Note 9 – Fair Value Disclosures and Reporting, the Fair Value Option and Fair Value Measurements

FASB's standards on financial instruments, and on fair value measurements and disclosures, require all entities to disclose in their financial statement footnotes the estimated fair values of financial instruments for which it is practicable to estimate fair values. In addition to disclosure requirements, FASB's standard on investments requires that our debt securities, which are classified as available for sale, and our equity securities that have readily determinable fair values, be measured and reported at fair value in our statement of financial position. Certain impaired loans are also reported at fair value, as explained in greater detail below, and foreclosed assets are carried at the lower of cost or fair value. FASB's standard on financial instruments permits companies to report certain other financial assets and liabilities at fair value, but we have not elected the fair value option for any additional financial assets or liabilities.

Fair value measurements and disclosure standards also establish a framework for measuring fair values. Fair value is defined as 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. Further, the standards establish a fair value hierarchy that encourages an entity to maximize the use of observable inputs and limit the use of unobservable inputs when measuring fair values. The standards describe 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 observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

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

Fair value estimates are made at a specific point in time based on relevant market data and information about the financial instruments. The estimates do not reflect any premium or discount that could result from offering the Company's entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to realized gains and losses could have a significant effect on fair value estimates but have not been considered in any estimates. Because no market exists for a significant portion of the Company's financial instruments, fair value disclosures are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors. The estimates are subjective and involve uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the fair values presented. The following methods and assumptions were used by the Company to estimate the fair value of its financial instruments disclosed at September 30, 2014 and December 31, 2013:

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Cash and cash equivalents and fed funds sold: The carrying amount is estimated to be fair value.

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Investment securities: Fair values are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on their relationship to other benchmark quoted securities when quoted prices for specific securities are not readily available.

•

Loans and leases: For variable-rate loans and leases that re-price frequently with no significant change in credit risk or interest rate spread, fair values are based on carrying values. Fair values for other loans and leases are estimated by discounting projected cash flows at interest rates being offered at each reporting date for loans and leases with similar terms, to borrowers of comparable creditworthiness. The carrying amount of accrued interest receivable approximates its fair value.

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Loans held for sale: Since loans designated by the Company as available-for-sale are typically sold shortly after making the decision to sell them, realized gains or losses are usually recognized within the same period and fluctuations in fair values are not relevant for reporting purposes. If available-for-sale loans are on our books for an extended period of time, the fair value of those loans is determined using quoted secondary-market prices.

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Collateral-dependent impaired loans: Collateral-dependent impaired loans are carried at fair value when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the original loan agreement and the loan has been written down to the fair value of its underlying collateral, net of expected disposition costs where applicable.

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Cash surrender value of life insurance policies: Fair values are based on net cash surrender values at each reporting date.

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Investments in, and capital commitments to, limited partnerships: The fair values of our investments in WNC Institutional Tax Credit Fund Limited Partnerships and any other limited partnerships are estimated using quarterly indications of value provided by the general partner. The fair values of undisbursed capital commitments are assumed to be the same as their book values.

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Other investments: Certain investments for which no secondary market exists are carried at cost unless an impairment analysis indicates the need for adjustments, and the carrying amount for those investments approximates their estimated fair value.

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Deposits: Fair values for non-maturity deposits are equal to the amount payable on demand at the reporting date, which is the carrying amount. Fair values for fixed-rate certificates of deposit are estimated using a cash flow analysis, discounted at interest rates being offered at each reporting date by the Bank for certificates with similar remaining maturities. The carrying amount of accrued interest payable approximates its fair value.

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Short-term borrowings: The carrying amounts approximate fair values for federal funds purchased, overnight FHLB advances, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days of the reporting dates. Fair values of other short-term borrowings are estimated by discounting projected cash flows at the Company's current incremental borrowing rates for similar types of borrowing arrangements.

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Long-term borrowings: Fair values are estimated using projected cash flows discounted at the Company's current incremental borrowing rates for similar types of borrowing arrangements.

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Subordinated debentures: Fair values are determined based on the current market value for like instruments of a similar maturity and structure.

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Commitments to extend credit and letters of credit: If funded, the carrying amounts for currently unused commitments would approximate fair values for the newly created financial assets at the funding date. However, because of the high degree of uncertainty with regard to whether or not those commitments will ultimately be funded, fair values for loan commitments and letters of credit in their current undisbursed state cannot reasonably be estimated, and only notional values are disclosed in the table below.

Estimated fair values for the Company's financial instruments are as follows, as of the dates noted:

Fair Value of Financial Instruments
(dollars in thousands, unaudited)	September 30, 2014
			Estimated Fair Value
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Financial assets:
Cash and cash equivalents	$	39,678	$	39,678	$	-	$	-	$	39,678
Investment securities available for sale		467,688		2,562		465,126		-		467,688
Loans and leases, net held for investment		858,309		-		869,307		-		869,307
Collateral dependent impaired loans		15,860		-		15,860		-		15,860
Loans held-for-sale		-		-		-		-		-
Cash surrender value of life insurance policies		40,425		-		40,425		-		40,245
Other investments		6,122		-		6,122		-		6,122
Investment in limited partnership		7,579		-		7,579		-		7,579
Accrued interest receivable		5,248		-		5,248		-		5,248

Financial liabilities:
Deposits:
Noninterest-bearing	$	361,388	$	361,388	$	-	$	-	$	361,388
Interest-bearing		861,658		-		861,857		-		861,857
Fed funds purchased and repurchase agreements		7,170		-		7,170		-		7,170
Short-term borrowings		22,390		-		22,390		-		22,390
Long-term borrowings		-		-		-		-		-
Subordinated debentures		30,928		-		11,347		-		11,347
Limited partnership capital commitment		914		-		914		-		914
Accrued interest payable		122		-		122		-		122

		Notional Amount
Off-balance-sheet financial instruments:
Commitments to extend credit	$	395,368
Standby letters of credit		6,871
Commercial lines of credit		7,592

	December 31, 2013
			Estimated Fair Value
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Financial assets:
Cash and cash equivalents	$	78,006	$	78,006	$	-	$	-	$	78,006
Investment securities available for sale		425,044		2,456		422,588		-		425,044
Loans and leases, net held for investment		778,382		-		797,383		-		797,383
Collateral dependent impaired loans		14,705		-		14,705		-		14,705
Loans held-for-sale		105		105		-		-		105
Cash surrender value of life insurance policies		39,424		-		39,424		-		39,424
Other Investments		5,932		-		5,932		-		5,932
Investment in limited partnership		9,204		-		9,204		-		9,204
Accrued interest receivable		4,990		-		4,990		-		4,990

Financial liabilities:
Deposits:
Noninterest-bearing	$	365,997	$	365,997	$	-	$	-	$	365,997
Interest-bearing		808,182		-		808,182		-		808,182
Fed funds purchased and repurchase agreements		5,974		-		5,974		-		5,974
Short-term borrowings		-		-		-		-		-
Long-term borrowings		-		-		-		-		-
Subordinated debentures		30,928		-		11,175		-		11,175
Limited partnership capital commitment		962		-		962		-		962
Accrued interest payable		186		-		186		-		186

		Notional Amount
Off-balance-sheet financial instruments:
Commitments to extend credit	$	420,707
Standby letters of credit		8,703
Commercial lines of credit		8,070

For financial asset categories that were actually reported at fair value at September 30, 2014 and December 31, 2013, the Company used the following methods and significant assumptions:

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Foreclosed assets: Repossessed real estate (OREO) and other foreclosed assets are carried at the lower of cost or fair value. Fair value is the appraised value less expected selling costs for OREO and some other assets such as mobile homes, and for any other foreclosed assets fair value is represented by the estimated sales proceeds as determined using reasonably available sources. Foreclosed assets for which appraisals can be feasibly obtained are periodically measured for impairment using updated appraisals. Fair values for other foreclosed assets are adjusted as necessary, subsequent to a periodic re-evaluation of expected cash flows and the timing of resolution. If impairment is determined to exist, the book value of a foreclosed asset is immediately written down to its estimated impaired value through the income statement, thus the carrying amount is equal to the fair value and there is no valuation allowance.

Assets reported at fair value on a recurring basis are summarized below:

Fair Value Measurements - Recurring
(dollars in thousands, unaudited)
	Fair Value Measurements at September 30, 2014, using

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Investment securities
US Government agencies	$	-	$	4,389	$	-	$	4,389
Mortgage-backed securities		-		362,114		-		362,114
State and poltical subdivisions		-		98,623		-		98,623
Equity securities		2,562		-		-		2,562

Total available-for-sale securities	$	2,562	$	465,126	$	-	$	467,688

	Fair Value Measurements at December 31, 2013, using

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Input(Level 3)		Total
Investment securities
US Government agencies	$	-	$	5,304	$	-	$	5,304
Mortgage-backed securities		-		320,721		-		320,721
State and poltical subdivisions		-		96,563		-		96,563
Equity securities		2,456		-		-		2,456

Total available-for-sale securities	$	2,456	$	422,588	$	-	$	425,044

Assets reported at fair value on a nonrecurring basis are summarized below:

Fair Value Measurements - Nonrecurring
(dollars in thousands, unaudited)
	Fair Value Measurements at September 30, 2014, Using

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Collateral dependent impaired loans	$	-	$	15,860	$	-	$	15,860
Foreclosed assets	$	-	$	4,719	$	-	$	4,719

	Fair Value Measurements at December 31, 2013, using

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Collateral dependent impaired loans	$	-	$	14,705	$	-	$	14,705
Foreclosed assets	$	-	$	8,185	$	-	$	8,185

The table above includes collateral-dependent impaired loan balances for which a specific reserve has been established or on which a write-down has been taken. Information on the Company's total impaired loan balances, and specific loss reserves associated with those balances, is included in Note 11 below, and in Management's Discussion and Analysis of Financial Condition and Results of Operation in the “Nonperforming Assets” and “Allowance for Loan and Lease Losses” sections.

The unobservable inputs are based on management's best estimates of appropriate discounts in arriving at fair market value. Increases or decreases in any of those inputs could result in a significantly lower or higher fair value measurement. For example, a change in either direction of actual loss rates would have a directionally opposite change in the calculation of the fair value of unsecured impaired loans.