Note 12 – 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 determined that they should 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 March 31, 2020 and December 31, 2019. No assets were transferred from one hierarchy level to another during the first three months of 2020 or 2019.


					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
March 31, 2020
Securities available for sale:
U.S. Government agencies	$	9,755	$	—	$	9,755	$	—
Mortgage-backed		94,620		—		94,620		—
		104,375		—		104,375		—

Equity		1,350		—		1,350		—
Total	$	105,725	$	—	$	105,725	$	—


					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
December 31, 2019
Securities available for sale:
U.S. Government agencies	$	23,826	$	—	$	23,826	$	—
Mortgage-backed		98,965		—		98,965		—
		122,791		—		122,791		—

Equity		1,342		—		1,342		—
Total	$	124,133	$	—	$	124,133	$	—

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 according to the contractual terms of the loan agreement when due. 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 establishing a new cost basis. Subsequently, foreclosed assets are carried at the lower of carrying value or 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 March 31, 2020 and December 31, 2019, 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
								Weighted
(Dollars in thousands)	Fair Value		Valuation Technique		Unobservable Input		Range	Average (3)
March 31, 2020
Nonrecurring measurements:

Impaired loans	$	610	Appraisal of collateral	(1)	Liquidation expense	(2)	10%	(10%)


Impaired loans	$	2,586	Discounted cash flow analysis	(1)	Discount rate		4% - 7.25%	(6%)

Other real estate owned	$	38	Appraisal of collateral	(1)	Appraisal adjustments	(2)	0% - 19%	(19%)


	Quantitative Information about Level 3 Fair Value Measurements
(Dollars in thousands)	Fair Value		Valuation Technique		Unobservable Input		Range
December 31, 2019
Nonrecurring measurements:

Impaired loans	$	2,489	Appraisal of collateral	(1)	Liquidation expense	(2)	10%


Impaired loans	$	2,599	Discounted cash flow analysis	(1)	Discount rate		4% - 7.25%

Other real estate owned	$	74	Appraisal of collateral	(1)	Appraisal adjustments	(2)	0% - 31%
					Liquidation expense	(2)	10%

(1)

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.

(2)

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.

(3)

Unobservable inputs were weighted by the relative fair value of the instruments.

The carrying amounts and estimated fair values of the Company’s financial instruments not carried at fair value on the Company’s Consolidated Balance Sheets are presented in the following table. Fair values for March 31, 2020 and December 31, 2019 were estimated using an exit price notion.


	March 31, 2020				December 31, 2019
			Estimated				Estimated
	Carrying		Fair		Carrying		Fair
(Dollars in thousands)	Amount		Value		Amount		Value
Financial assets
Level 1 inputs
Cash and cash equivalents	$	96,251	$	96,251	$	94,971	$	94,971

Level 2 inputs
Investment securities held to maturity	$	8,687	$	8,718	$	8,786	$	8,654
Restricted securities		4,263		4,263		4,190		4,190
Cash surrender value on life insurance		30,027		30,027		29,770		29,770

Level 3 inputs
Loans, net	$	1,266,615	$	1,250,797	$	1,238,147	$	1,242,867

Financial liabilities
Level 2 inputs
Deposits:
Noninterest-bearing demand	$	355,054	$	355,054	$	356,618	$	356,618
Checking plus interest		296,421		296,421		302,227		302,227
Money market		268,355		268,355		262,050		262,050
Savings		146,202		146,202		143,322		143,322
Club		774		774		387		387
Certificates of deposit, $100,000 or more		131,003		133,113		127,600		128,167
Other time		150,985		152,240		149,130		149,209
Short-term borrowings		2,162		2,162		1,226		1,226
Long-term borrowings		15,000		15,005		15,000		15,040