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: The fair values for available for sale investment securities 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.

Net adjustments totaled $201 thousand the first nine months of 2018 and $68 for the first nine months of 2017 and resulted in a Level 3 classification of the inputs for determining fair value. Net adjustments totaled $(9) thousand for the three months ended September 30, 2018 and $68 thousand for the three months ended September 30, 2017 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 $0 for both the nine months and three months ended September 30, 2018. Such adjustments were $141 thousand for the nine months ended September 30, 2017 and $103 thousand for the three months ended September 30, 2017, 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 September 30, 2018 (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. treasury notes	$	3,940	$	—	$	3,940	$	—
U. S. government agencies		31,921		—		31,921		—
States and municipals		70,955		—		70,955		—
Mortgage-backed - residential		126,706		—		126,706		—
Mortgage-backed-commercial		44,772		—		44,772		—
Equity securities		281		281		—		—
Total	$	278,575	$	281	$	278,294	$	—

Fair Value Measurements at December 31, 2017 (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. 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	$	—

There were no transfers between level 1 and level 2 during 2018 or 2017.

Assets measured at fair value on a non-recurring basis are summarized below (in thousands):


	Fair Value Measurements at September 30, 2018 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	$	127	—	$	—	$	127

Other real estate owned, net:
Residential		93	—		—		93
Commercial		246	—		—		246


	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

Impaired loans measured for impairment using the fair value of the collateral for collateral dependent loans had a net carrying amount of $127 thousand, which includes a valuation allowance of $10 thousand as of September 30, 2018. Impaired loans measured for impairment using the fair value of the collateral for collateral dependent loans had a net carrying amount of $183 thousand, with a valuation allowance of $23 thousand at December 31, 2017.

Four additional loans were impaired at September 30, 2018 when compared to December 31, 2017 and resulted in additional provision for loan loss expense of $201 thousand for the nine months endedSeptember 30, 2018 and $0 for the three months ended September 30, 2018. One new loan became impaired during the nine months and three months ended September 30, 2017 which resulted in $68 thousand in additional provision for loan losses expense.

Other real estate owned measured at fair value less costs to sell had a net carrying amount of $339 thousand, which is made up of the outstanding balance of $752 thousand, net of a valuation allowance of $413 thousand as of September 30, 2018. Other real estate owned which was measured at fair value less costs to sell, had a net carrying amount of $1.1 million, which was made up of the outstanding balance of $1.9 million, net of a valuation allowance of $777 thousand at December 31, 2017. The Company recorded $0 in write-downs of other real estate owned properties for the nine months and three months ended September 30, 2018 and $141 thousand for the nine months ended and $103 thousand for the three months ended September 30, 2017.

At December 31 , 2017, impaired mortgage servicing rights, which are carried at the lower of cost or fair value, were carried at their fair value of $1.3 million, which was made up of the outstanding balance of $1.4 million, net of a valuation allowance of $56 thousand. There were no impaired mortgage servicing rights as of September 30, 2018. For the first nine months of 2018, the Company recorded a net recovery of prior write-downs of $56 thousand and $0 for the three months ended September 30, 2018. For the nine months ended September 30, 2017, the Company recorded a net recovery of prior write-downs of $40 thousand and net reocveries of prior write-downs of $6 thousand for the three months ended September 30, 2017.

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis as of September 30, 2018 and December 31, 2017:


					Range
September 30, 2018		Fair	Valuation	Unobservable	(Weighted
(In thousands)		Value	Technique(s)	Input(s)	Average)
Impaired loans
Real estate mortgage:
1-4 family residential	$	127	sales comparison	adjustment for differences between the comparable sales	0%-27%	(2)%
Other real estate owned:
Residential		93	sales comparison	adjustment for differences between the comparable sales	0%-16%	(6)%
Commercial		246	income approach	capitalization rate	10%-10%	(10)%


					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)%

Fair Value of Financial Instruments

The carrying amounts and estimated fair values of financial instruments, as of September 30, 2018 and December 31, 2017 are as follows:

September 30, 2018:


	Carrying
(in thousands)	Value		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	26,097	$	26,097	$	—	$	—	$	26,097
Interest bearing time deposits		2,275		2,275		—		—		2,275
Securities available for sale		278,575		281		278,294		—		278,575
Loans held for sale		3,699		—		3,745		—		3,745
Net Loans		677,539		—		—		669,317		669,317
Federal Home Loan Bank stock		7,034		—		—		—		N/A
Interest receivable		4,138		—		1,228		2,910		4,138
Financial liabilities
Total deposits	$	820,740	$	617,646	$	199,878	$	—	$	817,524
Repurchase agreements		8,248		—		8,280		—		8,280
Short-term Federal Home Loan Bank advances		11,900		—		11,900		—		11,900
Long-term Federal Home Loan Bank advances		91,824		—		91,377		—		91,377
Note payable		2,841		—		2,975		—		2,975
Subordinated debentures		7,217		—		—		7,209		7,209
Interest payable		818		—		804		14		818

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		—		—		—		—
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

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 are estimated based on discounted cash flows of portfolios of loans with similar credit quality and financial characteristics including the type of loan, interest terms and repayment history. The Company calculates a fair value by using a net present value of scheduled cash flows methodology incorporating estimated maturities using estimated market discount rates. Estimated market discount rates are reflective of market rates for similarly offered products, market interest rate projections, credit spreads and prepayment assumptions. In accordance with ASU 2016-01, the fair value of loans as of September 30, 2018 are based on the notion of exit price.

The methods utilized to estimate the fair value of loans as of December 31, 2017 was measured using an entry price notion.

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.