Fair Value Measurements

The Company follows ASC 820, "Fair Value Measurements" to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. ASC 820 clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy under ASC 820 based on these two types of inputs are as follows:


Level I.	Quoted prices are available in active markets for identical assets or liabilities as of the reported date.


Level II.	Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed.


Level III.	Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

Measured on a recurring basis

The following describes the valuation techniques and inputs used by the Company in determining the fair value of certain assets recorded at fair value on a recurring basis in the financial statements.

Securities Available for Sale

The Company primarily values its investment portfolio using Level II fair value measurements, but may also use Level I or Level III measurements if required by the composition of the portfolio. 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 II). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified as Level III of the valuation hierarchy.

Interest Rate Swaps and Interest Rate Cap

Interest rate swaps and caps are recorded at fair value based on third party vendors who compile prices from various sources and may determine fair value of identical or similar instruments by using pricing models that consider observable market data (Level II).

The following tables present the balances of assets and liabilities measured at fair value on a recurring basis as of September 30, 2015 and December 31, 2014.



(Dollars in thousands)	September 30, 2015
Description	Total		Level I		Level II		Level III
Assets:
U.S. government agencies	$	67,717	$	—	$	67,717	$	—
U.S. Treasury securities	50		—		50		—
Obligations of states and political subdivisions	76,569		—		76,569		—
Mortgage-backed securities:
Agency	141,684		—		141,684		—
Non-agency	14,882		—		14,882		—
Other asset backed securities	54,988		—		54,988		—
Corporate securities	16,889		—		16,889		—
Interest rate swaps	136		—		136		—
Interest rate cap	35		—		35		—
Liabilities:
Interest rate swaps	619		—		619		—



(Dollars in thousands)	December 31, 2014
Description	Total		Level I		Level II		Level III
Assets:
U.S. government agencies	$	41,397	$	—	$	41,397	$	—
Obligations of states and political subdivisions	57,740		—		57,740		—
Mortgage-backed securities:
Agency	173,213		—		173,213		—
Non-agency	28,123		—		28,123		—
Other asset backed securities	31,713		—		31,713		—
Corporate securities	16,077		—		16,077
Interest rate swaps	50		—		50		—
Liabilities:
Interest rate swaps	337		—		337		—

Measured on nonrecurring basis

The Company may be required, from time to time, to measure and recognize certain other assets at fair value on a nonrecurring basis in accordance with GAAP. The following describes the valuation techniques and inputs used by the Company in determining the fair value of certain assets recorded at fair value on a nonrecurring basis in the financial statements.

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 agreement will not be collected when due. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level II). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level III. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable financial statements of the business 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 III). 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.

When collateral-dependent loans are performing in accordance with the original terms of their contract, the Company continues to use the appraisal that was performed at origination as the basis for the collateral value. When loans become collateral-dependent and considered nonperforming, they are reviewed to determine the next appropriate course of action, either foreclosure or modification with forbearance agreement. The loans would then be reappraised prior to foreclosure or before a forbearance agreement is executed. This process does not vary by loan type.

The Company's procedure to monitor the value of collateral for collateral-dependent impaired loans between receipt of the original appraisal and an updated appraisal is to review annual tax assessment records. At this time, adjustments are made, if necessary. Information considered in the determination not to order an updated appraisal includes the availability and reliability of tax assessment records and significant changes in capitalization rates for income properties. Other facts and circumstances on a case-by-case basis may be considered relative to a decision not to order an updated appraisal. If, in the judgment of management, a reliable collateral value cannot be obtained by an alternative method, an updated appraisal would be obtained.

Circumstances that may warrant a reappraisal for nonperforming loans might include foreclosure proceedings or a material adverse change in the borrower's condition or that of the collateral underlying the loan. In some cases, management may decide that an updated appraisal for a nonperforming loan is not necessary, In such cases, an estimate of the fair value of the collateral would be made by management by reference to current tax assessments, the latest appraised value, and knowledge of collateral value fluctuations in a loan's market area. If, in management's judgment, a reliable collateral value cannot be obtained by an alternative method, an updated appraisal would be obtained.

For the purpose of evaluating the allowance for loan losses, new appraisals are discounted by 10% for estimated selling costs when determining the amount of specific reserves. Thereafter, for collateral-dependent impaired loans, we consider each loan on a case-by-case basis to determine whether or not the recorded values are appropriate given current market conditions. When necessary, new appraisals are obtained. If an appraisal is less than 12 months old, the only adjustment made is the 10% discount for selling costs. If an appraisal is older than 12 months, management will use judgment based on knowledge of current market values and specific facts surrounding any particular property to determine if an additional valuation adjustment may be necessary.

Other Real Estate Owned

The value of other real estate owned (“OREO”) is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level II). For OREO properties that may be in construction, the Company’s policy is to obtain “as-is” appraisals on an annual basis as opposed to “as-completed” appraisals. This approach provides current values without regard to completion of any construction or renovation that may be in process. Accordingly, the Company considers the valuations to be Level II valuations even though some properties may be in process of renovation or construction. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability or other factors, then the fair value is considered Level III. Any initial fair value adjustment is charged against the Allowance for Loan Losses. Any subsequent fair value adjustments are recorded in the period incurred and included in other non-interest expense on the consolidated statements of income.

For the purpose of OREO valuations, appraisals are discounted 10% for selling costs and it is the policy of the Company to obtain annual appraisals for properties held in accordance with the bank's OREO policy. Any fair value adjustments are recorded in the period incurred as loss on other real estate owned on the consolidated statements of income.

Repossessed Assets

The value of repossessed assets is determined by the Company based on marketability and other factors and is considered Level III.

The following table summarizes the Company’s non-financial assets that were measured at fair value on a nonrecurring basis during the period.



(Dollars in thousands)	September 30, 2015
	Total		Level I		Level II		Level III
Assets:
Impaired loans	$	8,419	$	—	$	4,351	$	4,068
Other real estate owned	$	3,871	$	—	$	3,871	$	—
Repossessed assets⁽¹⁾	$	1,044	$	—	$	—	$	1,044

(Dollars in thousands)	December 31, 2014
	Total		Level I		Level II		Level III
Assets:
Impaired loans	$	5,799	$	—	$	1,289	$	4,510
Other real estate owned	$	4,051	$	—	$	4,051	$	—
Repossessed assets ⁽¹⁾	$	1,132	$	—	$	—	$	1,132

⁽¹⁾Included in other assets on the consolidated balance sheets.

The following table presents quantitative information as of September 30, 2015 and December 31, 2014 about Level III fair value measurements for assets measured at fair value on a nonrecurring basis:



September 30, 2015	Fair Value (in thousands)		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
Impaired loans	$	4,068	Discounted appraised value	Discount for age of appraisals	0% - 100% (5%)
Repossessed assets	$	1,044	Market analysis	Historical sales activity	50%



December 31, 2014	Fair Value (in thousands)		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
Impaired loans	$	4,510	Discounted appraised value	Discount for age of appraisals	0% - 100% (7%)
Repossessed assets	$	1,132	Market analysis	Historical sales activity	50%

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. 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 financial 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. U.S. generally accepted accounting principles excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments (not previously described) for which it is practicable to estimate that value:

Cash and Cash Equivalents

For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value.

Securities held to maturity

Certain debt securities that management has the positive intent and ability to hold until maturity are recorded at amortized cost. Fair values are determined in a manner that is consistent with securities available for sale.

Restricted securities

The restricted security category is comprised of FHLB and Federal Reserve Bank stock. These stocks are classified as restricted securities because their ownership is restricted to certain types of entities and they lack a market. When the FHLB or Federal Reserve Bank repurchases stock, they repurchase at the stock's book value. Therefore, the carrying amounts of restricted securities approximate fair value.

Loans, Net

For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. For fixed rate loans, the fair value is estimated by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality. Where quoted market prices were available, primarily for certain residential mortgage loans, such market rates were utilized as estimates for fair value. Fair value for impaired loans is described above.

Bank Owned Life Insurance

The carrying amount of bank owned life insurance is a reasonable estimate of fair value.

Accrued Interest Receivable and Payable

The carrying amounts of accrued interest approximate fair values.

Deposits

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. For all other deposits, the fair value is determined using the discounted cash flow method. The discount rate is equal to the rate currently offered on similar products.

Securities Sold Under Agreements to Repurchase

The carrying amounts approximate fair values.

FHLB Borrowings and Subordinated Debt

For variable rate long-term debt, fair values are based on carrying values. For fixed rate debt, fair values are estimated based on observable market prices and discounted cash flow analysis using interest rates for borrowings of similar remaining maturities and characteristics. The fair values of the Company's Subordinated Debentures are estimated using discounted cash flow analysis based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.

Off-Balance Sheet Financial Instruments

The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of standby 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 September 30, 2015 and December 31, 2014, the fair values of loan commitments and standby letters of credit were deemed immaterial; therefore, they have not been included in the tables below.

Fair Value of Financial Instruments

The estimated fair values, and related carrying amounts, of the Company's financial instruments are as follows:



(Dollars in thousands)	September 30, 2015
					Fair value measurements using:
	Carrying Amount		Total Fair Value		Level I		Level II		Level III
Financial assets:
Cash and cash equivalents	$	39,779	$	39,779	$	39,779	$	—	$	—
Securities held to maturity	1,500		1,375		—		1,375		—
Securities available for sale	372,779		372,779		—		372,779		—
Loans, net	769,467		781,466		—		4,351		777,115
Bank owned life insurance	23,107		23,107		—		23,107		—
Accrued interest receivable	5,007		5,007		—		5,007		—
Interest rate swaps	136		136		—		136		—
Interest rate cap	35		35		—		35		—
Financial liabilities:
Deposits	$	1,032,353	$	1,032,511	$	—	$	1,032,511	$	—
Securities sold under agreements to repurchase	24,468		24,468		—		24,468		—
FHLB borrowings	60,000		60,022		—		60,022		—
Subordinated debt	5,155		5,157		—		5,157		—
Accrued interest payable	396		396		—		396		—
Interest rate swaps	619		619		—		619		—



(Dollars in thousands)	December 31, 2014
					Fair value measurements using:
	Carrying Amount		Total Fair Value		Level I		Level II		Level III
Financial assets:
Cash and cash equivalents	$	55,022	$	55,022	$	55,022	$	—	$	—
Securities held to maturity	1,500		1,397		—		1,397		—
Securities available for sale	348,263		348,263		—		348,263		—
Loans, net	743,060		751,572		—		1,289		750,283
Bank-owned life insurance	22,617		22,617		—		22,617		—
Accrued interest receivable	4,285		4,285		—		4,285		—
Interest rate swaps	50		50		—		50		—
Financial liabilities:
Deposits	$	989,080	$	989,563	$	—	$	989,563	$	—
Securities sold under agreements to repurchase	38,551		38,551		—		38,551		—
FHLB borrowings	55,000		55,042		—		55,042		—
Subordinated debt	5,155		5,159		—		5,159		—
Accrued interest payable	403		403		—		403		—
Interest rate swaps	337		337		—		337		—

The Company assumes interest rate risk as a result of its normal operations. As a result, the fair values of the Company's financial instruments will change when interest rate levels change, which may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company's overall interest rate risk.