Fair Value Measurements

LCNB measures certain assets at fair value using various valuation techniques and assumptions, depending on the nature of the asset. Fair value is defined as the price that would be received from the sale of an asset in an orderly transaction between market participants at the measurement date.

The inputs to the valuation techniques used to measure fair value are assigned to one of three broad levels:


•	Level 1 – quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the reporting date.

•

Level 2 – inputs other than quoted prices included within level 1 that are observable for the asset or liability either directly or indirectly. Level 2 inputs may include quoted prices for similar assets in active markets, quoted prices for identical assets or liabilities in markets that are not active, inputs other than quoted prices (such as interest rates or yield curves) that are observable for the asset or liability, and inputs that are derived from or corroborated by observable market data.


•	Level 3 - inputs that are unobservable for the asset or liability.

The majority of LCNB's financial debt securities are classified as available-for-sale. The securities are reported at fair value with unrealized holding gains and losses reported net of income taxes in accumulated other comprehensive income (loss).

LCNB utilizes a pricing service for determining the fair values of most of its investment securities. Fair value for U.S. Treasury notes are determined based on market quotations (level 1). Fair value for most of the other investment securities is calculated using the discounted cash flow method for each security. The discount rates for these cash flows are estimated by the pricing service using rates observed in the market (level 2). Cash flow streams are dependent on estimated prepayment speeds and the overall structure of the securities given existing market conditions. In addition, LCNB has invested in trust preferred securities, equity securities, and three mutual funds that are not priced by the pricing service. Market quotations (level 1) are used to determine fair values for the trust preferred securities, equity securities, and a publicly traded mutual fund. Investments in two mutual funds that are measured at fair value using net asset values ("NAV") per share as a practical expedient are not required to be classified in the fair value hierarchy. These funds can be redeemed at any time at their current NAVs. An investment in a mutual fund that is not traded in an active market is considered to have level 2 inputs because an investor can have its interest in the fund redeemed for the balance of its capital account at any quarter-end assuming the fund is given a 60 day notice. The investment in this fund is carried at fair value, which approximates cost.

Assets that may be recorded at fair value on a nonrecurring basis include impaired loans, other real estate owned, and other repossessed assets. A loan is considered impaired when management believes it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement. Impaired loans are carried at the present value of estimated future cash flows using the loan's existing rate or the fair value of collateral if the loan is collateral dependent, if this value is less than the loan balance. These inputs are considered to be level 3.

Other real estate owned is adjusted to fair value upon transfer of the loan to foreclosed assets, usually based on an appraisal of the property. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. These inputs are also considered to be level 3.

The following table summarizes the valuation of LCNB's assets recorded at fair value by input levels as of March 31, 2017 and December 31, 2016 (in thousands):



				Fair Value Measurements at the End of the Reporting Period Using
		Fair Value Measurements		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
March 31, 2017
Recurring fair value measurements:
	Investment securities available-for-sale:
	U.S. Treasury notes	$	33,305	$	33,305	$	—	$	—
	U.S. Agency notes	90,325		—		90,325		—
	U.S. Agency mortgage-backed securities	67,968		—		67,968		—
	Municipal securities:
	Non-taxable	112,486		—		112,486		—
	Taxable	19,351		—		19,351		—
	Mutual funds	1,000		—		1,000		—
	Mutual funds measured at net asset value (a)	1,491
	Trust preferred securities	49		49		—		—
	Equity securities	701		701		—		—
	Total recurring fair value measurements	$	326,676	$	34,055	$	291,130	$	—

Nonrecurring fair value measurements:
	Impaired loans	$	2,857	$	—	$	—	$	2,857

December 31, 2016
Recurring fair value measurements:
	Investment securities available-for-sale:
	U.S. Treasury notes	$	28,145	$	28,145	$	—	$	—
	U.S. Agency notes	85,400		—		85,400		—
	U.S. Agency mortgage-backed securities	71,047		—		71,047		—
	Municipal securities:
	Non-taxable	113,015		—		113,015		—
	Taxable	19,845		—		19,845		—
	Mutual funds	1,000		—		1,000		—
	Mutual funds measured at net asset value (a)	1,482
	Trust preferred securities	48		48		—		—
	Equity securities	677		677		—		—
	Total recurring fair value measurements	$	320,659	$	28,870	$	290,307	$	—

Nonrecurring fair value measurements:
	Impaired loans	$	5,340	$	—	$	—	$	5,340

(a)	In accordance with Subtopic 820-10, certain investments that are measured at fair value using the net asset value per share practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the Consolidated Condensed Balance Sheets.

The following table presents quantitative information about unobservable inputs used in nonrecurring level 3 fair value measurements at March 31, 2017 and December 31, 2016 (dollars in thousands):



					Range
	Fair Value		Valuation Technique	Unobservable Inputs	High		Low		Weighted Average
March 31, 2017
Impaired loans	$	2,857	Estimated sales price	Adjustments for comparable properties, discounts to reflect current market conditions	Not applicable
			Discounted cash flows	Discount rate	8.25	%	3.25	%	5.62	%

December 31, 2016
Impaired loans	$	5,340	Estimated sales price	Adjustments for comparable properties, discounts to reflect current market conditions	Not applicable
			Discounted cash flows	Discount rate	8.25	%	4.50	%	5.56	%

Carrying amounts and estimated fair values of financial instruments as of March 31, 2017 and December 31, 2016 are as follows (in thousands):



					Fair Value Measurements at the End of the Reporting Period Using
	Carrying Amount		Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
March 31, 2017
FINANCIAL ASSETS:
Cash and cash equivalents	$	33,274	$	33,274	$	33,274	$	—	$	—
Investment securities, held-to-maturity	38,455		38,012		—		—		38,012
Federal Reserve Bank stock	2,732		2,732		2,732		—		—
Federal Home Loan Bank stock	3,638		3,638		3,638		—		—
Loans, net	807,153		790,919		—		—		790,919
Accrued interest receivable	4,176		4,176		—		4,176		—

FINANCIAL LIABILITIES:
Deposits	1,148,198		1,150,366		934,924		215,442		—
Short-term borrowings	15,957		15,957		15,957		—		—
Long-term debt	480		491		—		491		—
Accrued interest payable	280		280		—		280		—

December 31, 2016
FINANCIAL ASSETS:
Cash and cash equivalents	$	18,865	$	18,865	$	18,865	$	—	$	—
Investment securities, held-to-maturity	41,003		40,490		—		—		40,490
Federal Reserve Bank stock	2,732		2,732		2,732		—		—
Federal Home Loan Bank stock	3,638		3,638		3,638		—		—
Loans, net	816,228		799,791		—		—		799,791
Accrued interest receivable	3,559		3,559		—		3,559		—

FINANCIAL LIABILITIES:
Deposits	1,110,905		1,113,187		896,147		217,040		—
Short-term borrowings	42,040		42,040		42,040		—		—
Long-term debt	598		614		—		614		—
Accrued interest payable	307		307		—		307		—

The fair values of off-balance-sheet financial instruments such as loan commitments and letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements. The fair values of such instruments were not material at March 31, 2017 and December 31, 2016.

Fair values of financial instruments are based on various assumptions, including the discount rate and estimates of future cash flows. Therefore, the fair values presented may not represent amounts that could be realized in actual transactions. In addition, because the required disclosures exclude certain financial instruments and all nonfinancial instruments, any aggregation of the fair value amounts presented would not represent the underlying value of LCNB. The following methods and assumptions were used to estimate the fair value of certain financial instruments:

Cash and cash equivalents

The carrying amounts presented are deemed to approximate fair value.

Investment securities, held-to-maturity

Fair values for investment securities, held-to-maturity are based on quoted market prices for similar securities and/or discounted cash flow analysis or other methods.

Federal Home Loan Bank stock and Federal Reserve Bank stock

The carrying value of Federal Home Loan Bank and Federal Reserve Bank stock approximates fair value based on the respective redemptive provisions.

Loans

Fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, incorporating assumptions of current and projected prepayment speeds. These current rates approximate market rates.

Deposits

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities, which approximates market rates.

Borrowings

The carrying amounts of federal funds purchased, repurchase agreements, and U.S. Treasury demand note borrowings are deemed to approximate fair value of short-term borrowings. For long-term debt, fair values are estimated based on the discounted value of expected net cash flows using current interest rates.

Accrued interest receivable and Accrued interest payable

Carrying amount approximates fair value.