Fair Value

9 Months Ended

Sep. 30, 2015

Fair Value

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (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. There are three levels of inputs that may be used to measure fair value.

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the Corporation has the ability to access at the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect the Corporation’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

An asset or liability’s level is based on the lowest level of input that is significant to the fair value measurement.

The Corporation used the following methods and significant assumptions to estimate fair value:

Cash and cash equivalents – The carrying value of cash and due from banks and interest earning deposits with banks approximates fair value and are classified as Level 1.

Securities available for sale – The fair value of all investment securities are based upon the assumptions market participants would use in pricing the security. If available, investment securities are determined by quoted market prices (Level 1). Level 1 includes U.S. Treasury, federal agency securities and certain equity securities. For investment securities where quoted market prices are not available, fair values are calculated based on market prices on similar securities (Level 2). Level 2 includes U.S. Government sponsored entities and agencies, mortgage-backed securities, collateralized mortgage obligations, state and political subdivision securities and corporate debt securities. For investment securities where quoted prices or market prices of similar securities are not available, fair values are calculated by using unobservable inputs (Level 3) and may include certain equity securities held by the Corporation. The Level 3 equity security valuations were supported by an analysis prepared by the Corporation which relies on inputs such as the security issuer’s publicly attainable financial information, multiples derived from prices in observed transactions involving comparable businesses and other market, financial and nonfinancial factors.

Loans – The fair value of loans receivable was estimated based on the discounted value of the future cash flows using the current rates being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification.

Impaired loans – At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive a specific allowance for loan losses. For collateral dependent loans, fair value is commonly based on real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly. As of September 30, 2015, the fair value of impaired loans measured using the fair value of collateral consisted of loan balances of $670,000, net of a valuation allowance of $223,000, compared to loan balances of $3.0 million, net of a valuation allowance of $596,000, at December 31, 2014. There was $0 and $235,000 of additional provision for loan losses recorded for impaired loans during the three and nine month periods ended September 30, 2015. There was $41,000 and $707,000 of additional provision for loan losses recorded for impaired loans during the three and nine month periods ended September 30, 2014.

Other real estate owned (OREO) – Assets acquired through or instead of foreclosure are initially recorded at fair value less costs to sell when acquired,

establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals. Management’s ongoing review of appraisal information may result in additional discounts or adjustments to the valuation based upon more recent market sales activity or more current appraisal information derived from properties of similar type and/or locale. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. As of September 30, 2015, OREO measured at fair value less costs to sell had a net carrying amount of $20,000, which was made up of the outstanding balance of $23,000 and write-downs of $3,000. At December 31, 2014, the Corporation had no OREO measured at fair value. There was $0 and $3,000 of expense recorded during the three and nine months ended September 30, 2015 associated with the write-down of OREO, compared to $0 for the same periods in 2014.

Appraisals for both collateral-dependent impaired loans and OREO are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed by the Corporation. Once received, management reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. On an annual basis, the Corporation compares the actual selling price of OREO that has been sold to the most recent appraisal to determine what additional adjustment should be made to the appraisal value to arrive at fair value. The most recent analysis performed indicated that a discount of 10% should be applied.

Federal bank stock – It is not practical to determine the fair value of federal bank stocks due to restrictions placed on its transferability.

Deposits – The fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, checking with interest, savings and money market accounts, is equal to the amount payable on demand resulting in either a Level 1 or Level 2 classification. The fair values of time deposits are based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar maturities resulting in a Level 2 classification.

Borrowings – The fair value of borrowings with the FHLB is estimated using discounted cash flows based on current incremental borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

Accrued interest receivable and payable – The carrying value of accrued interest receivable and payable approximates fair value. The fair value classification is consistent with the related financial instrument.

For assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy are as follows:

(Dollar amounts in thousands)			(Level 1)		(Level 2)
			Quoted Prices in		Significant		(Level 3)
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
Description	Total		Assets		Inputs		Inputs
September 30, 2015:
U.S. Treasury and federal agency	$	1,487	$	1,487	$	-	$	-
U.S. government sponsored entities and agencies		17,245		-		17,245		-
U.S. agency mortgage-backed securities: residential		34,780		-		34,780		-
U.S. agency collateralized mortgage obligations: residential		32,996		-		32,996		-
State and political subdivision		28,061		-		28,061		-
Corporate debt securities		4,007		-		4,007		-
Equity securities		2,748		1,916		-		832
	$	121,324	$	3,403	$	117,089	$	832

December 31, 2014:
U.S. Treasury and federal agency	$	1,456	$	1,456	$	-	$	-
U.S. government sponsored entities and agencies		35,224		-		35,224		-
U.S. agency mortgage-backed securities: residential		38,771		-		38,771		-
U.S. agency collateralized mortgage obligations: residential		36,617		-		36,617		-
State and political subdivisions		33,024		-		33,024		-
Corporate debt securities		1,998		-		1,998		-
Equity securities		2,771		1,873		-		898
	$	149,861	$	3,329	$	145,634	$	898

The Corporation’s policy is to transfer assets or liabilities from one level to another when the methodology to obtain the fair value changes such that there are more or fewer unobservable inputs as of the end of the reporting period. During the three and nine month periods ended September 30, 2015 and 2014, the Corporation had no transfers between levels. The following table presents changes in Level 3 assets measured on a recurring basis for the three and nine month periods ended September 30, 2015 and 2014:

(Dollar amounts in thousands)	Three months ended				Nine months ended
	September 30,				September 30,
	2015		2014		2015		2014
Balance at the beginning of the period	$	835	$	653	$	898	$	653
Total gains or losses (realized/unrealized):		-		-		-		-
Included in earnings		-		-		-		-
Included in other comprehensive income		(3)		-		(66)		-
Issuances		-		-		-		-
Transfers in and/or out of Level 3		-		-		-		-
Balance at the end of the period	$	832	$	653	$	832	$	653

For assets measured at fair value on a non-recurring basis, the fair value measurements by level within the fair value hierarchy are as follows:

(Dollar amounts in thousands)			(Level 1)		(Level 2)
			Quoted Prices in		Significant		(Level 3)
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
Description	Total		Assets		Inputs		Inputs
September 30, 2015:
Impaired commercial business loans	$	447	$	-	$	-	$	447
Other residential real estate owned		20		-		-		20

	$	467	$	-	$	-	$	467

December 31, 2014:
Impaired commercial real estate loans	$	495	$	-	$	-	$	495
Impaired commercial business loans		1,865		-		-		1,865
	$	2,360	$	-	$	-	$	2,360

The following table presents quantitative information about Level 3 fair value measurements for assets measured at fair value on a non-recurring basis:

(Dollar amounts in thousands)		Valuation	Unobservable
		Techniques(s)	Input (s)	Range
September 30, 2015:
Impaired commercial business loans	447	Liquidation value of business assets	Adjustment for differences between comparable business assets		71	%
Other residential real estate owned	20	Sales comparison approach	Adjustment for differences between comparable sales		10	%

December 31, 2014:
Impaired commercial real estate loans	495	Sales comparison approach/ Contractual provision of USDA loan	Adjustment for differences between comparable sales		10	%
Impaired commercial business loans	1,865	Liquidation value of business assets	Adjustment for differences between comparable business assets		44% - 78	%

The two tables above exclude two impaired residential mortgage loans totaling $142,000, an $89,000 impaired commercial real estate loan and a $252,000 impaired commercial business loan classified as TDRs which were measured using a discounted cash flow methodology at September 30, 2015.

The following table sets forth the carrying amount and estimated fair values of the Corporation’s financial instruments included in the consolidated balance sheet as of September 30, 2015 and December 31, 2014:

(Dollar amounts in thousands)

	Carrying		Fair Value Measurements using:
Description	Amount		Total		Level 1		Level 2		Level 3

September 30, 2015:
Financial Assets:
Cash and cash equivalents	$	12,265	$	12,265	$	12,265	$	-	$	-
Securities available for sale		121,324		121,324		3,403		117,089		832
Loans, net		406,044		413,281		-		-		413,281
Federal bank stock		2,182		N/A		N/A		N/A		N/A
Accrued interest receivable		1,595		1,595		41		376		1,178
		543,410		548,465		15,709		117,465		415,291
Financial Liabilities:
Deposits		505,159		506,233		386,395		119,838		-
Borrowed funds		16,400		17,059		-		17,059		-
Accrued interest payable		186		186		7		179		-
		521,745		523,478		386,402		137,076		-

	Carrying		Fair Value Measurements using:
	Amount		Total		Level 1		Level 2		Level 3
December 31, 2014:
Financial Assets:
Cash and cash equivalents	$	11,856	$	11,856	$	11,856	$	-	$	-
Securities available for sale		149,861		149,861		3,329		145,634		898
Loans, net		379,648		385,264		-		-		385,264
Federal bank stock		2,406		N/A		N/A		N/A		N/A
Accrued interest receivable		1,543		1,543		30		434		1,079
		545,314		548,524		15,215		146,068		387,241
Financial Liabilities:
Deposits		501,819		504,230		380,685		123,545		-
Borrowed funds		21,500		22,338		-		22,338		-
Accrued interest payable		199		199		32		167		-
		523,518		526,767		380,717		146,050		-

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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