Note 2 - Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2018

Notes to Financial Statements

Fair Value Disclosures [Text Block]

NOTE

2

– FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (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.

The following is a description of the Company’s valuation methodologies used to measure and disclose the fair values of its financial assets and liabilities on a recurring or nonrecurring basis:

Securities:

  The fair values for 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

). During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Impaired Loans:

  At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for loan losses. For collateral dependent loans, fair value is commonly based on recent real estate appraisals. 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 independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically 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, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level

3

fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned:

  Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals. 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 independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level

3

classification of the inputs for determining fair value. 

Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, a member of management reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with management’s own assumptions of fair value based on factors that include recent market data or industry-wide statistics. On an as-needed basis, the Company reviews the fair value of collateral, taking into consideration current market data, as well as all selling costs that typically approximate

10%.

Interest Rate Swap Agreements

:

  The fair value of interest rate swap agreements is determined using the market standard methodology of netting the discounted future fixed cash payments (or receipts) and the discounted expected variable cash receipts (or payments). The variable cash receipts (or payments) are based on the expectation of future interest rates (forward curves) derived from observed market interest rate curves (Level

2

).

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, 2018 Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Assets:
U.S. Government sponsored entity securities		----	$	16,452			----
Agency mortgage-backed securities, residential		----		88,425			----
Interest rate swap derivatives		----		159			----
Interest rate swap derivatives		----		(159	)		----

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Assets:
U.S. Government sponsored entity securities		----	$	13,473			----
Agency mortgage-backed securities, residential		----		87,652			----
Interest rate swap derivatives		----		59			----
Interest rate swap derivatives		----		(59	)		----

There were

no

transfers between Level

1

and Level

2

during

2018

or

2017.

Assets

and Liabilities

Measured on a Nonrecurring Basis

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

	Fair Value Measurements at September 30, 2018, Using
	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		----		----	$	332
Other real estate owned:
Commercial real estate:
Construction		----		----		822

	Fair Value Measurements at December 31, 2017, Using
	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:
Nonowner-occupied		----		----	$	216
Construction		----		----		756
Other real estate owned:
Commercial real estate:
Construction		----		----		822

At

September 30, 2018,

the Company’s recorded investment of impaired loans measured for impairment using the fair value of collateral for collateral-dependent loans totaled

$741,

with a corresponding valuation allowance of

$409.

This resulted in an increase of

$409

to provision expense during the

three

and

nine

months ended

September 30, 2018,

with

no

additional charge-offs recognized. This is compared to a

$142

increase to provision expense during the

three

and

nine

months ended

September 30, 2017,

with

no

additional charge-offs recognized. At

December 31, 2017,

the recorded investment of impaired loans measured for impairment using the fair value of collateral for collateral-dependent loans totaled

$972,

with

no

corresponding valuation allowance, resulting in

no

impact to provision expense and

no

charge-offs during the year ended

December 31, 2017.

Other real estate owned that was measured at fair value less costs to sell at

September 30, 2018

and

December 31, 2017

had a net carrying amount of

$822

,

which is made up of the outstanding balance of

$2,217

,

net of a valuation allowance of

$1,395

.

There were

no

corresponding write downs during the

three

and

nine

months ended

September 30, 2018

and

2017.

The following table presents quantitative information about Level

3

fair value measurements for financial instruments measured at fair value on a non-recurring basis at

September 30, 2018

and

December 31, 2017:

September 30, 2018	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range				(Weighted Average)
Impaired loans:
Residential real estate	$	332	Sales approach	Adjustment to comparables		0%	to	33%		12.4%
Other real estate owned:
Commercial real estate:
Construction		822	Sales approach	Adjustment to comparables		5%	to	40%		18.1%

December 31, 2017	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range				(Weighted Average)
Impaired loans:
Commercial real estate:
Nonowner-occupied	$	216	Sales approach	Adjustment to comparables		1.6%	to	50%		26.7%
Construction		756	Sales approach	Adjustment to comparables		1.3%	to	56%		32.9%
Other real estate owned:
Commercial real estate:
Construction		822	Sales approach	Adjustment to comparables		5%	to	40%		18.1%

The carrying amounts and estimated fair values of financial instruments at

September 30, 2018

and

December 

31,

2017

are as follows:

			Fair Value Measurements at September 30, 2018 Using:
	Carrying Value		Level 1		Level 2		Level 3		Total
Financial Assets:
Cash and cash equivalents	$	65,119	$	65,119	$	----	$	----	$	65,119
Certificates of deposit in financial institutions		2,310		----		2,310		----		2,310
Securities available for sale		104,877		----		104,877		----		104,877
Securities held to maturity		17,219		----		8,697		8,841		17,538
Restricted investments in bank stocks		7,506		N/A		N/A		N/A		N/A
Loans, net		774,062		----		----		771,705		771,705
Accrued interest receivable		2,862		----		389		2,473		2,862
Financial liabilities:
Deposits		852,895		232,575		618,608		----		851,183
Other borrowed funds		40,514		----		38,207		----		38,207
Subordinated debentures		8,500		----		6,606		----		6,606
Accrued interest payable		1,128		3		1,125		----		1,128

			Fair Value Measurements at December 31, 2017 Using:
	Carrying Value		Level 1		Level 2		Level 3		Total
Financial Assets:
Cash and cash equivalents	$	74,573	$	74,573	$	----	$	----	$	74,573
Certificates of deposit in financial institutions		1,820		----		1,820		----		1,820
Securities available for sale		101,125		----		101,125		----		101,125
Securities held to maturity		17,581		----		9,020		9,059		18,079
Restricted investments in bank stocks		7,506		N/A		N/A		N/A		N/A
Loans, net		761,820		----		----		760,746		760,746
Accrued interest receivable		2,503		----		268		2,235		2,503
Financial liabilities:
Deposits		856,724		253,655		602,268		----		855,923
Other borrowed funds		35,949		----		34,810		----		34,810
Subordinated debentures		8,500		----		6,678		----		6,678
Accrued interest payable		792		4		788		----		792

The methods and assumptions,

not

previously presented, used to estimate fair values are described as follows:

Cash and Cash Equivalents

: The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level

1.

Certificates of

Deposit

in Financial Institutions

: The carrying amounts of certificates of deposit in financial institutions approximate fair values and are classified as Level

2.

Securities Held to Maturity:

  The fair values for securities held to maturity are determined in the same manner as securities held for sale and discussed earlier in this note.  Level

3

securities consist of nonrated municipal bonds and tax credit (“QZAB”) bonds.

Restricted Investments in Bank Stocks

: It is

not

practical to determine the fair value of Federal Home Loan Bank, Federal Reserve Bank and United Bankers Bank stock due to restrictions placed on their transferability.

Loans

: The estimated fair value of loans as of

September 30, 2018

follows the guidance in ASU

2016

-

01,

which prescribes an “exit price” approach in estimating and disclosing fair value of financial instruments. The fair value calculation at that date discounted estimated future cash flows using rates that incorporated discounts for credit, liquidity, and marketability factors. The fair value estimate shown as of

December 31, 2017

used an “entry price” approach. The fair value calculation for that date discounted estimated future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Consequently, the fair value disclosures for

September 30, 2018

and

December 31, 2017

are

not

directly comparable.

Deposit

s

: The fair values disclosed for noninterest-bearing deposits are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level

1

classification. The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date resulting in a Level

2

classification. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level

2

classification.

Other Borrowed Funds

: The carrying values of the Company’s short-term borrowings, generally maturing within

ninety

days, approximate their fair values resulting in a Level

2

classification. The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level

2

classification.

Subordinated Debentures

: The fair values of the Company’s Subordinated Debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level

2

classification.

Accrued Interest Receivable and Payable

: The carrying amount of accrued interest approximates fair value, resulting in a classification that is consistent with the earning assets and interest-bearing liabilities with which it is associated.

Off-balance Sheet Instruments

:  Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is

not

material.

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do

not

reflect any premium or discount that could result from offering for sale at

one

time the Company’s entire holdings of a particular financial instrument. Because

no

market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.