Fair Value Measurements

Accounting guidance on fair value measurements and disclosures defines fair value and establishes a framework for measuring the fair value of assets and liabilities using a hierarchy system. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts business.

The Company's balance sheet contains investment securities available for sale and derivative instruments that are recorded at fair value on a recurring basis. The three-level valuation hierarchy for disclosure of fair value is as follows:

Level 1 uses quoted market prices in active markets for identical assets or liabilities.

Level 2 uses observable market-based inputs or unobservable inputs that are corroborated by market data.

Level 3 uses unobservable inputs that are not corroborated by market data.

The Company's policy is to recognize transfers between Levels at the end of each reporting period, if applicable. There were no transfers between Levels of the fair value hierarchy during 2015 or 2014.

The following is a description of valuation methodologies used for financial assets and liabilities recorded at fair value on a recurring basis.

Investment securities available for sale: When available, quoted market prices are used to determine the fair value of investment securities. If quoted market prices are not available, the Company determines fair value based on various sources and may apply matrix pricing with observable prices for similar bonds where a price for the identical bond is not observable. The fair values of these securities are determined by pricing models that consider observable market data such as interest rate volatilities, LIBOR yield curve, credit spreads, prices from market makers and live trading systems. Level 1 securities include certain corporate bonds and preferred stocks, and would include U.S. Treasuries, if any were held. Level 2 securities include U.S. government and agency securities, collateralized mortgage obligations, mortgage-backed securities, state and political subdivision securities and one trust preferred security. The Company currently holds no investment securities classified as Level 3.

Generally, management obtains the fair value of investment securities at the end of each reporting period via a third-party pricing service. Management, with the assistance of an independent investment advisory firm, reviewed the valuation process used by the third party and believed that process was valid. On a quarterly basis, management corroborates the fair values of investment securities by obtaining pricing from an independent investment advisory firm and compares the two sets of fair values. Any significant variances are reviewed and investigated. In addition, the Company has a practice of further testing the fair values of a sample of securities. For that sample, the prices are further validated by management, with assistance from an independent investment advisory firm, by obtaining details of the inputs used by the pricing service. Those inputs were independently tested, and management concluded the fair values were consistent with GAAP requirements and securities were properly classified in the fair value hierarchy.

Derivative instruments: The Company's derivative instruments consist of interest rate swaps, which are accounted for as cash flow hedges. The Company's derivative position is classified within Level 2 of the fair value hierarchy and is valued using models generally accepted in the financial services industry and that use actively quoted or observable market input values from external market data providers and/or nonbinding broker-dealer quotations. The fair value of the derivatives are determined using discounted cash flow models. These models’ key assumptions include the contractual terms of the respective contract along with significant observable inputs, including interest rates, yield curves, nonperformance risk and volatility. Derivative contracts are executed with a Credit Support Annex, which is a bilateral ratings-sensitive agreement that requires collateral postings at established credit threshold levels. These agreements protect the interests of the Company and its counterparties should either party suffer a credit rating deterioration.

The following tables present the balances of assets and liabilities measured at fair value on a recurring basis by level as of December 31, 2015 and 2014.



	2015
Description	Total		Level 1		Level 2		Level 3
Financial assets:
Investment securities available for sale:
U.S. government agencies and corporations	$	2,692	$	—	$	2,692	$	—
State and political subdivisions	73,079		—		73,079		—
Collateralized mortgage obligations	132,615		—		132,615		—
Mortgage-backed securities	101,088		—		101,088		—
Trust preferred security	1,105		—		1,105		—
Corporate notes and equity securities	10,135		9,835		300		—

Financial liabilities:
Derivative instruments, interest rate swaps	$	774	$	—	$	774	$	—



	2014
Description	Total		Level 1		Level 2		Level 3
Financial assets:
Investment securities available for sale:
U.S. government agencies and corporations	$	12,820	$	—	$	12,820	$	—
State and political subdivisions	52,359		—		52,359		—
Collateralized mortgage obligations	125,870		—		125,870		—
Mortgage-backed securities	66,153		—		66,153		—
Trust preferred security	918		—		918		—
Corporate notes and equity securities	14,670		14,370		300		—

Financial liabilities:
Derivative instruments, interest rate swaps	$	261	$	—	$	261	$	—

The following table presents changes in investment securities available for sale with significant unobservable inputs (Level 3) for the years ended December 31, 2015, 2014 and 2013. The activity in the table consists of one pooled trust preferred security, which was sold in December 2014.



Investment securities available for sale:	2015		2014			2013
Beginning balance	$	—	$	1,850		$	1,334
Transfer into Level 3	—		—			—
Total gains or (losses):
Included in earnings	—		(493		)	—
Included in other comprehensive income	—		2,321			516
Sale of security	—		(3,593		)	—
Principal payments	—		(85		)	—
Ending balance	$	—	$	—		$	1,850

Certain assets are measured at fair value on a nonrecurring basis. That is, they are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following tables present those assets carried on the balance sheet by caption and by level within the valuation hierarchy as of December 31, 2015 and 2014.



	2015
Description		Total		Level 1		Level 2		Level 3
Impaired loans		$	98	$	—	$	—	$	98
Other real estate owned		—		—		—		—



	2014
Description		Total		Level 1		Level 2		Level 3
Impaired loans		$	1,266	$	—	$	—	$	1,266
Other real estate owned		2,235		—		—		2,235

Loans in the previous tables consist of impaired loans for which a fair value adjustment was recorded. Impaired loans are evaluated and valued at the lower of cost or fair value when the loan is identified as impaired. Fair value is measured based on the value of the collateral securing these loans. Collateral may be real estate or business assets such as equipment, inventory or accounts receivable. Fair value is determined by management evaluations or independent appraisals. Appraised or reported values may be discounted based on management's opinions concerning market developments or the client's business. Other real estate owned in the tables above consists of property acquired through foreclosures and loan settlements. Property acquired is carried at fair value of the property less estimated disposal costs. Fair value of other real estate owned is determined by management obtaining appraisals or other market value information at the time of acquisition, is updated at least annually and may be discounted.

The following tables present additional quantitative information about assets measured at fair value on a nonrecurring basis for which the Company has utilized Level 3 inputs to determine fair value as of December 31, 2015 and 2014.



	December 31, 2015
	Fair Value		Valuation Technique	Unobservable Input	Range (Average)
Impaired loans	$	98	Evaluation of collateral	Estimation of value	NM*



	December 31, 2014
	Fair Value		Valuation Technique	Unobservable Input	Range (Average)
Impaired loans	$	1,266	Evaluation of collateral	Estimation of value	NM*
Other real estate owned	2,235		Appraisal	Appraisal adjustment	0.0% - 25.0% (25.0%)

* Not Meaningful. Evaluations of the underlying assets are completed for each impaired loan with a specific reserve. The types of collateral vary widely and could include accounts receivable, inventory, a variety of equipment and real estate. Collateral evaluations are reviewed and discounted as appropriate based on knowledge of the specific type of collateral. In the case of real estate, an independent appraisal may be obtained. Types of discounts considered include aging of receivables, condition of the collateral, potential market for the collateral and estimated disposal costs. These discounts will vary from loan to loan, thus providing a range would not be meaningful.

GAAP requires disclosure of the fair value of financial assets and liabilities, including those that are not measured and reported at fair value on a recurring or nonrecurring basis. The methodologies for estimating the fair value of financial assets and liabilities that are measured at fair value on a recurring or nonrecurring basis are discussed above. The methodologies for other financial assets and liabilities are discussed below.

Cash and due from banks: The carrying amount approximates fair value.

Federal funds sold: The carrying amount approximates fair value.

Investment securities held to maturity: The fair values of these securities, which are all state and political subdivisions, are determined by the same method described previously for investment securities available for sale.

FHLB stock: The fair value of this restricted stock is estimated at its carrying value and redemption price of $100 per share.

Loans: The fair values of fixed rate loans are estimated using discounted cash flow analysis based on observable market interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The carrying values of variable rate loans approximate their fair values.

Deposits: The carrying amounts for demand and savings deposits, which represent the amounts payable on demand, approximate their fair values. The fair values for time deposits are estimated using discounted cash flow analysis, based on observable market interest rates currently being offered on time deposits with similar terms.

Accrued interest receivable and payable: The fair values of both accrued interest receivable and payable approximate their carrying amounts.

Borrowings: The carrying amounts of federal funds purchased, short-term borrowings, variable rate FHLB advances and variable rate long-term borrowings approximate their fair values. Fair values of subordinated notes, fixed rate FHLB advances and other long-term borrowings are estimated using a discounted cash flow analysis, based on observable market interest rates currently being offered with similar terms.

Commitments to extend credit and standby letters of credit: The approximate fair values of commitments and standby letters of credit are based on the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and creditworthiness of the counterparties.

The following table presents the carrying amounts and approximate fair values of financial assets and liabilities as of December 31, 2015 and 2014.



		2015				2014
	Fair Value Hierarchy Level	Carrying Amount		Approximate Fair Value		Carrying Amount		Approximate Fair Value
Financial assets:
Cash and due from banks	Level 1	$	57,329	$	57,329	$	27,936	$	27,936
Federal funds sold	Level 1	15,322		15,322		11,845		11,845
Investment securities available for sale	See previous table	320,714		320,714		272,790		272,790
Investment securities held to maturity	Level 2	51,259		51,918		51,343		51,501
Federal Home Loan Bank stock	Level 1	12,447		12,447		15,075		15,075
Loans, net ⁽¹⁾	Level 2	1,231,721		1,235,336		1,170,438		1,199,832
Accrued interest receivable	Level 1	4,688		4,688		4,425		4,425
Financial liabilities:
Deposits	Level 2	$	1,440,729	$	1,440,762	$	1,270,462	$	1,270,987
Federal funds purchased	Level 1	2,760		2,760		2,975		2,975
Short-term borrowings	Level 1	19,000		19,000		66,000		66,000
Subordinated notes	Level 2	20,619		11,908		20,619		13,330
Federal Home Loan Bank advances, net	Level 2	98,385		98,812		96,888		96,312
Long-term debt	Level 2	8,415		8,324		12,676		12,571
Accrued interest payable	Level 1	343		343		419		419
Interest rate swaps	Level 2	774		774		261		261
Off-balance-sheet financial instruments:
Commitments to extend credit	Level 3	—		—		—		—
Standby letters of credit	Level 3	—		—		—		—


(1)	All loans are Level 2 except impaired loans of $98 and $1,266 as of December 31, 2015 and 2014, respectively, which are Level 3.