Note 11 - Fair Value of Financial Instruments and Fair Value Measurements

9 Months Ended

Sep. 30, 2016

(11

) Fair Value of Financial Instruments

and Fair Value Measurements

Generally accepted accounting standards in the U.S. require disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate fair value. The assumptions used in the estimation of the fair value of Colony Bankcorp, Inc. and Subsidiary’s financial instruments are detailed hereafter. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of the Company, but rather a good-faith estimate of the increase or decrease in value of financial instruments held by the Company since purchase, origination or issuance.

Cash and Short-Term Investments

– For cash, due from banks, bank-owned deposits and federal funds sold, the carrying amount is a reasonable estimate of fair value and is classified as Level 1.

Investment Securities

– Fair values for investment securities are based on quoted market prices where available and classified as Level 1. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable instruments and classified as Level 2. If a comparable is not available, the investment securities are classified as Level 3.

Federal Home Loan Bank Stock

– The fair value of Federal Home Loan Bank stock approximates carrying value and is classified as Level 1.

Loans

– The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. For variable rate loans, the carrying amount is a reasonable estimate of fair value. Most loans are classified as Level 2, but impaired loans with a related allowance are classified as Level 3.

Bank-Owned Life Insurance –

The carrying value of bank-owned life insurance policies approximates fair value and is classified as Level 1.

Deposit Liabilities

– The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date and is classified as Level 1. The fair value of fixed maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities and is classified as Level 2.

Subordinated Debentures

– The fair value of subordinated debentures is estimated by discounting the future cash flows using the current rates at which similar advances would be obtained. Subordinate Debentures are classified as Level 2.

Other Borrowed Money

– The fair value of other borrowed money is calculated by discounting contractual cash flows using an estimated interest rate based on current rates available to the Company for debt of similar remaining maturities and collateral terms. Other borrowed money is classified as Level 2 due to their expected maturities.

Disclosures of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis, are required in the financial statements.

The carrying amount, estimated fair values, and placement in the fair value hierarchy of the Company’s financial instruments as of September 30, 2016 and December 31, 2015 are as follows:

	Fair Value Measurements at
	September 30, 2016
	Carrying		Estimated			Level		Level		Level
	Value		Fair Value			1		2		3

Assets
Cash and Short-Term Investments	$	31,675	$	31,675	$	31,675	$	-	$	-
Investment Securities Available for Sale		286,089		286,089		-		285,493		596
Federal Home Loan Bank Stock		3,010		3,010		3,010		-		-
Loans, Net		766,532		767,161		-		760,499		6,662
Bank-Owned Life Insurance		15,246		15,246		15,246		-		-

Liabilities
Deposits		978,590		979,967		603,615		376,352		-
Subordinated Debentures		24,229		24,229		-		24,229		-
Other Borrowed Money		46,000		46,541		-		46,541		-

	Fair Value Measurements at
	December 31, 2015
	Carrying		Estimated			Level		Level		Level
	Value		Fair Value			1		2		3

Assets
Cash and Short-Term Investments	$	60,872	$	60,872	$	60,872	$	-	$	-
Investment Securities Available for Sale		296,149		296,149		-		295,219		930
Federal Home Loan Bank Stock		2,731		2,731		2,731		-		-
Loans, Net		749,675		750,412		-		741,867		8,545
Bank-Owned Life Insurance		14,830		14,830		14,830		-		-

Liabilities
Deposits		1,011,554		1,013,111		611,822		401,289		-
Subordinated Debentures		24,229		24,229		-		24,229		-
Other Borrowed Money		40,000		40,421		-		40,421		-

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on many judgments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial instruments include deferred income taxes and premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

Fair Value Measurements

Generally accepted accounting principles related to

Fair Value Measurements,

define fair value, establish a framework for measuring fair value, establish a three-level valuation hierarchy for disclosure of fair value measurements and enhance disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:

●	Level 1	inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

●	Level 2	inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

●	Level 3	inputs to the valuation methodology are unobservable and represent the Company’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring and nonrecurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Assets

Securities

– Where quoted prices are available in an active market, securities are classified within level 1 of the valuation hierarchy. Level 1 inputs include securities that have quoted prices in active markets for identical assets. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow. Examples of such instruments, which would generally be classified within level 2 of the valuation hierarchy, include certain collateralized mortgage and debt obligations and certain high-yield debt securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within level 3 of the valuation hierarchy. When measuring fair value, the valuation techniques available under the market approach, income approach and/or cost approach are used. The Company’s evaluations are based on market data and the Company employs combinations of these approaches for its valuation methods depending on the asset class.

Impaired Loans

– Impaired loans are those loans which the Company 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.

Other Real Estate

– Other real estate owned assets are adjusted to fair value less estimated selling costs upon transfer of the loans to other real estate owned. Typically, an external, third-party appraisal is performed on the collateral upon transfer into the other real estate owned account to determine the asset’s fair value. Subsequent adjustments to the collateral’s value may be based upon either updated third-party appraisals or management’s knowledge of the collateral and the current real estate market conditions. Appraised amounts used in determining the asset’s fair value, whether internally or externally prepared, are discounted 10 percent to account for selling and marketing costs. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a level 3 classification of the inputs for determining fair value. Because of the high degree of judgment required in estimating the fair value of other real estate owned assets and because of the relationship between fair value and general economic conditions, we consider the fair value of other real estate owned assets to be highly sensitive to changes in market conditions.

Assets and Liabilities Measured at Fair Value on a Recurring and Nonrecurring Basis –

The following table presents the recorded amount of the Company’s assets measured at fair value on a recurring and nonrecurring basis as of September 30, 2016 and December 31, 2015, aggregated by the level in the fair value hierarchy within which those measurements fall. The table below includes only impaired loans with a specific reserve and only other real estate properties with a valuation allowance at September 30, 2016. Those impaired loans and other real estate properties are shown net of the related specific reserves and valuation allowances.

			Fair Value Measurements at Reporting Date Using
			Quoted Prices in				Significant
			Active Markets for		Significant Other		Unobservable
	Total Fair		Identical Assets		Observable		Inputs
September 30, 2016	Value		(Level 1)		Inputs (Level 2)		(Level 3)

Recurring Securities Available for Sale
U.S. Government Agencies
Mortgage-Backed	$	281,381	$	-	$	281,381	$	-
State, County and Municipal		4,708		-		4,112		596
	$	286,089	$	-	$	285,493	$	596

Nonrecurring
Impaired Loans	$	6,662	$	-	$	-	$	6,662

Other Real Estate	$	2,850	$	-	$	-	$	2,850

			Fair Value Measurements at Reporting Date Using
			Quoted Prices in				Significant
			Active Markets for		Significant Other		Unobservable
	Total Fair		Identical Assets		Observable		Inputs
December 31, 2015	Value		(Level 1)		Inputs (Level 2)		(Level 3)

Recurring Securities Available for Sale
U.S. Government Agencies
Mortgage-Backed	$	291,050	$	-	$	291,050	$	-
State, County and Municipal		5,099		-		4,169		930
	$	296,149	$	-	$	295,219	$	930

Nonrecurring
Impaired Loans	$	8,545	$	-	$	-	$	8,545

Other Real Estate	$	2,536	$	-	$	-	$	2,536

Liabilities

The Company did not identify any liabilities that are required to be presented at fair value.

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)

The following table presents quantitative information about the significant unobservable inputs used in the fair value measurements for assets in level 3 of the fair value hierarchy measured on a nonrecurring basis at September 30, 2016 and December 31, 2015. This table is comprised primarily of collateral dependent impaired loans and other real estate owned:

			Valuation	Unobservable	Range
	September 30, 2016		Techniques	Inputs	Weighted Avg

Real Estate
Commercial Construction		51	Sales Comparison	Adjustment for Differences	(5.00 )%	-	99.00%
				Between the Comparable Sales		47.00 %

				Management Adjustments for	0.00%	-	10.00%
				Age of Appraisals and/or Current		5.00 %
				Market Conditions

Residential Real Estate		416	Sales Comparison	Adjustment for Differences	(22.00 )%	-	0.00%
				Between the Comparable Sales		(11.00 )%

				Management Adjustments for	0.00%	-	40.00%
				Age of Appraisals and/or Current		20.00%
				Market Conditions

Commercial Real Estate		5,846	Sales Comparison	Adjustment for Differences	(14.08 )%	-	24.62%
				Between the Comparable Sales		5.27%

				Management Adjustments for	0.00%	-	100.00%
				Age of Appraisals and/or Current		50.00%
				Market Conditions

			Income Approach	Capitalization Rate		10.67 %

Farmland		349	Sales Comparison	Adjustment for Differences	(27.00 )%	-	15.00%
				Between the Comparable Sales		(6.00 )%

				Management Adjustments for	10.00%	-	75.00%
				Age of Appraisals and/or Current		42.50%
				Market Conditions

Other Real Estate Owned		2,850	Sales Comparison	Adjustment for Differences	(50.80 )%	-	142.90%
				Between the Comparable Sales		46.05%

				Management Adjustments for	0.62%	-	72.75%
				Age of Appraisals and/or Current		29.23%
				Market Conditions

			Income Approach	Discount Rate		12.50%

			Valuation	Unobservable	Range
	December 31, 2015		Techniques	Inputs	Weighted Avg

Commercial	$	28	Sales Comparison	Adjustment for Differences	(31.77)%	-	34.00%
				Between the Comparable Sales		1.12%

				Management Adjustment for	0.00%	-	10.00%
				Age of Appraisals and/or Current		5.00%
				Market Conditions

			Income Approach	Capitalization Rate		11.00%

Real Estate
Commercial Construction		51	Sales Comparison	Adjustment for Differences	(5.00)%	-	99.00%
				Between the Comparable Sales		47.00%

				Management Adjustments for	0.00%	-	10.00%
				Age of Appraisals and/or Current		5.00%
				Market Conditions

Residential Real Estate		767	Sales Comparison	Adjustment for Differences	(22.00)%	-	10.80%
				Between the Comparable Sales		5.60%

				Management Adjustments for	0.00%	-	25.00%
				Age of Appraisals and/or Current		12.50%
				Market Conditions

Commercial Real Estate		7,348	Sales Comparison	Adjustment for differences	(31.77)%	-	34.00%
				Between the comparable Sales		1.12%

				Management Adjustments for	0.00%	-	10.00%
				Age of Appraisals and/or Current		5.00%
				Market Conditions

			Income Approach	Capitalization Rate		10.25%

Farmland		351	Sales Comparison	Adjustment for Differences	(27.00)%	-	15.00%
				Between the Comparable Sales		(6.00)%

				Management Adjustments for	10.00%	-	75.00%
				Age of Appraisals and/or Current		42.50%
				Market Conditions

Other Real Estate Owned		2,536	Sales Comparison	Adjustment for Differences	(50.80)%	-	142.90%
				Between the Comparable Sales		46.05%

				Management Adjustment for	15.53%	-	72.75%
				Age of Appraisals and/or Current		43.37%
				Market Conditions

			Income Approach	Discount Rate		12.50%

The table below presents a reconciliation and statement of income classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (level 3) for the nine months ended September 30, 2016 and the twelve months ended December 31, 2015.

	Available for Sale Securities
	September 30, 2016			December 31, 2015

Balance, Beginning	$	930		$	948
Transfers out of Level 3		-			-
Maturities		(330	)		-
Loss on OTTI Impairment Included		-
in Noninterest Income		-			-
Unrealized Gains included in Other Comprehensive Income (Loss)		(4	)		(18	)


Balance, Ending	$	596		$	930

The Company’s policy is to recognize transfers in and transfers out of levels 1, 2 and 3 as of the end of a reporting period. There were no transfers of securities between levels for the nine months ended September 30, 2016 and the twelve months ended December 31, 2015.

The following table presents quantitative information about recurring level 3 fair value measurements as of September 30, 2016.

			Valuation	Unobservable	Range
	Fair Value		Techniques	Inputs	Weighted Avg

State, County and Municipal	$	596	Discounted Cash Flow	Discount Rate		N/A*

* The Company relies on a third-party pricing service to value its municipal securities. The details of the unobservable inputs and other adjustments used by the third-party pricing service were not readily available to the Company.

- 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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