NOTE 11 – 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 instruments measured on a recurring basis by the above pricing observability levels as of March 31, 2020 and December 31, 2019:


			Quoted Prices
			in
			Active		Significant
			Markets		Other		Significant
	Fair		for Identical		Observable		Unobservable
	Value		Assets		Inputs		Inputs
(Dollars in thousands)	Measurements		(Level I)		(Level II)		(Level III)
March 31, 2020
U.S. government agencies	$	8,100	$	—	$	8,100	$	—
U.S. government-sponsored enterprises		51,020		—		51,020		—
State and political subdivisions		47,914		—		47,914		—
Mortgage-backed securities -
U.S. government-sponsored enterprises		85,674		—		85,674		—
Private mortgage-backed securities		26,832		—		24,330		2,502
Corporate debt		12,665		—		11,651		1,014
Derivative instruments
Interest rate swaps
Liabilities		17,136		—		17,136		—

December 31, 2019
U.S. government agencies	$	8,679	$	—	$	8,679	$	—
U.S. government-sponsored enterprises		53,249		—		53,249		—
State and political subdivisions		32,214		—		32,214		—
Mortgage-backed securities -
U.S. government-sponsored enterprises		82,469		—		82,469		—
Private mortgage-backed securities		22,445		—		19,873		2,572
Corporate debt		13,125		—		12,096		1,029
Derivative instruments
Interest rate swaps
Assets		689		—		689		—
Liabilities		3,890		—		3,890		—

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 March 31, 2020 and December 31, 2019 are as follows:


			Quoted Prices
			in
			Active		Significant
			Markets		Other		Significant
	Fair		for Identical		Observable		Unobservable
	Value		Assets		Inputs		Inputs
(Dollars in thousands)	Measurements		(Level I)		(Level II)		(Level III)
March 31, 2020
Impaired loans	$	1,555	$	—	$	—	$	1,555

December 31, 2019
Impaired loans	$	1,630	$	—	$	—	$	1,630
Foreclosed real estate		2,183		—		—		2,183

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)
March 31, 2020
Impaired loans	$	1,555	Appraisal of	Appraisal	0% to -72.0%
			collateral	adjustments (1)	(-3.6%)
December 31, 2019
Impaired loans	$	1,630	Appraisal of	Appraisal	0% to -72.0%
			collateral	adjustments (1)	(-3.6%)

Foreclosed real estate		2,183	Appraisal of collateral	Selling 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 March 31, 2020 and December 31, 2019:

Securities: The fair value of securities, available for sale (carried at fair value) 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 of market participants’ estimate is used. Management’s best estimate consists of both internal and external support on certain Level III measurements. Internal cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) were used to support fair values of certain Level III investments.

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, less estimated selling costs. These assets are included in Level III fair values, based upon the lowest level of input that is significant to the fair value measurements.

Derivatives (Carried at Fair Value): The fair value of the Company’s derivatives is determined using discounted cash flow analysis using observable market-based inputs, which are considered Level 2 inputs.

Other Real Estate Owned (Carried at Fair Value):

Other Real Estate Owned is recorded at estimated fair value, less estimated selling costs when acquired, thus establishing a new cost basis. Fair value is generally based on independent appraisals. These appraisals include adjustments to comparable assets based on the appraisers’ market knowledge and experience. When an asset is acquired, the excess of the loan balance over fair value, less estimated selling costs, a writedown is recorded through expense.

The fair values of our financial instruments at March 31, 2020 and December 31, 2019, were as follows:


					Quoted Prices
					in Active		Significant
					Markets		Other		Significant
	March 31, 2020				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	$	40,305	$	40,305	$	40,305	$	—	$	—
Time deposits with other banks		200		200		—		200		—
Securities available for sale		232,205		232,205		—		228,689		3,516
Securities held to maturity		6,339		6,399		—		3,265		3,134
Other bank stock		12,487		12,487		—		12,487		—
Loans receivable, net of allowance		1,674,271		1,750,798		—		—		1,750,798
Accrued interest receivable		6,856		6,856		—		6,856		—

Financial liabilities:
Non-maturity deposits		1,021,120		1,021,120		—		1,021,120		—
Time deposits		577,431		574,876		—		574,876		—
Short-term borrowings		196,145		196,609		196,609		—		—
Long-term borrowings		34,127		34,779		—		34,779		—
Subordinated debentures		27,871		28,884		—		28,884		—
Accrued interest payable		1,670		1,670		—		1,670		—
Interest rate swaps		17,136		17,136		—		17,136		—


					Quoted Prices
					in Active		Significant
					Markets		Other		Significant
	December 31, 2019				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	$	43,686	$	43,686	$	43,686	$	—	$	—
Time deposits with other banks		200		200		—		200		—
Securities available for sale		212,181		212,181		—		208,580		3,601
Securities held to maturity		4,012		4,083		—		2,593		1,490
Other bank stock		12,498		12,498		—		12,498		—
Loans receivable, net of allowance		1,618,579		1,605,295		—		—		1,605,295
Accrued interest receivable		6,175		6,175		—		6,175		—
Interest rate swaps		689		689		—		689		—

Financial liabilities:
Non-maturity deposits		971,653		971,653		—		971,653		—
Time deposits		553,388		551,886		—		551,886		—
Short-term borrowings		193,000		193,081		193,081		—		—
Long-term borrowings		40,114		40,228		—		40,228		—
Subordinated debentures		27,869		26,930		—		26,930		—
Accrued interest payable		1,466		1,466		—		1,466		—
Interest rate swaps		3,890		3,890		—		3,890		—