Note 20. Fair Values of Assets and Liabilities

FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820 requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs and also establishes a fair value hierarchy that prioritizes the valuation inputs into three broad levels. 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 or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3—Valuation is determined using model-based techniques with significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of third party pricing services, option pricing models, discounted cash flow models and similar techniques.

FASB ASC 825, Financial Instruments, allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Company has not made any material FASB ASC 825 elections as of December 31, 2019.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The Company utilizes fair value measurements to record adjustments to certain assets to determine fair value disclosures. Securities available for sale and the cash flow hedge are recorded at fair value on a recurring basis. The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis (dollars in thousands):


	December 31, 2019
	Total		Level 1		Level 2		Level 3
Investment securities available for sale
U.S. Treasury securities	$	—	$	—	$	—	$	—
U.S. Government agencies		21,936		—		21,936		—
State, county and municipal		98,592		10,072		88,520		—
Mortgage backed securities		48,740		1,181		47,559		—
Asset backed securities		11,604		—		11,604		—
Corporate bonds		6,097		—		6,097		—
Total investment securities available for sale		186,969		11,253		175,716		—
Total assets at fair value	$	186,969	$	11,253	$	175,716	$	—
Cash flow hedge liability	$	44		—	$	44		—
Total liabilities at fair value	$	44	$	—	$	44	$	—


	December 31, 2018
	Total		Level 1		Level 2		Level 3
Investment securities available for sale
U.S. Treasury securities	$	13,124	$	1,479	$	11,645	$	—
U.S. Government agencies		24,609		2,178		22,431		—
State, county and municipal		112,542		2,644		109,898		—
Mortgage backed securities		46,417		3,496		42,921		—
Asset backed securities		5,411		—		5,411		—
Corporate bonds		4,623		—		4,623		—
Total investment securities available for sale		206,726		9,797		196,929		—
Cash flow hedge asset		253		—		253		—
Total assets at fair value	$	206,979	$	9,797	$	197,182	$	—
Total liabilities at fair value	$	—	$	—	$	—	$	—

Investment securities available for sale

Investment securities available for sale are recorded at fair value each reporting period. Fair value measurement is based upon quoted prices, if available (Level 1). 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 2).

The Company utilizes a third party vendor to provide fair value data for purposes of determining the fair value of its available for sale securities portfolio. The third party vendor uses reputable pricing companies for security market data. The third party vendor has controls in place for month-to-month market checks and zero pricing, and a Statement on Standards for Attestation Engagements No. 18 report is obtained from the third party vendor on an annual basis. The Company makes no adjustments to the pricing service data received for its securities available for sale.

Cash flow hedge

The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The Company is also required to measure and recognize certain other financial assets at fair value on a nonrecurring basis on the consolidated balance sheet. The following tables present assets measured at fair value on a nonrecurring basis for the years ended December 31, 2019 and 2018 (dollars in thousands):


	December 31, 2019
	Total		Level 1		Level 2		Level 3
Impaired loans	$	3,020	$	—	$	—	$	3,020
Loans held for sale		501		—		501		—
Bank premises and equipment held for sale		1,589		—		—		1,589
Other real estate owned		4,527		—		—		4,527
Total assets at fair value	$	9,637	$	—	$	501	$	9,136
Total liabilities at fair value	$	—	$	—	$	—	$	—


	December 31, 2018
	Total		Level 1		Level 2		Level 3
Impaired loans	$	9,343	$	—	$	—	$	9,343
Loans held for sale		146		—		146		—
Bank premises and equipment held for sale		1,252		—		—		1,252
Other real estate owned		1,099		—		—		1,099
Total assets at fair value	$	11,840	$	—	$	146	$	11,694
Total liabilities at fair value	$	—	$	—	$	—	$	—

Impaired loans

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 the impairment in accordance with FASB ASC 310, Receivables. The fair value of impaired loans is estimated using one of several methods, including collateral 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 exceeds the recorded investments in such loans. At December 31, 2019 and December 31, 2018, a majority of total impaired loans were evaluated based on the fair value of the collateral. The Company frequently obtains appraisals prepared by external professional appraisers for classified loans greater than $250,000 when the most recent appraisal is greater than 18 months old and deemed to be stale or invalid. The Company may also utilize internally prepared estimates that generally result from current market data and actual sales data related to the Company’s collateral. When the fair value of the collateral is based on an observable market price or a current appraised value without further adjustment for unobservable inputs, the Company records the impaired loan within Level 2.

The Company may also identify collateral deterioration based on current market sales data, including price and absorption, as well as input from real estate sales professionals and developers, county or city tax assessments, market data and on-site inspections by Company personnel. When management determines that the fair value of the collateral is further impaired below the appraised value, due to such things as absorption rates and market conditions, and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. In instances where an appraisal received subsequent to an internally prepared estimate reflects a higher collateral value, management does not revise the carrying amount. Impaired loans can also be evaluated for impairment using the present value of expected future cash flows discounted at the loan’s effective interest rate. The measurement of impaired loans using future cash flows discounted at the loan’s effective interest rate rather than the market rate of interest is not a fair value measurement and is therefore excluded from fair value disclosure requirements. Reviews of classified loans are performed by management on a quarterly basis.

Loans held for sale

The carrying amounts of loans held for sale approximate fair value (Level 2).

Bank premises and equipment held for sale

The fair value of bank premises and equipment held for sale was determined using the adjusted appraisal methodology described in the other real estate owned (OREO) asset section below.

Other real estate owned

OREO assets are adjusted to fair value less estimated disposal costs upon transfer of the related loans to OREO property establishing a new cost basis. Subsequent to the transfer, valuations are periodically performed by management and the assets are carried at the lower of carrying value or fair value less estimated disposal costs. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset within Level 2. When an appraised value is not available or management determines that the fair value of the collateral is further impaired below the appraised value due to such things as absorption rates and market conditions, the Company records the foreclosed asset within Level 3 of the fair value hierarchy.

Fair Value of Financial Instruments

FASB ASC 825, Financial Instruments, requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring or nonrecurring basis. FASB ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. Additionally, in accordance with FASB ASU 2016‑01, which the Company adopted on January 1, 2018 on a prospective basis, the Company uses the exit price notion, rather than the entry price notion, in calculating fair values of financial instruments not measured at fair value on a recurring basis.

The following reflects the fair value of financial instruments, whether or not recognized on the consolidated balance sheet, at fair value measures by level of valuation assumptions used for those assets. These tables exclude financial instruments for which the carrying value approximates fair value (dollars in thousands):


	December 31, 2019
			Estimated Fair
	Carrying Value		Value		Level 1		Level 2		Level 3
Financial assets:
Securities held to maturity	$	35,733	$	36,633	$	—	$	36,633	$	—
Loans, net of allowance		1,049,894		1,041,671		—		—		1,041,671
PCI loans, net of allowance		32,372		38,982		—		—		38,982

Financial liabilities:
Interest bearing deposits		984,864		985,853		—		985,853		—
Borrowings		72,624		72,457		—		72,457		—


	December 31, 2018
			Estimated Fair
	Carrying Value		Value		Level 1		Level 2		Level 3
Financial assets:
Securities held to maturity	$	42,108	$	42,253	$	—	$	42,253	$	—
Loans, net of allowance		984,722		978,778		—		—		978,778
PCI loans, net of allowance		38,129		42,674		—		—		42,674

Financial liabilities:
Interest bearing deposits		999,889		997,714		—		997,714		—
Borrowings		63,571		63,393		—		63,393		—