Fair Value

The Company measures, monitors, and discloses certain of its assets and liabilities on a fair value basis. Fair value is defined 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.

The Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. Fair value guidance establishes a fair value hierarchy that prioritizes the inputs used to measure fair value into three broad levels based on the reliability of the input assumptions. The hierarchy gives the highest priority to level 1 measurements and the lowest priority to level 3 measurements and the categorization of where an asset or liability falls within the hierarchy is based on the lowest level of input that is significant to the fair value measurement. The three levels of the fair value hierarchy are defined as follows:

Level 1 - Unadjusted quoted prices for identical assets or liabilities traded in active markets.

Level 2 - Observable inputs other than level 1 prices, such as quoted prices for similar instruments; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Securities

Available for Sale Securities. The fair value of securities available for sale is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). If the securities could not be priced using quoted market prices, observable market activity or comparable trades, the financial market was considered not active and the assets were classified as Level 3.

Single Issue Trust Preferred. In 2010 the Company purchased single-issue trust preferred securities that are classified as available for sale. With respect to these securities, the Company looks at rating agency actions, payment history, the capital levels of the banks and the financial performance as filed in regulatory reports. At December 31, 2014, the Company still held $0.8 million of these securities. During 2015, the last of the Company’s single-issue trust preferred securities were called and at December 31, 2015 none were held in the securities portfolio.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table summarizes, by measurement hierarchy, the various assets and liabilities of the Company that are measured at fair value on a recurring basis:



	Carrying Amount		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2015
U.S. government agencies	$	14,607	$	—	$	14,607	$	—
State and political subdivisions	10,181		—		10,181		—
U.S. government agency residential
mortgage-backed securities	126,029		—		126,029		—
Collateralized mortgage obligations:
Agency	17,833		—		12,812		5,021
Equities	2,790		—		2,790		—
Available-for-sale securities	$	171,440	$	—	$	166,419	$	5,021




	Carrying Amount		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2014
U.S. government agencies	$	21,109	$	—	$	21,109	$	—
State and political subdivisions	9,028		—		9,028		—
U.S. government agency residential
mortgage-backed securities	99,668		—		99,668		—
Collateralized mortgage obligations:
Agency	38		—		38		—
Equities	2,736		—		2,736		—
Collateralized debt obligations:
Single Issue	762		—		762		—
Corporate	2,030		—		2,030		—
Available-for-sale securities	$	135,371	$	—	$	135,371	$	—

There were no transfers between Level 1 and Level 2 during 2015 or 2014.

Assets and Liabilities Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs

The following table reconciles the beginning and ending balances of the assets of the Company that are measured at fair value on a recurring basis using significant unobservable inputs. There currently are no liabilities of the Company that are measured at fair value on a recurring basis using significant unobservable inputs.



	Securities Available for Sale
	CDOs
	2015		2014
Beginning balance, January 1	$	—	$	169
Transfers into Level 3	—		—
Total gains or losses (realized/unrealized) included in earnings
Sales	—		(169		)
Security impairment	—		—
Payment received	—		—
Other changes in fair value	—		—
Included in other comprehensive income	—		—
Ending Balance, December 31	$	—	$	—

For the period ended December 31, 2015, the Company had $5.0 million of local school district bonds that are measured at fair value on a recurring basis using unobservable inputs.

Assets Measured at Fair Value on a Non-Recurring Basis

The following table summarizes, by measurement hierarchy, financial assets of the Company that are measured at fair value on a non-recurring basis.



	Carrying Amount	Quoted Prices in Active Markets For Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
December 31, 2015
Impaired loans
1-4 family residential
Senior lien	572	—	—	572
OREO property
CRE - construction, land & development	1,140	—	—	1,140
Non-owner occupied	468	—	—	468
1-4 family residential
Senior lien	131	—	—	131



	Carrying Amount		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2014
Impaired loans
CRE - all other
Owner occupied	$	184	$	—	$	—	$	184
Non-owner occupied	542		—		—		542
1-4 family residential
Senior lien	201		—		—		201
OREO property
CRE - construction, land & development	2,823		—		—		2,823
CRE - all other
Owner occupied	488		—		—		488
Non-owner occupied	1,111		—		—		1,111
1-4 family residential
Senior lien	47		—		—		47

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 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. 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 accordingly.

Impaired loans had a carrying amount of $0.6 million with a specific loan loss allocation of $0.3 million at December 31, 2015, resulting in an additional provision for loan losses of $0.1 million for the twelve month period. In 2014 impaired loans had a carrying amount of $0.9 million with a specific loan loss allocation of $0.5 million during 2014, resulting in an additional provision for loan losses of $0.5 million for the year ended December 31, 2014. The majority of our impaired loans are collateralized by real estate.

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. Any write-downs in the carrying value of a property at the time of acquisition are charged against the allowance for loan losses. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Management periodically reviews the carrying value of other real estate owned. Any write-downs of the properties subsequent to acquisition, as well as gains or losses on disposition and income or expense from the operations of other real estate owned, are recognized in operating results in the period they are realized. 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 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.

OREO properties measured at fair value, less costs to sell, had a net carrying amount of $1.7 million which is made up of the outstanding balance of $2.9 million, net of a valuation allowance of $1.2 million at December 31, 2015. This compares to 2014 when OREO properties with an outstanding balance of $6.0 million was written down to a fair value of $4.5 million.

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, 2015 and December 31, 2014:



December 31, 2015	Fair Value	Valuation Technique	Unobservable Inputs	Range (Weighted Average)

Impaired loans		Sales comparison approach	Adjustment for differences between comparable sales
1-4 family residential
Senior lien	572			10% - 60% (17%)
OREO property
CRE - construction, land & development	1,140			5% - 70% (27%)
CRE - all other
Non-owner occupied	468			5% - 50% (16%)
1-4 family residential
Senior lien	131			6% - 55% (30%)



December 31, 2014	Fair Value		Valuation Technique	Unobservable Inputs	Range (Weighted Average)

Impaired loans			Sales comparison approach	Adjustment for differences between comparable sales
CRE - all other
Owner occupied	$	184			10% - 55% (19%)
Non-owner occupied	542				10% - 55% (11%)
1-4 family residential
Senior lien	201				10% - 60% (57%)
OREO property
CRE - construction, land & development	$	2,823			5% - 70% (25%)
CRE - all other
Owner occupied	488				15% - 55% (21%)
Non-owner occupied	1,111				5% - 50% (20%)
1-4 family residential
Senior lien	47				6% - 55% (38%)

The estimated fair values of the Company’s financial instruments are as follows:



			Fair Value measurements at December 31, 2015 Using
	Carrying Value		Level 1		Level 2		Level 3		Total

Financial assets
Cash and cash equivalents	$	27,655	$	27,655	$	—	$	—	$	27,655
Securities	171,440		—		166,419		5,021		171,440
Restricted securities	9,116		—		—		—		NA
Loans held for sale	735		—		760		—		760
Net loans	624,956		—		—		629,017		629,017
Accrued interest receivable	3,012		—		402		2,610		3,012
Financial liabilities
Deposits	$	718,504	$	—	$	718,689	$	—	$	718,689
Federal funds purchased and
securities sold under
agreements to repurchase	18,730		—		18,730		—		18,730
Federal Home Loan Bank advances	76,000		—		76,271		—		76,271
Subordinated debentures	20,620		—		—		13,933		13,933
Series B mandatorily redeemable
preferred stock	268		—		273		—		273
Accrued interest payable	235		—		169		66		235



			Fair Value measurements at December 31, 2014 Using
	Carrying Value		Level 1		Level 2		Level 3		Total

Financial assets
Cash and cash equivalents	$	49,167	$	44,167	$	5,000	$	—	$	49,167
Securities	135,371		—		135,371		—		135,371
Restricted securities	6,102		—		—		—		NA
Loans held for sale	364		—		379		—		379
Net loans	545,219		—		—		553,447		553,447
Accrued interest receivable	2,417		—		336		2,081		2,417
Financial liabilities
Deposits	$	698,824	$	—	$	699,471	$	—	$	699,471
Federal funds purchased and
securities sold under
agreements to repurchase	26,691		—		26,691		—		26,691
Federal Home Loan Bank advances	20,000		—		20,546		—		20,546
Notes payable	10,250		—		—		10,264		10,264
Subordinated debentures	20,620		—		—		13,851		13,851
Series B mandatorily redeemable
preferred stock	268		—		268		—		268
Accrued interest payable	5,142		—		369		4,773		5,142

Other assets and liabilities of the Company that are not defined as financial instruments are not included in the above disclosures, such as property and equipment. In addition, nonfinancial instruments typically not recognized in financial statements nevertheless may have value but are not included in the above disclosures. These include, among other items, the estimated earning potential of core deposit accounts, the earnings potential of loan servicing rights, the earnings potential of the trust operations, customer goodwill and similar items.

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

(a) Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. As of December 31, 2015 and December 31, 2014; $27.7 million and $44.2 million was classified as Level 1.

(b) Restricted securities

It is not practical to determine the fair value of restricted securities due to the restrictions placed on its transferability.

Fair values of loans, excluding loans held for sale, are estimated as follows: Fair values for loans are estimated using discounted cash flow analysis, 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 utilized to estimate the fair value of loans do not necessarily represent an exit price.

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

(d) 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 2. 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.

(e) Short-term Borrowings

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.

(f) Other Borrowings

The fair values of the Company’s long-term 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.

(g) Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification which is consistent with the underlying asset/liability they are associated with.

(h) 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 commitments is not material.