NOTE 6 FAIR VALUE OF INSTRUMENTS

FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair values of financial instruments are management’s estimate of the values at which the instruments could be exchanged in a transaction between willing parties. These estimates are subjective and may vary significantly from amounts that would be realized in actual transactions. In addition, other significant assets are not considered financial assets including deferred tax assets, premises, equipment and intangibles. Further, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on the fair value estimates and have not been considered in any of the estimates.

The following assumptions and methods were used in estimating the fair value for financial instruments.

Cash and Cash Equivalents

The carrying amounts reported in the balance sheet for cash, cash equivalents and federal funds sold approximate their fair values. Also included in this line item are the carrying amounts of interest-bearing deposits maturing within ninety days which approximate their fair values. Fair values of other interest-bearing deposits are estimated using discounted cash flow analyses based on current rates for similar types of deposits.

Securities – Available-for-sale

Fair values for securities, excluding Federal Home Loan Bank and Farmer Mac stock, are based on quoted market price, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

Other Securities

The carrying value of Federal Home Loan Bank and Farmer Mac stock, listed as “other securities”, approximates fair value based on the redemption provisions of the Federal Home Loan Bank.

Loans, net

For those variable-rate loans that re-price frequently, and with no significant change in credit risk, fair values are based on carrying values. The fair values of the fixed rate and all other loans are estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality.

Deposits

The fair values disclosed for deposits with no defined maturities are equal to their carrying amounts, which represent the amount payable on demand. The carrying amounts for variable-rate, fixed term money market accounts and certificates of deposit approximate their fair value at the reporting date. Fair value for fixed-rate certificates of deposit are estimated using a discounted cash flow analysis that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Federal Funds Purchased and Securities Sold Under Agreements to Repurchase

The carrying value of federal funds purchased and securities sold under agreements to repurchase approximates fair values.

Accrued Interest Receivable and Payable

The carrying amounts of accrued interest approximate their fair values.

Dividends Payable

The carrying amounts of dividends payable approximate their fair values and are generally paid within forty days of declaration.

Off Balance Sheet Financial 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 counter-parties’ credit standing.

The estimated fair values, and related carrying or notional amounts, for on and off-balance sheet financial instruments as of September 30, 2015 and December 31, 2014 are reflected below.


	(In Thousands)
	September 30, 2015
	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
Financial Assets:
Cash and Cash Equivalents	$	31,218	$	31,218	$	31,218	$	—	$	—
Securities - available-for-sale		244,786		244,786		38,904		198,277		7,605
Other Securities		3,717		3,717		—		—		3,717
Loans, net		629,074		637,848		—		—		637,848
Interest receivable		4,372		4,372		—		—		4,372

Total Assets	$	913,167	$	921,941	$	70,122	$	198,277	$	653,542

Financial Liabilities:
Interest bearing Deposits	$	414,680	$	414,682	$	—	$	—	$	414,682
Non-interest bearing Deposits		161,978		161,978		—		161,978		—
Time Deposits		191,384		191,619		—		—		191,619

Total Deposits	$	768,042	$	768,279	$	—	$	161,978	$	606,301
Federal Funds Purchased and Securities Sold Under Agreement to Repurchase		61,504		61,504		—		—		61,504
Interest payable		217		217		—		—		217
Dividends payable		1,009		1,009		—		1,009		—

Total Liabilities	$	830,772	$	831,009	$	—	$	162,987	$	668,022


	(In Thousands)
	December 31, 2014
	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
Financial Assets:
Cash and Cash Equivalents	$	24,295	$	24,295	$	24,295	$	—	$	—
Securities - available-for-sale		248,492		248,492		25,393		215,168		7,931
Other Securities		3,717		3,717		—		—		3,717
Loans, net		616,021		625,377		—		—		625,377
Interest receivable		3,578		3,578		—		—		3,578

Total Assets	$	896,103	$	905,459	$	49,688	$	215,168	$	640,603

Financial Liabilities:
Interest bearing Deposits	$	403,051	$	403,801	$	—	$	—	$	403,801
Non-interest bearing Deposits		164,009		164,009		—		164,009		—
Time Deposits		195,500		196,545		—		—		196,545

Total Deposits	$	762,560	$	764,355	$	—	$	164,009	$	600,346
Federal Funds Purchased and Securities Sold Under Agreement to Repurchase		55,962		55,962		—		—		55,962
Interest payable		207		207		—		—		207
Dividends payable		965		965		—		965		—

Total Liabilities	$	819,694	$	821,489	$	—	$	164,974	$	656,515

Fair Value Measurements

In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities in active markets that the Company has the ability to access.

Available-for-sale securities, when quoted prices are available in an active market, securities are valued using the quoted price and are classified as Level 1.

Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

Available-for-sale securities classified as Level 2 are valued using the prices obtained from an independent pricing service. The prices are not adjusted. Securities of obligations of state and political subdivisions are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate based on credit rating. Substantially all assumptions used by the independent pricing service are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace.

Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability. The Bank holds some local municipals that the Bank evaluates based on the credit strength of the underlying project such as hospital or retirement housing. The fair value is determined by valuing similar credit payment streams at similar rates.

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Company’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset.

The following summarizes financial assets measured at fair value on a recurring basis as of September 30, 2015 and December 31, 2014, segregated by level or the valuation inputs within the fair value hierarchy utilized to measure fair value:


	Assets and Liabilities Measured at Fair Value on a Recurring Basis (In Thousands)
September 30, 2015	Quoted Prices in Active Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Observable Inputs (Level 3)
Assets - (Securities Available-for-Sale)
U.S. Treasury	$	38,904	$	—	$	—
U.S. Government agency		—		100,804		—
Mortgage-backed securities		—		28,028		—
State and local governments		—		69,445		7,605

Total Securities Available-for-Sale	$	38,904	$	198,277	$	7,605


December 31, 2014	Quoted Prices in Active Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Observable Inputs (Level 3)
Assets - (Securities Available-for-Sale)
U.S. Treasury	$	25,393	$	—	$	—
U.S. Government agency		—		119,234		—
Mortgage-backed securities		—		29,562		—
State and local governments		—		66,372		7,931

Total Securities Available-for-Sale	$	25,393	$	215,168	$	7,931

The following table represents the changes in the Level 3 fair-value category of which unobservable inputs are relied upon as of September 30, 2015 and September 30, 2014.


	(In Thousands) Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
	State and Local Governments Tax-Exempt			State and Local Governments Taxable			State and Local Governments Total
Balance at January 1, 2015	$	6,638		$	1,293		$	7,931
Change in Market Value		(256	)		130			(126	)
Payments & Maturities		(200	)		—			(200	)

Balance at September 30, 2015	$	6,182		$	1,423		$	7,605


	(In Thousands) Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
	State and Local Governments Tax-Exempt			State and Local Governments Taxable			State and Local Governments Total
Balance at January 1, 2014	$	8,802		$	1,544		$	10,346
Change in Market Value		(1,262	)		(357	)		(1,619	)
Payments & Maturities		(820	)		—			(820	)

Balance at September 30, 2014	$	6,720		$	1,187		$	7,907

Most of the Company’s available-for-sale securities, including any bonds issued by local municipalities, have CUSIP numbers or have similar characteristics of those in the municipal markets, making them marketable and comparable as Level 2.

The Company also has assets that, under certain conditions, are subject to measurement at fair value on a non-recurring basis. At September 30, 2015 and December 31, 2014, such assets consist primarily of collateral dependent impaired loans. Collateral dependent impaired loans categorized as Level 3 assets consist of non-homogeneous loans that are considered impaired. The Company estimates the fair value of the loans based on the present value of expected future cash flows using management’s best estimate of key assumptions. These assumptions include future payment ability, timing of payment streams, and estimated realizable values of available collateral (typically based on outside appraisals.)

At September 30, 2015 and December 31, 2014, collateral dependent impaired loans categorized as Level 3 were $0.6 and $1.5 million, respectively. The specific allocation for impaired loans was $465 and $387 thousand as of September 30, 2015 and December 31, 2014, respectively, which are accounted for in the allowance for loan losses (see Note 4).

Other real estate is reported at either the lower of the fair value of the real estate minus the estimated costs to sell the asset or the cost of the asset. The determination of fair value of the real estate relies primarily on appraisals from third parties. If the fair value of the real estate, minus the estimated costs to sell the asset, is less than the asset’s cost, the deficiency is recognized as a valuation allowance against the asset through a charge to expense. The valuation allowance is therefore increased or decreased, through charges or credits to expense, for changes in the asset’s fair value or estimated selling costs.

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements:


	Fair Value at September 30, 2015		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
State and political subdivision securities	$	7,605	Discounted cash flow	Credit strength of underlying project or entity / Discount rate		0-5	%
Collateral dependent impaired loans	$	593	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability		0-50	%

	Fair Value at December 31, 2014		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
State and political subdivision securities	$	7,931	Discounted cash flow	Credit strength of underlying project or entity / Discount rate		0-5	%
Collateral dependent impaired loans	$	1,456	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability		0-50	%
Other real estate owned - residential	$	21	Appraisals	Discount to reflect current market		0-20	%
Other real estate owned - commercial	$	23	Appraisals	Discount to reflect current market		0-20	%

The following table presents impaired loans and other real estate owned as recorded at fair value on September 30, 2015 and December 31, 2014:


	Assets Measured at Fair Value on a Nonrecurring Basis at September 30, 2015
(In Thousands)	Balance at September 30, 2015		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Collateral dependent impaired loans	$	593	$	—	$	—	$	593
Other real estate owned commercial	$	225	$	—	$	—	$	225

	Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2014
(In Thousands)	Balance at December 31, 2014		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Collateral dependent impaired loans	$	1,456	$	—	$	—	$	1,456
Other real estate owned residential mortgages	$	21	$	—	$	—	$	21
Other real estate owned commercial	$	23	$	—	$	—	$	23

The Company also has other assets, which under certain conditions, are subject to measurement at fair value. These assets include loans held for sale, bank owned life insurance, and mortgage servicing rights. The Company estimated the fair values of these assets utilizing Level 3 inputs, including, the discounted present value of expected future cash flows. At September 30, 2015 and December 31, 2014, the Company estimates that there is no impairment of these assets.