9.FAIR VALUE MEASUREMENTS

ASC Topic 820, “Fair Value Measurements and Disclosures”, defines fair value, establishes a framework for measuring fair value, and sets forth disclosures about fair value measurements. ASC Topic 825, “Financial Instruments”, allows entities to choose to measure certain financial assets and liabilities at fair value. The Company has not elected the fair value option for any financial assets or liabilities.

ASC Topic 820 defines fair value as 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. It also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. This Topic describes three levels of inputs that may be used to measure fair value:

Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2 – Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 – Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate the fair value:

Investment Securities and Trading Assets: The fair values for available for sale investment securities and trading assets are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent third party real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available for similar loans and collateral underlying such loans. Such adjustments were $100 thousand for the first six months of 2016 and $14 thousand for the first six months of 2015, and $19 thousand for the three months ended June 30, 2016 and $42 thousand for the three months ended June 30, 2015, and resulted in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted in accordance with the allowance policy.

Other Real Estate Owned: Assets acquired through or instead of loan foreclosure and classified as other real estate owned (OREO) are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach with data from comparable properties. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments were $85 thousand for the six months ended June 30, 2016 and $227 thousand for the six months ended June 30, 2015 and resulted in a Level 3 classification of the inputs for determining fair value. Real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Mortgage Servicing Rights: Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively based on a valuation model that calculates the present value of estimated future net servicing income, resulting in a Level 3 classification.

Assets and Liabilities Measured on a Recurring Basis

Available for sale investment securities and trading assets are the Company’s only balance sheet items that meet the disclosure requirements for instruments measured at fair value on a recurring basis. Disclosures are as follows in the tables below.

Fair Value Measurements at June 30, 2016 (in thousands):


			Quoted Prices
			In Active
			Markets for		Significant Other		Significant
			Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)

U. S. government agencies	$	36,324	$	—	$	36,324	$	—
States and municipals		95,410		—		95,410		—
Mortgage-backed - residential		134,638		—		134,638		—
Equity securities		350		350		—		—
Trading Assets		5,704		5,704		—		—
Total	$	272,426	$	6,054	$	266,372	$	—

Fair Value Measurements at December 31, 2015 (in thousands):


			Quoted Prices
			In Active
			Markets for		Significant Other		Significant
			Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)

U. S. government agencies	$	48,863	$	—	$	48,863	$	—
States and municipals		91,962		—		91,962		—
Mortgage-backed - residential		123,043		—		123,043		—
Equity securities		344		344		—		—
Trading Assets		5,531		5,531		—		—
Total	$	269,743	$	5,875	$	263,868	$	—

There were no transfers between level 1 and level 2 during 2016 or 2015.

Assets measured at fair value on a non-recurring basis are summarized below:


	Fair Value Measurements at June 30, 2016 Using :
			Quoted Prices
			In Active
			Markets for	Significant Other	Significant
			Identical	Observable	Unobservable
	Carrying		Assets	Inputs	Inputs
(In thousands)	Value		(Level 1)	(Level 2)	(Level 3)

Description
Impaired loans:
Real Estate Mortgage:
Construction	$	164	—	—	$	164
1-4 family Residential		526	—	—		526
Non-farm & non-residential		371	—	—		371
Other real estate owned, net:
Residential		1,419	—	—		1,419
Loan servicing rights		1,106	—	—		1,106


	Fair Value Measurements at December 31, 2015 Using :
			Quoted Prices
			In Active
			Markets for	Significant Other	Significant
			Identical	Observable	Unobservable
	Carrying		Assets	Inputs	Inputs
(In thousands)	Value		(Level 1)	(Level 2)	(Level 3)

Description
Impaired loans:
Real Estate Mortgage:
Multi-family residential		540	—	—	$	540
Non-farm & non-residential		285	—	—		285
Agricultural		—	—	—		—
Other real estate owned, net:
Residential		1,504	—	—		1,504
Loan servicing rights		87	—	—		87

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $1.1 million, which includes a valuation allowance of $109 thousand at June 30, 2016. During the first six months of 2016, two new loans became impaired resulting in additional loan loss provision expense of $34 thousand. The total allowance for specific impaired loans decreased $32 thousand for the six months ended June 30, 2016 and decreased $301 thousand for the six months ended June 30, 2015.The total allowance for specific impaired loans decreased $399 thousand for the three months ended June 30, 2016 and decreased $101 thousand for the three months ended June 30, 2015. The decrease of $399 thousand in the allowance for specific impaired loans during the second quarter of 2016 was mostly attributed to one loan, which had a specific reserve of $350 thousand at March 31, 2016, no longer requiring a specific reserve at June 30, 2016. This loan had no specific reserve at December 31, 2015.

Other real estate owned, which is measured at fair value less costs to sell, had a net carrying amount of $1.4 million, which is made up of the outstanding balance of $2.1 million, net of a valuation allowance of $701 thousand at June 30, 2016. The Company recorded $85 thousand in write-downs of other real estate owned properties for the six months ended June 30, 2016. The Company recorded $227 thousand in net write-downs of other real estate owned properties during the six months ended June 30, 2015. The Company recorded no write-downs of other real estate owned properties during the three months ended June 30, 2016 and $201 thousand in write-downs of other real-estate owned properties during the three months ended June 30, 2015.

Impaired loan servicing rights, which are carried at the lower of cost or fair value, were carried at their fair value of $1.1 million, which is made up of the outstanding balance of $1.2 million, net of a valuation allowance of $61 thousand at June 30, 2016. For the first six months of 2016, the Company recorded net write-downs of $42 thousand and a net recovery of prior write-downs of $34 thousand for the six months ended June 30, 2015. For the three months ended June 30, 2016, the Company recorded net write-downs of $45 thousand. For the three months ended June 30, 2015, the Company recorded a net recovery of $20 thousand. At December 31, 2015, impaired loan servicing rights were carried at their fair value of $87 thousand, which is made up of the outstanding balance of $106 thousand, net of a valuation allowance of $19 thousand.

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at June 30, 2016 and December 31, 2015:


				Range
June 30, 2016	Fair	Valuation	Unobservable	(Weighted
(In thousands)	Value	Technique(s)	Input(s)	Average)
Impaired loans

Construction	164	sales comparison	adjustment for differences between the comparable sales	1%-4%	(3)%
1-4 family	526	sales comparison	adjustment for differences between the comparable sales	0%-12%	(7)%
Non-farm & non-residential	371	sales comparison	adjustment for differences between the comparable sales	4%-44%	(23)%
Other real estate owned:
Residential	808	sales comparison	adjustment for differences between the comparable sales	10%-28%	(19)%
	611	income approach	capitalization rate	10%-10%	(10)%

Loan Servicing Rights	1,106	discounted cash flow	discount rate	9%-20%	(11)%


				Range
December 31, 2015	Fair	Valuation	Unobservable	(Weighted
(In thousands)	Value	Technique(s)	Input(s)	Average)
Impaired loans
Real estate mortgage:
1-4 family residential	540	sales comparison	adjustment for differences between the comparable sales	1%-12%	(7)%
Non-farm & non-residential	285	sales comparison	adjustment for differences between the comparable sales	23%-31%	(27)%
Other real estate owned:
Residential	1,504	sales comparison	adjustment for differences between the comparable sales	10%-28%	(19)%
		income approach	capitalization rate	10%-10%	(10)%
Loan Servicing Rights	87	discounted cash flow	discount rate	8%-21%	(11)%

Fair Value of Financial Instruments

The carrying amounts and estimated fair values of financial instruments, at June 30, 2016 and December 31, 2015 are as follows:

June 30, 2016:


	Carrying
(in thousands)	Value		Level 1		Level 2		Level 3		Total

Financial assets
Cash and cash equivalents	$	16,628	$	16,628	$	—	$	—	$	16,628
Interest bearing deposits		4,829		4,829		—		—		4,829
Securities		266,722		350		266,372		—		266,722
Trading assets		5,704		5,704		—		—		5,704
Mortgage loans held for sale		1,485		—		1,532		—		1,532
Loans, net		646,018		—		—		645,250		645,250
FHLB Stock		7,034		—		—		—		N/A
Interest receivable		3,641		—		1,322		2,319		3,641
Financial liabilities
Deposits	$	751,396	$	557,472	$	195,233	$	—	$	752,705
Securities sold under agreements to repurchase		26,057		—		26,108		—		26,108
FHLB advances		99,617		—		98,366		—		98,366
Note payable		4,695				5,273				5,273
Subordinated debentures		7,217		—		—		7,208		7,208
Interest payable		693		—		623		70		693

December 31, 2015:


	Carrying
(in thousands)	Value		Level 1		Level 2		Level 3		Total

Financial assets
Cash and cash equivalents	$	28,048	$	28,048	$	—	$	—	$	28,048
Interest bearing deposits		4,874		4,874		—		—		4,874
Securities		264,212		344		263,868		—		264,212
Trading assets		5,531		5,531		—		—		5,531
Mortgage loans held for sale		624		—		633		—		633
Loans, net		617,600		—		—		616,206		616,206
FHLB Stock		7,034		—		—		—		N/A
Interest receivable		3,681		—		1,358		2,323		3,681
Financial liabilities
Deposits	$	758,981	$	557,146	$	203,192	$	—	$	760,338
Securities sold under agreements to repurchase		18,514		—		18,523		—		18,523
FHLB advances		87,833		—		82,349		—		82,349
Note payable		4,794		—		5,431		—		5,431
Subordinated debentures		7,217		—		—		7,206		7,206
Interest payable		659		—		649		10		659

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

Cash and Cash Equivalents - The carrying amounts of cash and cash equivalents approximate fair values and are classified as Level 1.

Interest Bearing Deposits – The carrying amounts of interest bearing deposits approximate fair values and are classified as Level 1.

FHLB Stock - It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

Loans - Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods used to estimate the fair value of loans do not necessarily represent an exit price.

The fair value of mortgage loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

Deposits - The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date resulting in a Level 1 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

Securities Sold Under Agreements to Repurchase and Other Borrowings - The carrying amounts of borrowings under repurchase agreements approximate their fair values resulting in a Level 2 classification.

The carrying amount of the Company’s variable rate borrowings approximate their fair values resulting in a Level 2 classification.

Federal Funds Purchased - The carrying amounts of federal funds purchased approximate fair values and are classified as Level 1.

FHLB Advances, Borrowings and Subordinated Debentures - The fair values of the Company’s FHLB advances and other borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

The fair values of the Company’s Subordinated Debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

Accrued Interest Receivable/Payable - The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification based on the level of the related asset/liability.

Off-balance Sheet Instruments - Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of off-balance sheet instruments is not material.