Note 5 - Fair Value Measurements

Fair value is the exchange price that would be received to sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair values:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3 – Significant unobservable inputs that are supported by little or no market activity, reflect a company’s own assumptions about market participant assumptions of fair value, and are significant to the fair value of the assets or liabilities.

In determining the appropriate levels, the Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Investment Securities: The fair value of securities available-for-sale are determined by obtaining quoted prices on nationally recognized securities exchanges (level 1 inputs) or matrix pricing, which is a mathematical technique used widely 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). The Company does not have any Level 1 securities. Level 2 securities include certain U.S. agency bonds, collateralized mortgage and debt obligations, and certain municipal securities. The Company also has one Level 3 security. The value of this single issue trust preferred security is obtained on a quarterly basis directly from the originating broker.

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally 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.

Other Real Estate Owned: Commercial and residential real estate properties classified as other real estate owned (OREO) are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use 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.

Appraisals for collateral-dependent impaired loans and real estate properties classified as other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by Bank management. The appraisal values for collateral-dependent impaired loans are discounted to allow for selling expenses and fees, the limited use nature of various properties, the age of the most recent appraisal, and additional discretionary discounts for location, condition, etc. The Bank annually obtains an updated current appraisal value for each OREO property to certify that the fair value has not declined. For each parcel of OREO that has declined in value, the Bank records the decline in value by a direct writedown of the asset.

Assets measured at fair value on a recurring basis:


	Fair Value Measurements at:
	(Dollars in Thousands)						(Dollars in Thousands)
	March 31, 2019						December 31, 2018
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Securities available-for-sale
U. S. government agencies and government sponsored entities		—	$	7,963		—		—	$	8,440		—
Agency mortgage-backed securities-residential		—		19,602		—		—		20,300		—
State and municipal		—		16,422		—		—		16,728		—
Trust preferred security		—		—		1,640		—		—		1,630
Corporate bonds		—		—		—		—		—		—
Total investment securities	$	—	$	43,987	$	1,640	$	—	$	45,468	$	1,630

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31:


	Trust Preferred Security
	2019		2018

Balance of recurring Level 3 assets at January 1	$	1,630	$	1,440
Total gains or (losses) for the period included in other comprehensive income		10		120
Balance of recurring Level 3 assets at March 31	$	1,640	$	1,560

There were no financial assets measured at fair value on a non-recurring basis as of March 31, 2019 or December 31, 2018.

There were no loans measured for impairment using the fair value of collateral dependent loans, no valuation allowance, and no resulting provision for loan losses as of March 31, 2019 or December 31, 2018.

There was no other real estate owned to measure at fair value at March 31, 2019 or December 31, 2018. No write-downs of other real estate were taken in the quarters ending March 31, 2019 or March 31, 2018.

The carrying amount and estimated fair values of financial instruments at March 31, 2019 and December 31, 2018 were as follows:


			Fair Value Measurements at
			March 31, 2019
	Carrying Amount		Level 1		Level 2		Level 3		Total
Financial Assets
Cash and due from financial institutions	$	6,998	$	6,998	$	—	$	—	$	6,998
Federal funds sold and interest-bearing deposits in other financial institutions		17,337		17,337		—		—		17,337
Available-for-sale-securities		45,627		—		43,987		1,640		45,627
Loans, net of allowance		373,523		—		—		371,482		371,482
Loans held for sale		117		—		119		—		119
Accrued interest receivable		1,651		11		217		1,423		1,651
Federal Home Loan Bank stock		2,065		—		—		—		N/A

Financial Liabilities
Demand and savings deposits	$	244,539	$	244,539	$	—	$	—	$	244,539
Time deposits		137,262		—		136,373		—		136,373
FHLB advances		30,000		—		29,965		—		29,965
Subordinated debentures		5,000		—		—		2,722		2,722
Accrued interest payable		421		20		344		57		421


			Fair Value Measurements at
			December 31, 2018
	Carrying Amount		Level 1		Level 2		Level 3		Total
Financial Assets
Cash and due from financial institutions	$	8,875	$	8,875	$	—	$	—	$	8,875
Federal funds sold and interest-bearing deposits in other financial institutions		26,010		26,010		—		—		26,010
Available-for-sale-securities		47,098		—		45,468		1,630		47,098
Loans, net of allowance		367,171		—		—		364,862		364,862
Loans held for sale		269		—		274		—		274
Accrued interest receivable		1,683		13		255		1,415		1,683
Federal Home Loan Bank stock		2,065		—		—		—		N/A

Financial Liabilities
Demand and savings deposits	$	247,768	$	247,768	$	—	$	—	$	247,768
Time deposits		140,841		—		138,869		—		138,869
FHLB advances		30,000		—		29,837		—		29,837
Subordinated debentures		5,000		—		—		2,722		2,722
Accrued interest payable		410		17		339		54		410

The methods and assumptions used to estimate fair value 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 Level 1.

(b)

Interest Bearing Deposits in Other Financial Institutions: Fair values are based on quoted market prices.

(c)

Loans, Net: Fair values of loans, excluding loans held for sale, was estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values were based on carrying values resulting in a Level 3 classification. Fair values for other loans were estimated using discounted cash flow analyses, using interest rates 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 fair value as described previously. The methods utilized to estimate the fair value of loans did not necessarily represent an exit price.

(d)

Loans Held for Sale: 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.

(e)

FHLB Stock: It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

(f)

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 1 classification. The carrying amounts of variable rate certificates of deposit approximate their fair values at the reporting date resulting in a Level 2 classification. 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.

(g)

FHLB Advances and Other Borrowings/Subordinated Debentures: 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.

(h)

Accrued Interest Receivable/Payable: The carrying amounts of accrued interest approximate fair value resulting in a classification consistent with the asset/liability they are associated with.