NOTE 20. 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 and equity securities with readily determinable fair values 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.

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 December 31, 2018 and 2017. No assets were transferred from one hierarchy level to another during 2018 or 2017.


					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
December 31, 2018
Securities available for sale:
U.S. Government agencies	$	33,636	$	-	$	33,636	$	-
Mortgage-backed		120,796		-		120,796		-
		154,432		-		154,432		-

Equity		1,269		-		1,269		-
Total	$	155,701	$	-	$	155,701	$	-

					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	$	-

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 following tables set forth the Company’s financial assets subject to fair value adjustments (impairment) on a nonrecurring basis at December 31, 2018 and 2017, that are valued at the lower of cost or market. Assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.


	Quantitative Information about Level 3 Fair Value Measurements
(Dollars in thousands)	Fair Value		Valuation Technique			Unobservable Input			Range
December 31, 2018
Nonrecurring measurements:

Impaired loans	$	3,839		Appraisal of collateral	1		Appraisal adjustments	2		0% - 17%
							Liquidation expense	2		0% - 10%

Impaired loans	$	5,902		Discounted cash flow analysis	1		Discount rate			4% - 7.25%

Other real estate owned	$	1,222		Appraisal of collateral	1		Appraisal adjustments	2		15% - 40%
							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%

Fair Value of Financial Assets and Financial Liabilities

The carrying amounts and estimated fair values of the Company’s financial instruments are presented in the following tables. Fair values for December 31, 2018 were estimated using an exit price notion in accordance with the prospective adoption of ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” Fair values for December 31, 2017 were estimated using the guidance in effect for that period, which permitted the use of an entry price notion in the compilation of this disclosure.


	December 31, 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	$	67,225	$	67,225	$	31,820	$	31,820

Level 2 inputs
Investment securities held to maturity	$	6,043	$	6,000	$	6,247	$	6,391
Restricted securities		6,476		6,476		3,735		3,735
Cash surrender value on life insurance		3,726		3,726		3,637		3,637

Level 3 inputs
Loans, net		1,185,012		1,150,418		1,083,733		1,072,951

Financial liabilities
Level 2 inputs
Deposits:
Noninterest-bearing demand	$	330,466	$	330,466	$	328,322	$	328,322
Checking plus interest		239,809		239,809		231,898		231,898
Money market		232,613		232,613		223,123		223,123
Savings		148,723		148,723		156,623		156,623
Club		387		387		398		398
Brokered Deposits		22,084		22,075		-		-
Certificates of deposit, $100,000 or more		97,905		96,435		107,343		105,691
Other time		140,354		136,292		155,074		151,339
Short-term borrowings		60,812		60,812		21,734		21,734
Long-term borrowings		15,000		15,012		-		-

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 of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.