NOTE O – FAIR VALUE MEASUREMENTS

ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 does not require any new fair value measurements, but clarifies and standardizes some divergent practices that have emerged since prior guidance was issued. ASC 820 creates a three-level hierarchy under which individual fair value estimates are to be ranked based on the relative reliability of the inputs used in the valuation.

Fair value estimates are made at a specific moment in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Fair Value Hierarchy

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flows models and similar techniques.

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

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include U.S. government agencies – GSE’s, mortgage-backed securities issued by GSE’s, corporate bonds and municipal bonds. Valuation techniques are consistent with methodologies used in prior periods.

The following tables summarize quantitative disclosures about the fair value measurement for each category of assets carried at fair value on a recurring basis as of December 31, 2019 and December 31, 2018 (dollars in thousands):


			Quoted Prices in		Significant
Investment securities			Active Markets		Other		Significant
available for sale			for Identical		Observable		Unobservable
December 31, 2019	Fair value		Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)
U.S. government agencies – GSE’s	$	9,996	$	—	$	9,996	$	—
Mortgage-backed securities – GSE’s		47,743		—		47,743		—
Corporate Bonds		2,299		—		2,299		—
Municipal bonds		12,329		—		12,329		—
Total investment available for sale	$	72,367	$	—	$	72,367	$	—


			Quoted Prices in		Significant
Investment securities			Active Markets		Other		Significant
available for sale			for Identical		Observable		Unobservable
December 31, 2018	Fair value		Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)
U.S. government agencies – GSE’s	$	9,837	$	—	$	9,837	$	—
Mortgage-backed securities – GSE’s		22,983		—		22,983		—
Corporate Bonds		1,722		—		1,722		—
Municipal bonds		16,991		—		16,991		—
Total investment available for sale	$	51,533	$	—	$	51,533	$	—

The following are descriptions of valuation methodologies used for assets and liabilities recorded at fair value on a non-recurring basis.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and a specific reserve in the allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with ASC 310, “Receivables”. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, or liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2019, and 2018, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. Impaired loans where a specific reserve is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. There were no transfers between levels from prior reporting periods. Valuation techniques are consistent with prior periods.

The significant unobservable inputs used in the fair value measurement of the Company’s impaired loans range between 1 – 50% and 5 – 50% discount from appraisals for expected liquidation and sales costs at December 31, 2019 and 2018.

Foreclosed Real Estate

Foreclosed real estate are properties recorded at estimated fair value, less the estimated costs to sell, at the date of foreclosure. Inputs include appraised values on the properties or recent sales activity for similar assets in the property’s market adjusted by discounts as determined by the Company. Therefore, foreclosed real estate is classified within Level 3 of the hierarchy. Valuation techniques are consistent with prior periods.

The significant unobservable input used in the fair value measurement of the Company’s foreclosed real estate range between 6% – 10% discount from appraisals for expected liquidation and sales costs at both December 31, 2019 and 2018, respectively.

Assets held for sale

During 2015, a branch facility was taken out of service as part of the Company’s branch restructuring plan and reclassified as held for sale. The property is recorded at the remaining book balance of the asset or an estimated fair value less estimated selling costs, whichever is less. Inputs include appraised values on the properties or recent sales activity for similar assets in the property’s market. The significant unobservable input used is the discount applied to appraised values to account for expected liquidation and selling costs ranged between 1% and 25 % at December 31, 2018. The branch was sold in 2019.

The following tables summarize quantitative disclosures about the fair value measurement for each category of assets carried at fair value on a nonrecurring basis as of December 31, 2019 and December 31, 2018 (dollars in thousands):


			Quoted Prices in		Significant
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
Asset Category December 31, 2019	Fair value		Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)

Impaired loans	$	5,941	$	—	$	—	$	5,941
Foreclosed real estate		3,533		—		—		3,533
Total	$	9,474	$	—	$	—	$	9,474


			Quoted Prices in		Significant
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
Asset Category December 31, 2018	Fair value		Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)
Impaired loans	$	7,257	$	—	$	—	$	7,257
Assets held for sale		668		—		—		668
Foreclosed real estate		1,088		—		—		1,088
Total	$	9,013	$	—	$	—	$	9,013

As of December 31, 2019, the Bank identified $11.2 million in impaired loans, of which $5.9 million were carried at fair value on a non-recurring basis which included $972,000 in loans that required a specific reserve of $413,000, and an additional $438,000 in other loans without specific reserves that had partial charge-offs. As of December 31, 2018, the Bank identified $11.7 million in impaired loans, of which $7.3 million were carried at fair value on a non-recurring basis which included $291,000 in loans that required a specific reserve of $87,000, and an additional $595,000 in other loans without specific reserves that had partial charge-offs.

Financial instruments include cash and due from banks, interest-earning deposits with banks, investments, loans, deposit accounts and borrowings. Due to the nature of the Company’s business, a significant portion of its assets and liabilities consist of financial instruments, the estimated values of which are disclosed. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no active market readily exists for a portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

The following table presents the carrying values and estimated fair values of the Company’s financial instruments at December 31, 2019 and 2018:


	December 31, 2019
	Carrying		Estimated
	Amount		Fair Value		Level 1		Level 2		Level 3
	(dollars in thousands)
Financial assets:
Cash and due from banks	$	19,110	$	19,110	$	19,110	$	—	$	—
Interest-earning deposits in other banks		50,920		50,920		50,920		—		—
Federal funds sold		9,047		9,047		9,047		—		—
Investment securities available for sale		72,367		72,367		—		72,367		—
Loans held for sale		928		928		—		928		—
Loans, net		1,021,651		1,016,239		—		—		1,016,239
Accrued interest receivable		4,189		4,189		—		4,189		—
Stock in the FHLB		3,045		3,045		—		—		3,045
Other non-marketable securities		719		719		—		—		719

Financial liabilities:
Deposits	$	992,838	$	995,056	$	—	$	995,056	$	—
Long-term debt		57,372		55,429		—		55,429		—
Accrued interest payable		578		578		—		578		—


	December 31, 2018
	Carrying		Estimated
	Amount		Fair Value		Level 1		Level 2		Level 3
	(dollars in thousands)
Financial assets:
Cash and due from banks	$	17,059	$	17,059	$	17,059	$	—	$	—
Certificates of deposits		1,000		1,000		1,000		—		—
Interest-earning deposits in other banks		121,303		121,303		121,303		—		—
Investment securities available for sale		51,533		51,533		—		51,533		—
Loans held for sale		580		580		—		580		—
Loans, net		977,371		970,330		—		—		970,330
Accrued interest receivable		3,889		3,889		—		3,889		—
Stock in the FHLB		3,283		3,283		—		—		3,283
Other non-marketable securities		762		762		—		—		762
Assets held for sale		668		668		—		—		668

Financial liabilities:
Deposits	$	980,427	$	979,570	$	—	$	979,570	$	—
Short-term debt		7,000		7,000		—		7,000		—
Long-term debt		57,372		55,504		—		55,504		—
Accrued interest payable		667		667		—		667		—