Fair Value Measurements

Accounting guidance on fair value measurements and disclosures defines fair value and establishes a framework for measuring the fair value of assets and liabilities using a hierarchy system. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts business.

The Company's balance sheet contains investment securities available for sale and derivative instruments that are recorded at fair value on a recurring basis. The three-level valuation hierarchy for disclosure of fair value is as follows:

Level 1 uses quoted market prices in active markets for identical assets or liabilities.

Level 2 uses observable market-based inputs or unobservable inputs that are corroborated by market data.

Level 3 uses unobservable inputs that are not corroborated by market data.

The Company's policy is to recognize transfers between Levels at the end of each reporting period, if applicable. There were no transfers between Levels of the fair value hierarchy during the nine months ended September 30, 2017.

The following is a description of valuation methodologies used for financial assets and liabilities recorded at fair value on a recurring basis.

Investment securities available for sale: When available, quoted market prices are used to determine the fair value of investment securities. If quoted market prices are not available, the Company determines fair value based on various sources and may apply matrix pricing with observable prices for similar bonds where a price for the identical bond is not observable. The fair values of these securities are determined by pricing models that consider observable market data such as interest rate volatilities, LIBOR yield curve, credit spreads, prices from market makers and live trading systems. Level 1 securities include certain corporate bonds and would include U.S. Treasuries, if any were held. Level 2 securities include U.S. government and agency securities, collateralized mortgage obligations, mortgage-backed securities, asset-backed securities, state and political subdivision securities, and trust preferred securities. The Company currently holds no investment securities classified as Level 3.

Generally, management obtains the fair value of investment securities at the end of each reporting period via a third-party pricing service. Management reviewed the valuation process used by the third party and believed that process was valid. On a quarterly basis, the Company tests the fair values by selecting a sample of investment securities from each category of securities, obtaining pricing from an independent investment portfolio management firm and comparing the two sets of fair values. Any significant variances are reviewed and investigated. For a sample of securities, prices are further validated by management, with assistance from an independent investment portfolio management firm, by obtaining details of the inputs used by the pricing service. Those inputs were independently tested, and management concluded the fair values were consistent with GAAP requirements and the investment securities were properly classified in the fair value hierarchy as of the end of the period covered by this report.

Derivative instruments: The Company's derivative instruments consist of interest rate swaps, which are accounted for as cash flow hedges. The Company's derivative positions are classified within Level 2 of the fair value hierarchy and are valued using models generally accepted in the financial services industry and that use actively quoted or observable market input values from external market data providers and/or non-binding broker-dealer quotations. The fair value of the derivatives is determined using discounted cash flow models. These models’ key assumptions include the contractual terms of the respective contract along with significant observable inputs, including interest rates, yield curves, nonperformance risk and volatility.

The following tables present the balances of financial assets and liabilities measured at fair value on a recurring basis by level as of September 30, 2017 and December 31, 2016.



	September 30, 2017
	Total		Level 1		Level 2		Level 3
Financial assets:
Investment securities available for sale:
U.S. government agencies and corporations	$	2,489	$	—	$	2,489	$	—
State and political subdivisions	134,256		—		134,256		—
Collateralized mortgage obligations	149,367		—		149,367		—
Mortgage-backed securities	54,787		—		54,787		—
Asset-backed securities	46,273		—		46,273		—
Trust preferred securities	1,700		—		1,700		—
Corporate notes	29,502		29,202		300		—
Derivative instrument, interest rate swap	786		—		786		—

Financial liabilities:
Derivative instrument, interest rate swap	$	351	$	—	$	351	$	—



	December 31, 2016
	Total		Level 1		Level 2		Level 3
Financial assets:
Investment securities available for sale:
U.S. government agencies and corporations	$	2,593	$	—	$	2,593	$	—
State and political subdivisions	64,336		—		64,336		—
Collateralized mortgage obligations	101,950		—		101,950		—
Mortgage-backed securities	80,158		—		80,158		—
Trust preferred security	1,250		—		1,250		—
Corporate notes	10,350		10,050		300		—
Derivative instrument, interest rate swap	1,068		—		1,068		—

Financial liabilities:
Derivative instrument, interest rate swap	$	496	$	—	$	496	$	—

Certain assets are measured at fair value on a nonrecurring basis. That is, they are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). As of both September 30, 2017 and December 31, 2016, impaired loans for which a fair value adjustment was recorded were recorded at a net value of $0. Impaired loans are evaluated and valued at the lower of cost or fair value when the loan is identified as impaired. Fair value is measured based on the value of the collateral securing these loans. The types of collateral vary widely and could include accounts receivables, inventory, a variety of equipment and real estate. Evaluations of the underlying assets are completed for each impaired loan with a specific reserve. Collateral evaluations are reviewed and discounted as appropriate based on knowledge of the specific type of collateral. In the case of real estate, an independent appraisal may be obtained. Types of discounts considered included aging of receivables, condition of the collateral, potential market for the collateral and estimated disposal costs. These discounts will vary from loan to loan and may be discounted based on management's opinions concerning market developments or the client's business.

GAAP requires disclosure of the fair value of financial assets and financial liabilities, including those that are not measured and reported at fair value on a recurring or nonrecurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or nonrecurring basis are discussed above. The methodologies for other financial assets and financial liabilities are discussed below.

Cash and due from banks: The carrying amount approximates fair value.

Federal funds sold: The carrying amount approximates fair value.

Investment securities held to maturity: The fair values of these securities, which are all state and political subdivisions, are determined by the same method previously described for investment securities available for sale.

FHLB stock: The fair value of this restricted stock is estimated at its carrying value and redemption price of $100 per share.

Loans: The fair values of fixed rate loans are estimated using discounted cash flow analysis based on observable market interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The carrying values of variable rate loans approximate their fair values.

Deposits: The carrying amounts for demand and savings deposits, which represent the amounts payable on demand, approximate their fair values. The fair values for time deposits are estimated using discounted cash flow analysis, based on observable market interest rates currently being offered on time deposits with similar terms.

Accrued interest receivable and payable: The fair values of both accrued interest receivable and payable approximate their carrying amounts.

Borrowings: The carrying amounts of federal funds purchased, short-term borrowings, variable rate FHLB advances, and variable rate long-term borrowings approximate their fair values. Fair values of subordinated notes, a fixed rate FHLB advance and other long-term borrowings are estimated using discounted cash flow analysis, based on observable market interest rates currently being offered with similar terms.

Commitments to extend credit and standby letters of credit: The approximate fair values of commitments and standby letters of credit are based on the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and creditworthiness of the counterparties.

The following table presents the carrying amounts and approximate fair values of financial assets and liabilities as of September 30, 2017 and December 31, 2016.



		September 30, 2017				December 31, 2016
	Fair Value Hierarchy Level	Carrying Amount		Approximate Fair Value		Carrying Amount		Approximate Fair Value
Financial assets:
Cash and due from banks	Level 1	$	33,560	$	33,560	$	40,943	$	40,943
Federal funds sold	Level 1	5,937		5,937		35,893		35,893
Investment securities available for sale	See previous table	418,374		418,374		260,637		260,637
Investment securities held to maturity	Level 2	45,597		46,356		48,386		47,789
Federal Home Loan Bank stock	Level 1	12,256		12,256		10,771		10,771
Loans, net⁽¹⁾	Level 2	1,440,547		1,439,084		1,383,758		1,382,569
Accrued interest receivable	Level 1	6,636		6,636		5,321		5,321
Interest rate swap	Level 2	786		786		1,068		1,068
Financial liabilities:
Deposits	Level 2	$	1,651,266	$	1,651,307	$	1,546,605	$	1,546,307
Federal funds purchased	Level 1	925		925		9,690		9,690
Short-term borrowings	Level 1	48,000		48,000		—		—
Subordinated notes, net	Level 2	20,408		14,021		20,398		12,703
Federal Home Loan Bank advances, net	Level 2	101,005		101,113		99,886		99,959
Long-term debt, net	Level 2	24,195		24,134		5,126		5,054
Accrued interest payable	Level 1	616		616		280		280
Interest rate swap	Level 2	351		351		496		496
Off-balance-sheet financial instruments:
Commitments to extend credit	Level 3	—		—		—		—
Standby letters of credit	Level 3	—		—		—		—

(1) All loans are Level 2 except impaired loans with a net value of $0 as of both September 30, 2017 and December 31, 2016, which are Level 3.