NOTE 8 - 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 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 was not practicable to determine the fair value of Federal Home Loan Bank stock due to the restrictions placed on its transferability. For deposits and variable rate deposits with infrequent repricing, fair value is based on discounted cash flows using current market rates applied to the estimated life. Fair values for loans is measured at the exit price notion by using the discounted cash flow or collateral value but also incorporates additional factors such as using economic factors, credit risk, and market rates and conditions. 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 June 30, 2019 were as follows:

				Fair Value Measurements at June 30, 2019 Using
	Carrying Amount			Level 1			Level 2			Level 3		Total
Financial assets
Cash and due from banks	$	63,218		$	63,218		$	-		$	-	$	63,218
Time deposits with other banks		1,094			-			1,093			-		1,093
Federal funds sold		32,183			32,183			-			-		32,183
Securities available for sale		360,715			-			360,215			500		360,715
Loans, net		1,134,480			-			-			1,120,657		1,120,657
Federal Home Loan Bank stock		3,538			n/a			n/a			n/a		n/a
Interest receivable		4,675			-			1,013			3,662		4,675

Financial liabilities
Deposits	$	(1,427,424	)	$	(1,018,529	)	$	(407,548	)	$	-	$	(1,426,077	)
Securities sold under agreements to repurchase		(20,834	)		-			(20,834	)		-		(20,834	)
FHLB advance		(6,349	)		-			(6,329	)		-		(6,329	)
Subordinated debt		(5,420	)		-			(5,459	)		-		(5,459	)
Interest payable		(885	)		(21	)		(864	)		-		(885	)

The carrying amounts and estimated fair values of financial instruments at December 31, 2018 were as follows:

				Fair Value Measurements at December 31, 2018 Using
	Carrying Amount			Level 1			Level 2			Level 3		Total
Financial assets
Cash and due from banks	$	62,903		$	62,903		$	-		$	-	$	62,903
Time deposits with other banks		1,094			-			1,085			-		1,085
Federal funds sold		17,872			17,872			-			-		17,872
Securities available for sale		365,731			-			365,231			500		365,731
Loans, net		1,135,563			-			-			1,121,517		1,121,517
Federal Home Loan Bank stock		3,628			n/a			n/a			n/a		n/a
Interest receivable		4,295			-			1,032			3,263		4,295

Financial liabilities
Deposits	$	(1,430,127	)	$	(1,039,430	)	$	(384,496	)	$	-	$	(1,423,926	)
Securities sold under agreements to repurchase		(22,062	)		-			(22,062	)		-		(22,062	)
FHLB advance		(8,819	)		-			(8,688	)		-		(8,688	)
Other borrowed funds		(2,500	)		-			(2,478	)		-		(2,478	)
Subordinated debt		(5,406	)		-			(5,509	)		-		(5,509	)
Interest payable		(733	)		(22	)		(711	)		-		(733	)

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 June 30, 2019 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	$	249,455	$	-	$	249,455	$	-
U. S. agency CMO’s - residential		73,089		-		73,089		-
Total mortgage-backed securities of government sponsored agencies		322,544		-		322,544		-
U. S. government sponsored agency securities		21,812		-		21,812		-
Obligations of states and political subdivisions		13,054		-		13,054		-
Other securities		3,305		-		2,805		500
Total securities available for sale	$	360,715	$	-	$	360,215	$	500

			Fair Value Measurements at December 31, 2018 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	$	255,242	$	-	$	255,242	$	-
U. S. agency CMO’s		68,543		-		68,543		-
Total mortgage-backed securities of government sponsored agencies		323,785		-		323,785		-
U. S. government sponsored agency securities		24,170		-		24,170		-
Obligations of states and political subdivisions		14,327		-		14,327		-
Other securities		3,449		-		2,949		500
Total securities available for sale	$	365,731	$	-	$	365,231	$	500

There were no transfers between Level 1 and Level 2 during 2019 or 2018.

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 six months ended June 30, 2019:

	Securities Available-for-sale
	Six Months Ended June 30, 2019
Balance of recurring Level 3 assets at beginning of period	$	500
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 period-end	$	500

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 June 30, 2019 are summarized below:

			Fair Value Measurements at June 30, 2019 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:
Residential real estate	$	28	$	-	$	-	$	28
Multifamily real estate		2,238		-		-		2,238
Commercial real estate
Owner occupied		1,412		-		-		1,412
Non-owner occupied		2,468		-		-		2,468
Commercial and industrial		194		-		-		194
Construction and land		380		-		-		380
Total impaired loans	$	6,720	$	-	$	-	$	6,720

Other real estate owned:
Residential real estate	$	1,149	$	-	$	-	$	1,149
Multifamily real estate		10,307		-		-		10,307
Commercial real estate
Owner occupied		103		-		-		103
Non-owner occupied		200		-		-		200
Construction and land		229		-		-		229
Total OREO	$	11,988	$	-	$	-	$	11,988

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $9,114,000 at June 30, 2019 with a valuation allowance of $2,394,000 and a carrying amount of $10,177,000 at December 31, 2018 with a valuation allowance of $2,796,000. The change resulted in a provision for loan losses of $226,000 for the six-months ended June 30, 2019, compared to a $520,000 provision for loan losses for the six-months ended June 30, 2018 and a $416,000 in provision for loan losses for the three months ended June 30, 2019, compared to a $187,000 provision for loan losses for the three months ended June 30, 2018. 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 $11,988,000 which is made up of the outstanding balance of $12,945,000 net of a valuation allowance of $957,000 at June 30, 2019. There were $131,000 of write downs during the six months ended June 30, 2019, compared to $120,000 of write downs during the six months ended June 30, 2018. For the three months ended June 30, 2019 there were $131,000 of additional write downs compared to $120,000 of additional write downs during the three months ended June 30, 2018.

At December 31, 2018, other real estate owned had a net carrying amount of $11,766,000, made up of the outstanding balance of $12,769,000, net of a valuation allowance of $1,003,000.

The significant unobservable inputs related to assets and liabilities measured at fair value on a non-recurring basis at June 30, 2019 are summarized below:

	June 30, 2019		Valuation Techniques	Unobservable Inputs	Range (Weighted Avg)
Impaired loans:
Residential real estate	$	28	sales comparison	adjustment for estimated realizable value	70.3%-70.3% (70.3%)
Multifamily real estate		2,238	sales comparison	adjustment for estimated realizable value	51.4%-51.4% (51.4%)
Commercial real estate
Owner occupied		1,412	sales comparison	adjustment for estimated realizable value	30.9%-30.9% (30.9%)
Non-owner occupied		2,468	income approach	adjustment for differences in net operating income expectations	16.1%-67.4% (54.0%)
Commercial and industrial		194	sales comparison	adjustment for estimated realizable value	0.0%-0.0% (0.0%)
Construction and land		380	sales comparison	adjustment for estimated realizable value	56.5%-56.5% (56.5%)
Total impaired loans	$	6,720

Other real estate owned:
Residential real estate	$	1,149	sales comparison	adjustment for estimated realizable value	0.2%-59.8% (20.3%)
Multifamily real estate		10,307	income approach	adjustment for differences in net operating income expectations	20.0%-20.0% (20.0%)
Commercial real estate
Owner occupied		103	sales comparison	adjustment for estimated realizable value	83.2%-83.2% (83.2%)
Non-owner occupied		200	sales comparison	adjustment for estimated realizable value	57.9%-57.9% (57.9%)
Construction and land		229	sales comparison	adjustment for estimated realizable value	37.5%-55.1% (48.9%)
Total OREO	$	11,988

Assets and liabilities measured at fair value on a non-recurring basis at December 31, 2018 are summarized below:

			Fair Value Measurements at December 31, 2018 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	$	2,514	$	-	$	-	$	2,514
Commercial real estate
Owner occupied		1,786		-		-		1,786
Non-owner occupied		2,514		-		-		2,514
Commercial and industrial		144		-		-		144
Construction and land		423		-		-		423
Total impaired loans	$	7,381	$	-	$	-	$	7,381

Other real estate owned:
Residential real estate	$	984	$	-	$	-	$	984
Multifamily real estate		10,307		-		-		10,307
Commercial real estate
Owner occupied		125		-		-		125
Non-owner occupied		200		-		-		200
Construction and land		150		-		-		150
Total OREO	$	11,766	$	-	$	-	$	11,766

The significant unobservable inputs related to assets and liabilities measured at fair value on a non-recurring basis at December 31, 2018 are summarized below:

	December 31, 2018		Valuation Techniques	Unobservable Inputs	Range (Weighted Avg)
Impaired loans:
Multifamily real estate	$	2,514	sales comparison	adjustment for estimated realizable value	45.3%-45.3% (45.3%)
Commercial real estate
Owner occupied		1,786	sales comparison	adjustment for estimated realizable value	31.5%-50.6% (35.5%)
Non-owner occupied		2,514	income approach	adjustment for differences in net operating income expectations	16.1%-67.2% (54.1%)
Commercial and industrial		144	sales comparison	adjustment for estimated realizable value	0.0%-0.0% (0.0%)
Construction and land		423	sales comparison	adjustment for estimated realizable value	53.2%-83.6% (54.5%)
Total impaired loans	$	7,381

Other real estate owned:
Residential real estate	$	984	sales comparison	adjustment for estimated realizable value	19.2%-59.8% (21.9%)
Multifamily real estate		10,307	income approach	adjustment for differences in net operating income expectations	20.0%-20.0% (20.0%)
Commercial real estate
Owner occupied		125	sales comparison	adjustment for estimated realizable value	42.4%-42.4% (42.4%)
Non-owner occupied		200	sales comparison	adjustment for estimated realizable value	57.9%-57.9% (57.9%)
Construction and land		150	sales comparison	adjustment for estimated realizable value	50.3%-50.3% (50.3%)
Total OREO	$	11,766