19. Disclosures about Fair Value Measurements and Financial Instruments

The following disclosures establish a hierarchal disclosure framework associated with the level of pricing observability utilized in measuring assets and liabilities at fair value. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The three broad levels defined within this hierarchy are as follows:

Level I: Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

Level II: Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed.

Level III: Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

Assets and Liability Measured and Recorded on a Recurring Basis

Securities classified as available for sale are reported at fair value utilizing Level 2 inputs. 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 quoted market spreads, cash flows, the US Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

The following tables present the assets measured and recorded on the Consolidated Balance Sheets at their fair value as of March 31, 2018 and December 31, 2017, by level within the fair value hierarchy (in thousands).

	Fair Value Measurements at March 31, 2018
	Total			(Level 1)		(Level 2)			(Level 3)
US Agency securities	$	6,655		$	—	$	6,655		$	—
US Agency mortgage-backed securities		81,546			—		81,546			—
Taxable municipal		8,590			—		8,590			—
Corporate bonds		35,599			—		35,599			—
Fair value swap asset		511			—		511			—
Fair value swap liability		(511	)		—		(511	)		—

	Fair Value Measurements at December 31, 2017
	Total			(Level 1)		(Level 2)			(Level 3)
US Agency securities	$	6,572		$	—	$	6,572		$	—
US Agency mortgage-backed securities		79,746			—		79,746			—
Taxable municipal		7,036			—		7,036			—
Corporate bonds		35,784			—		35,784			—
Fair value swap asset		92			—		92			—
Fair value swap liability		(92	)		—		(92	)		—

Assets Measured and Recorded on a Non-recurring Basis

Loans considered impaired are loans for which, based on current information and events, it is probable that the creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. As detailed in the allowance for loan loss footnote, impaired loans are reported at fair value of the underlying collateral if the repayment is expected solely from the collateral. Collateral values are estimated using Level 3 inputs based on observable market data which at times are discounted. At March 31, 2018, impaired loans with a carrying value of $926,000 were reduced by a specific valuation allowance totaling $835,000 resulting in a net fair value of $91,000. At December 31, 2017, impaired loans with a carrying value of $1.8 million were reduced by a specific valuation allowance totaling $909,000 resulting in a net fair value of $850,000.

Other real estate owned is measured at fair value based on appraisals, less estimated cost to sell. Valuations are periodically performed by management. Income and expenses from operations and changes in valuation allowance are included in the net expenses from OREO.

Assets measured and recorded at fair value on a non-recurring basis are summarized below (in thousands, except range data):

	Fair Value Measurements at March 31, 2018
	Total		(Level 1)		(Level 2)		(Level 3)
Impaired loans	$	91	$	—	$	—	$	91
Other real estate owned		168		—		—		168

	Fair Value Measurements at December 31, 2017
	Total		(Level 1)		(Level 2)		(Level 3)
Impaired loans	$	850	$	—	$	—	$	850
Other real estate owned		18		—		—		18

March 31, 2018

Quantitative Information About Level 3 Fair Value Measurements

Fair Value
Estimate

Valuation
Techniques

Unobservable Input

Range(Wgtd Avg)

Impaired loans

Appraisal of
collateral⁽¹⁾^,⁽³⁾

Appraisal
adjustments⁽²⁾

0% to 100%(90%)

Other real estate owned

168

Appraisal of
collateral⁽¹⁾^,⁽³⁾

Appraisal
adjustments⁽²⁾
Liquidation
expenses

0% to 25%(2%)
0% to 186%(35%)

December 31, 2017

Quantitative Information About Level 3 Fair Value Measurements

Fair Value

Estimate

Valuation

Techniques

Unobservable Input

Range(Wgtd Avg)

Impaired loans

850

Appraisal of
collateral⁽¹⁾^,⁽³⁾

Appraisal
adjustments⁽²⁾

21% to 75%(54%)

Other real estate owned

Appraisal of
collateral⁽¹⁾^,⁽³⁾

Appraisal
adjustments⁽²⁾
Liquidation
expenses

16% to 64%(29%)

2% to 206%(79%)

(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 such as economic conditions.

(3)

Includes qualitative adjustments by management and estimated liquidation expenses.

FAIR VALUE OF FINANCIAL INSTRUMENTS

For the Company, as for most financial institutions, approximately 90% of its assets and liabilities are considered financial instruments. Many of the Company’s financial instruments, however, lack an available trading market characterized by a willing buyer and willing seller engaging in an exchange transaction. Therefore, significant estimates and present value calculations were used by the Company for the purpose of this disclosure.

Fair values have been determined by the Company using independent third party valuations that use the best available data (Level 2) and an estimation methodology (Level 3) the Company believes is suitable for each category of financial instruments. Management believes that cash, cash equivalents, bank owned life insurance, regulatory stock, accrued interest receivable and payable, short term borrowings, and loans and deposits with floating interest rates have estimated fair values which approximate the recorded book balances.

The estimation methodologies used, the estimated fair values based on US GAAP measurements, and recorded book balances at March 31, 2018 and December 31, 2017, were as follows (in thousands):

	March 31, 2018
	Carrying Value		Fair Value		(Level 1)		(Level 2)		(Level 3)
FINANCIAL ASSETS:
Cash and cash equivalents	$	30,594	$	30,594	$	30,594	$	—	$	—
Investment securities – AFS		132,390		132,390		—		132,390		—
Investment securities – HTM		38,663		38,041		—		35,084		2,957
Regulatory stock		6,390		6,390		6,390		—		—
Loans held for sale		843		862		862		—		—
Loans, net of allowance for loan loss and unearned income		864,941		850,224		—		—		850,224
Accrued interest income receivable		3,555		3,555		3,555		—		—
Bank owned life insurance		37,992		37,992		37,992		—		—
Fair value swap asset		511		511		—		511		—
FINANCIAL LIABILITIES:
Deposits with no stated maturities	$	682,946	$	682,946	$	682,946	$	—	$	—
Deposits with stated maturities		261,260		261,070		—		—		261,070
Short-term borrowings		36,895		36,895		36,895		—		—
All other borrowings		66,366		68,894		—		—		68,894
Accrued interest payable		1,633		1,633		1,633		—		—
Fair value swap liability		511		511		—		511		—

	December 31, 2017
	Carrying Value		Fair Value		(Level 1)		(Level 2)		(Level 3)
FINANCIAL ASSETS:
Cash and cash equivalents	$	34,188	$	34,188	$	34,188	$	—	$	—
Investment securities – AFS		129,138		129,138		—		129,138		—
Investment securities – HTM		38,752		38,811		—		35,859		2,952
Regulatory stock		6,800		6,800		6,800		—		—
Loans held for sale		3,125		3,173		3,173		—		—
Loans, net of allowance for loan loss and unearned income		879,419		873,784		—		—		873,784
Accrued interest income receivable		3,603		3,603		3,603		—		—
Bank owned life insurance		37,860		37,860		37,860		—		—
Fair value swap asset		92		92		—		92		—
FINANCIAL LIABILITIES:
Deposits with no stated maturities	$	688,648	$	688,648	$	688,648	$	—	$	—
Deposits with stated maturities		259,297		260,153		—		—		260,153
Short-term borrowings		49,084		49,084		49,084		—		—
All other borrowings		66,617		69,684		—		—		69,684
Accrued interest payable		1,754		1,754		1,754		—		—
Fair value swap liability		92		92		—		92		—

The fair value of cash and cash equivalents, regulatory stock, accrued interest income receivable, short-term borrowings, and accrued interest payable are equal to the current carrying value.

The fair value of investment securities is equal to the available quoted market price for similar securities. The fair value measurements consider observable data that may include dealer quoted market spreads, cash flows, the US Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. The Level 3 securities are valued by discounted cash flows using the US Treasury rate for the remaining term of the securities.

Loans held for sale are priced individually at market rates on the day that the loan is locked for commitment with an investor. All loans in the held for sale account conform to Fannie Mae underwriting guidelines, with the specific intent of the loan being purchased by an investor at the predetermined rate structure. Loans in the held for sale account have specific delivery dates that must be executed to protect the pricing commitment (typically a 30, 45, or 60 day lock period).

The net loan portfolio has been valued using a present value discounted cash flow. The discount rate used in these calculations is based upon the treasury yield curve adjusted for non-interest operating costs, credit loss, current market prices and assumed prepayment risk. In accordance with ASU 2016-01, the discount rates used to determine fair value incorporate interest rate spreads that reflect factors such as liquidity, credit, and nonperformance risk of the loans.

The fair value of bank owned life insurance is based upon the cash surrender value of the underlying policies and matches the book value.

Deposits with stated maturities have been valued using a present value discounted cash flow with a discount rate approximating current market for similar assets and liabilities. Deposits with no stated maturities have an estimated fair value equal to both the amount payable on demand and the recorded book balance.

The fair value of all other borrowings is based on the discounted value of contractual cash flows. The discount rates are estimated using rates currently offered for similar instruments with similar remaining maturities.

The fair values of the fair value swaps used for interest rate risk management represents the amount the Company would have expected to receive or pay to terminate such agreements.

Commitments to extend credit and standby letters of credit are financial instruments generally not subject to sale, and fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unrecognized commitment, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment using fees currently charged to enter into similar agreements with similar credit risk, is not considered material for disclosure. The contractual amounts of unfunded commitments are presented in Note 16.

Changes in assumptions or estimation methodologies may have a material effect on these estimated fair values. The Company’s remaining assets and liabilities which are not considered financial instruments have not been valued differently than has been customary under historical cost accounting.