Note 7. Fair Value of Financial Instruments

The fair value topic of the ASC establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. This topic clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. This topic also requires disclosure about how fair value was determined for assets and liabilities and establishes a hierarchy for which these assets and liabilities must be grouped, based on significant levels of inputs as follows:

Level 1

Quoted prices in active markets for identical assets or liabilities;

Level 2

Quoted prices in active markets for similar assets and liabilities and inputs that are observable for the asset or liability; or

Level 3

Unobservable inputs, such as discounted cash flow models or valuations.

The determination of where assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

The following table presents assets and liabilities that are measured at fair value on a recurring basis as of March 31, 2014:


	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
	Assets		Inputs		Inputs
	(Level 1)		(Level 2)		(Level 3)		Totals
Securities available for sale
Obligations of U. S. Government Agencies	$	—	$	290,623,620	$	—	$	290,623,620
Mortgage-backed securities		—		16,471,787		—		16,471,787
State, county and municipal obligations		—		96,766,848		—		96,766,848
Other investments		—		—		2,763,689		2,763,689

Total	$	—	$	403,862,255	$	2,763,689	$	406,625,944

The following table presents assets and liabilities that are measured at fair value on a recurring basis as of December 31, 2013:


	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
	Assets		Inputs		Inputs
	(Level 1)		(Level 2)		(Level 3)		Totals
Securities available for sale
Obligations of U. S. Government Agencies	$	—	$	282,816,400	$	—	$	282,816,400
Mortgage-backed securities		—		17,166,394		—		17,166,394
State, county and municipal obligations		—		95,427,405		—		95,427,405
Other investments		—		—		2,766,203		2,766,203

Total	$	—	$	395,410,199	$	2,766,203	$	398,176,402

The following table reports the activity for 2014 in assets measured at fair value on a recurring basis using significant unobservable inputs.


	Fair Value Measurements Using
	Significant Unobservable Inputs
	(Level 3)
	Structured Financial Product
Balance at January 1, 2014	$	2,766,203
Unrealized losses included in other comprehensive income		(2,514	)

Balance at March 31, 2014	$	2,763,689

The Corporation recorded no gains or losses in earnings for the period that were attributable to the change in unrealized gains or losses relating to assets still held at the reporting date.

For assets measured at fair value on a nonrecurring basis during 2014 that were still held in the balance sheet at March 31, 2014, the following table provides the hierarchy level and the fair value of the related assets:


	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
	Assets		Inputs		Inputs
	(Level 1)		(Level 2)		(Level 3)		Totals
Impaired loans	$	—	$	—	$	7,790,243	$	7,790,243
Other real estate owned		—		—		1,700,995		1,700,995

Total	$	—	$	—	$	9,491,238	$	9,491,238

For assets measured at fair value on a nonrecurring basis during 2013 that were still held in the balance sheet at December 31, 2013, the following table provides the hierarchy level and the fair value of the related assets:


	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
	Assets		Inputs		Inputs
	(Level 1)		(Level 2)		(Level 3)		Totals
Impaired loans	$	—	$	—	$	8,782,923	$	8,782,923
Other real estate owned		—		—		645,468		645,468

Total	$	—	$	—	$	9,428,391	$	9,428,391

Impaired loans with a carrying value of $10,426,594 and $11,079,526 had an allocated allowance for loan losses of $2,636,352 and $2,296,603 at March 31, 2014 and December 31, 2013, respectively. The allocated allowance is based on the carrying value of the impaired loan and the fair value of the underlying collateral less estimated costs to sell.

Other real estate owned (“OREO”) acquired during the three-month period ended March 31, 2014, and recorded at fair value, less costs to sell, was $421,673, of which $8,099 was acquired and sold during this period. There were writedowns in the amount of $72,422 during the period on one property valued at $1,214,999. OREO acquired during 2013 and recorded at fair value, less costs to sell, was $1,697,450. Additional writedowns during 2013 on OREO acquired in previous years was $276,400 on four properties valued at $645,468.

The financial instruments topic of the ASC requires disclosure of financial instruments’ fair values, as well as the methodology and significant assumptions used in estimating fair values. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. The financial instruments topic of the ASC excludes certain financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Corporation and may not be indicative of amounts that might ultimately be realized upon disposition or settlement of those assets and liabilities.

The following represents the carrying value and estimated fair value of the Corporation’s financial instruments at March 31, 2014, and December 31, 2013:


			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant		Total
	Carrying		Identical		Observable		Unobservable		Fair
March 31, 2014	Value		Assets		Inputs		Inputs		Value
			(Level 1)		(Level 2)		(Level 3)
Financial assets
Cash and due from banks	$	19,962,984	$	19,962,984	$	—	$	—	$	19,962,984
Interest bearing deposits with banks		784,648		784,648		—		—		784,648
Securities available-for-sale		406,625,944		—		403,862,255		2,763,689		406,625,944
Net loans		381,472,367		—		—		382,927,531		382,927,531
Financial liabilities
Deposits	$	687,064,722	$	457,546,658	$	—	$	229,663,801	$	687,210,459
Federal Home Loan Bank advances		43,500,000		—		—		44,586,876		44,586,876
Securities Sold under Agreement to Repurchase		64,471,725		64,471,725		—		—		64,471,725


			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant		Total
	Carrying		Identical		Observable		Unobservable		Fair
December 31, 2013	Value		Assets		Inputs		Inputs		Value
			(Level 1)		(Level 2)		(Level 3)
Financial assets
Cash and due from banks	$	16,040,195	$	16,040,195	$	—	$	—	$	16,040,195
Interest bearing deposits with banks		684,100		684,100		—		—		684,100
Securities available-for-sale		432,065,590		—		395,410,199		2,766,203		398,176,402
Net loans		384,104,766		—		—		385,646,132		385,646,132
Financial liabilities
Deposits	$	654,629,796	$	422,186,092	$	—	$	232,602,224	$	654,788,316
Federal Home Loan Bank advances		33,500,000		—		—		34,622,359		34,622,359
Securities Sold under Agreement to Repurchase		82,420,781		82,420,781		—		—		82,420,781

The fair value estimates, methods and assumptions used by the Corporation in estimating its fair value disclosures for financial statements were as follows:

Cash and Due from Banks and Interest Bearing Deposits with Banks

The carrying amounts reported in the balance sheet for these instruments approximate fair value because of their immediate and shorter-term maturities, which are considered to be three months or less when purchased.

Securities Available-for-Sale

Fair values for investment securities are based on quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments (Level 2). When neither quoted prices nor comparable instruments are available, unobservable inputs are needed to form an expected future cash flow analysis to establish fair values (Level 3).

The Corporation owns certain beneficial interests in one collateralized debt obligation secured by community bank trust preferred securities. These interests do not trade in a liquid market, and therefore, market quotes are not a reliable indicator of their ultimate realizability. The Corporation utilizes a discounted cash flow model using inputs of (1) market yields of trust-preferred securities as the discount rate and (2) expected cash flows which are estimated using assumptions related to defaults, deferrals and prepayments to determine the fair values of these beneficial interests. Many of the factors that adjust the timing and extent of cash flows are based on judgment and not directly observable in the markets. Therefore, these fair values are classified as Level 3 valuations for accounting and disclosure purposes. Since observable transactions in these securities are extremely rare, the Corporation uses assumptions that a market participant would use in valuing these instruments. These assumptions primarily include cash flow estimates and market discount rates. The cash flow estimates are sensitive to the assumptions related to the ability of the issuers to pay the underlying trust preferred securities according to their terms. The market discount rates depend on transactions, which are rare given the lack of interest of investors in these types of beneficial interests.

Net Loans

For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans (i.e., commercial real estate and rental property mortgage loans, commercial and industrial loans, financial institution loans, and agricultural 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.

Deposits

The fair values for demand deposits, NOW and money market accounts and savings accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts for variable-rate, fixed-term money market accounts and time deposits approximate their fair values at the reporting date. Fair values for fixed-rate time deposits 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.

Federal Home Loan Bank (FHLB) Borrowings

The fair value of FHLB advances is based on a discounted cash flow analysis.

Securities Sold Under Agreement to Repurchase

Due to the short term nature of these instruments, which is generally three months or less, the carrying amount is equal to the fair value.

Off-Balance Sheet Instruments

The fair value of commitments to extend credit and letters of credit are estimated using fees currently charged to enter into similar agreements. The fees associated with these financial instruments are not material.