Fair Value Measurements

3 Months Ended

Mar. 31, 2015

Note 7. Fair Value Measurements

In determining fair value, the Company uses various valuation approaches, including market, income and cost approaches. Accounting standards establish a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability, which are developed based on market data obtained from sources independent of the Company. Unobservable inputs reflects the Company’s assumptions about the assumptions the market participants would use in pricing an asset or liability, which are developed based on the best information available in the circumstances.

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). A financial asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

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

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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; and

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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.

A description of the valuation methodologies used for assets recorded at fair value, and for estimating fair value of financial instruments not recorded at fair value, is set forth below.

Cash, Short-term Investments, Accrued Interest Receivable and Accrued Interest Payable

For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Securities

The estimated fair values of available-for-sale equity securities are determined by obtaining quoted prices on nationally recognized exchanges (Level 1 inputs). The estimated fair values for the Company’s investments in obligations of U.S. government agencies, obligations of state and political subdivisions, government-sponsored agency CMOs, government- sponsored agency residential mortgage-backed securities, and corporate debt securities are obtained by the Company from a nationally-recognized pricing service. This pricing service develops estimated fair values by analyzing like securities and applying available market information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing (Level 2 inputs), to prepare valuations. Matrix pricing 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. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things and are based on market data obtained from sources independent from the Company. The Level 2 investments in the Company’s portfolio are priced using those inputs that, based on the analysis prepared by the pricing service, reflect the assumptions that market participants would use to price the assets. The Company has determined that the Level 2 designation is appropriate for these securities because, as with most fixed-income securities, those in the Company’s portfolio are not exchange-traded, and such non-exchange-traded fixed income securities are typically priced by correlation to observed market data. The Company has reviewed the pricing service’s methodology to confirm its understanding that such methodology results in a valuation based on quoted market prices for similar instruments traded in active markets, quoted markets for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which the significant assumptions can be corroborated by market data as appropriate to a Level 2 designation.

For those securities for which the inputs used by an independent pricing service were derived from unobservable market information (Level 3 inputs), the Company evaluates the appropriateness and quality of each price. The Company reviewed the volume and level of activity for all classes of securities and attempted to identify transactions which may not be orderly or reflective of a significant level of activity and volume. For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing service may be adjusted, as necessary, to estimate fair value. If applicable, the adjustment to fair value was derived based on present value cash flow model projections prepared by the Company or obtained from third party providers utilizing assumptions similar to those incorporated by market participants.

The Company did not own any securities for which fair value was determined using Level 3 inputs at March 31, 2015 and December 31, 2014. The Company did own one security issued by a state and political subdivision that was valued using level 3 inputs during 2014, which was paid off prior to December 31, 2014. This security had a credit rating that was either withdrawn or downgraded by nationally recognized credit rating agencies, and as a result the market for these securities had become inactive. This security was historically priced using Level 2 inputs. The credit ratings withdrawal and downgrade have resulted in a decline in the level of significant other observable inputs for this investment security at the measurement dates. Broker pricing and bid/ask spreads were very limited for this security. At March 31, 2014, the Company had obtained a bid indication from a third-party municipal trading desk to determine the fair value of this security.

Loans

Except for collateral dependent impaired loans, fair values of loans are estimated by discounting the projected future cash flows using market discount rates that reflect the credit, liquidity, and interest rate risk inherent in the loan. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. The estimated fair value of collateral dependent impaired loans is based on the appraised loan value or other reasonable offers less estimated costs to sell. The Company does not record loans at fair value on a recurring basis. However from time to time, a loan is considered impaired and an allowance for credit losses is established. The specific reserves for collateral dependent impaired loans are based on the fair value of the collateral less estimated costs to sell. The fair value of the collateral is generally based on appraisals. In some cases, adjustments are made to the appraised values due to various factors including age of the appraisal, age of comparables included in the appraisal, and known changes in the market and in the collateral. When significant adjustments are based on unobservable inputs, the resulting fair value measurement is categorized as a Level 3 measurement.

Loans Held For Sale

Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices.

Mortgage Servicing Rights

The fair value of mortgage servicing rights is estimated using a discounted cash flow model that applies current estimated prepayments derived from the mortgage-backed securities market and utilizes a current market discount rate for observable credit spreads. The Company does not record mortgage servicing rights at fair value on a recurring basis.

Restricted Stock

Ownership in equity securities of FHLB of Pittsburgh and the FRB is restricted and there is no established market for their resale. The carrying amount is a reasonable estimate of fair value.

Deposits

The fair value of demand deposits, savings deposits, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated based on discounted cash flows using FHLB advance rates currently offered for similar remaining maturities.

Borrowed funds

The Company uses discounted cash flows using rates currently available for debt with similar terms and remaining maturities to estimate fair value.

Commitments to extend credit and standby letters of credit

The fair value of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of off-balance sheet commitments is insignificant and therefore not included in the table for non-recurring assets and liabilities.

Assets measured at fair value on a recurring basis

The following tables detail the financial asset amounts that are carried at fair value and measured at fair value on a recurring basis at March 31, 2015 and December 31, 2014, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine the fair value:

	Fair Value Measurements at March 31, 2015
					Significant		Significant
			Quoted Prices		Other		Other
			in Active Markets		Observable		Unobservable
			for Identical Assets		Inputs		Inputs
(in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
Available-for-sale securities:
Obligations of U.S. government agencies	$	26,927	$	-	$	26,927	$	-
Obligations of state and political subdivisions		11,307		-		11,307		-
U.S. government/ government-sponsored agencies:
Collateralized mortgage obligations - residential		25,792		-		25,792		-
Collateralized mortgage obligations - commercial		62,967		-		62,967		-
Residential mortgage-backed securities		74,002		-		74,002		-
Corporate debt securities		425		-		425		-
Negotiable certificates of deposit		2,245		-		2,245		-
Equity securities		970		970		-		-
Total available-for-sale securities	$	204,635	$	970	$	203,665	$	-

	Fair Value Measurements at December 31, 2014
					Significant		Significant
			Quoted Prices		Other		Other
			in Active Markets		Observable		Unobservable
			for Identical Assets		Inputs		Inputs
(in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
Available-for-sale securities:
Obligations of U.S. government agencies	$	29,276	$	-	$	29,276	$	-
Obligations of state and political subdivisions		24,509		-		24,509		-
U.S. government/ government-sponsored agencies:
Collateralized mortgage obligations - residential		26,231		-		26,231		-
Collateralized mortgage obligations - commercial		61,256		-		61,256		-
Residential mortgage-backed securities		74,098		-		74,098		-
Corporate debt securities		420		-		420		-
Negotiable certificates of deposit		2,232		-		2,232		-
Equity securities		967		967		-		-
Total available-for-sale securities	$	218,989	$	967	$	218,022	$	-

The following tables present a reconciliation and statement of operations classifications of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three month periods ended March 31, 2015 and 2014:

Fair Value Measurements
Using Significant Unobservable Inputs (Level 3)
	State and Political Subdivisions
	Three Months Ended March 31,
(in thousands)	2015		2014
Balance at January 1,	$	-	$	571
Amortization		-		-
Accretion		-		-
Purchases		-		-
Paydowns		-		(145)
Total gains or losses (realized/unrealized):
Included in earnings		-		-
Included in other comprehensive income		-		11
Balance at March 31,	$	-	$	437

There were no transfers between levels within the fair value hierarchy during the periods ended March 31, 2015 and 2014.

Assets measured at fair value on a non-recurring basis

The following tables present assets and liabilities measured at fair value on a non-recurring basis:

	Fair Value Measurements at March 31, 2015
			Quoted Prices in		Significant		Significant
			Active		Other		Other
			markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
(in thousands)	Fair Value (1)		(Level 1)		(Level 2)		(Level 3)
Collateral-dependent impaired loans	$	5,732	$	-	$	-	$	5,732
Other real estate owned	$	14	$	-	$	-	$	14

	Fair Value Measurements at December 31, 2014
			Quoted Prices in		Significant		Significant
			Active		Other		Other
			markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
(in thousands)	Fair Value (1)		(Level 1)		(Level 2)		(Level 3)
Collateral-dependent impaired loans	$	5,380	$	-	$	-	$	5,380
Other real estate owned	$	2,087	$	-	$	-	$	2,087

(1)

Represents carrying value and related write-downs for which adjustments are based on appraised value less estimated selling costs. Management may make adjustments to the appraised values as necessary to consider declines in real estate values since the time of the appraisal. Such adjustments are based on management’s knowledge of the local real estate markets.

Collateral-dependent impaired loans are classified as Level 3 assets and the estimated fair value of the collateral is based on the appraised value or other reasonable offers less estimated costs to sell. The Company estimates selling costs at 10.0% of appraised value. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance or is charged off. The amount shown is the balance of impaired loans, net of any charge-offs and the related allowance for loan losses. The related allowance representing the adjustment of the recorded investment to fair value at March 31, 2015 and December 31, 2014 was $146 thousand and $102 thousand, respectively. Included in the adjustment at March 31, 2015, was a full valuation allowance for one collateral dependent impaired construction, land acquisition and development loan for which the Company was unable to obtain a current appraisal prior to the valuation date. The collateral supporting this loan is located in Monroe County. Based on the decline in real estate values in this market area, management decided that a full valuation allowance in the amount of $94 thousand was warranted at March 31, 2015. There were no additional valuation adjustments other than 10.0% for estimated selling costs at December 31, 2014.

OREO properties are recorded at fair value less the estimated cost to sell at the date of the Company’s acquisition of the property. For OREO properties, the Company generally estimates selling costs at 10.0% of appraised value. Subsequent to the Company’s acquisition, the balance may be written down further. It is the Company’s policy to obtain certified external appraisals of real estate collateral underlying impaired loans and OREO, and estimate fair value using those appraisals. Other valuation sources may be used, including broker price opinions, letters of intent and executed sale agreements. Adjustments of the carrying value of OREO to fair value in the form of valuation adjustments at March 31, 2015 and December 31, 2014 totaled $12 thousand and $1.6 million, respectively.

The Company discloses fair value information about financial instruments, whether or not recognized in the Statement of Financial Condition, for which it is practicable to estimate that value. The following estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, management judgment is required to interpret data and develop fair value estimates. Accordingly, the estimates below are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

The following table summarizes the estimated fair values of the Company’s financial instruments at March 31, 2015 and at December 31, 2014:

	Fair Value		March 31, 2015			December 31, 2014
(in thousands)	Measurement	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial assets
Cash and short term investments	Level 1	$	37,375	$	37,375	$	35,667	$	35,667
Securities available for sale	See previous table		204,635		204,635		218,989		218,989
FHLB and FRB Stock	Level 2		4,411		4,411		4,154		4,154
Loans held for sale	Level 2		-		-		603		603
Loans, net	Level 3		661,221		661,164		658,747		659,231
Accrued interest receivable	Level 2		2,118		2,118		2,075		2,075
Mortgage servicing rights	Level 3		278		855		333		898

Financial liabilities
Deposits	Level 2		775,111		765,927		795,336		779,986
Borrowed funds	Level 2		102,922		106,579		96,504		100,020
Accrued interest payable	Level 2		10,788		10,788		10,262		10,262

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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