NOTE 16. FAIR VALUES OF FINANCIAL INSTRUMENTS

In accordance with FASB ASC Topic 820, Fair Value Measurement and Disclosure, disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, is required. 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. 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.

The 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 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 this guidance, 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:

Cash and Due from Banks – For these short-term instruments, fair value is the carrying value. Cash and due from banks is classified in level 1 of the fair value hierarchy.

Federal Funds Sold/Purchased and Securities Sold under Repurchase Agreements – The fair value is the carrying value based on the short-term nature of these items. The Company classifies these assets in level 1 of the fair value hierarchy.

Investments – Where quoted prices are available in an active market, the Company classifies these 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 these securities in level 3.

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. The Company classifies loans in level 3 of the fair value hierarchy.

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 3 of the fair value hierarchy.

Other Real Estate Owned – The fair values are estimated based on recent appraisal values of the property less costs to sell the property, as other 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 other 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 of the fair value hierarchy.

Deposit Liabilities—The fair values disclosed for noninterest-bearing demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). These noninterest-bearing deposits are classified in level 2 of the fair value hierarchy. The carrying amounts of variable-rate deposit accounts (for example interest-bearing checking, savings and money market accounts), 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. All interest-bearing deposits are classified in level 3 of the fair value hierarchy.

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. The Company classifies these borrowings in level 2 of the fair value hierarchy.

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 is therefore classified in level 3 of the fair value hierarchy.

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

Derivative Instruments – The fair value for interest rate swap agreements are based upon the amounts required to settle the contracts. These derivative instruments are classified in level 2 of the fair value hierarchy.

Fair Value of Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below as of the dates indicated (dollars in thousands).

			Quoted Prices in				Significant
			Active Markets for		Significant Other		Unobservable
			Identical Assets		Observable Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
December 31, 2016
Assets:
Obligations of other U.S. government agencies and corporations	$	29,490	$	-	$	29,490	$	-
Obligations of state and political subdivisions		27,855		-		10,199		17,656
Corporate bonds		14,968		-		14,344		624
Residential mortgage-backed securities		87,588		-		87,588		-
Commercial mortgage-backed securities		2,444		-		2,444		-
Equity securities		706		706		-		-
Derivative financial instruments		8		-		8		-
Total assets	$	163,059	$	706	$	144,073	$	18,280

December 31, 2015
Assets:
Obligations of other U.S. government agencies and corporations	$	26,473	$	-	$	26,473	$	-
Obligations of state and political subdivisions		21,467		-		11,072		10,395
Corporate bonds		14,824		-		13,688		1,136
Residential mortgage-backed securities		47,526		-		47,526		-
Commercial mortgage-backed securities		1,989		-		1,989		-
Equity securities		1,092		1,092		-		-
Total assets	$	113,371	$	1,092	$	100,748	$	11,531
Liabilities:
Derivative financial instruments	$	581	$	-	$	581	$	-

The Company reviews fair value hierarchy classifications on a quarterly basis. Changes in the Company’s ability to observe inputs to the valuation may cause reclassification of certain assets or liabilities within the fair value hierarchy. The table below provides a reconciliation for assets measured at fair value on a recurring basis using significant unobservable inputs, or Level 3 inputs (dollars in thousands).

	Obligations of
	State and Political			Corporate
	Subdivisions			Bonds			Total

Balance at December 31, 2014	$	-		$	-		$	-
Realized gains (losses) included in net income		-			-			-
Unrealized losses included in other comprehensive income		-			-			-
Purchases		10,395			1,136			11,531
Sales		-			-			-
Transfers into Level 3		-			-			-
Transfers out of Level 3		-			-			-
Balance at December 31, 2015	$	10,395		$	1,136		$	11,531
Realized gains (losses) included in net income		-			-			-
Unrealized losses included in other comprehensive income		(1,684	)		(27	)		(1,711	)
Purchases		9,065			-			9,065
Sales		-			-			-
Paydowns		(120	)		-			(120	)
Transfers into Level 3		-			-			-
Transfers out of Level 3		-			(485	)		(485	)
Balance at December 31, 2016	$	17,656		$	624		$	18,280

There were no liabilities measured at fair value on a recurring basis using Level 3 inputs at December 31, 2016, 2015 and 2014. For the year ended December 31, 2016, there were no gains or losses included in earnings, nor were there unrealized gains or losses related to the change in fair value of the assets measured on a recurring basis using significant unobservable inputs held at the end of the period.

Fair Value of Assets Measured on a Nonrecurring Basis

Assets measured at fair value on a nonrecurring basis are summarized below as of the dates indicated; there were no liabilities measured on a nonrecurring basis at December 31, 2016 or 2015 (dollars in thousands).

Estimated

Range of

Weighted Average

Fair Value

Valuation Technique

Unobservable Inputs

Discounts

Discount

December 31, 2016

Impaired loans

801

Discounted cash flows, Underlying collateral value

Collateral discounts and estimated costs to sell

1% - 100%

32%

December 31, 2015

Impaired loans

335

Discounted cash flows, Underlying collateral value

Collateral discounts and estimated costs to sell

2% - 100%

35%

Other real estate owned

Discounted cash flows, Underlying collateral value, Third party appraisals

Collateral discounts and discount rates

17%

The estimated fair values of the Company’s financial instruments at December 31, 2016 and December 31, 2015 are shown below (dollars in thousands).

	December 31, 2016
	Carrying		Estimated
	Amount		Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and due from banks	$	29,342	$	29,342	$	29,342	$	-	$	-
Federal funds sold		106		106		106		-		-
Investment securities		183,142		182,663		706		151,128		30,829
Other equity securities		5,362		5,362		-		5,362		-
Loans, net of allowance		886,375		890,949		-		-		890,949
Loan held for sale		-		-		-		-		-
Derivative financial instruments		8		8		-		8		-

Financial liabilities:
Deposits, noninterest-bearing	$	108,404	$	108,404	$	-	$	108,404	$	-
Deposits, interest-bearing		799,383		779,397		-		-		779,397
FHLB short-term advances and repurchase agreements		112,690		112,690		-		112,690		-
FHLB long-term advances		9,200		9,233		-		-		9,233
Junior subordinated debt		3,609		3,635		-		-		3,635
Other borrowings		1,000		1,001		-		1,001		-

	December 31, 2015
	Carrying		Estimated
	Amount		Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and due from banks	$	20,785	$	20,785	$	20,785	$	-	$	-
Federal funds sold		181		181		181		-		-
Investment securities		139,779		139,642		1,092		112,958		25,592
Other equity securities		5,835		5,835		-		5,835		-
Loans, net of allowance		739,313		738,614		-		-		738,614
Loan held for sale		80,509		80,509		-		-		80,509

Financial liabilities:
Deposits, noninterest-bearing	$	90,447	$	89,427	$	-	$	89,427	$	-
Deposits, interest-bearing		646,959		630,613		-		-		630,613
FHLB short-term advances and repurchase agreements		158,236		158,236		-		158,236		-
FHLB long-term advances		8,360		8,455		-		-		8,455
Junior subordinated debt		3,609		3,217		-		-		3,217
Derivative financial instruments		581		581		-		581		-