Note 15 - Fair Values

6 Months Ended

Jun. 30, 2014

Fair Value Disclosures [Abstract]

Fair Value Disclosures [Text Block]

NOTE 15. FAIR VALUES

The following table presents estimated fair values of the Company’s financial instruments as of June 30, 2014, and December 31, 2013, whether or not recognized or recorded at fair value in the Consolidated Balance Sheets. The table indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 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, 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 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 certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’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.

Estimated fair values are disclosed for financial instruments for which it is practicable to estimate fair value. These estimates are made at a specific point in time based on relevant market data and information about the financial instruments. These estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. 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 any of these estimates.

Non-financial assets and non-financial liabilities defined by the FASB ASC 820, Fair Value Measurement, such as Bank premises and equipment, deferred taxes and other liabilities are excluded from the table. In addition, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements of FASB ASC 825, Financial Instruments, such as Bank-owned life insurance policies.

(Dollars in thousands)			Fair Value Measurements Using
June 30, 2014	Carrying Amounts		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	66,745	$	66,745	$	-	$	-	$	66,745
Securities available-for-sale		188,686		-		188,686		-		188,686
Securities held-to-maturity		37,031		-		36,417		-		36,417
Portfolio loans, net		609,740		-		-		613,681		613,681
Federal Home Loan Bank Stock		4,021		4,021		-		-		4,021
Financial liabilities
Deposits	$	755,016	$	-	$	755,500	$	-	$	755,500
Federal Home Loan Bank advances		75,000		-		75,000		-		75,000
Subordinated debenture		15,465		-		8,484		-		8,484
Derivatives		3,420		-		3,420		-		3,420

(Dollars in thousands)			Fair Value Measurements Using
December 31, 2013	Carrying Amounts		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	58,515	$	58,515	$	-	$	-	$	58,515
Securities available-for-sale		216,640		-		216,640		-		216,640
Securities held-to-maturity		36,696		-		34,025		-		34,025
Portfolio loans, net		584,126		-		-		591,315		591,315
Promissory note due from the former mortgage subsidiary		2,607		-		-		2,607		2,607
Federal Home Loan Bank Stock		4,531		4,531		-		-		4,531
Financial liabilities
Deposits	$	746,293	$	-	$	746,332	$	-	$	746,332
Federal Home Loan Bank advances		75,000		-		75,000		-		75,000
Subordinated debenture		15,465		-		8,754		-		8,754
Derivatives		2,890		-		2,890		-		2,890

Fair Value Hierarchy

Level 1 valuations utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.

Level 2 valuations utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 valuations include quoted prices for similar assets and liabilities in active markets, 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 valuations are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. Valuation is generated from model-based techniques that use significant assumptions 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 the use of option pricing models, discounted cash flow models and similar techniques.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety.

The Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when developing fair value measurements. The Company’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.

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

Cash and cash equivalents – The carrying amounts reported in the Consolidated Balance Sheets for cash and cash equivalents are a reasonable estimate of fair value. The carrying amount is a reasonable estimate of fair value because of the relatively short term between the origination of the instrument and its expected realization. Therefore, the Company believes the measurement of fair value of cash and cash equivalents is derived from Level 1 inputs.

Securities – For investment securities, fair values are based on quoted market prices, where available, and are classified as Level 1. If quoted market prices are not available, fair values are estimated using quoted market prices or matrix pricing which is a mathematical technique used widely by the industry that relies on the securities relationship to other benchmark securities and are classified as Level 2.

Portfolio loans, net – For variable rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying values. For fixed rate loans, projected cash flows are discounted back to their present value based on specific risk adjusted spreads to the U.S. Treasury Yield Curve, with the rate determined based on the timing of the cash flows. The ALLL is considered to be a reasonable estimate of loan discount for credit quality concerns. Given that there are commercial loans with specific terms that are not readily available; the Company believes the fair value of portfolio loans is derived from Level 3 inputs.

FHLB stock – The carrying value of FHLB stock approximates fair value as the shares can only be redeemed by the issuing institution at par. The Company measures the fair value of FHLB stock using Level 1 inputs.

Promissory note due from Mortgage Company – To determine the fair value of the promissory note, the Company discounts the expected future cash flows after each payment based on a discount rate derived by the average of the bid/ask yields on debt issued by a large mortgage lender with similar risk characteristics, whose debt is currently traded in an active open market. In addition, a risk premium adjustment was added to incorporate certain inherent risks and credit risks associated with the payment of certain cash flows from the former mortgage subsidiary. Accordingly, the Company derived a 10% discount rate to discount the future expected cash flows over the remaining life of the loan. The Company believes the fair value of the promissory note is derived from Level 3 inputs. See Note 3, Note Receivable in these Notes to Unaudited Consolidated Financial Statements for additional detail on the promissory note due.

Deposits – The Company measures fair value of maturing deposits using Level 2 inputs. The fair values of deposits were derived by discounting their expected future cash flows based on the FHLB yield curves, and maturities. The Company obtained FHLB yield curve rates as of the measurement date, and believes these inputs fall under Level 2 of the fair value hierarchy. Deposits with no defined maturities, the fair values are the amounts payable on demand at the respective reporting date.

FHLB variable rate advances – For variable rate FHLB borrowings, the carrying value approximates fair value. The Company measures the fair value of FHLB advances using Level 2 inputs.

Subordinated debenture – The fair value of the subordinated debenture is estimated by discounting the future cash flows using market rates at the reporting date, of which similar debentures would be issued with similar credit ratings as ours and similar remaining maturities. At June 30, 2014, future cash flows were discounted at 5.93%. The Company measures the fair value of subordinated debentures using Level 2 inputs.

Commitments – Loan commitments and standby letters of credit generate ongoing fees, which are recognized over the term of the commitment period. In situations where the borrower’s credit quality has declined, we record a reserve for these unfunded commitments. Given the uncertainty in the likelihood and timing of a commitment being drawn upon, a reasonable estimate of the fair value of these commitments is the carrying value of the related unamortized loan fees plus the reserve, which is not material. As such, no disclosures are made on the fair value of commitments.

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Available-for-sale securities and derivatives are recorded at fair value on a recurring basis. From time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as collateral dependent impaired loans and certain other assets including OREO. These nonrecurring fair value adjustments involve the application of lower of cost or fair value accounting or write downs of individual assets.

The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value, as of June 30, 2014 and December 31, 2013.

(Dollars in thousands)	Fair Value at June 30, 2014
Recurring basis	Total		Level 1		Level 2		Level 3
Available-for-sale securities
U.S. government and agencies	$	7,787	$	-	$	7,787	$	-
Obligations of states and political subdivisions		55,369		-		55,369		-
Residential mortgage backed securities and collateralized mortgage obligations		45,798		-		45,798		-
Corporate securities		42,166		-		42,166		-
Commercial mortgage backed securities		9,833		-		9,833		-
Other investment securities (1)		27,733		-		27,733		-
Total assets measured at fair value	$	188,686	$	-	$	188,686	$	-
Derivatives – forward starting interest rate swap	$	3,420	$	-	$	3,420	$	-
Total liabilities measured at fair value	$	3,420	$	-	$	3,420	$	-

	Fair Value at December 31, 2013
Recurring basis	Total		Level 1		Level 2		Level 3
Available-for-sale securities
U.S. government and agencies	$	6,264	$	-	$	6,264	$	-
Obligations of states and political subdivisions		59,209		-		59,209		-
Residential mortgage backed securities and collateralized mortgage obligations		62,991		-		62,991		-
Corporate securities		48,230		-		48,230		-
Commercial mortgage backed securities		10,472		-		10,472		-
Other investment securities (1)		29,474		-		29,474		-
Total assets measured at fair value	$	216,640	$	-	$	216,640	$	-
Derivatives – forward starting interest rate swap	$	2,890	$	-	$	2,890	$	-
Total liabilities measured at fair value	$	2,890	$	-	$	2,890	$	-

(1) Principally represents residential mortgage backed securities issued by both by governmental and nongovernmental agencies, and other asset backed securities.

Recurring Items

Debt Securities – The available-for-sale securities amount in the recurring fair value table above represents securities that have been adjusted to their fair values. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions among other things. The Company has determined that the source of these fair values falls within Level 2 of the fair value hierarchy.

Forward starting interest rate swaps – The valuation of the Company’s interest rate swaps were obtained from third party pricing services. The fair values of the interest rate swaps were determined by using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis was based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves. The Company has determined that the source of these derivatives’ fair values falls within Level 2 of the fair value hierarchy.

There were no assets or liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis for the six months ended June 30, 2014 and no transfers in or out of level 3 during the six months ended June 30, 2014. The following table provides a reconciliation of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis for the three and six months ended June 30, 2013. The amount included in the “Beginning balance” column represents the beginning balance of an item in the period for which it was designated as a Level 3 fair value measure.

(Dollars in thousands)	Beginning balance		Transfers into Level 3		Change included in earnings		Purchases and issuances		Sales and settlements			Transfers out			Ending balance		Net change in unrealized gains or (losses) relating to items held at end of period
Three months ended June 30, 2013
Obligations of states and political subdivisions	$	-		-		-		-		-			-		$	-	$	-
Mortgage backed securities	$	750		-		-		-		-			(750	)	$	-	$	-
Six months ended June 30, 2013
Obligations of states and political subdivisions	$	1,131								-			(1,131	)	$	-	$	-
Mortgage backed securities	$	13,747		-		-		-		(749	)		(12,998	)	$	-	$	-

Classification transfers of $1.1 million and $13.7 million in municipal bonds and non-agency mortgage backed securities from Level 2 to Level 3 were made in December 2012. The Company determined the fair values of these securities were derived by both observable and unobservable inputs. Accordingly, a Level 3 classification was deemed necessary. During the three months ended June 30, 2013, the Company transferred $750 thousand associated with one non-agency mortgage backed security from Level 3 to Level 2. During this period the Company was able to obtain observable inputs to determine the securities fair value. During the six months ended June 30, 2013, the Company transferred $1.1 million and $13.0 million in municipal bonds and non-agency mortgage backed securities from Level 3 to Level 2, the Company determined the fair values of these securities were derived from observable inputs.

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. These adjustments to fair value generally result from the application of lower of cost or fair value accounting or write-downs of individual assets due to impairment. The following table presents information about the Company’s assets and liabilities measured at fair value on a nonrecurring basis for which a nonrecurring change in fair value has been recorded during the reporting period. The amounts disclosed below represent the fair values at the time the nonrecurring fair value measurements were made, and not necessarily the fair values as of the date reported upon.

(Dollars in thousands)	Fair Value at June 30, 2014
Nonrecurring basis	Total		Level 1		Level 2		Level 3
Collateral dependent impaired loans	$	17,749	$	0	$	0	$	17,749
Other real estate owned		460		-		-		460
Total assets measured at fair value	$	18,209	$	0	$	0	$	18,209

	Fair Value at December 31, 2013
Nonrecurring basis	Total		Level 1		Level 2		Level 3
Collateral dependent impaired loans	$	2,317	$	0	$	0	$	2,317
Other real estate owned		913		-		-		913
Total assets measured at fair value	$	3,230	$	0	$	0	$	3,230

The following table presents the losses resulting from nonrecurring fair value adjustments for the three and six months ended June 30, 2014 and 2013:

(Dollars in thousands)	Three months ended June 30,				Six months ended June 30,
	2014		2013		2014		2013
Collateral dependent impaired loans	$	892	$	238	$	5,501	$	394
Other real estate owned		-		-		290		3
Total	$	892	$	238	$	5,791	$	397

For the six months ended June 30, 2014:

● Collateral dependent impaired loans with a carrying amount of $23.3 million were written down to their fair value of $17.7 million resulting in a $5.5 million adjustment to the ALLL.

● One OREO property with an carrying value of $750 thousand was written down by $290 thousand to the fair value of $460 in anticipation of its pending sale

The loan amounts above represent impaired, collateral dependent loans that have been adjusted to fair value during the respective reporting period. When we identify a collateral dependent loan as impaired, we measure the impairment using the current fair value of the collateral, less selling costs. Depending on the characteristics of a loan, the fair value of collateral is generally estimated by obtaining external appraisals. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we recognize this impairment and adjust the carrying value of the loan to fair value through the ALLL.

The loss represents charge offs or impairments on collateral dependent loans for fair value adjustments based on the fair value of collateral. The carrying value of loans fully charged off is zero. When the fair value of the collateral is based on a current appraised value, 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. 

The OREO amount above represents impaired real estate that has been adjusted to fair value during the respective reporting period. The loss represents impairments on OREO for fair value adjustments based on the fair value of the real estate. The determination of fair value is generally based on recent appraisals of the foreclosed properties, which take into account recent sales prices adjusted for unobservable inputs, such as opinions provided by local real estate brokers and other real estate experts. The Company records OREO as a nonrecurring Level 3. During the three months ended June 30, 2014 no additional impairment was deemed necessary. During the six months ended June 30, 2014 one OREO property with a carrying value of $750 thousand was written down by $290 thousand to the fair value of $460 in anticipation of its pending sale

Limitations – Fair value estimates are made at a specific point in time, based on relevant market information and other 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. Because no market exists for a significant 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, involve uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on current on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial assets or liabilities include deferred tax assets and liabilities, and property, plant and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.