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 level within the hierarchy does not represent risk.

The following methods and assumptions were used to estimate the fair values of the Corporation’s financial instruments at December 31, 2017 and 2016.

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.

Deposits and other 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 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.

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



	December 31, 2017
	Carrying		Fair
(Dollars in thousands)	Amount		Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	58,603	$	58,603	$	58,603	$	—	$	—
Investment securities available for sale		127,336		127,336		365		126,971		—
Restricted stock		456		456		—		456		—
Loans held for sale		442		442		—		442		—
Net loans		931,908		929,891		—		—		929,891
Accrued interest receivable		3,847		3,847		—		3,847		—

Financial liabilities:
Deposits	$	1,047,181	$	1,046,476	$	—	$	1,046,476	$	—
Accrued interest payable		149		149		—		149		—

	December 31, 2016
	Carrying		Fair
(Dollars in thousands)	Amount		Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	36,665	$	36,665	$	36,665	$	—	$	—
Investment securities available for sale		143,875		143,875		290		143,585		—
Restricted stock		1,767		1,767		—		1,767		—
Loans held for sale		540		540		—		540		—
Net loans		882,798		889,910		—		—		889,910
Accrued interest receivable		3,592		3,592		—		3,592		—

Financial liabilities:
Deposits	$	982,120	$	981,949	$	—	$	981,949	$	—
Short-term debt		24,270		24,270		24,270		—		—
Accrued interest payable		116		116		—		116		—

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 December 31, 2017 and 2016 are as follows:



(Dollars in Thousands	Fair Value at December 31, 2017
Asset Description	Level 1		Level 2		Level 3		Total
Equity securities	$	365	$	—	$	—	$	365
U.S. Government and Agency securities		—		11,472		—		11,472
Municipal securities		—		57,772		—		57,772
Trust Preferred Securities		—		5,817		—		5,817
Agency mortgage-backed securities		—		50,937		—		50,937
Private-label mortgage-backed securities		—		946		—		946
Asset-backed securities		—		27		—		27
Total assets	$	365	$	126,971	$	—	$	127,336



(Dollars in Thousands)	Fair Value at December 31, 2016
Asset Description	Level 1		Level 2		Level 3		Total
Equity securities	$	290	$	—	$	—	$	290
U.S. Government and Agency securities		—		12,720		—		12,720
Municipal securities		—		62,985		—		62,985
Trust Preferred Securities		—		5,461		—		5,461
Agency mortgage-backed securities		—		61,284		—		61,284
Private-label mortgage-backed securities		—		1,104		—		1,104
Asset-backed securities		—		31		—		31
Total assets	$	290	$	143,585	$	—	$	143,875

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 December 31, 2017 and 2016 are as follows:



(Dollars in Thousands)	Fair Value at December 31, 2017
Asset Description	Level 1		Level 2		Level 3		Total
Other real estate owned (1)	$	—	$	—	$	90	$	90
Total assets	$	—	$	—	$	90	$	90



(Dollars in Thousands)	Fair Value at December 31, 2016
Asset Description	Level 1		Level 2		Level 3		Total
Premises held-for-sale (1)	$	—	$	—	$	200	$	200
Other real estate owned (1)		—		—		2,407		2,407
Total assets	$	—	$	—	$	2,607	$	2,607

(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.

Other real estate: The fair value of other real estate, upon initial recognition, is obtained through a process similar to the valuation process for impaired loans. In connection with the measurement and initial recognition of the foregoing assets, the Corporation recognizes charge-offs through the allowance for loan losses.

Premises held-for-sale: The fair value of premises held-for-sale is obtained through a process similar to the valuation process for other real estate.

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, 2017. 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, 2017.

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
December 31, 2017		Fair Value	Valuation Technique	Unobservable Input	(Weighted Average)
Other real estate owned	$	90	Appraisal	N/A	—
				Cost to sell	8% (8%)

					Range
December 31, 2016		Fair Value	Valuation Technique	Unobservable Input	(Weighted Average)
Premises held-for-sale	$	200	Appraisal	Qualitative adjustment	5% (5%)

Other real estate owned		2,407	Appraisal	N/A	—
				Cost to sell	8% (8%)