Note 11 – Fair Value Measurements

Accounting guidance under GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an 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. This accounting guidance also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, loans held for sale and other real estate owned (foreclosed assets). These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Under fair value accounting guidance, assets and liabilities are grouped at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine their fair values. These hierarchy levels are:

Level 1 inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.

Level 2 inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs – Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

Below is a discussion on the Company’s assets measured at fair value on a recurring basis.

Investment Securities Available for Sale

Fair value measurement for investment securities available for sale is based on quoted prices from an independent pricing service. The fair value measurements consider observable data that may include present value of future cash flows, prepayment assumptions, credit loss assumptions and other factors. The Company classifies its investments in U.S. Treasury securities, if any, as Level 1 in the fair value hierarchy, and it classifies its investments in U.S. Government agencies securities and mortgage-backed securities issued or guaranteed by U.S. Government sponsored entities as Level 2.

Equity Securities

Fair value measurement for equity securities is based on quoted market prices retrieved by the Company via on-line resources. Although these securities have readily available fair market values, the Company deems that they be classified as level 2 investments in the fair value hierarchy due to not being considered traded in a highly active market.

The tables below present the recorded amount of assets measured at fair value on a recurring basis at September 30, 2018 and December 31, 2017. No assets were transferred from one hierarchy level to another during the first nine months of 2018 or 2017.


					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
September 30, 2018
Securities available for sale:
U.S. Government agencies	$	41,546	$	-	$	41,546	$	-
Mortgage-backed		126,129		-		126,129		-
		167,675		-		167,675		-
Equity		649		-		649		-
Total	$	168,324	$	-	$	168,324	$	-

					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
December 31, 2017
Securities available for sale:
U.S. Government agencies	$	45,332	$	-	$	45,332	$	-
Mortgage-backed		150,965		-		150,965		-
Equity		658		-		658		-
Total	$	196,955	$	-	$	196,955	$	-

Below is a discussion on the Company’s assets measured at fair value on a nonrecurring basis.

Impaired Loans

Loans are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loan impairment is measured using the present value of expected cash flows, the loan’s observable market price or the fair value of the collateral (less selling costs) if the loans are collateral dependent and these are considered Level 3 in the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The value of business equipment, inventory and accounts receivable, discounted on management’s review and analysis. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and the client’s business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the factors identified above. Valuation techniques are consistent with those techniques applied in prior periods.

Other Real Estate Owned (Foreclosed Assets)

Foreclosed assets are adjusted for fair value upon transfer of loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value and fair value. The estimated fair value for foreclosed assets included in Level 3 are determined by independent market based appraisals and other available market information, less costs to sell, that may be reduced further based on market expectations or an executed sales agreement. If the fair value of the collateral deteriorates subsequent to the initial recognition, the Company records the foreclosed asset as a non-recurring Level 3 adjustment. Valuation techniques are consistent with those techniques applied in prior periods.

The tables below present the recorded amount of assets measured at fair value on a nonrecurring basis at September 30, 2018 and December 31, 2017.


	Quantitative Information about Level 3 Fair Value Measurements
(Dollars in thousands)	Fair Value		Valuation Technique			Unobservable Input			Range
September 30, 2018
Nonrecurring measurements:

Impaired loans	$	303		Appraisal of collateral	1		Liquidation expense	2		10%

Impaired loans	$	5,908		Discounted cash flow analysis	1		Discount rate			4% - 8.5%

Other real estate owned	$	1,518		Appraisal of collateral	1		Appraisal adjustments	2		20% - 30%
							Liquidation expense	2		5% - 10%


	Quantitative Information about Level 3 Fair Value Measurements
(Dollars in thousands)	Fair Value		Valuation Technique			Unobservable Input			Range
December 31, 2017
Nonrecurring measurements:

Impaired loans	$	510		Appraisal of collateral	1		Liquidation expense	2		10%

Impaired loans	$	6,005		Discounted cash flow analysis	1		Discount rate			4% - 8.5%

Other real estate owned	$	1,794		Appraisal of collateral	1		Appraisal adjustments	2		20% - 30%
							Liquidation expense	2		5% - 10%

The following table provides information on the estimated fair values of the Company’s financial assets and liabilities that are reported in the balance sheets not recorded at fair value on a recurring basis as of September 30, 2018 and December 31, 2017. The financial assets and liabilities have been segregated by their classification level in the fair value hierarchy.


	September 30, 2018				December 31, 2017
			Estimated				Estimated
	Carrying		Fair		Carrying		Fair
(Dollars in thousands)	Amount		Value		Amount		Value
Financial assets
Level 1 inputs
Cash and cash equivalents	$	48,777	$	48,777	$	31,820	$	31,820

Level 2 inputs
Investment securities held to maturity	$	6,037	$	5,983	$	6,247	$	6,391
Restricted securities		8,110		8,110		3,735		3,735
Cash surrender value on life insurance		3,676		3,676		3,637		3,637

Level 3 inputs
Loans, net (1)	$	1,170,229	$	1,139,344	$	1,083,733	$	1,072,951

Financial liabilities
Level 2 inputs
Deposits:
Noninterest-bearing demand	$	331,766	$	331,766	$	328,322	$	328,322
Checking plus interest		214,898		214,898		231,898		231,898
Money market		216,394		216,394		223,123		223,123
Savings		153,973		153,973		156,623		156,623
Club		1,535		1,535		398		398
Brokered Deposits		23,547		23,519		-		-
Certificates of deposit, $100,000 or more		96,498		94,212		107,343		105,691
Other time		143,225		138,187		155,074		151,339
Short-term borrowings		114,043		114,043		21,734		21,734

(1) Carrying amount is net of unearned income and the allowance for credit losses. In accordance with the prospective adoption
of ASU No. 2016-01, the fair value of loans as of September 30, 2018 was measured using an exit price notion. The fair value of
loans as of December 31, 2017 was measured using an entry price notion.

Fair value is generally determined through independent appraisals of the underlying collateral (impaired loans and OREO) or discounted cash flow analyses (impaired loans), which generally include various level III inputs which are not identifiable.

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