Note 21.

Fair Value Measurements

The Company uses fair value to record certain assets and liabilities and to determine fair value disclosures. Authoritative accounting guidance clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

Authoritative accounting guidance specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy based on these two types of inputs are as follows:


Level 1 –		Valuation is based on quoted prices in active markets for identical assets and liabilities.

Level 2 –		Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.

Level 3 –		Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:

Securities available-for-sale: Securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy.

Defined benefit plan assets: Defined benefit plan assets are recorded at fair value on an annual basis at year end. Fair value measurement is based upon quoted market prices, when available (Level 1).

Mortgage servicing rights: MSRs are recorded at fair value on a recurring basis, with changes in fair value recorded in the result of operations. A model is used to determine fair value, which establishes pools of performing loans, calculates cash flows for each pool and applies a discount rate to each pool. Loans are segregated into 14 pools based on each loan’s term and seasoning (age). All loans have fixed interest rates. Cash flows are then estimated by utilizing assumed service costs and prepayment speeds. Service costs were assumed to be $5.75 per loan as of December 31, 2014 and $6.00 per loan as of December 31, 2013. Prepayment speeds are determined primarily based on the average interest rate of the loans in each pool. The prepayment scale used is the Public Securities Association (“PSA”) model, where “100% PSA” means prepayments are zero in the first month, then increase by 0.2% of the loan balance each month until reaching 6.0% in month 30. Thereafter, the 100% PSA model assumes an annual prepayment of 6.0% of the remaining loan balance. The average PSA speed assumption in the fair value model is 184% as of December 31, 2014 and 162% as of December 31, 2013. A discount rate of 10.0% was then applied to each pool as of both December 31, 2014 and 2013. This discount rate is intended to represent the estimated market yield for the highest quality grade of comparable servicing. MSRs are classified as Level 3.

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2014 and December 31, 2013:


(Dollars in thousands)			Fair Value Measurements at December 31, 2014 Using
Description	Balance		Level 1		Level 2		Level 3
Securities available-for-sale:
U. S. Government agencies	$	16,965	$	845	$	16,120	$	—
State and municipal obligations		23,401		—		23,401		—
Certificates of deposit		2,238		—		2,238		—

Total securities available-for-sale	$	42,604	$	845	$	41,759	$	—


Mortgage servicing rights	$	596	$	—	$	—	$	596


Defined benefit plan assets:
Cash and cash equivalents	$	4	$	4	$	—	$	—
Mutual funds - fixed income		1,139		1,139		—		—
Mutual funds - equity		1,754		1,754		—		—

Total defined benefit plan assets	$	2,897	$	2,897	$	—	$	—


			Fair Value Measurements at December 31, 2013 Using
Description	Balance		Level 1		Level 2		Level 3
Securities available-for-sale:
U. S. Government agencies	$	9,308	$	—	$	9,308	$	—
State and municipal obligations		26,557		—		26,557		—
Certificates of deposit		1,745		—		1,745		—
Auction rate securities		912		—		—		912

Total securities available-for-sale	$	38,522	$	—	$	37,610	$	912


Mortgage servicing rights	$	579	$	—	$	—	$	579


Defined benefit plan assets:
Cash and cash equivalents	$	3	$	3	$	—	$	—
Mutual funds - fixed income		1,070		1,070		—		—
Mutual funds - equity		1,747		1,747		—		—

Total defined benefit plan assets	$	2,820	$	2,820	$	—	$	—

The reconciliation of items using Level 3 inputs is as follows:


(Dollars in thousands)	Auction Rate Security			MSRs
Balance, January 1, 2014	$	912		$	579
Purchases		—			—
Fair value adjustments		—			17
Sales		(912	)		—

Balance, December 31, 2014	$	—		$	596

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:

Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. Any given loan may have multiple types of collateral. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the ALL are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Other Real Estate Owned: OREO is measured at fair value less estimated costs to sell, based on an appraisal conducted by an independent, licensed appraiser outside of the Company. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. OREO is measured at fair value on a nonrecurring basis. The initial fair value of OREO is based on an appraisal done at the time of foreclosure. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest income on the Consolidated Statements of Income.

The following table summarizes the Company’s assets that were measured at fair value on a nonrecurring basis at the end of the respective period.


			Fair Value Measurements at December 31, 2014 Using
(Dollars in thousands)	Balance as of
Description	December 31, 2014		Level 1		Level 2		Level 3
Impaired Loans, net	$	1,958	$	—	$	—	$	1,958
Other real estate owned, net		2,791		—		—		2,791


			Fair Value Measurements at December 31, 2013 Using
Description	Balance as of December 31, 2013		Level 1		Level 2		Level 3
Impaired Loans, net	$	2,077	$	—	$	—	$	2,077
Other real estate owned, net		3,897		—		—		3,897

The following table displays quantitative information about Level 3 Fair Value Measurements as of December 31, 2014:

(Dollars in thousands)

Balance as of
December 31, 2014

Valuation
Technique

Unobservable
Input

Range
(Weighted
Average)

Impaired Loans, net

1,958

Discounted appraised value

Selling Cost

10% 20% (10%)

Lack of Marketability

25% - 75% (53%)

Other real estate owned, net

2,791

Discounted appraised value

Selling Cost

3% - 13% (5%)

Lack of Marketability

7% - 20% (11%)

The following table displays quantitative information about Level 3 Fair Value Measurements as of December 31, 2013:

(Dollars in thousands)

Balance as of
December 31, 2013

Valuation
Technique

Unobservable
Input

Range
(Weighted
Average)

Impaired Loans, net

2,077

Discounted appraised value

Selling Cost

10% - 20% (10%)

Lack of Marketability

25% - 100% (54%)

Other real estate owned, net

3,897

Discounted appraised value

Selling Cost

3% - 13% (6%)

Lack of Marketability

7% - 30% (15%)

The estimated fair values of financial instruments are shown in the following table. The carrying amounts in the table are included in the balance sheet under the applicable captions.


			Fair Value Measurements at December 31, 2014 Using
(Dollars in thousands)	Balance as of
Description	December 31, 2014		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	6,181	$	6,181	$	—	$	—
Interest-bearing deposits		14,784		14,784		—		—
Federal funds sold		119		119		—		—
Securities available-for-sale		42,604		845		41,759		—
Restricted securities		2,430		—		—		2,430
Loans, net		295,242		—		—		300,481
Accrued interest receivable		1,197		—		1,197		—
Mortgage servicing rights		596		—		—		596

Financial Liabilities:
Non-interest-bearing liabilities	$	63,308	$	63,308	$	—	$	—
Savings and other interest-bearing deposits		122,502		—		122,502		—
Time deposits		121,775		—		—		122,662
Securities sold under repurchase agreements		6,012		—		6,012		—
FHLB advances		35,000		—		35,951		—
Accrued interest payable		149		—		149		—


			Fair Value Measurements at December 31, 2013 Using
	Balance as of
Description	December 31,2013		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	6,789	$	6,789	$	—	$	—
Interest-bearing deposits		8,900		8,900		—		—
Federal funds sold		120		120		—		—
Securities available-for-sale		38,522		—		37,610		912
Restricted securities		1,638		—		—		1,638
Loans, net		247,912		—		—		253,139
Loans held for sale		196		—		—		196
Accrued interest receivable		1,124		—		1,124		—
Mortgage servicing rights		579		—		—		579

Financial Liabilities:
Non-interest-bearing liabilities	$	57,805	$	57,805	$	—	$	—
Savings and other interest-bearing deposits		114,056		—		114,056		—
Time deposits		96,486		—		—		98,049
Securities sold under repurchase agreements		9,118		—		9,118		—
FHLB advances		15,000		—		15,923		—
Accrued interest payable		167		—		167		—

The carrying amounts of cash and due from banks, interest-bearing deposits, federal funds sold or purchased, accrued interest, loans held for sale and non-interest-bearing deposits, are payable on demand, or are of such short duration that carrying value approximates market value.

Securities available-for-sale are carried at quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy.

The carrying value of restricted securities approximates fair value based on the redemption provisions of the issuer.

MSRs are carried at fair value. As described above, a valuation model is used to determine fair value. This model utilizes a discounted cash flow analysis with servicing costs and prepayment assumptions based on comparable instruments and a discount rate.

The fair value of performing loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar remaining maturities. This calculation ignores loan fees and certain factors affecting the interest rates charged on various loans such as the borrower’s creditworthiness and compensating balances and dissimilar types of real estate held as collateral. The fair value of impaired loans is measured as described within the Impaired Loans section of this note. The fair value of loans does not consider the lack of liquidity and uncertainty in the market that would affect the valuation.

Time deposits are presented at estimated fair value by discounting the future cash flows using interest rates offered for deposits of similar remaining maturities.

The fair value of the FHLB advances is estimated by discounting the future cash flows using the current interest rates offered for similar advances.

The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter parties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counter parties at the reporting date. At December 31, 2014 and December 31, 2013, the fair value of loan commitments and standby letters of credit was immaterial and therefore, they are not included in the table above.

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair value of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.