Note 4 - Fair Value

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an 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.

Financial assets and financial liabilities measured at fair value on a recurring basis include the following:

Securities available-for-sale: When available, the fair values of available-for-sale securities are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs). For securities where quoted market prices are not available, fair values are calculated based on market prices of similar securities (Level 2 inputs). 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 inputs). The fair value of the Level 3 security is calculated using the spread to the swap and LIBOR curves. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on the individual security is reviewed and incorporated into the calculation.

Assets and liabilities measured at fair value on a recurring basis are summarized below, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

			Fair Value Measurements at
			September 30, 2013 Using
	Balance at
	September 30,
	2013		Level 1		Level 2		Level 3
Assets:
Obligations of U.S. government-sponsored entities and agencies	$	11,615	$	—	$	11,615	$	—
Obligations of states and political subdivisions		40,403		—		40,403		—
Mortgage-backed securities – residential		55,692		—		55,692		—
Collateralized mortgage obligations		5,136		—		5,136		—
Trust preferred security		162		—		—		162

			Fair Value Measurements at
			June 30, 2013 Using
		Balance at
	June 30, 2013		Level 1		Level 2		Level 3
Assets:
Obligations of U.S. government-sponsored entities and agencies	$	4,658	$	—	$	4,658	$	—
Obligations of states and political subdivisions		39,812		—		39,812		—
Mortgage-backed securities - residential		46,889		—		46,889		—
Collateralized mortgage obligations		5,708		—		5,708		—
Trust preferred security		162		—		—		162

There were no transfers between Level 1 and Level 2 during the first three months of the 2014 fiscal year or the during the 2013 fiscal year.

The following table presents a reconciliation of the trust preferred security measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended September 30, 2013 and 2012:

	2013		2012
Beginning balance	$	162	$	64
Change in fair value included in other comprehensive income		—		10
Ending balance, September 30	$	162	$	74

The significant unobservable inputs used in the fair value measurement of the Corporation’s trust preferred security are probabilities of specific-issuer defaults and deferrals and specific-issuer recovery assumptions. Significant increases in specific-issuer default assumptions or decreases in specific-issuer recovery assumptions would result in a significantly lower fair value measurement. Conversely, decreases in specific-issuer default assumptions or increases in specific-issuer recovery assumptions would result in a higher fair value measurement.

Certain financial assets and financial liabilities are measured at fair value on a non-recurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances. Financial assets and financial liabilities measured at fair value on a non-recurring basis include the following:

Impaired Loans: At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for loan losses. For collateral dependent loans, fair value is commonly 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.

Other real estate owned: Property acquired through or instead of loan foreclosure are classified as other real estate owned (OREO). Property acquired is recorded at fair value at the date of acquisition and subsequently carried at the lower of cost or net realizable value. Any required write-down of the loan to its net realizable value is charged against the allowance for loan losses. The estimated fair value of OREO properties is determined by independent market-based appraisals and other available market information. Accordingly, the valuations of OREO are subject to significant judgment and typically result in a Level 3 classification. OREO properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Financial assets and financial liabilities measured at fair value on a non-recurring basis are summarized below:

			Fair Value Measurements at
			September 30, 2013 Using
		Balance at
		September 30,
	2013		Level 1		Level 2		Level 3
Impaired loans:
1-4 Family
Owner occupied	$	121	$	—	$	—	$	121
Non-owner occupied		445		—		—		445
Other real estate owned:
Commercial real estate		709		—		—		709

			Fair Value Measurements at
			June 30, 2013 Using
	Balance at
	June 30, 2013		Level 1		Level 2		Level 3
Impaired loans:
Commercial	$	43	$	—	$	—	$	43
1-4 Family
Owner occupied		101		—		—		101
Non-owner occupied		475		—		—		475

Impaired loans included in the table above are measured for impairment using the fair value of the collateral and had a carrying amount of $698, with a specific allocation of the allowance for loan losses of $132 at September 30, 2013. The resulting impact to the provision for loan losses was a reduction of $88 being recorded for the three month period ended September 30, 2013.

Impaired loans included in the table above are measured for impairment using the fair value of the collateral and had a carrying amount of $839, with a specific allocation of the allowance for loan losses of $220 at June 30, 2013. The resulting impact to the provision for loan losses was a reduction of $27 for the three month period ended September 30, 2012.

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 September 30, 2013:

		Fair	Valuation				Weighted
		Value	Technique	Unobservable Inputs	Range		Average
Impaired loans:
1-4 Family
Owner occupied	$	121	Sales comparison approach	Adjustment for differences between comparable sales	-17.61% to 23.60	%	4.77	%
Non-owner occupied		445	Income approach	Capitalization rate	9.58	%	9.58	%
Other real estate owned:
Commercial real estate		709	Income approach	Capitalization rate	9.63	%	9.63	%

The following table shows the estimated fair values of financial instruments that are reported at amortized cost in the Corporation’s consolidated balance sheets, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

	September 30, 2013				June 30, 2013
			Estimated				Estimated
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
Financial Assets:
Level 1 inputs:
Cash and cash equivalents	$	11,905	$	11,905	$	9,356	$	9,356
Level 2 inputs:
Certificates of deposits in other financial institutions		3,195		3,195		4,175		4,175
Loans held for sale		181		185		93		97
Accrued interest receivable		1,100		1,100		1,044		1,044
Level 3 inputs:
Securities held-to-maturity		3,000		2,935		3,000		2,926
Loans, net		213,919		211,553		214,544		212,555
Financial Liabilities:
Level 2 inputs:
Demand and savings deposits		221,117		221,117		214,898		214,898
Time deposits		77,597		77,725		79,209		79,575
Short-term borrowings		16,041		16,041		12,490		12,490
Federal Home Loan Bank advances		6,348		6,946		6,366		7,049
Accrued interest payable		52		52		48		48

The assumptions used to estimate fair value are described as follows:

Estimated fair value for cash and cash equivalents, certificates of deposits in other financial institutions, accrued interest receivable and payable, demand and savings deposits and short-term borrowings were considered to approximate carrying value. The methodologies for other financial assets and financial liabilities are discussed below:

Loans held for sale: The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 3 classification.

Loans: Fair value for loans was estimated for portfolios of loans with similar financial characteristics. For adjustable rate loans that reprice at least annually and for fixed rate commercial loans with maturities of six months or less which possess normal risk characteristics, carrying value was determined to be fair value. Fair value of other types of loans (including adjustable rate loans which reprice less frequently than annually and fixed rate term loans or loans which possess higher risk characteristics) was estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for similar anticipated maturities resulting in a Level 3 classification. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

Securities held-to-maturity: The held-to-maturity security is a revenue bond made to a local municipality. The fair value of this security is calculated using a spread to the Bloomberg municipal fair market health care curve resulting in a Level 3 classification.

Time deposits: Fair value of fixed-maturity certificates of deposit was estimated using the rates offered at September 30, 2013 and June 30, 2013, for deposits of similar remaining maturities. Estimated fair value does not include the benefit that results from low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market resulting in a Level 2 classification.

Federal Home Loan Bank advances: Fair value of Federal Home Loan Bank advances was estimated using current rates at September 30, 2013 and June 30, 2013 for similar financing resulting in a Level 2 classification.

Federal bank and other restricted stocks, at cost: Federal bank and other restricted stocks include stock acquired for regulatory purposes, such as Federal Home Loan Bank stock and Federal Reserve Bank stock that are accounted for at cost due to restrictions placed on their transferability; and therefore, are not subject to the fair value disclosure requirements.

The Corporation’s lending commitments have variable interest rates and “escape” clauses if the customer’s credit quality deteriorates. Therefore, the fair values of these items are not significant and are not included in the above table.