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FAIR VALUE OF FINANCIAL INSTRUMENTS

3 Months Ended

Mar. 31, 2018

NOTE 6 - FAIR VALUE OF FINANCIAL INSTRUMENTS

Accounting guidance 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 standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate fair value:

Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2), using matrix pricing. Matrix pricing is a mathematical technique commonly used to price debt securities that are not actively traded, values debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to the other benchmark quoted securities (Level 2 inputs). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3 inputs). A third party is engaged to obtain the discounted cash flows and the resulting fair value. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Impaired Loans: The fair value of impaired loans with specific allocations of the ALLL is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available for similar loans and collateral underlying such loans. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairments and adjusted accordingly.

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below (dollars in thousands):

	Fair Value Measurement using:
At March 31, 2018	Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Residential mortgage-backed securities	$	-	$	23,038	$	-
Residential collateralized mortgage obligation		-		2,521		-
Commercial collateralized mortgage obligations		-		1,532		-
Municipal bond		-		1,100		-
CRA Mutual Fund		2,085		-		-

At December 31, 2017
Assets:
Residential mortgage-backed securities	$	-	$	24,684	$	-
Residential collateralized mortgage obligation		-		2,706		-
Commercial collateralized mortgage obligations		-		1,550		-
Municipal bond		-		1,109		-
CRA Mutual Fund		2,108		-		-

There were no transfers between Level 1 and Level 2 during 2018.

There were no assets and liabilities measured at fair value on a non-recurring basis as of March 31, 2018 and December 31, 2017.

As of March 31, 2018 and December 31, 2017, there were no loans measured at fair value on a non-recurring basis.

Carrying amount and estimated fair values of financial instruments at March 31, 2018 and at year ended December 31, 2017 were as follows (dollars in thousands):

			Fair Value Measurement Using:
At March 31, 2018	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Fair Value
Financial assets:
Cash and due from banks	$	370,950	$	370,950	$	-	$	-	$	370,950
Securities available for sale		30,276		2,085		28,191		-		30,276
Securities held to maturity		5,212		-		5,022		-		5,022
Loans, net		1,509,906		-		-		1,570,421		1,570,421
Other investments		-		-		-		-		-
FRB Stock		7,214		N/A		N/A		N/A		N/A
FHLB Stock		2,352		N/A		N/A		N/A		N/A
SBA Loan Fund		5,000		N/A		N/A		N/A		N/A
Certificates of deposit		2,000		2,000		-		-		2,000
Accrued interest receivable		4,366		21		127		4,218		4,366
Financial liabilities:
Deposits without stated maturities	$	1,546,510	$	1,546,510	$	-	$	-	$	1,546,510
Deposits with stated maturities		70,606		-		71,401		-		71,401
Borrowed funds		33,000		-		33,201		-		33,201
Trust preferred securities payable		20,620		-		-		19,977		19,977
Subordinated debt, net of issuance cost		24,503		-		25,375		-		25,375
Accrued interest payable		454		19		361		74		454

			Fair Value Measurement Using:
At December 31, 2017	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Fair Value
Financial assets:
Cash and due from banks	$	261,231	$	261,231	$	-	$	-	$	261,231
Securities available for sale		32,157		2,108		30,049		-		32,157
Securities held to maturity		5,428		-		5,330		-		5,330
Loans, net		1,405,009		-		-		1,410,860		1,410,860
Other investments
FRB Stock		3,911		N/A		N/A		N/A		N/A
FHLB Stock		2,766		N/A		N/A		N/A		N/A
SBA Loan Fund		5,000		N/A		N/A		N/A		N/A
Certificates of deposit		2,000		2,000		-		-		2,000
Accrued interest receivable		4,421		11		116		4,294		4,421
Financial liabilities:
Deposits without stated maturities	$	1,324,110	$	1,324,110	$	-	$	-		1,324,110
Deposits with stated maturities		80,245		-		80,079		-		80,079
Borrowed funds		42,198		-		42,188		-		42,188
Trust preferred securities payable		20,620		-		-		19,997		19,997
Subordinated debt, net of issuance cost		24,489		-		25,500		-		25,500
Accrued interest payable		749		27		258		464		749

The methods and assumptions used to estimate fair value are described as follows:

Cash and Due from Banks: Carrying amounts of cash approximate fair value, since these instruments are either payable on demand or have short-term maturities and as such are classified as Level 1.

Securities Available for Sale and Held to Maturity: If available, the estimated fair values are based on independent dealer quotations on nationally recognized securities exchanges and are classified as Level 1. For securities where quoted prices are not available, fair value is based on matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities resulting in a Level 2 classification.

Other Investments: It is not practicable to determine the fair value of Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) stock, and investments in Solomon Hess SBA Loan Fund (“SBA Loan Fund”), due to restrictions placed on transferability. Certificates of deposit values are based on actively quoted prices and as such are classified as Level 1.

Loans: Fair values of loans, excluding loans held for sale are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality establishing discount factors for these types of loans and resulting in a Level 3 classification. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

Deposits without stated maturities: The fair values disclosed for demand deposits (e.g. interest and non-interest checking, savings and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the recording date (i.e., their carrying amount) resulting in a Level 1 price.

Deposits with stated maturities: The estimated fair values of certificates of deposit are based on discounted cash flow calculations that use a replacement cost of funds approach to establishing discount rates for certificate of deposit maturities resulting in a Level 2 classification.

Borrowed funds: Represents FHLB advances for which the estimated fair values are based on discounted cash flow calculations that use a replacement cost of funds approach to establishing discount rates for funding maturities resulting in a Level 2 classification for all other maturity terms.

Trust Preferred Securities: The estimated fair value is based on estimates using market data for similarly risk weighted items and takes into consideration the features of the debentures which is an unobservable input resulting in a Level 3 classification.

Subordinated Debt, net of debt issuance costs: The fair value of subordinated debt is estimated using discounted cash flow analyses based on then current borrowing rates for similar types of borrowing arrangements (deemed a Level 2 valuation), and is provided to the Company independently by a market maker in the underlying security.

Accrued Interest Receivable and Payable: For these short-term instruments, the carrying amount is a reasonable estimate of the fair value resulting in a Level 1, 2 or 3 classification consistent with the underlying asset or liability the interest is associated with.

Off-Balance-Sheet Liabilities: The fair value of off-balance-sheet commitments to extend credit is estimated using fees currently charged to enter into similar agreements. The fair value was immaterial as of March 31, 2018 and December 31, 2017.

Fair value estimates are made at specific points in time and are based on existing on-and off-balance sheet financial instruments. These estimates are subjective in nature and dependent on a number of significant assumptions associated with each financial instrument or group of financial instruments, including estimates of discount rates, risks associated with specific financial instruments, estimates of future cash flows, and relevant available market information. Changes in assumptions could significantly affect the estimates. In addition, fair value estimates do not reflect the value of anticipated future business, premiums or discounts that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument, or the tax consequences of realizing gains or losses on the sale of financial instruments.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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