,631			9,993
Pensions and other employee benefits		980		918			2,902			3,237
Occupancy expense, net		654		652			2,004			2,073
Furniture and equipment expense		500		690			1,610			2,066
FDIC assessments		382		393			1,201			1,651
Pennsylvania shares tax		305		318			916			954
Other operating expense		1,794		1,972			5,228			6,099
Total other expenses		7,969		8,277			23,492			26,073
Income (loss) before income tax provision (credit)		6,535		(42,685	)		18,560			(68,113	)
Income tax provision (credit)		1,671		(14,491	)		4,389			(24,163	)
Net income (loss)		4,864		(28,194	)		14,171			(43,950	)
U.S Treasury preferred dividends		729		373			1,474			1,055
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS	$	4,135	$	(28,567	)	$	12,697		$	(45,005	)

PER SHARE DATA:
Net income (loss) per average common share - basic	$	0.34	$	(3.17	)	$	1.05		$	(5.01	)
Net income (loss) per average common share - diluted	$	0.34	$	(3.17	)	$	1.05		$	(5.01	)

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENT OF CASH FLOWS

(In Thousands) (Unaudited)

	Nine Months Ended Sept. 30,
	2010			2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	14,171		$	(43,950	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Provision for loan losses		472			554
Realized (gains) losses on available-for-sale securities, net		(765	)		83,522
(Gain) loss on sale of foreclosed assets, net		(113	)		11
Depreciation expense		1,787			2,159
(Gain) loss on disposition of premises and equipment		(442	)		8
Accretion and amortization on securities, net		1,740			220
Accretion and amortization on loans, deposits and borrowings, net		(179	)		(266	)
Increase in cash surrender value of life insurance		(352	)		(384	)
Stock-based compensation		50			336
Amortization of core deposit intangibles		132			243
Deferred income taxes		6,360			(27,928	)
Origination of mortgage loans for sale		(19,228	)		(8,846	)
Proceeds from sales of mortgage loans		19,038			8,636
Net decrease in trading securities		1,045			663
Decrease (increase) in accrued interest receivable and other assets		3,543			(1,311	)
(Increase) decrease in accrued interest payable and other liabilities		(238	)		557
Net Cash Provided by Operating Activities		27,021			14,224
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of held-to-maturity securities		300			105
Proceeds from sales of available-for-sale securities		51,528			16,936
Proceeds from calls and maturities of available-for-sale securities		137,313			50,301
Purchase of available-for-sale securities		(219,143	)		(89,633	)
Purchase of Federal Home Loan Bank of Pittsburgh stock		0			(4	)
Net (increase) decrease in loans		(5,615	)		13,493
Proceeds from bank-owned life insurance		1,442			0
Purchase of premises and equipment		(595	)		(1,042	)
Return of principal on limited liability entity investments		49			25
Proceeds from disposition of premises and equipment		100			0
Proceeds from sale of foreclosed assets		1,100			336
Net Cash Used in Investing Activities		(33,521	)		(9,483	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		56,711			32,789
Net (decrease) in short-term borrowings		(20,827	)		(15,494	)
Repayments of long-term borrowings		(37,453	)		(20,297	)
Issuance of US Treasury preferred stock and warrant		0			26,409
Redemption of US Treasury preferred stock and warrant		(26,840	)		0
Issuance of common stock		0			1,840
Sale of treasury stock		0			30
Tax benefit from compensation plans		29			143
US Treasury preferred dividends paid		(952	)		(768	)
Common dividends paid		(3,008	)		(5,454	)
Net Cash (Used in) Provided by Financing Activities		(32,340	)		19,198
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(38,840	)		23,939
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR		92,065			24,028
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	53,225		$	47,967

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Assets acquired through foreclosure of real estate loans	$	644		$	1,457
Interest paid	$	15,280		$	19,117
Income taxes (refunded) paid	$	(3,781	)	$	3,475

The accompanying notes are an integral part of these consolidated financial statements.

Consolidated Statement of Changes in Stockholders' Equity

Nine Months Ended September 30, 2010 and 2009

(In Thousands Except Per Share Data)

(Unaudited)

												Accum. Other			Unamortized
	Preferred			Common		Paid-in			Retained			Comprehensive			Stock			Treasury
	Stock			Stock		Capital			Earnings			Income (Loss)			Compensation			Stock			Total
Nine Months Ended September 30, 2010:
Balance, December 31, 2009	$	25,749		$	12,374	$	66,833		$	53,027		$	(891	)	$	(107	)	$	(4,575	)	$	152,410
Comprehensive income:
Net income										14,171												14,171
Unrealized gain on securities, net of reclassification and tax													4,915									4,915
Other comprehensive income related to defined benefit plans													138									138
Total comprehensive income																						19,224
Accretion of discount associated with U.S. Treasury preferred stock		691								(691	)											0
Cash dividends on U.S. Treasury preferred stock										(783	)											(783	)
Redemption of U.S. Treasury preferred stock		(26,440	)																			(26,440	)
Redemption of U.S. Treasury warrant							(400	)														(400	)
Cash dividends declared on common stock, $.27 per share										(3,273	)											(3,273	)
Common shares issued for dividend reinvestment plan					23		242															265
Restricted stock granted							(59	)								(100	)		159			0
Forfeiture of restricted stock							(2	)								17			(15	)		0
Stock-based compensation expense																50						50
Tax benefit from employee benefit plan										29												29
Balance, September 30, 2010	$	0		$	12,397	$	66,614		$	62,480		$	4,162		$	(140	)	$	(4,431	)	$	141,082

Consolidated Statement of Changes in Stockholders' Equity, (continued)

Nine Months Ended September 30, 2010 and 2009

(In Thousands Except Per Share Data)

(Unaudited)

											Accum. Other			Unamortized
	Preferred		Common		Paid-in			Retained			Comprehensive			Stock			Treasury
	Stock		Stock		Capital			Earnings			Income (Loss)			Compensation			Stock			Total
Nine Months Ended September 30, 2009:
Balance, December 31, 2008	$	0	$	9,284	$	44,308		$	97,757		$	(23,214	)	$	(48	)	$	(6,061	)	$	122,026
Comprehensive (loss) income:
Net loss									(43,950	)											(43,950	)
Unrealized gain on securities, net of reclassification and tax												25,901									25,901
Other comprehensive loss related to defined benefit plans												(252	)								(252	)
Total comprehensive loss																					(18,301	)
Reclassify non-credit portion of other- than-temporary impairment losses recognized in prior period									2,378			(2,378	)								0
Issuance of U.S. Treasury preferred stock		25,588				821															26,409
Accretion of discount associated with U.S. Treasury preferred stock		118							(118	)											0
Cash dividends on U.S. Treasury preferred stock									(937	)											(937	)
Cash dividends declared on common stock, $.72 per share									(6,490	)											(6,490	)
Common shares issued				115		1,725															1,840
Common shares issued for dividend reinvestment plan						93												904			997
Common shares issued from treasury related to exercise of stock options						(4	)											34			30
Restricted stock granted						10									(79	)		69			0
Forfeiture of restricted stock						(1	)								3			(2	)		0
Stock-based compensation expense						273									63						336
Tax benefit from employee benefit plan						2			141												143
Balance, September 30, 2009	$	25,706	$	9,399	$	47,227		$	48,781		$	57		$	(61	)	$	(5,056	)	$	126,053

The accompanying notes are an integral part of these consolidated financial statements.

Notes to Consolidated Financial Statements

1. BASIS OF INTERIM PRESENTATION

The consolidated financial information included herein, with the exception of the consolidated balance sheet dated December 31, 2009, is unaudited. Such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations, cash flows and changes in stockholders’ equity for the interim periods; however, the information does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for complete financial statements. Certain 2009 information has been reclassified for consistency with the 2010 presentation.

Operating results reported for the three- and nine-months ended September 30, 2010 might not be indicative of the results for the year ending December 31, 2010. The Corporation evaluates subsequent events through the date of filing with the Securities and Exchange Commission.

This document has not been reviewed or confirmed for accuracy or relevance by the Federal Deposit Insurance Corporation or any other regulatory agency.

2. PER COMMON SHARE DATA

Basic net income (loss) per average common share represents income (loss) available to common shareholders divided by the weighted-average number of shares of common stock outstanding. For all periods presented, all outstanding stock options and the warrant (issued in January 2009 and redeemed in September 2010) are anti-dilutive, and are therefore excluded in determining diluted income (loss) per common share.

				Weighted-		Net Income
	Net			Average		(Loss)
	Income			Common		Per
	(Loss)			Shares		Share
Nine Months Ended September 30, 2010
Earnings per common share – basic and diluted	$	12,697,000			12,125,142	$	1.05

Nine Months Ended September 30, 2009
Earnings per common share – basic and diluted	$	(45,005,000	)		8,978,665	$	(5.01	)

Quarter Ended September 30, 2010
Earnings per common share – basic and diluted	$	4,135,000			12,136,516	$	0.34

Quarter Ended September 30, 2009
Earnings per common share – basic and diluted	$	(28,567,000	)		9,005,850	$	(3.17	)

3. COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) is the total of (1) net income (loss), and (2) all other changes in equity from non-stockholder sources, which are referred to as other comprehensive income. The components of comprehensive income (loss), and the related tax effects, are as follows:

	3 Months Ended						9 Months Ended
(In Thousands)	Sept. 30,						Sept. 30,
	2010			2009			2010			2009
Net income (loss)	$	4,864		$	(28,194	)	$	14,171		$	(43,950	)

Unrealized gains (losses) on available-for-sale securities:
Unrealized holding gains (losses) on available-for-sale securities		4,467			(20,631	)		8,191			(44,278	)
Reclassification adjustment for (gains) losses realized in income		(388	)		47,848			(765	)		83,522
Other comprehensive gain before income tax		4,079			27,217			7,426			39,244
Income tax related to other comprehensive gain		1,370			9,254			2,511			13,343
Other comprehensive gain on available-for-sale securities		2,709			17,963			4,915			25,901

Unfunded pension and postretirement obligations:
Change in items from defined benefit plans included in accumulated other comprehensive income (loss)		16			0			168			(462	)
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost		13			14			40			80
Other comprehensive (loss) gain before income tax		29			14			208			(382	)
Income tax related to other comprehensive (loss) gain		9			5			70			(130	)
Other comprehensive (loss) gain on unfunded retirement obligations		20			9			138			(252	)

Net other comprehensive gain		2,729			17,972			5,053			25,649

Total comprehensive income (loss)	$	7,593		$	(10,222	)	$	19,224		$	(18,301	)

The Corporation recognized other comprehensive income of $52,000 before income tax ($34,000 after income tax) related to available-for-sale debt securities for which a portion of an other-than-temporary impairment (OTTI) loss has been recognized in earnings in the nine months ended September 30, 2010, with no other comprehensive income in the third quarter 2010. In the nine-month period ended September 30, 2009, the Corporation recognized other comprehensive loss of $2,773,000 before income tax ($1,830,000 after income tax) related to available-for-sale debt securities for which a portion of an OTTI loss has been recognized in earnings. In the third quarter 2009, the Corporation recognized other comprehensive income of $9,268,000 before income tax, or $6,117,000 after income tax, related to available-for-sale securities for which a portion of an OTTI loss has been recognized in earnings.

The components of accumulated other comprehensive income (loss), included in stockholders’ equity, are as follows:

	Sept. 30,			Dec. 31,
	2010			2009
Net unrealized gain (loss) on available-for-sale securities	$	6,657		$	(769	)
Tax effect		(2,264	)		247
Net-of-tax amount		4,393			(522	)

Unrealized loss on defined benefit plans		(355	)		(563	)
Tax effect		124			194
Net-of-tax amount		(231	)		(369	)

Total accumulated other comprehensive income (loss)	$	4,162		$	(891	)

4. FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS

The Corporation measures certain assets at fair value on a recurring basis. Fair value is defined as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. FASB ASC topic 820, “Fair Value Measurements and Disclosures” (formerly Statement of Financial Accounting Standards No. 157) establishes a framework for measuring fair value that includes a hierarchy used to classify the inputs used in measuring fair value. The hierarchy prioritizes the inputs used in determining valuations into three levels. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. The levels of the fair value hierarchy are as follows:

Level 1 – Fair value is based on unadjusted quoted prices in active markets that are accessible to the Corporation for identical assets. These generally provide the most reliable evidence and are used to measure fair value whenever available.

Level 2 – Fair value is based on significant inputs, other than Level 1 inputs, that are observable either directly or indirectly for substantially the full term of the asset through corroboration with observable market data. Level 2 inputs include quoted market prices in active markets for similar assets, quoted market prices in markets that are not active for identical or similar assets and other observable inputs.

Level 3 – Fair value is based on significant unobservable inputs. Examples of valuation methodologies that would result in Level 3 classification include option pricing models, discounted cash flows and other similar techniques.

At September 30, 2010 and December 31, 2009, assets measured at fair value on a recurring basis and the valuation methods used are as follows:

			September 30, 2010
			Market Values Based on:
	Quoted Prices		Other
	in Active		Observable		Unobservable		Total
	Markets		Inputs		Inputs		Fair
(In Thousands)	(Level 1)		(Level 2)		(Level 3)		Value

AVAILABLE-FOR-SALE SECURITIES:
Obligations of other U.S. Government agencies	$	0	$	52,032	$	0	$	52,032
Obligations of states and political subdivisions		4,365		119,413		0		123,778
Mortgage-backed securities		0		126,283		0		126,283
Collateralized mortgage obligations, Issued by U.S. Government agencies		10,666		100,062		0		110,728
Corporate bonds		0		1,031		0		1,031
Trust preferred securities issued by individual institutions		0		5,649		240		5,889
Collateralized debt obligations:
Pooled trust preferred securities - senior tranches		0		0		8,000		8,000
Other collateralized debt obligations		0		690		0		690
Total debt securities		15,031		405,160		8,240		428,431
Marketable equity securities		4,961		0		0		4,961
Total available-for-sale securities	$	19,992	$	405,160	$	8,240	$	433,392

			December 31, 2009
			Market Values Based on:
	Quoted Prices		Other
	in Active		Observable		Unobservable		Total
	Markets		Inputs		Inputs		Fair
(In Thousands)	(Level 1)		(Level 2)		(Level 3)		Value

AVAILABLE-FOR-SALE SECURITIES:
Obligations of other U.S. Government agencies	$	13,512	$	35,481	$	0	$	48,993
Obligations of states and political subdivisions		0		104,990		0		104,990
Mortgage-backed securities		5,212		151,166		0		156,378
Collateralized mortgage obligations:
Issued by U.S. Government agencies		5,095		42,613		0		47,708
Private label		0		15,494		0		15,494
Corporate bonds		0		1,041		0		1,041
Trust preferred securities issued by individual institutions		0		5,218		800		6,018
Collateralized debt obligations:
Pooled trust preferred securities - senior tranches		0		0		8,199		8,199
Pooled trust preferred securities - mezzanine tranches		0		0		115		115
Other collateralized debt obligations		0		690		0		690
Total debt securities		23,819		356,693		9,114		389,626
Marketable equity securities		6,662		0		0		6,662
Total available-for-sale securities		30,481		356,693		9,114		396,288

TRADING SECURITIES,
Obligations of states and political subdivisions		0		1,045		0		1,045

Total	$	30,481	$	357,738	$	9,114	$	397,333

Management determined there have been few trades of pooled trust-preferred securities since the first half of 2008, except for a limited number of transactions that have taken place as a result of bankruptcies, forced liquidations or similar circumstances. Also, in management’s judgment, there were no available quoted market prices in active markets for assets sufficiently similar to the Corporation’s pooled trust-preferred securities to be reliable as observable inputs. Accordingly, in the third quarter of 2008, the Corporation changed its method of valuing pooled trust-preferred securities from a Level 2 methodology that had been used in prior periods, based on price quotes received from pricing services, to a Level 3 methodology, using discounted cash flows.

At September 30, 2010, management calculated the fair value of the Corporation’s senior tranche pooled trust-preferred security by applying a discount rate to the estimated cash flows. Management used the cash flow estimates determined using the process described in Note 5 for evaluating pooled trust-preferred securities for other-than-temporary impairment (OTTI). Management used a discount rate considered reflective of a market participant’s expectations regarding the extent of credit and liquidity risk inherent in the security. In establishing the discount rate, management considered: (1) the implied discount rate as of the end of 2007, prior to the market for trust-preferred securities becoming inactive; (2) adjustment to the year-end 2007 discount rate for the change in the spread between indicative market rates over corresponding risk-free rates in 2010; and (3) an additional adjustment – an increase of 2% in the discount rate – for liquidity risk. Management considered the additional 2% increase in the discount rate necessary in order to give some consideration to price estimates based on trades made under distressed conditions, as reported by brokers and pricing services. Management’s estimate of cash flows and the discount rate used to calculate the fair value of the pooled trust-preferred security were based on sensitive assumptions, and market participants might use substantially different assumptions, which could result in calculations of a fair value that would be substantially different than the amount calculated by management.

In the fourth quarter 2009, the Corporation transferred a trust preferred security issued by a financial institution (The South Financial Group, Inc.) to Level 3 from Level 2. This security was transferred to Level 3 because management had been trying to sell the security since October 2009, but had not been able to obtain a bid from a potential buyer nor otherwise been able to find a price quote. In April 2010, management received an offer to purchase a portion of the Corporation’s holding and sold a portion of the security held. The Corporation received total proceeds of $240,000.

During the third quarter 2010, The Toronto-Dominion Bank received regulatory and shareholder approval to acquire The South Financial Group, Inc. The acquisition closed in October 2010. Management is in the process of evaluating how the acquisition will affect the trust preferred security owned by the Corporation, and will evaluate whether the fair value of the security can be determined using Level 2 inputs during the fourth quarter 2010. Management has valued the security at September 30, 2010 based on the price from the April 2010 sale.

Following is a reconciliation of activity for available-for-sale securities measured at fair value based on significant unobservable information:

	3 Months Ended						Fiscal Year To Date
	Sept. 30,			Sept. 30,			9 Months Ended Sept. 30,
	2010			2009			2010			2009
	(Current)			(Prior Year)			(Current)			(Prior Year)
Balance, beginning of period	$	8,240		$	37,470		$	9,114		$	58,914
Purchases, issuances and settlements		(20	)		34			(519	)		75
Proceeds from sales		(284	)		0			(524	)		0
Realized gains (losses), net		284			0			284			(335	)
Unrealized losses included in earnings		0			(42,495	)		(423	)		(72,776	)
Unrealized gains included in other comprehensive income		20			14,120			308			23,251
Balance, end of period	$	8,240		$	9,129		$	8,240		$	9,129

Unrealized losses included in earnings are from the Corporation’s other-than-temporary impairment analysis of securities, as described in Note 5, and are included in net impairment losses recognized in earnings in the consolidated statement of operations.

Assets measured at fair value on a nonrecurring basis include impaired commercial loans and foreclosed real estate assets held for sale. All of the Corporation’s impaired commercial loans for which a valuation allowance was necessary at September 30, 2010 and December 31, 2009 were valued based on the estimated amount of net proceeds from liquidation of real estate and other collateral, or based on the estimated present value of cash flows to be received. The Corporation considers the fair value of such impaired commercial loans to be based on unobservable inputs (Level 3), and the balance of impaired loans for which a valuation allowance was recorded, net of allowance for loan losses, was $1,461,000 at September 30, 2010 and $1,564,000 at December 31, 2009. Similarly, the carrying values of foreclosed real estate assets held for sale were based on unobservable inputs (Level 3), with a balance of $530,000 at September 30, 2010 and $873,000 at December 31, 2009.

Certain of the Corporation’s financial instruments are not measured at fair value in the consolidated financial statements. 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 instrument. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements. Therefore, the aggregate fair value amounts presented may not represent the underlying fair value of the Corporation.

The Corporation used the following methods and assumptions in estimating fair value disclosures for financial instruments:

CASH AND CASH EQUIVALENTS - The carrying amounts of cash and short-term instruments approximate fair values.

SECURITIES - Fair values for securities, excluding restricted equity securities, are based on quoted market prices or other methods as described above. The carrying value of restricted equity securities approximates fair value based on applicable redemption provisions.

LOANS - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial real estate, residential mortgage and other consumer. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories. The fair value of performing loans is calculated by discounting contractual cash flows, adjusted for estimated prepayments based on historical experience, using estimated market discount rates that reflect the credit and interest rate risk inherent in the loans. Fair value of nonperforming loans is based on recent appraisals or estimates prepared by the Corporation’s lending officers.

DEPOSITS - The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, money market and interest checking accounts, is (by definition) equal to the amount payable on demand at September 30, 2010 and December 31, 2009. The fair value of all other deposit categories 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 of deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible.

BORROWED FUNDS - The fair value of borrowings is estimated using discounted cash flow analyses based on rates currently available to the Corporation for similar types of borrowing arrangements.

ACCRUED INTEREST - The carrying amounts of accrued interest receivable and payable approximate fair values.

OFF-BALANCE SHEET COMMITMENTS – The Corporation has commitments to extend credit and has issued standby letters of credit. Standby letters of credit are conditional guarantees of performance by a customer to a third party. Estimates of the fair value of these off-balance sheet items were not made because of the short-term nature of these arrangements and the credit standing of the counterparties.

The estimated fair values, and related carrying amounts, of the Corporation’s financial instruments are as follows:

(In Thousands)	September 30, 2010				December 31, 2009
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
Financial assets:
Cash and cash equivalents	$	53,225	$	53,225	$	92,065	$	92,065
Trading securities		0		0		1,045		1,045
Available-for-sale securities		433,392		433,392		396,288		396,288
Held-to-maturity securities		0		0		300		302
Restricted equity securities		8,757		8,757		8,970		8,970
Loans, net		718,087		724,057		713,338		719,689
Accrued interest receivable		5,303		5,303		5,613		5,613

Financial liabilities:
Deposits		983,516		991,813		926,789		935,380
Short-term borrowings		18,402		18,187		39,229		38,970
Long-term borrowings		158,654		181,576		196,242		218,767
Accrued interest payable		471		471		681		681

5. SECURITIES

Amortized cost and fair value of available-for-sale and held-to-maturity securities at September 30, 2010 and December 31, 2009 are summarized as follows:

September 30, 2010

Gross

Unrealized

Amortized

Holding