Fair Value of Financial Instruments

Determination of Fair Value

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the fair value measurements and disclosures topic of FASB ASC 820, "Fair Value Measurement and Disclosures", the fair value of an instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the Company groups its assets and liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.



Level 1 –	Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2 –	Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3 –	Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

The following describes the valuation techniques used by the Company to measure certain assets and liabilities recorded at fair value on a recurring basis in the financial statements:

Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). If no observable market data is available, valuations are based upon third party model based techniques (Level 3).

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis at the dates indicated (dollars in thousands):



	Fair Value Measurements at June 30, 2015 Using
	Balance at June 30,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2015		Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Federal agencies and GSEs	$	96,366	$	—	$	96,366	$	—
Mortgage-backed and CMOs	60,401		—		60,401		—
State and municipal	188,669		—		188,669		—
Corporate	8,789		—		8,789		—
Equity	1,370		—		—		1,370
Total	$	355,595	$	—	$	354,225	$	1,370



	Fair Value Measurements at December 31, 2014 Using
	Balance at December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2014		Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Federal agencies and GSEs	$	82,106	$	2,995	$	79,111	$	—
Mortgage-backed and CMOs	57,425		—		57,425		—
State and municipal	195,493		1,172		194,321		—
Corporate	8,379		—		8,379		—
Equity	1,313		—		—		1,313
Total	$	344,716	$	4,167	$	339,236	$	1,313



	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
			Total Realized / Unrealized Gains (Losses) Included in
	Balances as of January 1, 2015		Net Income		Other Comprehensive Income		Purchases, Sales, Issuances and Settlements, Net		Transfer In (Out) of Level 3		Balances as of June 30, 2015
Securities available for sale:
Equity	$	1,313	$	—	$	57	$	—	$	—	$	1,370

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:

Loans held for sale: Loans held for sale are carried at estimated fair value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the six month period ended June 30, 2015 or the year ended December 31, 2014. Gains and losses on the sale of loans are recorded within mortgage banking income on the Consolidated Statements of Income.

Impaired loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreements will not be collected. In addition, the impairment of a loan may be measured using a present value of future cash flows analysis (Level 3). Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the Company's collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal, of one year or less, conducted by an independent, licensed appraiser using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the property is more than one year old and not solely based on observable market comparables or management determines the fair value of the collateral is further impaired below the appraised value, then a Level 3 valuation is considered to measure the fair value. The value of business equipment is based upon an outside appraisal, of one year or less, if deemed significant, or the net book value on the applicable business's financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Other real estate owned: Measurement for fair values for other real estate owned are the same as real estate collateral discussed with impaired loans.

The following table summarizes the Company's assets that were measured at fair value on a nonrecurring basis at the dates indicated (dollars in thousands):



	Fair Value Measurements at June 30, 2015 Using
	Balance at June 30,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2015		Level 1		Level 2		Level 3
Assets:
Loans held for sale	$	2,720	$	—	$	2,720	$	—
Impaired loans, net of valuation allowance	1,835		—		—		1,835
Other real estate owned	2,113		—		—		2,113



	Fair Value Measurements at December 31, 2014 Using
	Balance at December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2014		Level 1		Level 2		Level 3
Assets:
Loans held for sale	$	616	$	—	$	616	$	—
Impaired loans, net of valuation allowance	1,705		—		—		1,705
Other real estate owned	2,119		—		—		2,119

The following tables summarize the Company's quantitative information about Level 3 fair value measurements at the dates indicated:

Quantitative Information About Level 3 Fair Value Measurements for June 30, 2015



Assets	Valuation Technique	Unobservable Input	Weighted Rate

Securities available for sale	Consideration of equity conversion options	Stock price in different rate environments	37	%

Impaired loans	Discounted appraised value	Selling cost	6	%
	Discounted cash flows	Market rate for borrower (discount rate)	6	%

Other real estate owned	Discounted appraised value	Selling cost	6	%

Quantitative Information About Level 3 Fair Value Measurements for December 31, 2014



Assets	Valuation Technique	Unobservable Input	Weighted Rate

Securities available for sale	Consideration of equity conversion options	Stock price in different rate environments	31	%

Impaired loans	Discounted appraised value	Selling cost	6	%
	Discounted cash flows	Market rate for borrower (discount rate)	4	%

Other real estate owned	Discounted appraised value	Selling cost	6	%

The carrying values and estimated fair values of the Company's financial instruments at June 30, 2015 are as follows (dollars in thousands):



	Fair Value Measurements at June 30, 2015 Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs		Fair Value
	Carrying Value		Level 1		Level 2		Level 3		Balance
Financial Assets:
Cash and cash equivalents	$	75,714	$	75,714	$	—	$	—	$	75,714
Securities available for sale	355,595		—		354,225		1,370		355,595
Restricted stock	5,329		—		5,329		—		5,329
Loans held for sale	2,720		—		2,720		—		2,720
Loans, net of allowance	970,112		—		—		976,220		976,220
Bank owned life insurance	17,376		—		17,376		—		17,376
Accrued interest receivable	4,562		—		4,562		—		4,562

Financial Liabilities:
Deposits	$	1,234,018	$	—	$	834,455	$	400,782	$	1,235,237
Repurchase agreements	50,123		—		50,123		—		50,123
Other borrowings	9,947		—		—		40,425		40,425
Trust preferred capital notes	27,571		—		—		21,353		21,353
Accrued interest payable	598		—		598		—		598

The carrying values and estimated fair values of the Company's financial instruments at December 31, 2014 are as follows (dollars in thousands):



	Fair Value Measurements at December 31, 2014 Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs		Fair Value
	Carrying Value		Level 1		Level 2		Level 3		Balance
Financial Assets:
Cash and cash equivalents	$	67,303	$	67,303	$	—	$	—	$	67,303
Securities available for sale	344,716		4,167		339,236		1,313		344,716
Restricted stock	4,367		—		4,367		—		4,367
Loans held for sale	616		—		616		—		616
Loans, net of allowance	828,498		—		—		832,708		832,708
Bank owned life insurance	15,193		—		15,193		—		15,193
Accrued interest receivable	4,534		—		4,534		—		4,534
Financial Liabilities:
Deposits	$	1,075,837	$	—	$	712,019	$	365,310	$	1,077,329
Repurchase agreements	53,480		—		53,480		—		53,480
Other borrowings	9,935		—		—		10,432		10,432
Trust preferred capital notes	27,521		—		—		22,009		22,009
Accrued interest payable	587		—		587		—		587

The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:

Cash and cash equivalents. The carrying amount is a reasonable estimate of fair value.

Securities. Fair values are based on quoted market prices or dealer quotes.

Loans held for sale. The carrying amount is a reasonable estimate of fair value.

Loans. For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for fixed-rate loans are estimated based upon discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for nonperforming loans are estimated using discounted cash flow analysis or underlying collateral values, where applicable.

Bank owned life insurance. Bank owned life insurance represents insurance policies on officers, directors, and past directors of the Company. The cash values of the policies are estimates using information provided by insurance carriers. These policies are carried at their cash surrender value, which approximates the fair value.

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

Deposits. The fair value of demand deposits, savings deposits, and money market deposits equals the carrying value. The fair value of fixed-rate certificates of deposit is estimated by discounting the future cash flows using the current rates at which similar deposit instruments would be offered to depositors for the same remaining maturities.

Repurchase agreements. The carrying amount is a reasonable estimate of fair value.

Other borrowings. The fair values of other borrowings are estimated using discounted cash flow analyses based on the interest rates for similar types of borrowing arrangements.

Trust preferred capital notes. Fair value is calculated by discounting the future cash flows using the estimated current interest rates at which similar securities would be issued.

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

Off-balance sheet instruments. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. At June 30, 2015 and December 31, 2014, the fair value of off-balance sheet instruments was deemed immaterial, and therefore was not included in the previous table.

The Company assumes interest rate risk (the risk that interest rates will change) in its normal operations. As a result, the fair values of the Company's financial instruments will change when interest rates change and that change may be either favorable or unfavorable to the Company.