Disclosure Regarding Fair Value of Financial Statements

9 Months Ended

Sep. 30, 2018

Fair Value Disclosures [Abstract]

Disclosure Regarding Fair Value of Financial Statements

Note 4: Disclosure Regarding Fair Value of Financial Statements

Fair value measurements apply whenever GAAP requires or permits assets or liabilities to be measured at fair value either on a recurring or nonrecurring basis. Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or the most advantageous market in an orderly transaction between market participants at the measurement date. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction. GAAP establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs.  Observable inputs, which are developed based on market data we have obtained from independent sources, are ones that market participants would use in pricing an asset or liability.  Unobservable inputs, which are developed based on the best information available in the circumstances, reflect our estimate of assumptions that market participants would use in pricing an asset or liability.

The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

● Level 1: valuation is based upon unadjusted quoted market prices for identical instruments traded in active markets.

● Level 2: valuation is based upon quoted market prices for similar instruments traded in active markets, quoted market prices for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by market data.

● Level 3: valuation is derived from other valuation methodologies, including discounted cash flow models and similar techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in determining fair value.

Fair value estimates are made at a specific point of time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale our entire holdings of a particular financial instrument. Because no active market exists for a significant portion of our financial instruments, fair value estimates are based on judgements regarding future expected loss experience, current economic conditions, current interest rates and prepayment trends, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgement and therefore cannot be determined with precision. Changes in any of these assumptions used in calculating fair value also would affect significantly the estimates. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.

The following paragraphs describe the valuation methodologies used for assets and liabilities recorded at fair value on a recurring basis:

Investment Securities Available for Sale

Investment Securities are recorded at fair value on a recurring basis and are based upon quoted prices if available. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, or by dealers or brokers in active over-the counter markets. Level 2 securities include mortgage backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Derivative Instruments

Derivative instruments include interest rate lock commitments and forward sale commitments. These instruments are valued based on the change in the value of the underlying loan between the commitment date and the end of the period. We classify these instruments as Level 3.

We had no embedded derivative instruments requiring separate accounting treatment. We had freestanding derivative instruments consisting of fixed rate conforming loan commitments as interest rate locks and commitments to sell fixed rate conforming loans on a best efforts basis. We do not currently engage in hedging activities. Based on short term fair value of the mortgage loans held for sale (derivative contract), our derivative instruments were immaterial to our consolidated financial statements as of September 30, 2018 and December 31, 2017.

Assets and liabilities measured at fair value on a recurring basis as of September 30, 2018 and December 31, 2017 are as follows:

	Balance as of September 30, 2018
	Level 1		Level 2		Level 3		Total
U.S. Treasury Notes	$	31,839,733	$	—	$	—	$	31,839,733
Government-Sponsored Enterprises		—		58,570,650		—		58,570,650
Municipal Securities		—		21,649,135		6,543,683		28,192,818
Total	$	31,839,733	$	80,219,785	$	6,543,683	$	118,603,201

	Balance as of December 31, 2017
	Level 1		Level 2		Level 3		Total
U.S. Treasury Notes	$	35,559,845	$	—	$	—	$	35,559,845
Government-Sponsored Enterprises		—		63,556,504		—		63,556,504
Municipal Securities		—		28,675,012		11,458,889		40,133,901
Total	$	35,559,845	$	92,231,516	$	11,458,889	$	139,250,250

There were no liabilities recorded at fair value on a recurring basis as of September 30, 2018 or December 31, 2017.

The following table reconciles the changes in assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months and nine months ended September 30, 2018 and 2017:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Beginning Balance	$	7,096,356		$	12,488,995		$	11,458,889		$	13,977,857
Total realized/unrealized gains (losses)
Included in earnings		—			—			—			—
Included in other comprehensive income		52,254			13,852			119,721			254,940
Purchases, issuances, and settlements net of maturities		(604,927	)		(593,719	)		(5,034,927	)		(2,323,719	)
Transfers in and/or out of Level 3		—			—			—			—
Ending Balance	$	6,543,683		$	11,909,128		$	6,543,683		$	11,909,078

There were no transfers between fair value levels during the nine months ended September 30, 2018 or September 30, 2017.

The following paragraphs describe the valuation methodologies used for assets and liabilities recorded at fair value on a nonrecurring basis:

Other Real Estate Owned (“OREO”)

Loans secured by real estate are adjusted to the lower of the recorded investment in the loan or the fair value of the real estate upon transfer to OREO. Subsequently, OREO is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral, or our estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraisal, we record the asset as nonrecurring Level 2. When an appraised value is not available or we determine the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we record the asset as nonrecurring Level 3.

Impaired Loans

Impaired loans are carried at the lower of recorded investment or fair value. The fair value of the collateral less estimated costs to sell is the most frequently used method. Depending on the particular circumstances surrounding the loan, including the location of the collateral, the date of the most recent appraisal, and the value of the collateral relative to the recorded investment in the loan, we may order an independent appraisal immediately or, in some instances, may elect to perform an internal analysis. Specifically as an example, in situations where the collateral on a nonperforming commercial real estate loan is out of our primary market area, we would typically order an independent appraisal immediately, at the earlier of the date the loan becomes nonperforming or immediately following the determination that the loan is impaired. However, as a second example, on a nonperforming commercial real estate loan where we are familiar with the property and surrounding areas and where the original appraisal value far exceeds the recorded investment in the loan, we may perform an internal analysis whereby the previous appraisal value would be reviewed considering recent current conditions, and known recent sales or listings of similar properties in the area, and any other relevant economic trends. This analysis may result in the call for a new appraisal. These valuations are reviewed and updated on a quarterly basis.

In accordance with ASC 820 “Fair Value Measurement”, impaired loans, where an allowance is established based on the fair value of collateral, require classification in the fair value hierarchy. These impaired loans are classified as Level 3. Impaired loans measured using discounted future cash flows are not deemed to be measured at fair value.

Mortgage Loans to be Sold

Mortgage loans to be sold are carried at the lower of cost or market value. The fair values of mortgage loans to be sold are based on current market rates from investors within the secondary market for loans with similar characteristics. Carrying value approximates fair value. These loans are classified as Level 2.

Certain assets and liabilities are measured at fair value on a nonrecurring 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 (for example, when there is evidence of impairment).

The following tables present information about certain assets and liabilities measured at fair value on a nonrecurring basis as of September 30, 2018 and December 31, 2017:

	September 30, 2018
		Quoted Market Price in active markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs  (Level 3)		Total
Impaired loans		$	—	$	—	$	2,229,800	$	2,229,800
Other real estate owned			—		—		—		—
Loans held for sale			—		2,861,227		—		2,861,227
Total		$	—	$	2,861,227	$	2,229,800	$	5,091,027

	December 31, 2017
			Quoted Market Price in active markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Impaired loans		$	—	$	—	$	1,735,051	$	1,735,051
Other real estate owned			—		—		435,479		435,479
Loans held for sale			—		2,093,723		—		2,093,723
Total		$	—	$	2,093,723	$	2,170,530	$	4,264,253

There were no liabilities measured at fair value on a nonrecurring basis as of September 30, 2018 or December 31, 2017.

The following table provides information describing the unobservable inputs used in Level 3 fair value measurements as of September 30, 2018 and 2017:

		Inputs
	Valuation Technique	Unobservable Input	General Range of Inputs
Impaired Loans	Appraisal Value/Comparison Sales/Other Estimates	Appraisals and/or Sales of Comparable Properties	Appraisals Discounted 10% to 20% for Sales Commissions and Other Holding Costs
Other Real Estate Owned	Appraisal Value/Comparison Sales/Other Estimates	Appraisals and/or Sales of Comparable Properties	Appraisals Discounted 10% to 20% for Sales Commissions and Other Holding Costs

Accounting standards require disclosure of fair value information for all of our assets and liabilities that are considered financial instruments, whether or not recognized on the balance sheet, for which it is practicable to estimate fair value.

Under the accounting standard, fair value estimates are based on existing financial instruments without attempting to estimate the value of anticipated future business and the value of the assets and liabilities that are not financial instruments. Accordingly, the aggregate fair value amounts of existing financial instruments do not represent the underlying value of those instruments on our books.

The following paragraphs describe the methods and assumptions we use in estimating the fair values of financial instruments:

a. Cash and due from banks, interest-bearing deposits at the Federal Reserve

The carrying value approximates fair value. All mature within 90 days and do not present unanticipated credit concerns.

b. Investment securities available for sale

Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.

c. Loans, net

During the first quarter of 2018, the Company adopted ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities. The amendments included within this standard, which are applied prospectively, require the Company to measure and disclose fair value of balance sheet financial instruments using an exit price notion. Prior to adopting the amendments included in the standard, the Company measured fair value under an entry price notion. The entry price notion previously applied by the Company used a discounted cash flows technique to calculate the present value of expected future cash flows for a financial instrument. The exit price notion uses the same approach, but also incorporates other factors, such as enhanced credit risk, illiquidity risk, and market factors that sometimes exist in exit prices in dislocated markets.

As of September 30, 2018, the technique used by the Company to estimate the exit price of the loan portfolio consists of similar procedures to those used as of December 31, 2017, but with added emphasis on both illiquidity risk and credit risk not captured by the previously applied entry price notion. The fair value of the Company’s loan portfolio has always included a credit risk assumption in the determination of the fair value of its loans. This credit risk assumption is intended to approximate the fair value that a market participant would realize in a hypothetical orderly transaction. The Company’s loan portfolio is initially fair valued using a segmented approach. The Company divides its loan portfolio into the following categories: variable rate loans, impaired loans and all other loans. The results are then adjusted to account for credit risk as described above. However, under the new guidance, the Company believes a further credit risk discount must be applied through the use of a discounted cash flow model to compensate for illiquidity risk, based on certain assumptions included within the discounted cash flow model, primarily the use of discount rates that better capture inherent credit risk over the lifetime of a loan. This consideration of enhanced credit risk provides an estimated exit price for the Company’s loan portfolio.

For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values approximate carrying values. Fair values for impaired loans are estimated using discounted cash flow models or based on the fair value of the underlying collateral.

As of December 31, 2017, the fair value of the Company’s loan portfolio included a credit risk assumption in the determination of the fair value of its loans. This credit risk assumption was intended to approximate the fair value that a market participant would realize in a hypothetical orderly transaction. The Company’s loan portfolio is initially fair valued using a segmented approach. The Company divides its loan portfolio into the following categories: variable rate loans, impaired loans and all other loans. The results are then adjusted to account for credit risk. For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values approximate carrying values. Fair values for impaired loans are estimated using discounted cash flow models or based on the fair value of the underlying collateral. For other loans, fair values are estimated using discounted cash flow models, using current market interest rates offered for loans with similar terms to borrowers of similar credit quality. The values derived from the discounted cash flow approach for each of the above portfolios are then further discounted to incorporate credit risk. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price as of December 31, 2017.

d. Deposits

The estimated fair value of deposits with no stated maturity is equal to the carrying amount. The fair value of time deposits is estimated by discounting contractual cash flows, using interest rates currently being offered on the deposit products. The fair value estimates for deposits do not include the benefit that results from the low cost funding provided by the deposit liabilities as compared to the cost of alternative forms of funding (deposit base intangibles).

e. Accrued interest receivable and payable

Since these financial instruments will typically be received or paid within three months, the carrying amounts of such instruments are deemed to be a reasonable estimate of fair value.

f. Loan commitments

Estimates of the fair value of these off-balance sheet items are not made because of the short-term nature of these arrangements and the credit standing of the counterparties.

The following tables present the carrying amount, fair value, and placement in the fair value hierarchy of our financial instruments as of September 30, 2018 and December 31, 2017. 

Fair Value Measurements at September 30, 2018
	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	8,187,758	$	8,187,758	$	8,187,758	$	—	$	—
Interest-bearing deposits at the Federal Reserve		21,573,263		21,573,263		21,573,263		—		—
Investment securities available for sale		118,603,201		118,603,201		31,839,733		80,219,785		6,543,683
Mortgage loans to be sold		2,861,227		2,861,227		—		2,861,227		—
Loans, net		270,521,873		264,323,028		—		—		264,323,028
Accrued interest receivable		1,471,368		1,471,368		—		1,471,368		—
Financial Liabilities:
Demand deposits		339,719,194		339,719,194		—		339,719,194		—
Time deposits		43,322,064		44,653,911		—		44,653,911		—
Accrued interest payable		149,179		149,179		—		149,179		—

Fair Value Measurements at December 31, 2017
	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	8,486,025	$	8,486,025	$	8,486,025	$	—	$	—
Interest-bearing deposits at the Federal Reserve		24,034,194		24,034,194		24,034,194		—		—
Investment securities available for sale		139,250,250		139,250,250		35,559,845		92,231,516		11,458,889
Mortgage loans to be sold		2,093,723		2,093,723		—		2,093,723		—
Loans, net		266,305,242		265,277,204		—		—		265,277,204
Accrued interest receivable		1,720,920		1,720,920		—		1,720,920		—
Financial Liabilities:
Demand deposits		360,967,884		360,967,884		—		360,967,884		—
Time deposits		41,920,416		40,722,870		—		40,722,870		—
Accrued interest payable		96,190		96,190		—		96,190		—