Note 18 - Fair Value of Financial Instruments

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

Fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

ASC Topic 860 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC Topic 860 are as follows:

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity).

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy utilized at December 31, 2015 and 2014 are as follows:



Description	(Level 1) Quoted Prices in Active Markets for Identical Assets		(Level 2) Significant Other Observable Inputs		(Level 3) Significant Unobservable Inputs		Total

		(In Thousands)
U.S. Government agency obligations	$	-	$	34,570	$	-	$	34,570
Municipal bonds		-		41,204		-		41,204
U.S. Government Sponsored Enterprise (GSE) -
Mortgage-backed securities - residential		-		1,479		-		1,479
December 31, 2015 Securities available for sale	$	-	$	77,253	$	-	$	77,253

U.S. Government agency obligations	$	-	$	30,076	$	-	$	30,076
Municipal bonds		-		38,624		-		38,624
U.S. Government Sponsored Enterprise (GSE) -
Mortgage-backed securities - residential		-		7,501		-		7,501
Corporate bonds		-		996		-		996
December 31, 2014 Securities available for sale	$	-	$	77,197	$	-	$	77,197

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2015 and 2014 are as follows:



Description	(Level 1) Quoted Prices in Active Markets for Identical Assets		(Level 2) Significant Other Observable Inputs		(Level 3) Significant Unobservable Inputs		Total

		(In Thousands)
December 31, 2015 Impaired loans (1)	$	-	$	-	$	785	$	785
December 31, 2015 Impaired loans (2)	$	-	$	-	$	-	$	-
December 31, 2015 Other real estate owned (1)	$	-	$	-	$	1,224	$	1,224
December 31, 2014 Impaired loans (1)	$	-	$	-	$	863	$	863
December 31, 2014 Impaired loans (2)	$	-	$	-	$	479	$	479
December 31, 2014 Other real estate owned (1)	$	-	$	-	$	1,106	$	1,106

(1) Fair Value is generally determined through independent appraisals of the underlying collateral, which generally include various
Level 3 input which are not identifiable. Fair values may also include qualitative adjustments by management based on economic
conditions and liquidation expenses.
(2) Fair Value determined using the debt service of the borrower.

Impaired loans are those that are accounted for under existing FASB guidance, in which the Bank has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Real estate properties acquired through, or in lieu of, foreclosure are to be sold and are carried at fair value less estimated cost to sell. Fair value is based upon independent market prices or appraised value of the property. These assets are included in Level 3 fair value based upon the lowest level of input that is significant to the fair value measurement.

At December 31, 2015, of the impaired loans having an aggregate balance of $6.4 million, $5.2 million did not require a valuation allowance because the value of the collateral securing the loan was determined to meet or exceed the balance owed on the loan. Of the remaining $1.2 million in impaired loans, an aggregate valuation allowance of $370 thousand was required to reflect what was determined to be a shortfall in the value of the collateral as compared to the balance on such loans.

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Company has utilized Level 3 inputs to determine fair value:



		Quantitative Information about Level 3 Fair Value Measurements
Description		Fair Value Estimate		Valuation Techniques	Unobservable Input	Range (Weighted Average)

			(Dollars In Thousands)
December 31, 2015:
Impaired loans		$	785	Appraisal of collateral (1)	Appraisal adjustments (2)	0% to -25% (-25.0%)
					Liquidation expenses (3)	0% to -7.5% (-7.5%)
Impaired loans		$	-	Discounted Cash Flows (5)
Other real estate owned		$	1,224	Listings, Letters of Intent & Third Party Evaluations (4)	Liquidation expenses (3)	-5% (-5%)
December 31, 2014:
Impaired loans		$	863	Appraisal of collateral (1)	Appraisal adjustments (2)	0% to -25% (-17.6%)
					Liquidation expenses (3)	0% to -8.5% (-8.2%)
Impaired loans		$	479	Discounted Cash Flows (5)
Other real estate owned		$	1,106	Listings, Letters of Intent & Third Party Evaluations (4)	Liquidation expenses (3)	-5% (-5%)

(1)	Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various
	Level 3 inputs which are not identifiable.
(2)	Appraisals may be adjusted by management for qualitative factors including economic conditions and the age of the appraisal.
	The range and weighted average of appraisal adjustments are presented as a percent of the appraisal.
(3)	Appraisals and pending agreements of sale are adjusted by management for liquidation expenses. The range and weighted average
	of liquidation expense adjustments are presented as a percent of the appraisal or pending agreement of sale.
(4)	Fair value is determined by listings, letters of intent or third-party evaluations.
(5)	Fair value is determined using the debt service of the borrower.

The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at December 31, 2015 and December 31, 2014:

Cash and Cash Equivalents (Carried at Cost)

The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets’ fair values.

Interest Bearing Time Deposits (Carried at Cost)

Fair values for fixed-rate time certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits. The Company generally purchases amounts below the insured limit, limiting the amount of credit risk on these time deposits.

Securities Available for Sale (Carried at Fair Value)

The fair value of securities available for sale are determined by matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted prices. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the security’s terms and conditions, among other things.

Loans Receivable (Carried at Cost)

The fair values of loans, excluding impaired loans carried at fair value of collateral, are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, and projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.

Restricted Investment in Bank Stock (Carried at Cost)

The carrying amount of restricted investment in bank stock approximates fair value, and considers the limited marketability of such securities.

Accrued Interest Receivable and Payable (Carried at Cost)

The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.

Deposit Liabilities (Carried at Cost)

The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Securities Sold Under Agreements to Repurchase and Short-term Borrowings (Carried at Cost)

These borrowings are short term and the carrying amount approximates the fair value.

Long-Term Borrowings (Carried at Cost)

Fair values of FHLB and Univest advances are estimated using discounted cash flow analysis, based on quoted prices for new FHLB and Univest advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.

Off-Balance Sheet Financial Instruments (Disclosed at Cost)

Fair values for the Company’s off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing.

The estimated fair values of the Company’s financial instruments were as follows at December 31, 2015 and 2014:



		Carrying Amount		Fair Value Estimate		(Level 1) Quoted Prices in Active Markets for Identical Assets		(Level 2) Significant Other Observable Inputs		(Level 3) Significant Unobservable Inputs

	(In Thousands)
December 31, 2015:
Financial assets:
Cash and cash equivalents	$	19,526	$	19,527	$	19,527	$	-	$	-
Interest bearing time deposits						-		-		-
Securities available-for-sale		77,253		77,253		-		77,253		-
Loans receivable, net of allowance		684,047		688,645		-		-		688,645
Restricted investments in bank stock		2,178		2,178		-		2,178		-
Accrued interest receivable		1,637		1,637		-		1,637		-
Financial liabilities:
Deposits		660,266		639,677		-		639,677		-
Securities sold under agreements to
repurchase and federal funds purchased		27,535		27,529		-		27,529		-
Short-term borrowings		39,306		39,273		-		39,273		-
Long-term borrowings		3,820		3,740		-		-		3,740
Accrued interest payable		462		462		-		462		-
Off-balance sheet financial instruments:
Commitments to grant loans		-		-		-		-		-
Unfunded commitments under lines of credit		-		-		-		-		-
Standby letters of credit		-		-		-		-		-

December 31, 2014:
Financial assets:
Cash and cash equivalents	$	16,390	$	16,390	$	16,390	$	-	$	-
Interest bearing time deposits		250		251		-		251		-
Securities available-for-sale		77,197		77,197		-		77,197		-
Loans receivable, net of allowance		604,697		611,256		-		-		611,256
Restricted investments in bank stock		784		784		-		784		-
Accrued interest receivable		1,599		1,599		-		1,599		-
Financial liabilities:
Deposits		611,668		611,975		-		611,975		-
Securities sold under agreements to
repurchase and federal funds purchased		30,304		30,302		-		30,302		-
Short-term borrowings		9,000		9,000				9,000
Long-term borrowings		1,900		1,877		-		-		1,877
Accrued interest payable		349		349		-		349		-
Off-balance sheet financial instruments:
Commitments to grant loans		-		-		-		-		-
Unfunded commitments under lines of credit		-		-		-		-		-
Standby letters of credit		-		-		-		-		-