NOTE 7 – FAIR VALUE

Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures, defines fair value as the exchange 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. Assets and liabilities are measured using valuation techniques specific to the following three-tier hierarchy, which prioritizes the inputs used in measuring fair value.

Level I, II and III Valuation Techniques

Level I:

Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.

Level II:

Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

Level III:

Unobservable inputs for the asset or liability.

The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2015 and December 31, 2014 by level within the hierarchy:

(dollars in thousands)
September 30, 2015	Total		Level I		Level II		Level III
Assets:
Securities available-for-sale:
U.S. government-sponsored entities and agencies	$	7,014	$	-	$	7,014	$	-
State and political subdivisions		5,608		-		5,608		-
Mortgage-backed securities - residential		27,037		-		27,037		-
Collateralized mortgage obligations		25,148		-		25,148		-
Corporate bonds		2,568		-		2,568		-
Liabilities:
Derivative liability		754		-		754		-

December 31, 2014	Total		Level I		Level II		Level III
Assets:
Securities available-for-sale:
U.S. government-sponsored entities and agencies	$	7,157	$	-	$	7,157	$	-
State and political subdivisions		7,060		-		7,060		-
Mortgage-backed securities - residential		31,360		-		31,360		-
Collateralized mortgage obligations		28,962		-		28,962		-
Corporate bonds		3,094		-		3,094		-
Liabilities:
Derivative liability		725		-		725		-

There were no transfers between Level 1 and Level 2 during the three and nine months ended September 30, 2015 and the year ended December 31, 2014.

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

Securities Available-for-Sale:

The fair value of securities available-for-sale is determined by obtaining quoted prices on nationally-recognized securities exchanges (Level I 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 II inputs).

Derivatives:

The fair value of derivatives is based on valuation models using observable market data as of the measurement date resulting in a Level II classification.

The following table presents information about our assets measured at fair value on a non-recurring basis as of September 30, 2015 and December 31, 2014, by level within the fair value hierarchy. The amounts in the tables represent only assets for which the carrying amount has been adjusted for impairment during the period; therefore, these amounts will differ from the total amounts outstanding.

(dollars in thousands)
September 30, 2015	Total		Level I		Level II		Level III
Impaired Loans (Collateral Dependent):
Real estate mortgage loans:
Residential	$	1,037	$	-	$	1,037	$	-
Commercial		1,293		-		1,018		275
Construction and land		109		-		109		-
Other real estate owned:
Real estate mortgage loans:
Construction and land		3,768		-		3,768		-
Assets held for sale		-		-		-		-

December 31, 2014	Total		Level I		Level II		Level III
Impaired Loans (Collateral Dependent):
Real estate mortgage loans:
Residential	$	495	$	-	$	-	$	495
Commercial		275		-		-		275
Construction and land		252		-		-		252
Other real estate owned:
Real estate mortgage loans:
Construction and land		3,773		-		-		3,773
Assets held for sale		786		-		786		-

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

Impaired Loans (Collateral Dependent):

Management determined fair value measurements on impaired loans primarily through evaluations of appraisals performed. The Company considered the appraisal as the starting point for determining fair value and then considered other factors and events in the environment that affected the fair value. Appraisals for impaired loans are obtained by the Chief Credit Officer and performed by certified general appraisers whose qualifications and licenses have been reviewed and verified by the Company. Once reviewed, a third-party specialist reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison to independent data sources such as recent market data or industry-wide statistics. On at least an annual basis, the Company compares the actual selling price of collateral that has been sold to the most recent appraised value to determine what additional adjustments, if any, should be made to the appraised value of existing collateral to arrive at fair value. Adjustments may be made to reflect the age of the appraisal and the type of underlying property. Appraised values may be discounted to estimated fair value based on current market data such as recent sales of similar properties, discussions with potential buyers and negotiations with existing customers.

Other Real Estate Owned (OREO):

Assets acquired as a result of, or in lieu of, loan foreclosure are initially recorded at fair value (based on the lower of the current appraised value or listing price) at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of the carrying amount or fair value less cost to sell. Management has determined fair value measurements on OREO primarily through evaluations of appraisals performed and current and past offers for the OREO under evaluation. Appraisals of OREO are obtained subsequent to acquisition as deemed necessary by the Chief Credit Officer. Appraisals are reviewed for accuracy and consistency by a third-party specialist. Third-party specialists are selected from the approved appraisers list, which is maintained by management, and supervised by the Chief Credit Officer. Appraised values may be discounted to estimated fair value based on factors such as sales prices for comparable properties in similar geographic areas and/or assessment through observation of such properties.

Assets Held-for-Sale

The Company reclassifies long-lived assets to assets held-for-sale when all criteria for such reclassification are met. The assets held-for-sale are recorded at the lower of carrying value or fair value less costs to sell. Management determined the fair value of the assets held-for-sale using an offer made to the Company for the property.

Transfers of assets and liabilities between levels within the fair value hierarchy are recognized when an event or change in circumstances occurs. During the three and nine months ended September 30, 2015, there were transfers from Level III to Level II in impaired loans and OREO, as the current fair value was based on current appraised values that do not include significant unobservable inputs and that were not further discounted, or contracted offers to purchase certain properties. There were no transfers between fair value levels during the three months and nine months ended September 30, 2014.

Quantitative Information about Level III Fair Value Measurements

The following table presents quantitative information about unobservable inputs for assets measured on a non-recurring basis using Level III measurements as of September 30, 2015 and December 31, 2014. This quantitative information is the same for each class of loans.

(dollars in thousands) September 30, 2015	Fair Value			Valuation Technique		Unobservable Inputs		Range of Inputs				Weighted Average
Impaired loans (collateral dependent)	$	275		Market comparable properties		Marketability discount			10	%			10	%

December 31, 2014

Fair

Value

Valuation Technique

Unobservable Inputs

Range of Inputs

Weighted Average

Impaired loans (collateral dependent)

1,022

Market comparable properties

Marketability discount

0% – 20.0

6.2

Other real estate owned

3,773

Market comparable properties

Comparability adjustments

0% – 8.1

2.8

The table below summarizes the outstanding balance, valuation allowance and net carrying amount and period expense related to Level III non-recurring instruments for the nine months ended September 30, 2015 and 2014:

(dollars in thousands) September 30, 2015	Outstanding Balance			Valuation Allowance			Net Carrying Amount			Period Expense
Impaired loans (collateral dependent)	$	471		$	196		$	275		$	(18	)

September 30, 2014	Outstanding Balance		Valuation Allowance		Net Carrying Amount		Period Expense
Impaired loans (collateral dependent)	$	6,094	$	2,220	$	3,874	$	434
Other real estate owned		3,880		1,006		2,874		48
Assets held for sale		940		-		925		15

Fair Value of Financial Instruments

The carrying amount and estimated fair values of financial instruments as of September 30, 2015 and December 31, 2014 were as follows:

	September 30, 2015				December 31, 2014
(dollars in thousands)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Cash and cash equivalents	$	26,410	$	26,410	$	24,372	$	24,372
Securities available-for-sale		67,375		67,375		77,633		77,633
Loans, net		386,941		392,896		360,279		366,686
Federal Home Loan Bank stock		928		N/A		1,243		N/A
Accrued interest receivable		1,366		1,366		1,464		1,464

Financial liabilities:
Deposits	$	433,032	$	433,555	$	415,756	$	416,432
Federal Home Loan Bank advances and other borrowings		11,860		11,721		17,629		17,743
Subordinated debentures		16,266		8,951		16,218		8,552
Accrued interest payable		116		116		130		130
Interest rate swap		754		754		725		725

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

Cash and cash equivalents:

The carrying amounts of cash and cash equivalents approximate the fair value and are classified as either Level I or Level II in the fair value hierarchy, with Level II comprised solely of national certificates of deposit held by the Bank. As of September 30, 2015 and December 31, 2014, respectively, the breakdown of cash and cash equivalents between Level I and Level II were as follows:

	September 30, 2015						December 31, 2014
(dollars in thousands)	Level I			Level II			Level I			Level II
Cash and cash equivalents		$	23,197		$	3,213		$	20,186		$	4,186

Loans, net:

The fair value of variable-rate loans that re-price frequently and with no significant change in credit risk is based on the carrying value and results in a classification of Level III within the fair value hierarchy, excluding impaired loans as previously discussed. Fair value for other loans is estimated using a 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 III classification in the fair value hierarchy, excluding impaired loans as previously discussed. The methods used to estimate the fair value of loans do not necessarily represent an exit price.

Nonmarketable equity securities:

Nonmarketable equity securities include FHLB stock and other nonmarketable equity securities. It is not practicable to determine the fair value of nonmarketable equity securities due to restrictions placed on their transferability.

Deposits:

The fair value of demand deposits (e.g., interest and noninterest-bearing, savings and certain types of money market accounts) is, by definition, equal to the amount payable on demand at the reporting date (i.e., carrying value) resulting in a Level II classification in the fair value hierarchy. The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair value at the reporting date resulting in a Level II classification in the fair value hierarchy. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow 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 II classification.

Federal Home Loan Bank advances:

The fair value of FHLB advances is estimated using a discounted cash flow analysis based on the current borrowing rates for similar types of borrowings and is classified as a Level II in the fair value hierarchy.

Accrued interest receivable/payable:

The carrying amounts of accrued interest receivable approximate fair value resulting in a Level II or III classification. The carrying amounts of accrued interest payable approximate fair value resulting in a Level II classification.

Subordinated debt:

The fair value of subordinated debt, where a market quote is not available, is based on discounted cash flows, using a rate appropriate to the instrument and the term of the issue resulting in a Level II classification.

Off-balance sheet instruments:

The fair value of off-balance sheet instruments is based on the current fees that would be charged to enter into or terminate such arrangements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of these commitments as of September 30, 2015 was not material.