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.

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)
March 31, 2017
U.S. government agencies	$	12,193	$	—	$	12,193	$	—
State and political subdivisions	9,098		—		6,431		2,667
U.S. government agency residential
mortgage-backed securities	118,354		—		118,354		—
Collateralized mortgage obligations:
Agency	13,627		—		13,627		—
Equities	3,030		—		3,030		—
Available-for-sale securities	$	156,302	$	—	$	153,635	$	2,667




	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, 2016
U.S. government agencies	$	12,071	$	—	$	12,071	$	—
State and political subdivisions	9,065		—		6,398		2,667
U.S. government agency residential
mortgage-backed securities	127,313		—		127,313		—
Collateralized mortgage obligations:
Agency	14,456		—		14,456		—
Equities	3,022		—		3,022		—
Available-for-sale securities	$	165,927	$	—	$	163,260	$	2,667

There were no transfers between Level 1 and Level 2 during the first three months of 2017 and all of 2016.

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

For the periods ended March 31, 2017 and December 31, 2016, the Company had $2.7 million of local school district bonds that are measured at fair value on a recurring basis using unobservable inputs. The Company utilizes non binding broker quotes for the fair value determination of these school district bonds. These school district bond balances are the only asset of the Company that are measured at fair value on a recurring basis using significant 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)
March 31, 2017
Impaired loans
Commercial
Closed-end	$	10	$	—	$	—	$	10
Line of credit	194		—		—		194
CRE - construction, land & development	12		—		—		12
CRE - all other
Non-owner occupied	2,299		—		—		2,299
1-4 family residential
Senior lien	2,464		—		—		2,464
OREO property
CRE - construction, land & development	568		—		—		568
CRE - all other
Non-owner occupied	55		—		—		55
1-4 family residential
Senior lien	38		—		—		38



	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, 2016
Impaired loans
Commercial
Closed-end	$	25	$	—	$	—	$	25
Line of credit	39		—		—		39
CRE - construction, land & development	12		—		—		12
1-4 family residential
Senior lien	140		—		—		140
OREO property
CRE - construction, land & development	1,867		—		—		1,867
CRE - all other
Non-owner occupied	476		—		—		476
1-4 family residential
Senior lien	163		—		—		163

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 carried at fair value had a net carrying amount of $5.0 million at March 31, 2017, which is made up of the outstanding balance of $7.0 million with $2.0 million specific loan loss allocation. The effect of these impaired loans carried at fair value on the provision for loans losses was $1.5 million for the three month period. At December 31, 2016 impaired loans carried at fair value had a net carrying amount of $0.2 million which was made up of the outstanding balance of $0.8 million with a specific loan loss allocation of $0.6 million during 2016, resulting in an additional provision for loan losses of $0.6 million for the year ended December 31, 2016. The majority of the Bank's 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 $0.7 million which is made up of the outstanding balance of $1.3 million, net of a valuation allowance of $0.6 million at March 31, 2017. This compares to December 31, 2016 when OREO properties with an outstanding balance of $3.7 million was written down to a fair value of $2.5 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 March 31, 2017 and December 31, 2016:



March 31, 2017	Fair Value		Valuation Technique	Unobservable Inputs	Range (Weighted Average)

Impaired loans			Sales comparison approach	Adjustment for differences between comparable sales
Commercial
Closed-end	$	10			20% - 100% (56%)
Line of credit	$	194			20% - 100% (75%)
CRE - construction, land & development	$	12			10% - 85% (80%)
CRE - all other
Non-owner occupied	2,299				10% - 55% (17%)
1-4 family residential
Senior lien	2,464				10% - 60% (27%)
OREO property			Sales comparison approach	Adjustment for differences between comparable sales
CRE - construction, land & development	568				5% - 70% (34%)
CRE - all other
Non-owner occupied	55				5% - 50% (15%)
1-4 family residential
Senior lien	38				6% - 55% (24%)



December 31, 2016	Fair Value		Valuation Technique	Unobservable Inputs	Range (Weighted Average)

Impaired loans			Sales comparison approach	Adjustment for differences between comparable sales
Commercial
Closed-end	$	25			20% - 100% (36%)
Line of credit	39				20% - 100% (89%)
CRE - construction, land & development	12				10% - 85% (80%)
1-4 family residential
Senior lien	140				10% - 60% (57%)
OREO property			Sales comparison approach	Adjustment for differences between comparable sales
CRE - construction, land & development	1,867				5% - 80% (30%)
CRE - all other
Non-owner occupied	476				5% - 50% (15%)
1-4 family residential
Senior lien	163				6% - 65% (37%)

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



			Fair Value measurements at March 31, 2017 Using
	Carrying Value		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	31,237	$	31,237	$	—	$	—	$	31,237
Securities	156,302		—		153,635		2,667		156,302
Restricted securities	8,019		—		—		—		NA
Net loans	679,148		—		—		678,226		678,226
Accrued interest receivable	2,454		—		591		1,863		2,454
Financial liabilities
Deposits	$	728,489	$	—	$	728,513	$	—	$	728,513
Federal funds purchased and
securities sold under
agreements to repurchase	11,303		—		11,303		—		11,303
Federal Home Loan Bank advances	93,000		—		93,058		—		93,058
Subordinated debentures	10,310		—		—		9,724		9,724
Series B mandatory redeemable
preferred stock	209		—		211		—		211
Accrued interest payable	160		—		144		16		160



			Fair Value measurements at December 31, 2016 Using
	Carrying Value		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	22,507	$	22,507	$	—	$	—	$	22,507
Securities	165,927		—		163,260		2,667		165,927
Restricted securities	9,860		—		—		—		NA
Net loans	676,871		—		—		677,832		677,832
Accrued interest receivable	2,750		—		511		2,239		2,750
Financial liabilities
Deposits	$	740,046	$	—	$	740,106	$	—	$	740,106
Federal funds purchased and
securities sold under
agreements to repurchase	11,168		—		11,168		—		11,168
Federal Home Loan Bank advances	85,000		—		85,039		—		85,039
Notes payable	—		—		—		—		—
Subordinated debentures	10,310		—		—		9,525		9,525
Series B mandatory redeemable
preferred stock	209		—		211		—		211
Accrued interest payable	286		—		272		14		286

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 March 31, 2017 and December 31, 2016; $31.2 million and $22.5 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 analyses, 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.