Fair Value Measurements

6 Months Ended

Jun. 30, 2016

Fair Value Disclosures [Abstract]

Fair Value Measurements

Note 4 – Fair Value Measurements

Fair value is the exchange price that would be received to sell 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 at the measurement date. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair values:

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

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted market 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 a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

In determining the appropriate levels, the Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on matrix pricing which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities relationship to other benchmark quoted securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other non-observable market indicators (Level 3). The fair values of Level 3 investment securities are determined by an independent third party. These valuations are then reviewed by the Company’s Controller and Chief Accounting Officer. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Interest Rate Swap Derivatives: The fair value of interest rate swap derivatives is determined based on discounted cash flow valuation models using observable market data as of the measurement date (Level 2 inputs). The fair value adjustment is included in other liabilities.

Mortgage Banking Derivatives: The fair value of mortgage banking derivatives is determined by individual third party sales contract prices for the specific loans held at each reporting period end (Level 2 inputs). The fair value adjustment is included in other assets.

Loans Held for Sale: Loans held for sale are carried at fair value, as determined by outstanding commitments, from third party investors (Level 2).

Impaired Loans: The fair value of collateral dependent impaired loans is generally based on recent 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 appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and 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 Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated 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. The fair value of other real estate owned is generally based on recent 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 appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Appraisals for both collateral dependent impaired loans and other real estate owned are performed by certified general appraisers, certified residential appraisers or state licensed appraisers whose qualifications and licenses are annually reviewed and verified by the Company. Once received, a member of the Real Estate Valuation Department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value and determines if reasonable. Appraisals for collateral dependent impaired loans and other real estate owned are updated annually. On an annual basis the Company compares the actual selling costs of collateral that has been liquidated to the selling price to determine what additional adjustment should be made to the appraisal value. The most recent analysis performed indicated that an additional discount of 8% should be applied to properties with appraisals performed within 12 months.

Assets and Liabilities Measured on a Recurring Basis

The following tables present the balances of assets and liabilities measured at fair value on a recurring basis by level within the hierarchy as of June 30, 2016 and December 31, 2015.

	June 30,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	2016		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Available-for-sale securities
Obligations of U.S. Government agencies	$	103,042		-		103,042		-
Obligations of states and political subdivisions		134,048		-		134,048		-
Mortgage-backed securities
U.S. GSE’s MBS - residential		130,009		-		130,009		-
U.S. GSE’s MBS - commercial		29,382		-		29,382		-
U.S. GSE’s CMO		180,560		-		180,560		-
Corporate bonds		119,216		-		119,216		-
Total available-for-sale securities	$	696,257		-		696,257		-
Loans held for sale		13,737		-		13,737		-
Mortgage banking derivatives		179		-		179		-
	$	710,173		-		710,173		-
Liabilities:
Interest rate swap derivatives		2,973		-		2,973		-
	$	2,973		-		2,973		-

	December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	2015		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Available-for-sale securities
Obligations of U.S. Government agencies	$	145,976		-		145,976		-
Obligations of states and political subdivisions		140,060		-		140,060		-
Mortgage-backed securities
U.S. GSE’s MBS - residential		121,508		-		121,508		-
U.S. GSE’s MBS - commercial		21,669		-		21,669		-
U.S. GSE’s CMO		145,577		-		145,577		-
Corporate bonds		116,773		-		116,773		-
Total available-for-sale securities	$	691,563		-		691,563		-
Loans held for sale		18,647		-		18,647		-
Mortgage banking derivatives		24		-		24		-
	$	710,234		-		710,234		-
Liabilities:
Interest rate swap derivatives		2,013		-		2,013		-
	$	2,013		-		2,013		-

The Company’s policy is to recognize transfers into or out of a level as of the end of the reporting period.

Transfers between Level 1 and Level 2:

No securities were transferred between Level 1 and Level 2 during the three and six months ended June 30, 2016 and 2015.

Transfers between Level 2 and Level 3:

No securities were transferred between Level 2 and Level 3 during the three months ended June 30, 2016 and 2015. No securities were transferred between Level 2 and Level 3 during the six months ended June 30, 2016. During the six months ended June 30, 2015, one corporate security was transferred out of Level 3 and into Level 2 based on observable market data for this security due to increased market activity for this security. This security with a market value of $138 as of March 31, 2015 was transferred on March 31, 2015.

During the six months ended June 30, 2016, there were no assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3).

The following table presents a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended June 30, 2015.

Fair Value Measurements Using Significant Unobservable

Inputs (Level 3)

	Total			Corporate bonds
	(Dollars in thousands)
Beginning balance, January 1, 2015	$	112		$	112
Total gains or losses (realized/unrealized)
Included in earnings
Gain (loss) on sales		-			-
Other-than-temporary impairment		-			-
Included in other comprehensive income		26			26
Purchases, sales, issuances and settlements
Purchases		-			-
Sales, Calls		-			-
Issuances		-			-
Settlements		-			-
Principal repayments		-			-
Transfers into Level 3		-			-
Transfers out of Level 3		(138	)		(138	)
Ending balance, June 30, 2015	$	-		$	-

The Company uses an independent third party to value its U.S. government agencies, mortgage-backed securities, and corporate bonds. Their approach uses relevant information generated by transactions that have occurred in the market place that involve similar assets, as well as using cash flow information when necessary. These inputs are observable, either directly or indirectly in the market place for similar assets. The Company considers these valuations to be Level 2 pricing.

The fair value of the Company’s municipal securities is determined by another independent third party. Their approach uses relevant information generated by transactions that have occurred in the market place that involve similar assets. These inputs are observable, either directly or indirectly in the market place for similar assets. The Company considers these valuations to be Level 2 pricing.

For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows (Level 3 pricing) as determined by an independent third party. The significant unobservable inputs used in the valuation model include prepayment rates, constant default rates, loss severity and yields.

On a quarterly basis, the Company selects a random sample of investment security valuations, as determined by the independent third party, to validate pricing and level assignments.

At June 30, 2016 and December 31, 2015, there were no financial instruments measured at fair value on a recurring basis using level 3 inputs.

Assets and Liabilities Measured on a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis as of June 30, 2016 and December 31, 2015 are summarized below.

	June 30,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	2016		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Impaired loans (1)	$	4,058		-		-		4,058
Other real estate owned		360		-		-		360
	$	4,418		-		-		4,418

(1) Includes loans directly charged down to fair value.

	December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	2015		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Impaired loans (1)	$	10,171		-		-		10,171
Other real estate owned		360		-		-		360
	$	10,531		-		-		10,531

(1) Includes loans directly charged down to fair value.

The following represents impairment charges recognized during the period:

Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a recorded investment of $4,257, with a valuation allowance of $199, resulting in an additional provision for loan losses of $199 and $233 for the three and six months ended June 30, 2016.

As of December 31, 2015, impaired loans had a recorded investment of $10,171, resulting in an additional provision for loan losses of $3,342 for the year ending 2015.

Other real estate owned was $360 which consisted of the outstanding balance of $607, less a valuation allowance of $247. There were no write downs on this property for the three and six months ended June 30, 2016.

As of December 31, 2015, other real estate owned was $360 which consisted of the outstanding balance of $607, less a valuation allowance of $247. There were no write downs on this property during the year ended 2015.

The following tables present quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at June 30, 2016 and December 31, 2015.

	June 30,		Valuation	Unobservable	Range
	2016		Techniques	Inputs	(Weighted Avg)
	(Dollars in thousands)
Impaired loans	$	4,058	sales comparison	adjustment for		0.00% - 146.92% (19.32%)
				differences between
				the comparable sales
			income approach	capitalization rate		8.25% - 9.75% (9.35%)
Other real estate owned		360	sales comparison	adjustment for		11.00% - 25.00% (18.00%)
				differences between
				the comparable sales

	Dec. 31,		Valuation	Unobservable	Range
	2015		Techniques	Inputs	(Weighted Avg)
	(Dollars in thousands)
Impaired loans	$	10,171	sales comparison	adjustment for		0.00% - 70.99% (15.71%)
				differences between
				the comparable sales
			income approach	capitalization rate		8.25% - 10.82% (9.69%)
			income approach	discount rate		4.75	%
			liquidation value
Other real estate owned		360	sales comparison	adjustment for		11.00% - 25.00% (18.00%)
				differences between
				the comparable sales

Fair Value Option:

The Company has elected the fair value option for loans held for sale. These loans are intended for sale and the Company believes that the fair value is the best indicator of the resolution of these loans. None of these loans are past due 90 days or more or on nonaccrual as of June 30, 2016 and December 31, 2015

As of June 30, 2016 and December 31, 2015, the aggregate fair value, unpaid principal balance (including accrued interest), and gain or loss was as follows:

	June 30, 2016		Dec. 31, 2015
	(Dollars in thousands)
Aggregate fair value	$	13,737		18,647
Unpaid principal balance		13,299		18,345
Gain		438		303

Interest income on loans held for sale is recognized based on contractual rates and is reflected in loan interest income in the consolidated statements of comprehensive income. The following table details gains and losses from changes in fair value included in earnings for three and six months ended June 30, 2016 and 2015 for loans held for sale.

	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2016			2015		2016		2015
	(Dollars in thousands)					(Dollars in thousands)
Change in fair value	$	(18	)		85		135		94

Fair Value of Financial Instruments:

Disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value is required. Fair value estimates are made at a specific point in time, based on relevant market information and 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 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 and 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 existing 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. 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.

The assumptions used in the estimation of the fair value of the Company’s financial instruments are explained below. Where quoted market prices are not available, fair values are based on estimates using discounted cash flow and other valuation techniques. Discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following fair value estimates cannot be substantiated by comparison to independent markets and should not be considered representative of the liquidation value of the Company’s financial instruments, but rather a good-faith estimate of the fair value of financial instruments held by the Company. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements.

The following methods and assumptions, not previously presented, were used by the Company in estimating the fair value of its financial instruments:

(a) Cash and Cash Equivalents

Fair value equals the carrying value of such assets due to their nature and is classified as Level 1.

(b) Loans, net

The fair value of loans is calculated using discounted cash flows by loan type resulting in a Level 3 classification. The discount rate used to determine the present value of the loan portfolio is an estimated market rate that reflects the credit and interest rate risk inherent in the loan portfolio without considering widening credit spreads due to market illiquidity. The estimated maturity is based on the Company’s historical experience with repayments adjusted to estimate the effect of current market conditions. The carrying amount of related accrued interest receivable, due to its short term nature, approximates its fair value, is not significant and is not disclosed. The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification. The allowance for loan losses is considered a reasonable discount for credit risk. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

(c) Restricted Equity Securities

The fair value of Federal Home Loan Bank (“FHLB”) stock was not practicable to determine due to restrictions placed on its transferability.

(d) Deposits

Fair values for certificates of deposit have been determined using discounted cash flows. The discount rate used is based on estimated market rates for deposits of similar remaining maturities and are classified as Level 2. The carrying amounts of all other deposits, due to their short-term nature, approximate their fair values and are classified as Level 1. The carrying amount of related accrued interest payable, due to its short-term nature, approximates its fair value, is not significant and is not disclosed.

(e) Securities Sold Under Repurchase Agreements

Fair value approximates the carrying value of such liabilities due to their short-term nature and is classified as Level 1.

(f) Advances from FHLB

The fair value of the FHLB advances is obtained from the FHLB and is calculated by discounting contractual cash flows using an estimated interest rate based on the current rates available to the Company for debt of similar remaining maturities and collateral terms resulting in a Level 2 classification.

(g) Subordinated debentures

The fair value for subordinated debentures is calculated using discounted cash flows based upon current market spreads to LIBOR for debt of similar remaining maturities and collateral terms resulting in a Level 3 classification.

(h) Commitments

The difference between the carrying values and fair values of commitments to extend credit are not significant and are not disclosed.

The carrying amounts and estimated fair values of the Company’s financial instruments at June 30, 2016 and December 31, 2015, not previously presented, are as follows:

	June 30, 2016
	Carrying		Fair Value Measurements
	amount		Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	90,935		90,935		90,935		-		-
Loans, net		1,001,588		1,004,220		-		-		1,004,220
Restricted equity securities		5,478		N/A
Financial liabilities:
Deposits with stated maturities		325,611		326,431		-		326,431		-
Deposits without stated maturities		1,258,842		1,258,842		1,258,842		-		-
Securities sold under repurchase agreements		631		631		631		-		-
Advances from FHLB		90,000		91,818		-		91,818		-
Subordinated debentures		20,000		15,167		-		-		15,167

	December 31, 2015
	Carrying		Fair Value Measurements
	amount		Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	42,917		42,917		42,917		-		-
Loans, net		977,611		981,011		-		-		981,011
Restricted equity securities		5,169		N/A
Financial liabilities:
Deposits with stated maturities		333,345		334,920		-		334,920		-
Deposits without stated maturities		1,195,735		1,195,735		1,195,735		-		-
Securities sold under repurchase agreements		15,684		15,691		15,691		-		-
Advances from FHLB		85,000		86,854		-		86,854		-
Subordinated debentures		20,000		15,065		-		-		15,065