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.

Interest Bearing Time Deposits

Fair values 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.

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 Held for Sale

The carrying amount approximates fair value due to insignificant amount of time between origination and date of sale.

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.

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.

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.

The estimated fair values, and related carrying or notional amounts, for on and off-balance sheet financial instruments as of September 30, 2017 and December 31, 2016 are reflected below.


	(In Thousands)
	September 30, 2017
	Carrying		Fair
	Amount		Value		Level 1		Level 2		Level 3
Financial Assets:
Cash and Cash Equivalents	$	49,104	$	49,104	$	49,104	$	—	$	—
Interest-bearing time deposits		2,541		2,541		—		2,541		—
Securities - available-for-sale		192,811		192,811		15,676		175,693		1,442
Other Securities		3,717		3,717		—		—		3,717
Loans held for sale		2,147		2,147		—		—		2,147
Loans, net		788,335		790,893		—		—		790,893
Interest receivable		5,106		5,106		—		—		5,106
Financial Liabilities:
Interest bearing Deposits	$	519,822	$	519,865	$	—	$	—	$	519,865
Non-interest bearing Deposits		189,963		189,963		—		189,963		—
Time Deposits		193,581		194,342		—		—		194,342

Total Deposits	$	903,366	$	904,170	$	—	$	189,963	$	714,207
Federal Funds Purchased and Securities Sold Under Agreement to Repurchase	$	35,550	$	35,550	$	—	$	—	$	35,550
Federal Home Loan Bank advances		10,000		10,041		—		—		10,041
Interest payable		285		285		—		—		285

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	(In Thousands)
	December 31, 2016
	Carrying		Fair
	Amount		Value		Level 1		Level 2		Level 3
Financial Assets:
Cash and Cash Equivalents	$	28,322	$	28,322	$	28,322	$	—	$	—
Interest-bearing time deposits		1,915		1,918		—		1,918		—
Securities - available-for-sale		218,527		218,527		24,775		192,334		1,418
Other Securities		3,717		3,717		—		—		3,717
Loans held for sale		2,055		2,055		—		—		2,055
Loans, net		751,310		753,357		—		—		753,357
Interest receivable		3,880		3,880		—		—		3,880
Financial Liabilities:
Interest bearing Deposits	$	456,983	$	456,983	$	—	$	—	$	456,983
Non-interest bearing Deposits		186,390		186,390		—		186,390		—
Time Deposits		198,830		199,658		—		—		199,658

Total Deposits	$	842,203	$	843,031	$	—	$	186,390	$	656,641
Federal Funds Purchased and Securities Sold Under Agreement to Repurchase	$	70,324	$	70,324	$	—	$	—	$	70,324
Federal Home Loan Bank advances		10,000		10,041		—		—		10,041
Interest payable		256		256		—		—		256

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. 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, 2017 and December 31, 2016, 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)
	Quoted Prices in		Significant		Significant
	Active Markets		Observable		Observable
	for Identical		Inputs		Inputs
September 30, 2017	Assets (Level 1)		(Level 2)		(Level 3)
Assets - (Securities Available-for-Sale)
U.S. Treasury	$	15,676	$	—	$	—
U.S. Government agencies		—		78,160		—
Mortgage-backed securities		—		41,990		—
State and local governments		—		55,543		1,442

Total Securities Available-for-Sale	$	15,676	$	175,693	$	1,442


	Quoted Prices in		Significant		Significant
	Active Markets		Observable		Observable
	for Identical		Inputs		Inputs
December 31, 2016	Assets (Level 1)		(Level 2)		(Level 3)
Assets - (Securities Available-for-Sale)
U.S. Treasury	$	24,775	$	—	$	—
U.S. Government agencies		—		82,474		—
Mortgage-backed securities		—		48,461		—
State and local governments		—		61,399		1,418

Total Securities Available-for-Sale	$	24,775	$	192,334	$	1,418

The following table represents the changes in the Level 3 fair-value category of which unobservable inputs are relied upon as of September 30, 2017 and September 30, 2016.


	(In Thousands)
	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
	State and Local			State and Local		State and Local
	Governments			Governments		Governments
	Tax-Exempt			Taxable		Total
Balance at January 1, 2017	$	—		$	1,418	$	1,418
Change in Market Value		—			24		24
Payments & Maturities		—			—		—

Balance at September 30, 2017	$	—		$	1,442	$	1,442


	(In Thousands)
	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
	State and Local			State and Local		State and Local
	Governments			Governments		Governments
	Tax-Exempt			Taxable		Total
Balance at January 1, 2016	$	5,904		$	1,448	$	7,352
Change in Market Value		—			93		93
Payments & Maturities		(5,904	)		—		(5,904	)

Balance at September 30 , 2016	$	—		$	1,541	$	1,541

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, 2017 and December 31, 2016, 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, 2017 and December 31, 2016, fair value of collateral dependent impaired loans categorized as Level 3 was $562 and $576 thousand, respectively. The specific allocation for impaired loans was $123 and $135 thousand as of September 30, 2017 and December 31, 2016, 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

Range

September 30, 2017

Valuation Technique

Unobservable Inputs

(Weighted Average)

(In Thousands)

State and local government

1,442

Discounted Cash Flow

Credit strength of underlying project or

0-5%(3.59%)

entity / Discount rate

Collateral dependent Impaired Loans

562

Collateral based measurements

Discount to reflect current market

0-50%(18.00%)

conditions and ultimate collectability

Other real estate owned - residential

—

Appraisals

Discount to reflect current market

0-20%(0.0%)

Other real estate owned - commercial

266

Appraisals

Discount to reflect current market

0-20%(5.15%)

Range

Fair Value at

(Weighted

December 31, 2016

Valuation Technique

Unobservable Inputs

Average)

(In Thousands)

State and local government

1,418

Discounted Cash Flow

Credit strength of underlying project or

0-5%(3.92%)

entity / Discount rate

Collateral dependent Impaired Loans

576

Collateral based measurements

Discount to reflect current market

0-50%(18.92%)

conditions and ultimate
collectability

Other real estate owned - residential

144

Appraisals

Discount to reflect current market

0-20%(0.51%)

Other real estate owned - commercial

—

Appraisals

Discount to reflect current market

0-20%(0.0%)

The following table presents impaired loans and other real estate owned as recorded at fair value on September 30, 2017 and December 31, 2016:


	Assets Measured at Fair Value on a Nonrecurring Basis at September 30, 2017
			(In Thousands)
			Quoted Prices in Active
			Markets for		Significant		Significant
	Balance at		Identical		Observable Inputs		Unobservable Inputs
	September 30, 2017		Assets (Level 1)		(Level 2)		(Level 3)
Collateral dependent impaired loans	$	562	$	—	$	—	$	562
Other real estate owned - residential		—		—		—		—
Other real estate owned - commercial		266		—		—		266

Total fair value							$	828


	Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2016
			(In Thousands)
			Quoted Prices in Active
			Markets for		Significant		Significant
	Balance at		Identical		Observable Inputs		Unobservable Inputs
	December 31, 2016		Assets (Level 1)		(Level 2)		(Level 3)
Collateral dependent impaired loans	$	576	$	—	$	—	$	576
Other real estate owned - residential		144		—		—		144
Other real estate owned - commercial		—		—		—		—

Total fair value							$	720