NOTE 17 - FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

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:

Securities Available for Sale and Trading Assets: The fair values for 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 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. Such adjustments are usually significant and typically result 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 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. 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 are usually significant and typically result 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.

Loan 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 are the Company’s only balance sheet item that meet the disclosure requirements for instruments measured at fair value on a recurring basis. Disclosures are as follows in the tables below.

December 31, 2017


			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. treasury notes	$	4,024	$	—	$	4,024	$	—
U. S. government agencies		41,705		—		41,705		—
States and municipals		90,135		—		90,135		—
Mortgage-backed - residential		130,377		—		130,377		—
Mortgage-backed-commercial		51,596		—		51,596		—
Equity securities		340		340		—		—
Total	$	318,177	$	340	$	317,837	$	—

December 31, 2016


			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	$	36,528	$	—	$	36,528	$	—
States and municipals		91,132		—		91,132		—
Mortgage-backed - residential		108,075		—		108,075		—
Mortgage-backed - commercial		37,695				37,695
Equity securities		340		340		—		—
Trading Assets		5,592		1,608		3,984		—
Total	$	279,362	$	1,948	$	277,414	$	—

There were no transfers between level 1 and level 2 during 2017 or 2016.

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


	Fair Value Measurements at December 31, 2017 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:
1-4 family Residential	$	183	$	—	$	—	$	183
Other real estate owned, net:
Residential		910		—		—		910
Commercial		200		—		—		200
Mortgage servicing rights		1,323		—		—		1,323


	Fair Value Measurements at December 31, 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:
1-4 family residential	$	1,685	$	—	$	—	$	1,685
Agricultural		2,234		—		—		2,234
Other real estate owned, net:
Residential		956		—		—		956
Commercial		272		—				272
Mortgage servicing rights		1,083		—		—		1,083

Impaired loans measured for impairment using the fair value of the collateral had a net carrying amount of $183 thousand, with a valuation allowance of $23 thousand at December 31, 2017. During 2017, one new loan became impaired resulting in an additional provision for loan losses of $23 thousand. The total allowance for specific impaired loans decreased $518 thousand for the year ending December 31, 2017. At December 31, 2016, impaired loans measured for impairment using the fair value of the collateral had a net carrying amount of $3.9 million, with a valuation allowance of $502 thousand. Four new loans became impaired during 2016 which resulted in an additional provision for loan losses of $427 thousand for the year ending December 31, 2016.

Other real estate owned measured at fair value less costs to sell, had a net carrying amount of $1.1 million, which is made up of the outstanding balance of $1.9 million, net of a valuation allowance of $777 thousand at December 31, 2017. Fair value adjustments of other real estate netted to a write-down of $20 thousand for the year ending December 31, 2017. At December 31, 2016, other real estate owned measured at fair value less costs to sell, had a net carrying amount of $1.2 million, which was made up of the outstanding balance of $2.0 million, net of a valuation allowance of $803 thousand at December 31, 2016. Fair value adjustments to other real estate owned netted to a write-down of $187 thousand for the year ending December 31, 2016.

Certain impaired loan servicing rights, which are carried at lower of cost or fair value, were carried at their fair value of $1.3 million, which is made up of the outstanding balance of $1.4 million, net of a valuation allowance of $56 thousand at December 31, 2017. Fair value adjustments for the loan servicing rights netted to a positive adjustment of $69 thousand for the year ending December 31, 2017. At December 31, 2016, impaired loan servicing rights 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 $125 thousand at December 31, 2016. Fair value adjustments netted to a negative adjustment of $105 thousand for the year ending December 31, 2016.

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 December 31, 2017 and 2016:

Range

December 31, 2017

Fair

Valuation

Unobservable

(Weighted

(In thousands)

Value

Technique(s)

Input(s)

Average)

Impaired loans

Real estate mortgage:

1-4 family residential

183

sales comparison

adjustment for differences between the comparable sales

3%-27%

(15)%

Other real estate owned:

Residential

910

sales comparison

adjustment for differences between the comparable sales

0%-16%

(6)%

Commercial

200

income approach

capitalization rate

10%-10%

(10)%

Mortgage Servicing Rights

1,323

discounted cash flow

constant prepayment rates

7%-25%

(10)%


				Range
December 31, 2016	Fair	Valuation	Unobservable	(Weighted
(In thousands)	Value	Technique(s)	Input(s)	Average)
Impaired loans
Real estate mortgage:
1-4 family residential	1,685	sales comparison	adjustment for differences between the comparable sales	0%-21%	(10)%
Agricultural	2,234	sales comparison	adjustment for differences between the comparable sales	2%-75%	(9)%
Other real estate owned:
Residential	956	sales comparison	adjustment for differences between the comparable sales	1%-16%	(9)%
Commercial	272	income approach	capitalization rate	10%-10%	(10)%
Loan Servicing Rights	1,083	discounted cash flow	constant prepayment rates	8%-45%	(13)%

Fair Value of Financial Instruments

The carrying amounts and estimated fair values of financial instruments, at December 31, 2017 and December 31, 2016 are as follows:

December 31, 2017:


	Carrying
(in thousands)	Value		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	39,172	$	39,172	$	—	$	—	$	39,172
Interest bearing time deposits		1,830		1,830		—		—		1,830
Securities available for sale		318,177		340		317,837		—		318,177
Loans held for sale		1,231		—		1,269		—		1,269
Net Loans		640,815		—		—		639,421		639,421
Federal Home Loan Bank stock		7,034		—		—		—		N/A
Interest receivable		3,951		—		1,378		2,573		3,951
Financial liabilities
Total deposits	$	815,273	$	621,139	$	195,143	$	—	$	816,282
Repurchase agreements		19,900		—		19,968		—		19,968
Short-term Federal Home Loan Bank advances		8,400		—		8,393		—		8,393
Long-term Federal Home Loan Bank advances		90,332		—		86,899		—		86,899
Note payable		3,321				3,560				3,560
Subordinated debentures		7,217		—		—		7,212		7,212
Interest payable		838		—		825		13		838

December 31, 2016:


	Carrying
(in thousands)	Value		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	43,250	$	43,250	$	—	$	—	$	43,250
Interest bearing time deposits		5,029		5,029		—		—		5,029
Securities available for sale		273,770		340		273,430		—		273,770
Trading assets		5,592		1,608		3,984		—		5,592
Loans held for sale		724		—		750		—		750
Net Loans		648,466		—		—		648,234		648,234
Federal Home Loan Bank stock		7,034		—		—		—		N/A
Interest receivable		3,715		—		1,334		2,381		3,715
Financial liabilities
Total deposits	$	802,981	$	607,617	$	195,528	$	—	$	803,145
Repurchase agreements		20,873		—		21,006		—		21,006
Long-term Federal Home Loan Bank advances		92,500		—		91,015		—		91,015
Note payable		4,090		—		4,564		—		4,564
Subordinated debentures		7,217		—		—		7,210		7,210
Interest payable		692		—		681		11		692

The methods and assumptions, not previously presented, used to estimate fair value are described as follows: Carrying amount is the estimated fair value for cash and cash equivalents, interest bearing deposits, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. The methods for determining the fair values for securities were described previously. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk (including consideration of widening credit spreads). The method used to determine the fair value of loans does not necessarily represent an exit price. Fair value of debt is based on current rates for similar financing. It was not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability. The fair value of off-balance sheet items is not considered material.