Fair Value

Management uses its best judgment in estimating the fair value of the Corporation’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Corporation could have realized in a sale transaction or exit price on the date indicated. The estimated fair value amounts have been measured as of their respective dates and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported.

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.


8.	Fair Value (continued)

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 the fair value of each type of financial instrument:

Securities (debt-available for sale, equities) – 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 certain 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 corporate debt and equity securities held by the Corporation. The Level 3 corporate debt securities consist of certain subordinated notes which are priced at par because management has determined that the par value approximates the fair value of these instruments. 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.

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 June 30, 2018 and December 31, 2017, the Corporation did not have any impaired loans carried at fair value measured using the fair value of collateral. There was no additional provision for loan losses recorded for impaired loans during the three and six month periods ended June 30, 2018 and 2017.

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 June 30, 2018 , OREO measured at fair value less costs to sell had a net carrying amount of $157,000, which consisted of the outstanding balance of $168,000 less write-downs of $11,000. As of December 31, 2017, the Corporation did not have any OREO measured at fair value.

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.


8.	Fair Value (continued)

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)		(Level 3)
Description	Total		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
June 30, 2018:
Securities available for sale
U.S. Treasury and federal agency	$	4,411	$	4,411	$	—	$	—
U.S. government sponsored entities and agencies	20,590		—		20,590		—
U.S. agency mortgage-backed securities: residential	22,544		—		22,544		—
U.S. agency collateralized mortgage obligations: residential	20,254		—		20,254		—
State and political subdivision	24,660		—		24,660		—
Corporate debt securities	7,427		—		3,927		3,500
	$	99,886	$	4,411	$	91,975	$	3,500

Equity securities	$	474	$	474	$	—	$	—

December 31, 2017:
Securities available for sale
U.S. Treasury and federal agency	4,472		4,472		—		—
U.S. government sponsored entities and agencies	13,926		—		13,926		—
U.S. agency mortgage-backed securities: residential	20,758		—		20,758		—
U.S. agency collateralized mortgage obligations: residential	21,924		—		21,924		—
State and political subdivisions	29,240		—		29,240		—
Corporate debt securities	9,030		—		1,032		7,998
	$	99,350	$	4,472	$	86,880	$	7,998

Equity securities	$	1,817	$	1,683	$	—	$	134


8.	Fair Value (continued)

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 six month period ended June 30, 2018 the Corporation reclassified a restricted bank stock from the equity security portfolio to other assets and certain corporate securities from Level 3 to Level 2. Also during the three and six month periods, $25,000 in Level 3 equity securities were sold from the portfolio. For the same periods in 2017, 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 six month periods ended June 30, 2018 and 2017:



(Dollar amounts in thousands)	Three months ended June 30,						Six months ended June 30,
	2018			2017			2018			2017
Balance at the beginning of the period	$	3,525		$	136		$	8,132		$	136
Total gains or losses (realized/unrealized):
Included in earnings	—			—			1			—
Included in other comprehensive income	—			(1		)	—			(1		)
Acquired	—			—			—			—
Sold out of Level 3	(25		)	—			(25		)	—
Transfers in and/or out of Level 3	—			—			(4,608		)	—
Balance at the end of the period	$	3,500		$	135		$	3,500		$	135

The Corporation had $157,000 in OREO assets measured at fair value on a non-recurring basis at June 30, 2018 compared to none at December 31, 2017.

The Corporation had an impaired residential mortgage loan totaling $67,000 and an impaired home equity loan totaling $7,000 at June 30, 2018 which were classified as TDRs and measured using a discounted cash flow methodology. At December 31, 2017 these loans were valued at $68,000 and $8,000, respectively.


8.	Fair Value (continued)

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 June 30, 2018 and December 31, 2017:



(Dollar amounts in thousands)
	Carrying		Fair Value Measurements using:
Description	Amount		Total		Level 1		Level 2		Level 3
June 30, 2018:
Financial Assets:
Cash and cash equivalents	$	30,576	$	30,576	$	30,576	$	—	$	—
Securities - available for sale	99,886		99,886		4,411		91,975		3,500
Securities - equities	474		474		474		—		—
Loans held for sale	—		—		—		—		—
Loans, net	587,258		578,642		—		—		578,642
Federal bank stock	4,403		N/A		N/A		N/A		N/A
Accrued interest receivable	2,250		2,250		65		382		1,803
	$	724,847	$	711,828	$	35,526	$	92,357	$	583,945
Financial Liabilities:
Deposits	685,551		687,403		515,638		171,765		—
Borrowed funds	20,050		19,653		—		19,653		—
Accrued interest payable	410		410		32		378		—
	$	706,011	$	707,466	$	515,670	$	191,796	$	—



	Carrying		Fair Value Measurements using:
	Amount		Total		Level 1		Level 2		Level 3
December 31, 2017:
Financial Assets:
Cash and cash equivalents	$	14,374	$	14,374	$	14,374	$	—	$	—
Securities - available for sale	99,350		99,350		4,472		86,880		7,998
Securities - equities	1,817		1,817		1,683		—		134
Loans held for sale	504		504		—		504		—
Loans, net	577,234		577,616		—		—		577,616
Federal bank stock	4,662		—		N/A		N/A		N/A
Accrued interest receivable	2,217		2,217		59		338		1,820
	$	700,158	$	695,878	$	20,588	$	87,722	$	587,568
Financial Liabilities:
Deposits	654,643		657,414		483,956		173,458		—
Borrowed funds	26,000		25,499		—		25,499		—
Accrued interest payable	413		413		23		390		—
	$	681,056	$	683,326	$	483,979	$	199,347	$	—