NOTE 10 – FAIR VALUE OF FINANCIAL INSTRUMENTS

Management uses its best judgment in estimating the fair value of our 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 we could have realized in a sale transaction on the dates indicated. The fair value amounts have been measured as of their respective period ends, and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period end.

In accordance with U.S. GAAP, we use a hierarchical disclosure framework associated with the level of pricing observability utilized in measuring assets and liabilities at fair value. The three broad levels defined by the hierarchy are as follows:

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

Level II - 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 asset and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.

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

The following table summarizes the fair value of our financial assets measured on a recurring basis by the above pricing observability levels as of September 30, 2015 and December 31, 2014:



			Quoted Prices in		Significant
			Active Markets		Other		Significant
	Fair		for Identical		Observable		Unobservable
	Value		Assets		Inputs		Inputs
(Dollars in thousands)	Measurements		(Level I)		(Level II)		(Level III)

September 30, 2015
U.S. government agencies	$	11,962	$	-	$	11,962	$	-
State and political subdivisions		37,697		-		37,697		-
Mortgage-backed securities -
U.S. government-sponsored enterprises		45,031		-		45,031		-
Equity securities-financial services industry and other		12		12		-		-

December 31, 2014
U.S. government agencies	$	7,858	$	-	$	7,858	$	-
State and political subdivisions		26,384		-		26,384		-
Mortgage-backed securities -
U.S. government-sponsored enterprises		43,724		-		43,724		-
Equity securities-financial services industry and other		10		10		-		-

Our available for sale and held to maturity securities portfolios contain investments, which were all rated within our investment policy guidelines at time of purchase, and upon review of the entire portfolio all securities are marketable and have observable pricing inputs.

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2015 and December 31, 2014 are as follows:



			Quoted Prices in		Significant
			Active Markets		Other		Significant
	Fair		for Identical		Observable		Unobservable
	Value		Assets		Inputs		Inputs
(Dollars in thousands)	Measurements		(Level I)		(Level II)		(Level III)

September 30, 2015
Impaired loans	$	1,542	$	-	$	-	$	1,542
Foreclosed real estate		868		-		-		868

December 31, 2014
Impaired loans	$	1,087	$	-	$	-	$	1,087
Foreclosed real estate		761		-		-		761

The following table presents additional qualitative information about assets measured at fair value on a nonrecurring basis and for which Level III inputs were used to determine fair value:


	Qualitative Information about Level III Fair Value Measurements
	Fair				Range
	Value		Valuation	Unobservable	(Weighted
(Dollars in thousands)	Estimate		Techniques	Input	Average)

September 30, 2015
Impaired loans	$	1,542	Appraisal of	Appraisal	0% to -58.6%
			collateral	adjustments (1)	(-7.4%)


Foreclosed real estate		868	Appraisal of	Selling
			collateral	expenses (1)	-7.0% (-7.0%)

December 31, 2014
Impaired loans	$	1,087	Appraisal of	Appraisal	0% to -67.9%
			collateral	adjustments (1)	(-7.8%)


Foreclosed real estate		761	Appraisal of	Selling
			collateral	expenses (1)	-7.0% (-7.0%)

(1) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated selling expenses. The range and weighted average of selling expenses and other appraisal adjustments are presented as a percentage of the appraisal.

The following information should not be interpreted as an estimate of the fair value of the entire company since a fair value calculation is only provided for a limited portion of our assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between our disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair value of our financial instruments at September 30, 2015 and December 31, 2014:

Cash and Cash Equivalents (Carried at Cost): The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets’ fair value.

Deposits (Carried at Cost): Fair value for fixed-rate time certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits. We generally purchase amounts below the insured limit, limiting the amount of credit risk on these time deposits.

Securities: The fair value of securities, available for sale (carried at fair value) and securities held to maturity (carried at amortized cost) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level I), or matrix pricing (Level II), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. For certain securities which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level III). In the absence of such evidence, management’s best estimate is used.

Federal Home Loan Bank Stock (Carried at Cost): The carrying amount of restricted investment in bank stock approximates fair value and considers the limited marketability of such securities.

Loans Receivable (Carried at Cost): The fair values of non-impaired loans are estimated using discounted cash flow analyses, using the market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.

Impaired Loans (Carried at Lower of Cost or Fair Value): Fair value of impaired loans is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included in Level III fair values, based upon the lowest level of input that is significant to the fair value measurements. The fair value of impaired loans totaled $1.5 million and $1.1 million at September 30, 2015 and December 31, 2014, respectively. These balances consist of loans that were written down or required additional reserves during the periods ended September 30, 2015 and December 31, 2014, respectively.

Deposit Liabilities (Carried at Cost): The fair values disclosed for demand, savings and money market accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Borrowings (Carried at Cost): Fair values of Federal Home Loan Bank (“FHLB”) advances are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.

Junior Subordinated Debentures (Carried at Cost): Fair values of junior subordinated debt are estimated using discounted cash flow analysis, based on market rates currently offered on such debt with similar credit risk characteristics, terms and remaining maturity.

Accrued Interest Receivable and Accrued Interest Payable (Carried at Cost): The carrying amounts of accrued interest receivable and payable approximate its fair value.

Off-Balance Sheet Instruments (Disclosed at Cost): Fair values for our off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing.

The fair values of our financial instruments at September 30, 2015 and December 31, 2014, were as follows:



					Quoted Prices in		Significant
					Active Markets		Other		Significant
	September 30, 2015				for Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
(Dollars in thousands)	Amount		Value		(Level I)		(Level II)		(Level III)

Financial assets:
Cash and cash equivalents	$	8,171	$	8,171	$	8,171	$	-	$	-
Time deposits with other banks		100		100		-		100		-
Securities available for sale		94,702		94,702		12		94,690		-
Securities held to maturity		5,857		6,034		-		6,034		-
Federal Home Loan Bank stock		4,015		4,015		-		4,015		-
Loans receivable, net of allowance		495,562		493,836		-		-		493,836
Accrued interest receivable		1,996		1,996		-		1,996		-

Financial liabilities:
Non-maturity deposits		380,080		380,080		-		380,080		-
Time deposits		122,429		122,789		-		122,789		-
Short-term borrowings		15,300		15,300		15,300		-		-
Long-term borrowings		56,000		57,453		-		57,453		-
Junior subordinated debentures		12,887		9,179		-		9,179		-
Accrued interest payable		265		265		-		265		-


					Quoted Prices in		Significant
					Active Markets		Other		Significant
	December 31, 2014				for Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
(Dollars in thousands)	Amount		Value		(Level I)		(Level II)		(Level III)

Financial assets:
Cash and cash equivalents	$	5,859	$	5,859	$	5,859	$	-	$	-
Time deposits with other banks		100		100		-		100		-
Securities available for sale		77,976		77,976		10		77,966		-
Securities held to maturity		6,006		6,190		-		6,190		-
Federal Home Loan Bank stock		3,908		3,908		-		3,908		-
Loans receivable, net of allowance		466,332		462,984		-		-		462,984
Accrued interest receivable		1,796		1,796		-		1,796		-

Financial liabilities:
Non-maturity deposits		351,653		351,653		-		351,653		-
Time deposits		106,617		107,011		-		107,011		-
Short-term borrowings		23,500		23,500		23,500		-		-
Long-term borrowings		46,000		47,766		-		47,766		-
Junior subordinated debentures		12,887		9,361		-		9,361		-
Accrued interest payable		243		243		-		243		-