NOTE 17 – FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

When possible, the Company looks to active and observable markets to price identical assets or liabilities. When identical assets and liabilities are not traded in active markets, the Company looks to observable market data for similar assets and liabilities. However, certain assets and liabilities are not traded in observable markets and the Company must use other valuation methods to develop a fair value.

Carrying amount is the estimated fair value for cash and due from banks, Federal funds sold, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. It was not practicable to determine the fair value of Federal Home Loan Bank stock due to the restrictions placed on its transferability. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of debt is based on current rates for similar financing. The fair value of commitments to extend credit and standby letters of credit is not material.

The carrying amounts and estimated fair values of financial instruments at December 31, 2013 were as follows:

				Fair Value Measurements at December 31, 2013 Using
	Carrying Amount			Level 1			Level 2			Level 3		Total
Financial assets
Cash and due from banks	$	63,984		$	63,984		$	-		$	-	$	63,984
Federal funds sold		12,777			12,777			-			-		12,777
Securities available for sale		218,066			-			217,926			140		218,066
Loans held for sale		77			-			-			77		77
Loans, net		729,743			-			-			725,588		725,588
Federal Home Loan Bank stock		4,183			n/a			n/a			n/a		n/a
Interest receivable		3,132			-			593			2,539		3,132

Financial liabilities
Deposits	$	(924,023	)	$	(592,664	)	$	(332,475	)	$	-	$	(925,139	)
Securities sold under agreements to repurchase		(11,319	)		-			(11,319	)		-		(11,319	)
Other borrowed funds		(13,800	)		-			(13,811	)		-		(13,811	)
Interest payable		(383	)		(5	)		(378	)		-		(383	)

The carrying amounts and estimated fair values of financial instruments at December 31, 2012 were as follows:

				Fair Value Measurements at December 31, 2012 Using
	Carrying Amount			Level 1			Level 2			Level 3		Total
Financial assets
Cash and due from banks	$	66,009		$	66,009		$	-		$	-	$	66,009
Federal funds sold		4,236			4,236			-			-		4,236
Securities available for sale		283,975			-			283,835			140		283,975
Loans held for sale		200			-			-			200		200
Loans, net		693,137			-			-			691,519		691,519
Federal Home Loan Bank stock		4,181			n/a			n/a			n/a		n/a
Interest receivable		3,403			-			827			2,576		3,403

Financial liabilities
Deposits	$	(930,583	)	$	(577,274	)	$	(356,730	)	$	-	$	(934,004	)
Securities sold under agreements to repurchase		(26,102	)		-			(26,102	)		-		(26,102	)
Other borrowed funds		(16,049	)		-			(16,022	)		-		(16,022	)
Interest payable		(489	)		(6	)		(483	)		-		(489	)

Assets and Liabilities Measured on a Recurring Basis

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument measured on a recurring basis:

Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

Assets and liabilities measured at fair value on a recurring basis at December 31, 2013 are summarized below:

			Fair Value Measurements at December 31, 2013 Using:
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Securities available for sale
Mortgage-backed securities
U. S. agency MBS - residential	$	27,823	$	-	$	27,823	$	-
U. S. agency CMO’s		176,722		-		176,722		-
Total mortgage-backed securities of government sponsored agencies		204,545		-		204,545		-
U. S. government sponsored agency securities		6,981		-		6,981		-
Obligations of states and political subdivisions		6,540		-		6,400		140
Total securities available for sale	$	218,066	$	-	$	217,926	$	140

Assets and liabilities measured at fair value on a recurring basis at December 31, 2012 are summarized below:

			Fair Value Measurements at December 31, 2012 Using:
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Securities available for sale
Mortgage-backed securities
U. S. agency MBS - residential	$	37,100	$	-	$	37,100	$	-
U. S. agency CMO’s - residential		212,847		-		212,847		-
Total mortgage-backed securities of government sponsored agencies		249,947		-		249,947		-
U. S. government sponsored agency securities		22,244		-		22,244		-
Obligations of states and political subdivisions		7,860		-		7,720		140
Other securities		3,924		-		3,924		-
Total securities available for sale	$	283,975	$	-	$	283,835	$	140

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2013 and 2012:

	Securities Available-for-sale
	Year Ended Dec. 31, 2013		Year Ended Dec. 31, 2012
Balance of recurring Level 3 assets at beginning of period	$	140	$	140
Total gains or losses (realized/unrealized):
Included in earnings – realized		-		-
Included in earnings – unrealized		-		-
Included in other comprehensive income		-		-
Purchases, sales, issuances and settlements, net		-		-
Transfers in and/or out of Level 3		-		-
Balance of recurring Level 3 assets at year-end	$	140	$	140

Assets and Liabilities Measured on a Non-Recurring Basis

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument measured on a non-recurring basis:

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent collateral appraisals. Real estate appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. 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 unique to each property and result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports. Management periodically evaluates the appraised collateral values and will discount the collateral’s appraised value to account for a number of factors including but not limited to the cost of liquidating the collateral, the age of the appraisal, observable deterioration since the appraisal, management’s expertise and knowledge of the client and client’s business, or other factors unique to the collateral. To the extent an adjusted collateral value is lower than the carrying value of an impaired loan, a specific allocation of the allowance for loan losses is assigned to the loan.

Other real estate owned (OREO): The fair value of OREO is based on appraisals less cost to sell at the date of foreclosure. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. 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. Management periodically evaluates the appraised values and will discount a property’s appraised value to account for a number of factors including but not limited to the cost of liquidating the collateral, the age of the appraisal, observable deterioration since the appraisal, or other factors unique to the property. To the extent an adjusted appraised value is lower than the carrying value of an OREO property, a direct charge to earnings is recorded as an OREO writedown.

Assets and liabilities measured at fair value on a non-recurring basis at December 31, 2013 are summarized below:

			Fair Value Measurements at December 31, 2013 Using
	Dec 31, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans:
Residential Real Estate	$	1,518	$	-	$	-	$	1,518
Commercial Real Estate
Owner Occupied		346		-		-		346
Non-owner Occupied		428		-		-		428
Commercial and Industrial		3,384		-		-		3,384
All Other		4,133		-		-		4,133
Total impaired loans		9,809	$	-	$	-	$	9,809

Other real estate owned:
Commercial Real Estate
Non-owner Occupied		290		-		-		290
All Other		8,496		-		-		8,496
Total OREO	$	8,786	$	-	$	-	$	8,786

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $12,301 at December 31, 2013 with a valuation allowance of $2,492 and a carrying amount of $20,285 at December 31, 2012 with a valuation allowance of $3,842, resulting in a negative provision for loan losses of $1,350 for the year ended December 31, 2013, compared to a $795 provision for loan losses for the year ended December 31, 2012.

Other real estate owned measured at fair value less costs to sell, had a net carrying amount of $8,786, which is made up of the outstanding balance of $11,163, net of a valuation allowance of $2,377 at December 31, 2013, resulting in write downs of $782 during the year ended December 31, 2013. At December 31, 2012, other real estate owned had a net carrying amount of $7,968, made up of the outstanding balance of $9,945 net of a $1,977 valuation allowance, resulting in write downs of $1,410 during the year ended December 31, 2012.

The significant unobservable inputs related to assets and liabilities measured at fair value on a non-recurring basis at December 31, 2013 are summarized below:

	December 31, 2013		Valuation Techniques	Unobservable Inputs	Range (Weighted Avg)
Impaired loans:
Residential Real Estate	$	1,518	sales comparison	adjustment for differences between the comparable sales		0.8%-63.5%(11.9%)
Commercial Real Estate
Owner Occupied		346	sales comparison	adjustment for limited salability of specialized property		62.5%-70.0%(64.0%)
Non-owner Occupied		428	sales comparison	adjustment for limited salability of specialized property		50.6%-50.6%(50.6%)
Commercial and Industrial		3,384	sales comparison	adjustment for limited salability of specialized property		25.0%-65.5%(57.8%)
All Other		4,133	sales comparison	adjustment for percentage of completion of construction		57.6%-99.3%(57.7%)
Total impaired loans		9,809

Other real estate owned:
Commercial Real Estate
Non-owner Occupied		290	sales comparison	adjustment for differences between the comparable sales		42.7%-42.7%(42.7%)
All Other		8,496	sales comparison	adjustment for estimated realizable value		9.5%-24.6%(12.5%)
Total OREO	$	8,786

Assets and liabilities measured at fair value on a non-recurring basis at December 31, 2012 are summarized below:

			Fair Value Measurements at December 31, 2012 Using
	Dec 31, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans:
Residential Real Estate	$	2,739	$	-	$	-	$	2,739
Commercial Real Estate
Owner Occupied		512		-		-		512
Non-owner Occupied		427		-		-		427
Commercial and Industrial		8,300		-		-		8,300
All Other		4,465		-		-		4,465
Total impaired loans		16,443	$	-	$	-	$	16,443

Other real estate owned:
Residential Real Estate	$	255	$	-	$	-	$	255
Commercial Real Estate
Owner Occupied		250		-		-		250
Non-owner Occupied		1,031		-		-		1,031
All Other		6,432		-		-		6,432
Total OREO	$	7,968	$	-	$	-	$	7,968

The significant unobservable inputs related to assets and liabilities measured at fair value on a non-recurring basis at December 31, 2012 are summarized below:

	December 31, 2012		Valuation Techniques	Unobservable Inputs	Range (Weighted Avg)
Impaired loans:
Residential Real Estate	$	2,739	sales comparison	adjustment for differences between the comparable sales		0.8%-76.8%(10.5%)
Commercial Real Estate
Owner Occupied		512	sales comparison	adjustment for limited salability of specialized property		40.0%-70.0%(44.1%)
Non-owner Occupied		427	sales comparison	adjustment for limited salability of specialized property		59.0%-59.0%(59.0%)
Commercial and Industrial		8,300	sales comparison	adjustment for limited salability of specialized property		0.0%-70.0%(44.3%)
All Other		4,465	sales comparison	adjustment for percentage of completion of construction		64.0%-91.4%(64.8%)
Total impaired loans		16,443

Other real estate owned:
Residential Real Estate	$	255	sales comparison	adjustment for differences between the comparable sales		0.0%-62.3%(44.1%)
Commercial Real Estate
Owner Occupied		250	sales comparison	adjustment for estimated realizable value		0.0%-17.9%(7.2%)
Non-owner Occupied		1,031	sales comparison	adjustment for differences between the comparable sales		82.7%-82.7%(82.7%)
All Other		6,432	sales comparison	adjustment for estimated realizable value		4.7%-16.6%(12.7%)
Total OREO	$	7,968