NOTE 12 – FAIR VALUE MEASUREMENTS

ASC Topic 820, Fair Value Measurements and Disclosures defines fair values, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This accounting standard applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements. The standard also emphasizes that fair value (i.e., the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date), among other things, is based on exit price versus entry price, should include assumptions about risk such as nonperformance risk in liability fair values, and is a market-based measurement, not an entity-specific measurement. When considering the assumptions that market participants would use in pricing an asset or liability, this accounting standard establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

The fair value hierarchy prioritizes inputs used to measure fair value into three broad levels.

Level 1 inputs – In general, fair values determined by Level 1 inputs use quoted market prices in active markets for identical assets or liabilities that we have the ability to access.

Level 2 inputs – Fair values determined by Level 2 inputs use inputs other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets where there are few transactions and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs – Level 3 inputs are unobservable inputs for the asset or liability and include situations where there is little, if any, market activity for the asset or liability.

In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Bank’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

Some assets and liabilities, such as securities available-for-sale, are measured at fair value on a recurring basis under accounting principles generally accepted in the United States. Other assets and liabilities, such as impaired loans, may be measured at fair value on a nonrecurring basis.

Following is a description of the Bank’s valuation methodology and significant inputs used for each asset and liability measured at fair value on a recurring or nonrecurring basis.

Securities available-for-sale – Securities available-for-sale may be classified as Level 1 or Level 2 measurements within the fair value hierarchy. Level 1 securities include equity securities traded on a national exchange. The fair value measurements of Level 1 securities are based on the quoted market price of those securities. Level 2 securities include U.S. government and agency securities, obligations of states and political subdivisions, corporate debt securities and mortgage-related securities. The fair value measurements of Level 2 securities are obtained from independent pricing services and are based on recent sales of similar securities and other observable market data.

Impaired loans – Loans are not measured at fair value on a recurring basis. However, loans determined to be impaired may be measured at fair value on a nonrecurring basis. The fair value measurements of collateral-dependent impaired loans are based on the fair values of the underlying collateral. Independent appraisals are obtained to determine the fair values of underlying collateral, and generally utilize one or more valuation methodologies, typically includes comparable sales and income approaches. Management routinely evaluates the fair value measurements of independent appraisers and adjusts those valuations based on differences noted between actual selling prices of collateral and the most recently appraised value. Such adjustments are usually significant, which results in a Level 3 classification. All other impaired loan measurements are based on the present value of expected future cash flows discounted at the applicable effective interest rate and are not considered fair value measurements.

Assets measured at fair value on a recurring basis are summarized below, along with the level of the fair value hierarchy of the inputs utilized to determine such fair value.


			Recurring Fair Value Measurements Using
	September 30, 2018		Level 1		Level 2		Level 3
	(in thousands)
Securities available-for-sale:
Obligations of states and political subdivisions	$	11,201	$	—	$	11,201	$	—
Government-sponsored mortgage-backed securities		51,136		—		51,136		—
Corporate collateralized mortgage obligations		439		—		439		—
Asset-backed securities		3,853		—		3,853		—
Corporate bonds		—		—		—		—
Certificates of deposit		246		—		246		—


			Recurring Fair Value Measurements Using
	December 31, 2017		Level 1		Level 2		Level 3
	(in thousands)
Securities available-for-sale:
Obligations of states and political subdivisions	$	20,630	$	—	$	20,630	$	—
Government-sponsored mortgage-backed securities		60,024		—		60,024		—
Corporate collateralized mortgage obligations		702		—		702		—
Asset-backed securities		4,832		—		4,832		—
Corporate bonds		1,251		—		1,251		—
Certificates of deposit		1,516		—		1,516		—

Assets measured at fair value on a nonrecurring basis are summarized below, along with the level of the fair value hierarchy of the inputs utilized to determine such fair value.


			Recurring Fair Value Measurements Using
	September 30, 2018		Level 1		Level 2		Level 3
	(in thousands)
Loans	$	85	$	—	$	—	$	85


			Recurring Fair Value Measurements Using
	December 31, 2017		Level 1		Level 2		Level 3
	(in thousands)
Loans	$	148	$	—	$	—	$	148

Loans with a carrying amount of $97 were considered impaired and written down to their estimated fair value of $85 as of September 30, 2018. As a result, the Bank recognized a specific valuation allowance against these impaired loans totaling $12 as of September 30, 2018. Loans with a carrying amount of $378 were considered impaired and were written down to their estimated fair value of $148 as of December 31, 2017. As a result, the Bank recognized a specific valuation allowance against these impaired loans totaling $230 as of December 31, 2017.

The following table presents quantitative information about nonrecurring Level 3 fair value measurements:


	September 30, 2018
	Fair Value		Valuation Technique	Unobservable Input(s)	Range/Weighted Average
	(dollars in thousands)
Impaired loans	$	85	Market and/or income approach	Management discount to appraised rates	10-20%


	December 31, 2017
	Fair Value		Valuation Technique	Unobservable Input(s)	Range/Weighted Average
	(dollars in thousands)
Impaired loans	$	148	Market and/or income approach	Management discount to appraised rates	10-20%

The Bank estimates fair values for all financial instruments, regardless of whether such instruments are measured at fair value. The following methods and assumptions were used by the Bank to estimate fair value of financial instruments not previously discussed.

Cash and cash equivalents – Fair value approximates the carrying value.

Loans held-for-sale – Fair value is based on commitments on hand from investors or prevailing market prices.

Loans – Fair values of variable rate loans that reprice frequently are based on carrying values. Fair values of other loans are estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings. Fair values of impaired and other nonperforming loans are estimated using discounted expected future cash flows or the fair value of the underlying collateral, as applicable.

Accrued interest receivable and payable – Fair value approximates the carrying value.

Cash surrender value of bank-owned life insurance – Fair value is based on third-party reported values of the assets.

Federal Home Loan Bank stock – Fair value is the redeemable (carrying) value based on the redemption provisions of the Federal Home Loan Bank of Chicago.

Deposits and advance payments by borrowers for taxes and insurance – Fair values of deposits with no stated maturity, such as demand deposits, savings and money market accounts, including advance payments by borrowers for taxes and insurance, by definition, are the amounts payable on demand on the reporting date. Fair values of fixed rate time deposits are estimated using discounted cash flows applying interest rates currently being offered on similar time deposits.

Federal Home Loan Bank advances – Fair value of fixed rate, fixed term borrowings are estimated by discounting future cash flows using the current rates at which similar borrowings would be made. Fair values of borrowings with variable rates, or maturing within 90 days, approximate the carrying values of those borrowings.

Commitments – These financial instruments are not generally marketable or subject to sale. Further, interest rates on any amounts drawn under these financial instruments would generally be established at market rates at the time of the draw(s). Fair values of the Bank’s commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the counterparty’s credit rating and discounted cash flow analyses. The fair values of the Bank’s commitments were not material at September 30, 2018 and December 31, 2017. The contractual amounts of commitments are presented in Note 9.

The carrying values and estimated fair values of financial instruments are presented below:


	September 30, 2018
	Carrying Value		Level 1		Level 2		Level 3
	(in thousands)
Financial assets:
Cash and cash equivalents	$	8,956	$	8,956	$	—	$	—
Securities available-for-sale		66,875		—		66,875		—
Loans held-for-sale		901		—		901		—
Loans		369,973		—		—		363,923
Accrued interest receivable		1,223		1,223		—		—
Cash surrender value of bank-owned life insurance		13,302		—		—		13,302
Federal Home Loan Bank stock		1,525		—		—		1,525
Financial liabilities:
Deposits		392,296		204,772		—		185,493
Advance payments made to borrowers for taxes and insurance		10,571		10,571		—		—
Federal Home Loan Bank advances		36,668		—		—		36,119
Accrued interest payable		343		343		—		—


	December 31, 2017
	Carrying Value		Level 1		Level 2		Level 3
	(in thousands)
Financial assets:
Cash and cash equivalents	$	12,497	$	12,497	$	—	$	—
Securities available-for-sale		88,955		—		88,955		—
Loans held-for-sale		217		—		217		—
Loans		331,206		—		—		328,526
Accrued interest receivable		1,214		1,214		—		—
Cash surrender value of bank-owned life insurance		13,732		—		—		13,732
Federal Home Loan Bank stock		1,436		—		—		1,436
Financial liabilities:
Deposits		389,291		203,048		—		185,758
Advance payments made to borrowers for taxes and insurance		385		385		—		—
Federal Home Loan Bank advances		34,693		—		—		34,229
Accrued interest payable		340		340		—		—

The fair value of a financial instrument is the current amount that would be exchanged between market participants, other than in a forced liquidation. Fair value is best determined based on quoted market prices. However, in many instances, there are no quoted market prices for the Bank’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. Consequently, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Bank.

Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates to not reflect any premium or discount that could result from offering for sale at one time the Bank’s entire holdings of a particular instrument. Because no market exists for a significant portion of the Bank’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 that could affect the estimates. Fair value estimates are based on existing on- and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business.

Deposits with no stated maturities are defined as having a fair value equivalent to the amount payable on demand. This prohibits adjusting fair value derived from retaining those deposits for an expected future period of time. This component, commonly referred to as a deposit base intangible, is neither considered in the above amounts, nor is it recorded as an intangible assets on the balance sheets. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.