Note 9. 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 period-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 September 30, 2016 and December 31, 2015.

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 as discussed below.

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 (including impaired 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.

Deposits and Short-term borrowings: 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 is estimated by discounting the future cash flows using rates approximating those currently offered for certificates of deposit with similar remaining maturities. For short-term borrowings, the carrying value approximates a reasonable estimate of the fair value.

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

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:



	September 30, 2016
	Carrying		Fair
(Dollars in thousands)	Amount		Value		Level 1		Level 2		Level 3

Financial assets:
Cash and cash equivalents	$	40,594	$	40,594	$	40,594	$	-	$	-
Investment securities available for sale		155,345		155,345		250		155,095		-
Restricted stock		1,118		1,118		-		1,118		-
Loans held for sale		367		367		-		367		-
Net loans		847,891		858,095		-		-		858,095
Accrued interest receivable		3,105		3,105		-		3,105		-

Financial liabilities:
Deposits	$	978,552	$	978,487	$	-	$	978,487	$	-
Accrued interest payable		137		137		-		137		-


	December 31, 2015
	Carrying		Fair
(Dollars in thousands)	Amount		Value		Level 1		Level 2		Level 3

Financial assets:
Cash and cash equivalents	$	39,166	$	39,166	$	39,166	$	-	$	-
Investment securities available for sale		159,473		159,473		233		159,240		-
Restricted stock		782		782		-		782		-
Loans held for sale		461		461		-		461		-
Net loans		771,930		779,742		-		-		779,742
Accrued interest receivable		3,164		3,164		-		3,164		-

Financial liabilities:
Deposits	$	918,512	$	918,401	$	-	$	918,401	$	-
Accrued interest payable		124		124		-		124		-

Recurring Fair Value Measurements

For financial assets and liabilities measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2016 and December 31, 2015 are as follows:



(Dollars in Thousands	Fair Value at September 30, 2016
Asset Description	Level 1		Level 2		Level 3		Total
Equity securities	$	250	$	-	$	-	$	250
U.S. Government and Agency securities		-		12,999		-		12,999
Municipal securities		-		68,080		-		68,080
Trust Preferred Securities		-		5,418		-		5,418
Agency mortgage-backed securities		-		67,379		-		67,379
Private-label mortgage-backed securities		-		1,187		-		1,187
Asset-backed securities		-		32		-		32
Total assets	$	250	$	155,095	$	-	$	155,345



(Dollars in Thousands)	Fair Value at December 31, 2015
Asset Description	Level 1		Level 2		Level 3		Total
Equity securities	$	233	$	-	$	-	$	233
U.S. Government and Agency securities		-		13,836		-		13,836
Municipal securities		-		69,188		-		69,188
Trust Preferred Securities		-		5,289		-		5,289
Agency mortgage-backed securities		-		69,519		-		69,519
Private-label mortgage-backed securities		-		1,372		-		1,372
Asset-backed securities		-		36		-		36
Total assets	$	233	$	159,240	$	-	$	159,473

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

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.

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 September 30, 2016 and December 31, 2015 are as follows:



(Dollars in Thousands)
	Fair Value at September 30, 2016
Asset Description	Level 1		Level 2		Level 3		Total
Other real estate owned (1)		-		-		325		325
Total assets	$	-	$	-	$	325	$	325



(Dollars in Thousands)	Fair Value at December 31, 2015
Asset Description	Level 1		Level 2		Level 3		Total
Premises held-for-sale (1)	$	-	$	-	$	225	$	225
Other real estate owned (1)		-		-		6,128		6,128
Total assets	$	-	$	-	$	6,353	$	6,353

(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.

Premises held-for-sale: The fair value of premises held for sale, upon initial recognition, is estimated using Level 3 inputs within the fair value hierarchy.

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. Subsequent charge-offs are recognized as an expense.

The Corporation did not record any liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at September 30, 2016. 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 September 30, 2016.

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


		Quantitative Information about Level 3 Fair Value Measurements
(Dollars in Thousands)		at September 30, 2016
					Range
Asset Description		Fair Value	Valuation Technique	Unobservable Input	(Weighted Average)

Other real estate owned (1)		325	Appraisal	Cost to sell	8% (8%)


		at December 31, 2015
Premises held-for-sale (1)	$	225	Appraisal	-	-
Other real estate owned (1)		6,128	Appraisal	Cost to sell	8% (8%)

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