Note 19. Fair Value Measurements and Fair Values of Financial Instruments

Management uses its best judgment in estimating the fair value of the Corporation’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Corporation could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective year-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates maybe different than the amounts reported at each year-end.

FASB ASC Topic 820, “Financial Instruments”, requires disclosure of the fair value of financial assets and liabilities, including those financial assets and liabilities that are not measured and reported at fair value on a recurring and nonrecurring basis. The Corporation does not report any nonfinancial assets at fair value. FASB ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under FASB ASC Topic 820 are as follows:

Level 1: Valuation is based on unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. There may be substantial differences in the assumptions used for securities within the same level. For example, prices for U.S. Agency securities have fewer assumptions and are closer to level 1 valuations than the private label mortgage backed securities that require more assumptions and are closer to level 3 valuations.

Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Corporation’s assumptions regarding what market participants would assume when pricing a financial instrument.

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The following methods and assumptions were used to estimate the fair values of the Corporation’s financial instruments at December 31, 2014 and 2013.

Cash and Cash Equivalents: For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Investment securities: The fair value of investment securities is determined in accordance with the methods described under FASB ASC Topic 820.

Restricted stock: The carrying value of restricted stock approximates its fair value based on redemption provisions for the restricted stock.

Loans held for sale: The fair value of loans held for sale is determined by the price set between the Bank and the purchaser prior to origination. These loans are usually sold at par.

Net loans: The fair value of fixed-rate loans is estimated for each major type of loan (e.g. real estate, commercial, industrial and agricultural and consumer) by discounting the future cash flows associated with such loans using rates currently offered for loans with similar terms to borrowers of comparable credit quality. The model considers scheduled principal maturities, repricing characteristics, prepayment assumptions and interest cash flows. The discount rates used are estimated based upon consideration of a number of factors including the treasury yield curve, expense and service charge factors. For variable rate loans that reprice frequently and have no significant change in credit quality, carrying values approximate the fair value.

Accrued Interest Receivable: The carrying amount is a reasonable estimate of fair value.

Mortgage servicing rights: The fair value of mortgage servicing rights is based on observable market prices when available or the present value of expected future cash flows when not available. Assumptions such as loan default rates, costs to service, and prepayment speeds significantly affect the estimate of future cash flows. Mortgage servicing rights are carried at the lower of cost or fair value.

Deposits, Securities sold under agreements to repurchase and Long-term debt: The fair value of demand deposits, savings accounts, and money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-rate certificates of deposit and long-term debt is estimated by discounting the future cash flows using rates approximating those currently offered for certificates of deposit and borrowings with similar remaining maturities. Other borrowings consist of a line of credit with the FHLB at a variable interest rate and securities sold under agreements to repurchase, for which the carrying value approximates a reasonable estimate of the fair value.

Accrued interest payable: The carrying amount is a reasonable estimate of fair value.

Derivatives: The fair value of the interest rate swaps is based on other similar financial instruments and is classified as Level 2.

The following information regarding the fair value of the Corporation’s financial instruments should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful.

The fair value of the Corporation's financial instruments are as follows:



	December 31, 2014
	Carrying		Fair
(Dollars in thousands)	Amount		Value		Level 1		Level 2		Level 3

Financial assets:
Cash and cash equivalents	$	48,593	$	48,593	$	48,593	$	-	$	-
Investment securities available for sale		171,751		171,751		1,053		170,698		-
Restricted stock		438		438		-		438		-
Loans held for sale		389		389		-		389		-
Net loans		717,420		721,680		-		-		721,680
Accrued interest receivable		3,038		3,038		-		3,038		-
Mortgage servicing rights		143		143		-		-		143

Financial liabilities:
Deposits	$	881,181	$	881,289	$	-	$	881,289	$	-
Securities sold under agreements to repurchase		9,079		9,079		-		9,079		-
Accrued interest payable		169		169		-		169		-
Interest rate swaps		191		191		-		191		-


	December 31, 2013
	Carrying		Fair
(Dollars in thousands)	Amount		Value		Level 1		Level 2		Level 3

Financial assets:
Cash and cash equivalents	$	40,745	$	40,745	$	40,745	$	-	$	-
Investment securities available for sale		159,674		159,674		1,970		157,704		-
Restricted stock		1,906		1,906		-		1,906		-
Loans held for sale		349		349		-		349		-
Net loans		713,711		722,119		-		-		722,119
Accrued interest receivable		3,087		3,087		-		3,087		-
Mortgage servicing rights		184		184		-		-		184

Financial liabilities:
Deposits	$	845,724	$	846,289	$	-	$	846,289	$	-
Securities sold under agreements to repurchase		23,834		23,834		-		23,834		-
Long-term debt		12,403		12,999		-		12,999		-
Accrued interest payable		229		229		-		229		-
Interest rate swaps		561		561		-		561		-

Recurring Fair Value Measurements

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2014 and 2013 are as follows:



(Dollars in Thousands)	Fair Value at December 31, 2014
Asset Description	Level 1		Level 2		Level 3		Total
Equity securities	$	1,053	$	-	$	-	$	1,053
U.S. Government and Agency securities		-		15,963		-		15,963
Municipal securities		-		68,366		-		68,366
Trust Preferred Securities		-		5,137		-		5,137
Agency mortgage-backed securities		-		79,494		-		79,494
Private-label mortgage-backed securities		-		1,695		-		1,695
Asset-backed securities		-		43		-		43
Total assets	$	1,053	$	170,698	$	-	$	171,751

Liability Description
Interest rate swaps	$	-	$	191	$	-	$	191
Total liabilities	$	-	$	191	$	-	$	191



(Dollars in Thousands)	Fair Value at December 31, 2013
Asset Description	Level 1		Level 2		Level 3		Total
Equity securities	$	1,970	$	-	$	-	$	1,970
U.S. Government and Agency securities		-		11,751		-		11,751
Municipal securities		-		56,857		-		56,857
Corporate debt securities		-		1,001		-		1,001
Trust Preferred Securities		-		5,051		-		5,051
Agency mortgage-backed securities		-		81,027		-		81,027
Private-label mortgage-backed securities		-		1,969		-		1,969
Asset-backed securities		-		48		-		48
Total assets	$	1,970	$	157,704	$	-	$	159,674

Liability Description
Interest rate swaps	$	-	$	561	$	-	$	561
Total liabilities	$	-	$	561	$	-	$	561

Investment securities: Level 1 securities represent equity securities that are valued using quoted market prices from nationally recognized markets. Level 2 securities represent debt securities that are valued using a mathematical model based upon the specific characteristics of a security in relationship to quoted prices for similar securities.

Interest rate swaps: The interest rate swaps are valued using a discounted cash flow model that uses verifiable market environment inputs to calculate the fair value. This method is not dependent on the input of any significant judgments or assumptions by Management.

Nonrecurring Fair Value Measurements

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2014 and 2013 are as follows:



(Dollars in Thousands)
	Fair Value at December 31, 2014
Asset Description	Level 1		Level 2		Level 3		Total
Impaired loans (1)	$	-	$	-	$	3,469	$	3,469
Other real estate owned (1)		-		-		760		760
Mortgage servicing rights		-		-		143		143
Total assets	$	-	$	-	$	4,372	$	4,372



(Dollars in Thousands)	Fair Value at December 31, 2013
Asset Description	Level 1		Level 2		Level 3		Total
Impaired loans (1)	$	-	$	-	$	8,588	$	8,588
Other real estate owned (1)		-		-		498		498
Mortgage servicing rights		-		-		184		184
Total assets	$	-	$	-	$	9,270	$	9,270

(1) Includes assets directly charged-down to fair value during the year-to-date period.

The Corporation used the following methods and significant assumptions to estimate the fair values for financial assets measured at fair value on a nonrecurring basis.

Impaired loans: Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 3 inputs based on customized discounting criteria.

Other real estate: The fair value of other real estate, upon initial recognition, is estimated using Level 2 inputs within the fair value hierarchy based on observable market data and Level 3 inputs based on customized discounting criteria. In connection with the measurement and initial recognition of the foregoing assets, the Corporation recognizes charge-offs through the allowance for loan losses.

Mortgage servicing rights: The fair value of mortgage servicing rights, upon initial recognition, is estimated using a valuation model that calculates the present value of estimated future net servicing income. The model incorporates Level 3 assumptions such as cost to service, discount rate, prepayment speeds, default rates and losses.

The Corporation did not record any liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at December 31, 2014. For financial assets and liabilities measured at fair value on a recurring basis, there were no transfers of financial assets or liabilities between Level 1 and Level 2 during the period ending December 31, 2014.

The following table presents additional quantitative information about Level 3 assets measured at fair value on a nonrecurring basis:



(Dollars in Thousands)	Quantitative Information about Level 3 Fair Value Measurements
				Range
December 31, 2014	Fair Value	Valuation Technique	Unobservable Input	(Weighted Average)
Impaired loans (1)	$ 3,469	Appraisal	Appraisal Adjustments (2)	0% - 100% (26%)
			Cost to sell	0% - 10% (5%)
Other real estate owned (1)	760	Appraisal	Appraisal Adjustments (2)
			Cost to sell	8% (8%)
Mortgage servicing rights	143	Discounted Cash Flow (3)

				Range
December 31, 2013	Fair Value	Valuation Technique	Unobservable Input	(Weighted Average)
Impaired loans (1)	$ 8,588	Appraisal	Appraisal Adjustments (2)	0% - 60% (5%)
			Cost to sell	5% - 13.5% (7%)
Other real estate owned (1)	498	Appraisal	Appraisal Adjustments (2)
			Cost to sell	8% (8%)
Mortgage servicing rights	184	Discounted Cash Flow (3)

(1) Includes assets directly charged-down to fair value during the year-to-date period.
(2) Qualitative adjustments are discounts specific to each asset and are made as needed.
(3) Valuation and inputs are determined by a third-party pricing service without adjustment.