NOTE 7 – 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 value:

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. Fair values of time deposits with other banks are based on current rates for similar time deposits using the remaining time to maturity. It is 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 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).

The carrying amounts and estimated fair values of financial instruments at September 30, 2017 were as follows:

				Fair Value Measurements at September 30, 2017 Using
	Carrying Amount			Level 1			Level 2			Level 3		Total
Financial assets
Cash and due from banks	$	63,512		$	63,512		$	-		$	-	$	63,512
Time deposits with other banks		2,582			-			2,589			-		2,589
Federal funds sold		11,632			11,632			-			-		11,632
Securities available for sale		289,203			-			289,203			-		289,203
Loans, net		1,042,965			-			-			1,029,145		1,029,145
Federal Home Loan Bank stock		3,185			n/a			n/a			n/a		n/a
Interest receivable		4,060			-			829			3,231		4,060

Financial liabilities
Deposits	$	(1,269,384	)	$	(925,328	)	$	(340,134	)	$	-	$	(1,265,462	)
Securities sold under agreements to repurchase		(25,116	)		-			(25,116	)		-		(25,116	)
Other borrowed funds		(6,000	)		-			(5,966	)		-		(5,966	)
Subordinated Debt		(5,368	)		-			(5,381	)		-		(5,381	)
Interest payable		(358	)		(7	)		(351	)		-		(358	)

The carrying amounts and estimated fair values of financial instruments at December 31, 2016 were as follows:

				Fair Value Measurements at December 31, 2016 Using
	Carrying Amount			Level 1			Level 2			Level 3		Total
Financial assets
Cash and due from banks	$	97,163		$	97,163		$	-		$	-	$	97,163
Time deposits with other banks		2,332			-			2,352			-		2,352
Federal funds sold		7,555			7,555			-			-		7,555
Securities available for sale		288,607			-			288,607			-		288,607
Loans, net		1,013,987			-			-			1,004,388		1,004,388
Federal Home Loan Bank stock		3,200			n/a			n/a			n/a		n/a
Interest receivable		3,862			-			771			3,091		3,862

Financial liabilities
Deposits	$	(1,279,386	)	$	(920,745	)	$	(354,885	)	$	-	$	(1,275,630	)
Securities sold under agreements to repurchase		(23,820	)		-			(23,820	)		-		(23,820	)
Other borrowed funds		(8,859	)		-			(8,906	)		-		(8,906	)
Subordinated debt		(5,343	)		-			(5,341	)		-		(5,341	)
Interest payable		(364	)		(7	)		(357	)		-		(364	)

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below:

			Fair Value Measurements at September 30, 2017 Using:
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale
Mortgage-backed securities
U. S. agency MBS - residential	$	199,933	$	-	$	199,933	$	-
U. S. agency CMO's - residential		56,514		-		56,514		-
Total mortgage-backed securities of government sponsored agencies		256,447		-		256,447		-
U. S. government sponsored agency securities		19,275		-		19,275		-
Obligations of states and political subdivisions		13,481		-		13,481		-
Total available for sale	$	289,203	$	-	$	289,203	$	-

			Fair Value Measurements at December 31, 2016 Using:
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale
Mortgage-backed securities
U. S. agency MBS - residential	$	174,177	$	-	$	174,177	$	-
U. S. agency CMO's - residential		73,267		-		73,267		-
Total mortgage-backed securities of government sponsored agencies		247,444		-		247,444		-
U. S. government sponsored agency securities		24,501		-		24,501		-
Obligations of states and political subdivisions		16,662		-		16,662		-
Total securities available for sale	$	288,607	$	-	$	288,607	$	-

There were no transfers between Level 1 and Level 2 during 2017 or 2016.

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. Management may obtain additional updated appraisals depending on the length of time since 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 write-down.

Assets and liabilities measured at fair value on a non-recurring basis at September 30, 2017 are summarized below:

			Fair Value Measurements at September 30, 2017 Using
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans:
Multifamily real estate	$	10,578	$	-	$	-	$	10,578
Commercial real estate:
Owner occupied		569		-		-		569
Non-owner occupied		1,984		-		-		1,984
Commercial and industrial		161		-		-		161
All other		3,593		-		-		3,593
Total impaired loans	$	16,885	$	-	$	-	$	16,885

Other real estate owned:
Residential real estate	$	370	$	-	$	-	$	370
Commercial real estate:
Owner occupied		175		-		-		175
Non-owner occupied		1,853		-		-		1,853
All other		2,855		-		-		2,855
Total OREO	$	5,253	$	-	$	-	$	5,253

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $18,483,000 at September 30, 2017 with a valuation allowance of $1,598,000 and a carrying amount of $4,446,000 at December 31, 2016 with a valuation allowance of $606,000. The change resulted in a provision for loan losses of $1,165,000 for the nine months ended September 30, 2017, compared to an $215,000 provision for loan losses for the nine months ended September 30, 2016 and a $423,000 provision for loan losses for the three months ended September 30, 2017, compared to a $24,000 provision for loan losses for the three months ended September 30, 2016. The detail of impaired loans by loan class is contained in Note 3 above.

Other real estate owned measured at fair value less costs to sell, had a net carrying amount of $5,253,000 which is made up of the outstanding balance of $8,642,000 net of a valuation allowance of $3,389,000 at September 30, 2017. There were $474,000 of additional write downs during the nine months ended September 30, 2017, compared to $478,000 of additional write downs during the nine months ended September 30, 2016. For the three months ended September 30, 2017 there were $111,000 of additional write downs compared to $478,000 of additional write downs during the three months ended September 30, 2016. At December 31, 2016, other real estate owned had a net carrying amount of $6,624,000, made up of the outstanding balance of $9,900,000, net of a valuation allowance of $3,276,000.

The significant unobservable inputs related to assets and liabilities measured at fair value on a non-recurring basis at September 30, 2017 are summarized below:

	September 30, 2017		Valuation Techniques	Unobservable Inputs	Range (Weighted Avg)
Impaired loans:
Multifamily real estate:	$	10,578	sales comparison	adjustment for differences between the comparable sales		4.0%-4.0% (4.0%)
Commercial real estate:
Owner occupied		569	sales comparison	adjustment for estimated realizable value		23.1%-23.1% (23.1%)
Non-owner occupied		1,984	income approach	adjustment for differences in net operating income expectations		67.4%-67.4% (67.4%)
Commercial and industrial		161	sales comparison	adjustment for estimated realizable value		8.0%-56.5% (52.8%)
All other		3,593	sales comparison	adjustment for percentage of completion of construction		8.0%-23.0% (22.7%)
Total impaired loans	$	16,885

Other real estate owned:
Residential real estate	$	370	sales comparison	adjustment for differences between the comparable sales		0.0%-50.2% (16.4%)
Commercial real estate:
Owner occupied		175	sales comparison	adjustment for estimated realizable value		21.8%-21.8% (21.8%)
Non-owner occupied		1,853	sales comparison	adjustment for estimated realizable value		31.8%-58.9% (34.7%)
All other		2,855	sales comparison	adjustment for estimated realizable value		15.1%-69.0% (18.8%)
Total OREO	$	5,253

Assets and liabilities measured at fair value on a non-recurring basis at December 31, 2016 are summarized below:

			Fair Value Measurements at December 31, 2016 Using
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans:
Commercial real estate:
Owner occupied	$	793	$	-	$	-	$	793
Commercial and Industrial		12		-		-		12
All Other		3,036		-		-		3,036
Total impaired loans	$	3,841	$	-	$	-	$	3,841

Other real estate owned:
Residential real estate:	$	613	$	-	$	-	$	613
Commercial real estate:
Owner occupied		175		-		-		175
Non-owner occupied		2,153		-		-		2,153
All other		3,683		-		-		3,683
Total OREO	$	6,624	$	-	$	-	$	6,624

The significant unobservable inputs related to assets and liabilities measured at fair value on a non-recurring basis at December 31, 2016 are summarized below:

	December 31, 2016		Valuation Techniques	Unobservable Inputs	Range (Weighted Avg)
Impaired loans:
Commercial Real Estate
Owner Occupied	$	793	sales comparison	adjustment for limited salability of specialized property		9.3%-76.4% (19.3%)
Commercial and Industrial		12	sales comparison	adjustment for differences between the comparable sales		8.0%-8.0% (8.0%)
All Other		3,036	sales comparison	adjustment for differences between the comparable sales		5.7%-9.0% (8.0%)
Total impaired loans	$	3,841

Other real estate owned:
Residential Real Estate	$	613	sales comparison	adjustment for differences between the comparable sales		0.7%-86.8% (25.2%)

Commercial Real Estate
Owner Occupied		175	sales comparison	adjustment for differences between the comparable sales		21.8%-21.8% (21.8%)

Non-owner Occupied		2,153	sales comparison	adjustment for differences between the comparable sales		17.2%-27.6% (25.7%)
All Other		3,683	sales comparison	adjustment for estimated realizable value		15.1%-45.4% (21.8%)
Total OREO	$	6,624