9.) Fair Value of Assets and Liabilities:

Measurements

The Company groups assets and liabilities recorded at fair value into 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. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement (with level 1 considered highest and level 3 considered lowest). A brief description of each level follows:

Level 1:

Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

Level 2:

Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but which trade less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.

Level 3:

Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where inputs into the determination of fair value require significant management judgment or estimation.

The following table presents the assets reported on the consolidated balance sheets, on a recurring basis, at their fair value as of June 30, 2018 and December 31, 2017 by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

	(Amounts in thousands)
			Fair Value Measurements at June 30, 2018 Using
Description	June 30, 2018		Level 1		Level 2		Level 3
ASSETS
U.S. Government agencies and corporations	$	8,952	$	—	$	8,952	$	—
Obligations of states and political subdivisions		51,781		—		51,781		—
U.S. Government-sponsored mortgage-backed securities		59,458		—		59,458		—
U.S. Government-sponsored collateralized mortgage obligations		12,883		—		12,883		—
U.S. Government-guaranteed small business administration pools		8,464		—		8,464		—
Loans held for sale		2,524		2,524		—		—
Interest rate derivatives		503		—		503		—

LIABILITIES
Interest rate derivatives	$	503	$	—	$	503	$	—

	(Amounts in thousands)
			Fair Value Measurements at December 31, 2017 Using
Description	December 31, 2017		Level 1		Level 2		Level 3
ASSETS
U.S. Government agencies and corporations	$	3,205	$	—	$	3,205	$	—
Obligations of states and political subdivisions		72,116		—		72,116		—
U.S. Government-sponsored mortgage-backed securities		67,668		—		67,668		—
U.S. Government-sponsored collateralized mortgage obligations		6,302		—		6,302		—
U.S. Government-guaranteed small business administration pools		9,655		—		9,655		—
Trust preferred securities		895		—		—		895
Loans held for sale		2,780		2,780		—		—
Interest rate derivatives		185		—		185		—

LIABILITIES
Interest rate derivatives	$	185	$	—	$	185	$	—

The following tables present the changes in the Level 3 fair value category for the three and six months ended June 30, 2018 and 2017. The Company classifies financial instruments in Level 3 of the fair-value hierarchy when there is reliance on at least one significant unobservable input to the valuation model. In addition to these unobservable inputs, the valuation models for Level 3 financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly.

	(Amounts in thousands)
	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2018			2017			2018			2017
	Trust preferred securities			Trust preferred securities			Trust preferred securities			Trust preferred securities
Beginning balance	$	1,090		$	827		$	895		$	825
Net realized/unrealized losses included in:
Noninterest income		—			—			—			—
Other comprehensive income (loss)		528			(10	)		723			(7	)
Discount accretion (premium amortization)		—			—			—			—
Sales		(1,618	)		—			(1,618	)		—
Purchases, issuance, and settlements		—			—			—			(1	)
Ending balance	$	—		$	817		$	—		$	817
Losses included in net income for the period relating to assets held at period end	$	—		$	—		$	—		$	—

The Company conducts OTTI analyses on a quarterly basis. The initial indication of other-than-temporary impairment for both debt and equity securities is a decline in the fair value below the amount recorded for an investment. A decline in value that is considered to be other-than-temporary is recorded as a loss within non-interest income in the consolidated statements of income. In determining whether an impairment is other than temporary, the Company considers a number of factors, including, but not limited to, the length of time and extent to which the market value has been less than cost, recent events specific to the issuer, including investment downgrades by rating agencies and economic conditions of its industry, and a determination that the Company does not intend to sell those investments and it is not more-likely-than-not that the Company will be required to sell the investments before recovery of its amortized cost basis less any current period credit loss. Among the factors that are considered in determining the Company’s intent and ability is a review of its capital adequacy, interest rate risk position and liquidity.

The Company also considers the issuer’s financial condition, capital strength and near-term prospects. In addition, for debt securities the Company considers the cause of the price decline (general level of interest rates and industry- and issuer-specific factors), current ability to make future payments in a timely manner and the issuer’s ability to service debt, the assessment of a security’s ability to recover any decline in market value, the ability of the issuer to meet contractual obligations and the Company’s intent and ability to retain the security. All of the foregoing require considerable judgment.

Trust Preferred Securities

Trust preferred securities, which are accounted for under FASB ASC Topic 325 Investments Other, were held in the investment portfolio until early June 2018. The Company evaluated current available information in estimating the future cash flows of securities and determined whether there had been favorable or adverse changes in estimated cash flows from the cash flows previously projected. The Company considered the structure and term of the pool and the financial condition of the underlying issuers. Specifically, the evaluation incorporated factors such as interest rates and appropriate risk premiums, the timing and amount of interest and principal payments and the allocation of payments to the various note classes. Estimates of cash flows were based on the most recent trustee reports, announcements of deferrals or defaults, expected future default rates and other relevant market information.

The following table details the breakdown of trust preferred securities for the periods indicated:

	(Dollar amounts in thousands)
	June 30, 2018		December 31, 2017
Total number of trust preferred securities		—		2
Par value	$	—	$	1,939

Number not considered OTTI		—		1
Par value	$	—	$	903

Number considered OTTI		—		1
Par value	$	—	$	1,036

Life-to-date impairment recognized in earnings	$	—	$	140
Life-to-date impairment recognized in other comprehensive income		—		723
Total life-to-date impairment	$	—	$	863

The following table details the one debt security with other-than-temporary impairment, its credit ratings at June 30, 2017 and the related losses recognized in earnings:

		(Amounts in thousands)
	Moody’s/Fitch Rating	Amount of OTTI related to credit loss at January 1, 2017		Additions in QTD March 31, 2017		Additions in QTD June 30, 2017		Amount of OTTI related to credit loss at June 30, 2017
Trapeza IX B-1	Caa2/CC	$	140	$	—	$	—	$	140
Total		$	140	$	—	$	—	$	140

The following table provides additional information related to the Company’s trust preferred securities as of December 31, 2017 used to evaluate other-than-temporary impairments:

	(Amounts in thousands)
Deal	Class	Amortized Cost		Fair Value		Unrealized Gain/(Loss)			Moody’s/ Fitch Rating	Number of Issuers Currently Performing		Deferrals and Defaults as a % of Current Collateral			Excess Subordination as a % of Current Performing Collateral
PreTSL XXIII	C-2	$	758	$	336	$	(422	)	Ba1/CCC		90		20.9	%		7.12	%
Trapeza IX	B-1		860		559		(301	)	Caa2/CC		30	14				—
Total		$	1,618	$	895	$	(723	)

The market for these securities at December 31, 2017 was not active and markets for similar securities are also not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which trust preferred securities trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive as new issuance is essentially nonexistent. There are currently very few market participants who are willing and/or able to transact for these securities. The pooled market value for these securities remains very depressed relative to historical levels. Although there has been marked improvement in the credit spread premium in the corporate bond space, only modest improvement has been noted in the market for trust preferred securities.

Given conditions in the debt markets and the absence of observable transactions in the secondary and the new issue markets, the Company determined the following:

●

The few observable transactions and market quotations that are available are not reliable for purposes of determining fair value at December 31, 2017;

●

An income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than the market approach valuation technique used at measurement dates prior to 2008; and

●

The trust preferred securities will be classified within Level 3 of the fair value hierarchy because the Company determined that significant judgments are required to determine fair value at the measurement date.

The Company enlisted the aid of an independent third party to perform the trust preferred security valuations. The approach to determining fair value involved the following process:

Estimate the credit quality of the collateral using average probability of default values for each issuer (adjusted for rating levels).

Consider the potential for correlation among issuers within the same industry for default probabilities (e.g. banks with other banks).

Forecast the cash flows for the underlying collateral and apply to each trust preferred security tranche to determine the resulting distribution among the securities, including prepayment and cures.

Discount the expected cash flows to calculate the present value of the security.

Financial Instruments

The Company discloses fair value information about financial instruments, whether or not recognized in the consolidated balance sheets, for which it is practicable to estimate the value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other estimation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.

Such techniques and assumptions, as they apply to individual categories of the financial instruments, are as follows:

Cash and cash equivalents – The carrying amounts for cash and cash equivalents are a reasonable estimate of those assets’ fair value.

Investment securities available-for-sale– Fair values of securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable securities. Prices on trust preferred securities were calculated using a discounted cash-flow technique. Cash flows were estimated based on credit and prepayment assumptions. The present value of the projected cash flows was calculated using a discount rate equal to the current yield used to accrete the beneficial interest.

Loans held for sale – Loans held for sale consist of residential mortgage loans originated for sale. Loans held for sale are recorded at fair value based on what the secondary markets have offered on best efforts commitments.

Loans, net – Market quotations are generally not available for loan portfolios. In accordance with the prospective adoption of ASU No. 2016-01, the fair value of loans as of June 30, 2018 was measured using an exit price notion, which incorporates adjustments to the discount rate for alternate cost of funds, liquidity premiums and capital and serving charges. The fair value of loans as of December 31, 2017 was measured by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality.

Bank-owned life insurance – The fair value is based upon the cash surrender value of the underlying policies net of any split dollar obligation and matches the book value.

Accrued interest receivable – The carrying amount is a reasonable estimate of these assets’ fair value.

Interest rate derivatives – The fair value is based on settlement values adjusted for credit risks associated with the counter parties and the Company and observable market interest rate curves.

Demand, savings and money market deposits – Demand, savings, and money market deposit accounts are valued at the amount payable on demand.

Time deposits – The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rates are estimated using market rates currently offered for similar instruments with similar remaining maturities.

Short term borrowings – Short term borrowings generally have an original term to maturity of one year or less. Consequently, their carrying value is a reasonable estimate of fair value.

FHLB advances - short term – Short term borrowings generally have an original term to maturity of one year or less. Advances of one month or less are considered to be at fair value. The fair value of notes with one to twelve month terms is based on the discounted value of contractual cash flows. The discount rates are estimated using market rates currently offered for similar instruments with similar remaining maturities.

FHLB advances - long term – The fair value for fixed rate advances is estimated by discounting the future cash flows using rates at which advances would be made to borrowers with similar credit ratings and for the same remaining maturities. The fair value for the fixed rate advances that are convertible to quarterly LIBOR floating rate advances on or after certain specified dates at the option of the FHLB and the FHLB fixed rate advances that are putable on or after certain specified dates at the option of the FHLB are priced using the FHLB of Cincinnati’s model.

Subordinated debt – The floating issuances curves to maturity are averaged to obtain an index. The spread between BBB-rated bank debt and 25-year swap rates is determined to calculate the spread on outstanding trust preferred securities. The discount margin is then added to the index to arrive at a discount rate, which determines the present value of projected cash flows.

Accrued interest payable – The carrying amount is a reasonable estimate of these liabilities’ fair value. The fair value of unrecorded commitments at June 30, 2018 and December 31, 2017 is not material.

In addition, other assets and liabilities of the Company that are not defined as financial instruments are not included in the disclosures, such as property and equipment. Also, non-financial instruments typically not recognized in financial statements nevertheless may have value but are not included in the above disclosures. These include, among other items, the estimated earning power of core deposit accounts, the trained work force, customer goodwill and similar items. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

The carrying amounts and fair values of the Company’s financial instruments are as follows:

	(Amounts in thousands)
	June 30, 2018
	Carrying Amount		Level 1		Level 2		Level 3		Fair Value
ASSETS:
Cash and cash equivalents	$	10,977	$	10,977	$	—	$	—	$	10,977
Investment securities available-for-sale		141,538		—		141,538		—		141,538
Loans held for sale		2,524		2,524		—		—		2,524
Loans		462,353		—		—		466,098		466,098
Bank-owned life insurance		15,550		15,550		—		—		15,550
Accrued interest receivable		2,137		2,137		—		—		2,137
Interest rate derivatives		503		—		503		—		503

LIABILITIES:
Demand, savings and money market deposits	$	439,229	$	439,229	$	—	$	—	$	439,229
Time deposits		118,594		—		—		119,579		119,579
Short term borrowings		1,609		1,609		—		—		1,609
Federal Home Loan Bank advances - short term		11,000		—		—		10,980		10,980
Federal Home Loan Bank advances - long term		16,000		—		—		15,799		15,799
Subordinated debt		5,155		—		—		4,723		4,723
Accrued interest payable		302		302		—		—		302
Interest rate derivatives		503		—		503		—		503

	(Amounts in thousands)
	December 31, 2017
	Carrying Amount		Level 1		Level 2		Level 3		Fair Value
ASSETS:
Cash and cash equivalents	$	19,125	$	19,125	$	—	$	—	$	19,125
Investment securities available-for-sale		159,841		—		158,946		895		159,841
Loans held for sale		2,780		2,780		—		—		2,780
Loans		482,912		—		—		486,230		486,230
Bank-owned life insurance		17,650		17,650		—		—		17,650
Accrued interest receivable		2,193		2,193		—		—		2,193
Interest rate derivatives		185		—		185		—		185

LIABILITIES:
Demand, savings and money market deposits	$	458,562	$	458,562	$	—	$	—	$	458,562
Time deposits		127,289		—		—		128,624		128,624
Short term borrowings		2,678		2,678		—		—		2,678
Federal Home Loan Bank advances - short term		32,000		—		—		31,982		31,982
Federal Home Loan Bank advances - long term		14,000		—		—		13,880		13,880
Subordinated debt		5,155		—		—		4,785		4,785
Accrued interest payable		325		325		—		—		325
Interest rate derivatives		185		—		185		—		185

The following table presents quantitative information about the Level 3 significant unobservable inputs for assets and liabilities measured at fair value on a recurring and nonrecurring basis at December 31, 2017:

	(Amounts in thousands)
	Fair value at December 31, 2017		Valuation Technique	Significant Unobservable Input	Description of Inputs
Trust preferred securities	$	895	Discounted Cash Flow	Projected Prepayments	1) Trust preferred securities issued by banks subject to Dodd-Frank's phase-out of trust preferred securities from Tier 1 Capital. All fixed rate within one year; variable rate at increasing intervals depending on spread. 2) Trust preferred securities issued by healthy, well capitalized banks that have fixed rate coupons greater than 8%. 3) 1% annually for all other fixed rate issues and all variable rate issues. 4) Zero for collateral issued by REITs and 2% for insurance companies.

				Projected Defaults	1) All deferring issuers that do not meet the criteria for curing, as described below, are projected to default immediately. 2) Banks with high, near team default risk are identified using a CAMELS model and projected to default immediately. Healthy banks are projected to default at a rate of 2% annually for 2 years, and 0.36% annually thereafter. 3) Insurance and REIT defaults are projected according to the historical default rates exhibited by companies with the same credit ratings. Historical default rates are doubled in each of the first two years of the projection to account for current economic conditions. Unrated issuers are assumed to have CCC- ratings.

				Projected Cures	1) Deferring issuers that have definitive agreements to either be acquired or recapitalized.

				Projected Recoveries	1) Zero for insurance companies, REITs and insolvent banks, and 10% for projected bank deferrals lagged 2 years.

				Discount Rates	1) Ranging from ~9.10% to ~14.74%, depending on each bond's seniority and remaining subordination after projected losses.

Impaired loans		4,891	Cash Flow	Discount Rates	Range 4.50% to 5.38% Weighted average 4.88%