NOTE 7. FAIR VALUES OF FINANCIAL INSTRUMENTS

In accordance with FASB ASC Topic 820, Fair Value Measurement and Disclosure (“ASC 820”), disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, is required. 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 under current market conditions. Fair value is best determined based upon quoted market prices. 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, and the fair value estimates may not be realized in an immediate settlement of the instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

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 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.

Fair Value Hierarchy

In accordance with ASC 820, the Company groups its financial assets and financial liabilities measured 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 fair value.

Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 – Valuation is based on inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on 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 for substantially the full term of the asset or liability.

Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:

Investments and Mortgage-Backed Securities – Where quoted prices are available in an active market, the Company classifies the securities within level 1 of the valuation hierarchy. Securities are defined as both long and short positions. Level 1 securities include highly liquid government bonds and exchange-traded equities.

If quoted market prices are not available, the Company estimates fair values using pricing models and discounted cash flows that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes, and credit spreads. Examples of such instruments, which would generally be classified within level 2 of the valuation hierarchy, include Government Sponsored Enterprise obligations, corporate bonds, and other securities. Mortgage-backed securities are included in level 2 if observable inputs are available. In certain cases where there is limited activity or less transparency around inputs to the valuation, the Company classifies those securities in level 3. Equity mutual funds are valued based on market quoted prices and are classified in level 1 as they are actively traded.

Cash and Due from Banks – For those short-term instruments, fair value is the carrying value.

Federal Funds Sold/Purchased and Securities Sold Under Repurchase Agreements – The fair value is the carrying value.

Loans – For variable-rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (for example, one-to-four family residential), credit card loans, and other consumer loans are based on quoted market prices of similar instruments sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. Fair values for other loans (for example, commercial real estate and investment property mortgage loans, commercial and industrial loans) are estimated using discounted cash flow analyses, using market interest rates for comparable loans. Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Loans held for sale are measured using quoted market prices when available. If quoted market prices are not available, comparable market values or discounted cash flow analyses may be utilized. The Company classifies these assets in level 2.

Real Estate Owned – The fair values are estimated based on recent appraisal values of the property less costs to sell the property, as real estate owned is valued at the lower of cost or fair value of the property, less estimated costs to sell. Certain inputs used in appraisals are not always observable, and therefore real estate owned may be classified in level 3 within the fair value hierarchy. When inputs are observable, these assets are classified in level 2.

Accrued Interest – The carrying amounts of accrued interest approximate fair value.

Deposit Liabilities – The fair values disclosed for demand deposits (for example, interest and noninterest checking, savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies market interest rates on comparable instruments to a schedule of aggregated expected monthly maturities on time deposits.

Short-Term Borrowings – The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within 90 days approximate their fair values. Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on current market rates for similar types of borrowing arrangements.

Long-Term Borrowings – The fair values of long-term borrowings are estimated using discounted cash flows analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. The fair value of the Company’s long-term debt would therefore be classified in level 3 within the fair value hierarchy.

Commitments – The fair value of commitments to extend credit was not significant.

Fair Value of Assets Measured on a Recurring Basis

Assets measured at fair value on a recurring basis are summarized below; there were no liabilities measured on a recurring basis at June 30, 2014 or December 31, 2013 (dollars in thousands):


	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
June 30, 2014
Mortgage-backed securities	$	45,279	$	—	$	45,279	$	—
Obligations of other U.S. government agencies		2,487		—		2,487		—
Obligations of state and political subdivisions		12,712		—		12,712		—
Corporate bonds		4,565		—		4,565		—
Equity mutual funds		485		485		—		—

Total	$	65,528	$	485	$	65,043	$	—

December 31, 2013
Mortgage-backed securities	$	34,462	$	—	$	34,462	$	—
Obligations of other U.S. government agencies		2,210		—		2,210		—
Obligations of state and political subdivisions		14,100		—		14,100		—
Corporate bonds		4,925		—		4,925		—
Equity mutual funds		476		476		—		—

Total	$	56,173	$	476	$	55,697	$	—

Fair Value Assets Measured on a Nonrecurring Basis

Assets measured at fair value on a non-recurring basis are summarized below; there were no liabilities measured on a non-recurring basis at June 30, 2014 or December 31, 2013 (dollars in thousands):


	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level3)
June 30, 2014
Loans held for sale	$	32,131	$	—	$	32,131	$	—
Impaired loans		4,174		—		4,174		—
Real estate owned		3,423		—		3,423		—

Total	$	39,728	$	—	$	39,728	$	—

December 31, 2013
Loans held for sale	$	5,029	$	—	$	5,029	$	—
Impaired loans		4,175		—		4,175		—
Real estate owned		3,515		—		3,515		—

Total	$	12,719	$	—	$	12,719	$	—

The estimated fair values of the Company’s financial instruments at June 30, 2014 and December 31, 2013 were as follows (dollars in thousands):


	June 30, 2014
	Carrying Amount		Total		Level 1		Level 2		Level 3
Financial assets:
Cash and due from banks	$	14,649	$	14,649	$	14,649	$	—	$	—
Federal funds sold		500		500		500		—		—
Investment securities		79,543		79,235		485		78,750		—
Other equity securities		3,409		3,409		—		3,409		—
Loans, net of allowance		592,224		596,919		—		—		596,919
Accrued interest receivable		1,921		1,921		1,921		—		—

Financial liabilities:
Deposits, noninterest-bearing	$	69,804	$	69,804	$	—	$	69,804	$	—
Deposits, interest-bearing		508,863		507,095		—		—		507,095
FHLB short-term advances and repurchase agreements		11,425		11,425		—		11,425		—
FHLB long-term advances		68,409		68,499		—		—		68,499
Other borrowed funds-long term		8,609		8,609		—		—		8,609
Accrued interest payable		289		289		289		—		—


	December 31, 2013
	Carrying Amount		Total		Level 1		Level 2		Level 3
Financial assets:
Cash and due from banks	$	27,703	$	27,703	$	27,703	$	—	$	—
Federal funds sold		500		500		500		—		—
Investment securities		62,752		62,159		476		61,683		—
Other equity securities		2,020		2,020		—		2,020		—
Loans, net of allowance		505,744		510,998		—		—		510,998
Accrued interest receivable		1,835		1,835		1,835		—		—

Financial liabilities:
Deposits, noninterest-bearing	$	72,795	$	72,795	$	—	$	72,795	$	—
Deposits, interest-bearing		459,811		456,046		—		—		456,046
FHLB short-term advances and repurchase agreements		10,203		10,203		—		10,203		—
FHLB long-term advances		30,818		30,896		—		—		30,896
Other borrowed funds-long term		3,609		3,605		—		—		3,605
Accrued interest payable		285		285		285		—		—