Fair Value Measurements

LCNB measures certain assets at fair value using various valuation techniques and assumptions, depending on the nature of the asset. Fair value is defined as the price that would be received from the sale of an asset in an orderly transaction between market participants at the measurement date.

The inputs to the valuation techniques used to measure fair value are assigned to one of three broad levels:


•	Level 1 – quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the reporting date.

•

Level 2 – inputs other than quoted prices included within level 1 that are observable for the asset or liability either directly or indirectly. Level 2 inputs may include quoted prices for similar assets in active markets, quoted prices for identical assets or liabilities in markets that are not active, inputs other than quoted prices (such as interest rates or yield curves) that are observable for the asset or liability, and inputs that are derived from or corroborated by observable market data.


•	Level 3 - inputs that are unobservable for the asset or liability.

The majority of LCNB's financial debt securities are classified as available-for-sale. The securities are reported at fair value with unrealized holding gains and losses reported net of income taxes in accumulated other comprehensive income.

LCNB utilizes a pricing service for determining the fair values of most of its investment securities. Fair value for U.S. Treasury notes are determined based on market quotations (level 1). Fair value for most of the other investment securities is calculated using the discounted cash flow method for each security. The discount rates for these cash flows are estimated by the pricing service using rates observed in the market (level 2). Cash flow streams are dependent on estimated prepayment speeds and the overall structure of the securities given existing market conditions. In addition, LCNB has invested in trust preferred securities, equity securities, and four mutual funds that are not priced by the pricing service. Market quotations (level1) are used to determine fair values for the trust preferred securities and equity securities. Investments in mutual funds that are publicly traded in active markets and that publish daily net asset values are considered to have level 1 inputs. An investment in a mutual fund that is not traded in an active market is considered to have level 2 inputs because an investor can have its interest in the fund redeemed for the balance of its capital account at any quarter-end assuming the fund is given a 60 day notice. The investment in this fund is carried at fair value, which approximates cost.

Assets that may be recorded at fair value on a nonrecurring basis include impaired loans, other real estate owned, and other repossessed assets. A loan is considered impaired when management believes it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement. Impaired loans are carried at the present value of estimated future cash flows using the loan's existing rate or the fair value of collateral if the loan is collateral dependent, if this value is less than the loan balance. The inputs are considered to be level 3.

Other real estate owned is adjusted to fair value upon transfer of the loan to foreclosed assets, usually based on an appraisal of the property. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. These inputs are also considered to be level 3.

The following table summarizes the valuation of LCNB's assets recorded at fair value by input levels as of June 30, 2015 and December 31, 2014 (in thousands):



			Fair Value Measurements at the End of the Reporting Period Using
	Fair Value Measurements		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
June 30, 2015
Recurring fair value measurements:
Investment securities available-for-sale:
U.S. Treasury notes	$	86,286	86,286	—	—
U.S. Agency notes	108,090		—	108,090	—
U.S. Agency mortgage-backed securities	28,182		—	28,182	—
Certificates of deposit with other banks	2,584		—	2,584	—
Municipal securities:
Non-taxable	93,812		—	93,812	—
Taxable	25,482		—	25,482	—
Mutual funds	2,472		1,472	1,000	—
Trust preferred securities	49		49	—	—
Equity securities	903		903	—	—
Total recurring fair value measurements	$	347,860	88,710	259,150	—
Nonrecurring fair value measurements:
Impaired loans	$	4,719	—	—	4,719
Other real estate owned and repossessed assets	1,364		—	—	1,364
Total nonrecurring fair value measurements	$	6,083	—	—	6,083

December 31, 2014
Recurring fair value measurements:
Investment securities available-for-sale:
U.S. Treasury notes	$	62,560	62,560	—	—
U.S. Agency notes	83,637		—	83,637	—
U.S. Agency mortgage-backed securities	38,032		—	38,032	—
Certificates of deposit with other banks	3,086		—	3,086	—
Municipal securities:
Non-taxable	77,395		—	77,395	—
Taxable	16,395		—	16,395	—
Mutual funds	2,461		1,461	1,000	—
Trust preferred securities	50		50	—	—
Equity securities	1,749		1,749	—	—
Total recurring fair value measurements	$	285,365	65,820	219,545	—
Nonrecurring fair value measurements:
Impaired loans	$	4,872	—	—	4,872
Other real estate owned and repossessed assets	1,370		—	—	1,370
Total nonrecurring fair value measurements	$	6,242	—	—	6,242

The following table presents quantitative information about unobservable inputs used in nonrecurring Level 3 fair value measurements at June 30, 2015 and December 31, 2014 (dollars in thousands):

Range

Fair Value

Valuation Technique

Unobservable Inputs

High

Low

Weighted Average

June 30, 2015:

Impaired loans

4,719

Estimated sales price

Adjustments for comparable properties, discounts to reflect current market conditions

Not applicable

Discounted cash flows

Discount rate

10.50

4.00

5.30

Other real estate owned

1,364

Estimated sales price

Adjustments for comparable properties, discounts to reflect current market conditions

Not applicable

December 31, 2014:

Impaired loans

4,872

Estimated sales price

Adjustments for comparable properties, discounts to reflect current market conditions

Not applicable

Discounted cash flows

Discount rate

10.50

4.00

5.36

Other real estate owned

1,370

Estimated sales price

Adjustments for comparable properties, discounts to reflect current market conditions

Not applicable

Carrying amounts and estimated fair values of financial instruments as of June 30, 2015 and December 31, 2014 are as follows (in thousands):



				Fair Value Measurements at the End of the Reporting Period Using
	Carrying Amount		Fair Value	Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
June 30, 2015
FINANCIAL ASSETS:
Cash and cash equivalents	$	27,913	27,913	27,913	—	—
Investment securities, held-to-maturity	24,677		24,590	—	—	24,590
Federal Reserve Bank stock	2,476		2,476	2,476	—	—
Federal Home Loan Bank stock	3,638		3,638	3,638	—	—
Loans, net	751,857		749,061	—	—	749,061

FINANCIAL LIABILITIES:
Deposits	1,084,033		1,085,255	855,070	230,185	—
Short-term borrowings	12,731		12,731	12,731	—	—
Long-term debt	6,085		6,534	—	6,534	—

December 31, 2014
FINANCIAL ASSETS:
Cash and cash equivalents	$	15,845	15,845	15,845	—	—
Investment securities, held-to-maturity	22,725		22,138	—	—	22,138
Federal Reserve Bank stock	2,346		2,346	2,346	—	—
Federal Home Loan Bank stock	3,638		3,638	3,638	—	—
Loans, net	695,835		699,715	—	—	699,715

FINANCIAL LIABILITIES:
Deposits	946,205		947,541	731,766	215,775	—
Short-term borrowings	16,645		16,645	16,645	—	—
Long-term debt	11,357		11,944	—	11,944	—

The fair value of off-balance-sheet financial instruments at June 30, 2015 and December 31, 2014 was not material.

Fair values of financial instruments are based on various assumptions, including the discount rate and estimates of future cash flows. Therefore, the fair values presented may not represent amounts that could be realized in actual transactions. In addition, because the required disclosures exclude certain financial instruments and all nonfinancial instruments, any aggregation of the fair value amounts presented would not represent the underlying value of LCNB. The following methods and assumptions were used to estimate the fair value of certain financial instruments:

Cash and cash equivalents

The carrying amounts presented are deemed to approximate fair value.

Investment securities

Fair values for securities, excluding Federal Home Loan Bank and Federal Reserve Bank stock, are based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities and/or discounted cash flow analyses or other methods. The carrying value of Federal Home Loan Bank and Federal Reserve Bank stock approximates fair value based on the respective redemptive provisions.

Loans

Fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, incorporating assumptions of current and projected prepayment speeds. These current rates approximate market rates.

Deposits

The fair value of demand deposits, savings accounts, 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 using the rates currently offered for deposits of similar remaining maturities, which approximates market rates.

Borrowings

The carrying amounts of federal funds purchased, repurchase agreements, and U.S. Treasury demand note borrowings are deemed to approximate fair value of short-term borrowings. For long-term debt, fair values are estimated based on the discounted value of expected net cash flows using current interest rates.