Note 17 – 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 net 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 Agreement to Repurchase

The carrying value of Federal Funds purchased and securities sold under agreement to repurchase approximates fair values.

FHLB Advances

Fair values or FHLB advances are estimated using discounted cash flow analysis based on the Company’s current incremental borrowing rates for similar types or borrowing arrangements.

Accrued Interest Receivable and Payable

The carrying amounts of accrued interest approximate fair values.

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 counterparties’ credit standing.

The estimated fair values, and related carrying or notional amounts, for on and off-balance sheet financial instruments as of December 31, 2015 and 2014, are reflected below. The aggregate fair values in the table below do not represent the total market value of the Bank’s assets and liabilities. The table excludes the following:

Bank Premises and Equipment, Goodwill, Mortgage Servicing Rights, Other Real Estate Owned, Other Assets, Other Liabilities and Accrued Expenses.


	(In Thousands)
	December 2015										December 2014
	Carrying Amount		Fair Value		Level 1		Level 2		Level 3		Carrying Amount		Fair Value		Level 1		Level 2		Level 3
Financial Assets:
Cash and Cash Equivalents	$	22,018	$	22,018	$	22,018	$	—	$	—	$	24,295	$	24,295	$	24,295	$	—	$	—
Securities - available for sale		235,115		235,115		38,505		189,258		7,352		248,492		248,492		25,393		215,168		7,931
Other Securities		3,717		3,717		—		—		3,717		3,717		3,717		—		—		3,717
Loans, net		679,821		683,332		—		—		683,332		616,021		625,377		—		—		625,377
Interest receivable		3,589		3,589		—		—		3,589		3,578		3,578		—		—		3,578

Financial Liabilities:
Interest bearing Deposits	$	415,942	$	415,942	$	—	$	—	$	415,942	$	403,051	$	403,801	$	—	$	—	$	403,801
Non-interest bearing Deposits		171,112		171,112		—		171,112		—		164,009		164,009		—		164,009		—
Time Deposits		184,285		184,308		—		—		184,308		195,500		196,545		—		—		196,545

Total Deposits	$	771,339	$	771,362	$	—	$	171,112	$	600,250	$	762,560	$	764,355	$	—	$	164,009	$	600,346

Federal Funds purchased and Securities sold under agreement to repurchase		78,815		78,815		—		—		78,815		55,962		55,962		—		—		55,962
Federal Home Loan Bank advances		10,000		9,986		—		—		9,986		—		—		—		—		—
Interest payable		185		185		—		—		185		207		207		—		—		207

Fair Value Measurements

The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis at December 31, 2015 and 2014, and the valuation techniques used by the Company to determine those fair values.

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. The quoted prices are not adjusted.

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


Assest and Liabilities Measured at Fair Value on a Recurring Basis (In Thousands)
December 31, 2015	Quoted Prices in 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	$	38,505	$	—	$	—
U.S. Government agencies		—		98,220		—
Mortgage-backed securities		—		26,324		—
State and local governments		—		64,714		7,352

Total Securities Available for Sale	$	38,505	$	189,258	$	7,352


December 31, 2014	Quoted Prices in 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 agencies		—		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


	(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		(259	)		155		(104	)
Purchases		—			—		—
Sales		—			—		—
Payments & Maturities		(475	)		—		(475	)

Balance at December 31, 2015	$	5,904		$	1,448	$	7,352


	(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		(1,104	)		(251	)		(1,355	)
Purchases		—			—			—
Sales		—			—			—
Payments & Maturities		(1,060	)		—			(1,060	)

Balance at December 31, 2014	$	6,638		$	1,293		$	7,931

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.

There have been no transfers between Levels 1, 2, and 3 during 2015 and 2014.

The Company also has assets that, under certain conditions, are subject to measurement at fair value on a non-recurring basis. At December 31, 2015 and 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 December 31, 2015 and 2014, collateral dependent impaired loans categorized as Level 3 were $1.8 and $1.5 million, respectively. The specific allocation for collateral dependent impaired loans was $329.3 thousand as of December 31, 2015 and $386.9 thousand as of December 31, 2014, respectively, which are accounted for in the allowance for loan losses (see Note 4).

Other real estate is reported at the lower of either the fair value of the real estate, minus the estimated costs to sell the asset, or the cost of the asset. The determination of the 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 collateral dependent impaired loans and other real estate owned as recorded at fair value:


Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2015
($ in Thousands)
	Balance at December 31, 2015		Quoted Prices in Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Change in fair value for twelve-month period ended Dec. 31, 2015
Collateral dependent impaired loans	$	549	$	—	$	—	$	549	$	(17	)
Other real estate owned - commercial		216		—		—		216		(32	)

Total change in fair value									$	(49	)


Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2014
($ in Thousands)
	Balance at December 31, 2015		Quoted Prices in Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Change in fair value for twelve-month period ended Dec. 31, 2015
Collateral dependent impaired loans	$	781	$	—	$	—	$	781	$	(168	)
Other real estate owned - residentialmortgages				—		—		44		(40	)

Total change in fair value									$	(208	)

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


	Fair Value at December 31, 2015		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
State and local government	$	7,352	Discounted Cash Flow	Credit strength of underlying project or	0-5%
				entity / Discount rate
Collateral dependent Impaired Loans		549	Collateral based measurements	Discount to reflect current market	0-50%
				conditions and ultimate collectability
Other real estate owned - commercial		216	Appraisals	Discount to reflect current market	0-20%

	Fair Value at December 31, 2014		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
State and local government	$	7,931	Discounted Cash Flow	Credit strength of underlying project or	0-5%
				entity / Discount rate
Collateral dependent Impaired Loans		782	Collateral based measurements	Discount to reflect current market	0-50%
				conditions and ultimate collectability
Other real estate owned - residential		44	Appraisals	Discount to reflect current market	0-20%

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 December 31, 2015, the Company estimates that there is no impairment of these assets and therefore, no impairment charge to other expense was required to adjust these assets to their estimated fair values.