Note 7. Fair Value Measurements

Determination of Fair Value

The Company follows ASC 820, “Fair Value Measurements and Disclosures,” to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. This codification clarifies that the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. 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. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured 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.

Level 1 –	Valuation is based on quoted prices in active markets for identical assets and liabilities.

Level 2 –	Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.

Level 3 –	Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the consolidated financial statements:

Securities available for sale

Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).

The following tables present the balances measured at fair value on a recurring basis as of September 30, 2015 and December 31, 2014 (dollars in thousands):

				Fair Value Measurements at September 30, 2015 Using:
				Quoted Prices in		Significant Other			Significant
				Active Markets for		Observable			Unobservable
				Identical Assets		Inputs			Inputs
Description	Balance			(Level 1)		(Level 2)			(Level 3)
Assets:
U.S. Government agencies	$	19,942	$		-	$	19,942	$		-
Corporate bonds		11,139			-		11,139			-
Asset-backed securities		2,098			-		2,098			-
Mortgage-backed securities/CMOs		59,586			-		59,586			-
Municipal bonds		22,695			-		22,695			-
Total securities available for sale	$	115,460	$		-	$	115,460	$		-

				Fair Value Measurements at December 31, 2014 Using:
				Quoted Prices in		Significant Other			Significant
				Active Markets for		Observable			Unobservable
				Identical Assets		Inputs			Inputs
Description	Balance			(Level 1)		(Level 2)			(Level 3)
Assets:
U.S. Government agencies	$	31,528	$		-	$	31,528	$		-
Corporate bonds		21,276			-		21,276			-
Asset-backed securities		2,105			-		2,105			-
Mortgage-backed securities/CMOs		63,220			-		63,220			-
Municipal bonds		23,687			-		23,687			-
Total securities available for sale	$	141,816	$		-	$	141,816	$		-

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write downs of individual assets. The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the consolidated financial statements:

Impaired Loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected when due. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3.

The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business' financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3).

Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income. The Company had $1.685 million and $1.697 million in impaired loans as of September 30, 2015 and December 31, 2014, respectively. None of these impaired loans required a valuation allowance after consideration was given for each borrowing as to the fair value of the collateral on the loan or the present value of expected future cash flows from the customer.

Other Real Estate Owned

Other real estate owned (“OREO”) is measured at fair value less cost to sell, based on an appraisal conducted by an independent, licensed appraiser outside of the Company. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. OREO is measured at fair value on a nonrecurring basis. Any initial fair value adjustment is charged against the Allowance for Loan Losses. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense on the Consolidated Statements of Income.

The following table presents the Company's assets that were measured at fair value on a nonrecurring basis as of September 30, 2015 and December 31, 2014 (dollars in thousands):

Fair Value Measurements at September 30, 2015 Using:

Significant

Quoted Prices in

Other

Significant

Active Markets for

Observable

Unobservable

Identical Assets

Inputs

Description

Balance

(Level 1)

(Level 2)

(Level 3)

Assets:

Other Real Estate Owned

540

Fair Value Measurements at December 31, 2014 Using:

Significant

Quoted Prices in

Other

Significant

Active Markets for

Observable

Unobservable

Identical Assets

Inputs

Description

Balance

(Level1

)

(Level2

)

(Level3

)

Assets:

Other Real Estate Owned

1,177

For the assets measured at fair value on a nonrecurring basis as of September 30, 2015, the following table displays quantitative information about Level 3 Fair Value Measurements (dollars in thousands):

Weighted

Description

Fair Value

Valuation Technique

Unobservable Inputs

Average

Assets:

Other Real Estate Owned

540

Market comparables

Discount applied to contract price *

6.0

^*A discount percentage is applied to the amount of the pending contract for sale, based on cost to sell.

ASC 825, “Financial Instruments”, requires disclosures about fair value of financial instruments for interim periods and excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

Cash and cash equivalents

For those short-term instruments, including cash, due from banks, federal funds sold and interest-bearing deposits maturing within ninety days, the carrying amount is a reasonable estimate of fair value.

Securities

Fair values for securities, excluding restricted securities, are based on third party vendor pricing models. The carrying value of restricted securities consists of stock in FRB, FHLB, and CBBFC and is based on the redemption provisions of each entity and therefore excluded from the following table.

Loans

The fair value of performing loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar remaining maturities. This calculation ignores loan fees and certain factors affecting the interest rates charged on various loans, such as the borrower's creditworthiness and compensating balances and dissimilar types of real estate held as collateral. The fair value of impaired loans is measured as described within the Impaired Loans section of this note.

Bank owned life insurance

The carrying amounts of bank owned life insurance approximate fair value.

Accrued interest

The carrying amounts of accrued interest approximate fair value.

Deposit liabilities

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 by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.

Securities sold under agreements to repurchase

The carrying amounts of securities sold under agreements to repurchase approximate fair value.

Off-balance sheet financial instruments

Fair values for off-balance-sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. For the reporting period, the fair value of unfunded loan commitments and standby letters of credit were deemed to be immaterial and therefore, they have not been included in the following tables.

The carrying values and estimated fair values of the Company's financial instruments as of September 30, 2015 and December 31, 2014 are as follows (dollars in thousands):

			Fair Value Measurement at September 30, 2015 using:
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
	Carrying value		Level 1		Level 2		Level 3		Fair Value
Assets
Cash and cash equivalent	$	17,464	$	17,464	$	-	$	-	$	17,464
Available for sale securities		115,460		-		115,460		-		115,460
Loans, net		386,585		-		-		379,167		379,167
Bank owned life insurance		13,364		-		13,364		-		13,364
Accrued interest receivable		1,299		-		467		832		1,299
Liabilities
Demand deposits and
interest-bearing transaction
and money market accounts	$	358,813	$	-	$	358,813	$	-	$	358,813
Certificates of deposit		112,832		-		115,914		-		115,914
Securities sold under
agreements to repurchase		19,436		-		19,436		-		19,436
Accrued interest payable		111		-		111		-		111


			Fair Value Measurement at December 31, 2014 using:
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
		Carrying value		Level 1		Level 2		Level 3		Fair Value
Assets
Cash and cash equivalent	$	54,107	$	54,107	$	-	$	-	$	54,107
Available for sale securities		141,816		-		141,816		-		141,816
Loans, net		310,090		-		-		310,806		310,806
Bank owned life insurance		13,034		-		13,034		-		13,034
Accrued interest receivable		1,296		-		566		730		1,296
Liabilities
Demand deposits and
interest-bearing transaction
and money market accounts	$	339,625	$	-	$	339,625	$	-	$	339,625
Certificates of deposit		117,094		-		117,189		-		117,189
Securities sold under
agreements to repurchase		17,995		-		17,995		-		17,995
Accrued interest payable		117		-		117		-		117

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company's financial instruments will change when interest rate levels change, and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk; however, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company's overall interest rate risk.