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Fair Value of Financial Instruments and Fair Value Measurements
 6 Months Ended
Jun. 30, 2017
Fair Value Disclosures [Abstract]  
Fair Value of Financial Instruments and Fair Value Measurements

7. Fair Value of Financial Instruments and Fair Value Measurements

 

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (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. There are 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 other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

Level 3 – Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

Fair value estimates of the Company’s financial instruments as of June 30, 2017 and December 31, 2016, including methods and assumptions utilized, are set forth below:

 

(Dollars in thousands)   As of June 30, 2017  
    Carrying                          
    amount     Level 1     Level 2     Level 3     Total  
Financial assets:                                        
Cash and cash equivalents   $ 10,594     $ 10,594     $ -     $ -     $ 10,594  
Investment securities available-for-sale     389,842       5,375       384,467       -       389,842  
Bank stocks, at cost     5,350       n/a       n/a       n/a       n/a  
Loans, net     422,739       -       -       420,935       420,935  
Loans held for sale, net     9,758       -       9,758       -       9,758  
Derivative financial instruments     711       -       711       -       711  
Accrued interest receivable     4,089       2       2,219       1,868       4,089  
                                         
Financial liabilities:                                        
Non-maturity deposits   $ (613,126 )   $ (613,126 )   $ -     $ -       (613,126 )
Time deposits     (131,896 )     -       (130,377 )     -       (130,377 )
FHLB borrowings     (31,000 )     -       (31,358 )     -       (31,358 )
Subordinated debentures     (21,384 )     -       (19,215 )     -       (19,215 )
Other borrowings     (11,447 )     -       (11,447 )     -       (11,447 )
Derivative financial instruments     (28 )     -       (28 )     -       (28 )
Accrued interest payable     (253 )     -       (253 )     -       (253 )

 

    As of December 31, 2016  
    Carrying                          
    amount     Level 1     Level 2     Level 3     Total  
Financial assets:                                        
Cash and cash equivalents   $ 19,996     $ 19,996     $ -     $ -     $ 19,996  
Investment securities available-for-sale     385,563       7,123       378,440       -       385,563  
Bank stocks, at cost     5,299       n/a       n/a       n/a       n/a  
Loans, net     420,461       -       -       417,957       417,957  
Loans held for sale     5,517       -       5,517       -       5,517  
Derivative financial instruments     662       -       662       -       662  
Accrued interest receivable     4,240       21       2,104       2,115       4,240  
                                         
Financial liabilities:                                        
Non-maturity deposits   $ (601,683 )   $ (601,683 )   $ -     $ -     $ (601,683 )
Time deposits     (139,838 )     -       (138,623 )     -       (138,623 )
FHLB borrowings     (39,100 )     -       (35,695 )     -       (35,695 )
Subordinated debentures     (21,284 )     -       (18,608 )     -       (18,608 )
Other borrowings     (12,483 )     -       (12,483 )     -       (12,483 )
Accrued interest payable     (268 )     -       (268 )     -       (268 )

 

Methods and Assumptions Utilized

 

The carrying amount of cash and cash equivalents is considered to approximate fair value.

 

The Company’s investment securities classified as available-for-sale include U.S. treasury securities, U.S. federal agency securities, municipal obligations, agency mortgage-backed securities, certificates of deposits and common stocks. Quoted exchange prices are available for the Company’s U.S treasury securities and common stock investments, which are classified as Level 1. U.S. federal agency securities and agency mortgage-backed obligations are priced utilizing industry-standard models that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions 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. These measurements are classified as Level 2. Municipal securities are valued using a type of matrix, or grid, pricing in which securities are benchmarked against U.S. treasury rates based on credit rating. These model and matrix measurements are classified as Level 2 in the fair value hierarchy.

 

It is not practical to determine the fair value of bank stocks due to restrictions placed on the transferability of FHLB and FRB stock.

 

The estimated fair value of the Company’s loan portfolio is based on the segregation of loans by collateral type, interest terms, and maturities. The fair value is estimated based on discounting scheduled and estimated cash flows through maturity using an appropriate risk-adjusted yield curve to approximate current interest rates for each category. No adjustment was made to the interest rates for changes in credit risk of performing loans where there are no known credit concerns. Management segregates loans in appropriate risk categories. Management believes that the risk factor embedded in the interest rates along with the allowance for loan losses applicable to the performing loan portfolio results in a fair valuation of such loans. The fair values of impaired loans are generally based on market prices for similar assets determined through independent appraisals or discounted values of independent appraisals and brokers’ opinions of value. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC Topic 820 and is classified as Level 3.

 

Mortgage loans originated and intended for sale in the secondary market are carried at the estimated fair value, determined on an aggregate basis. The mortgage loan valuations are based on quoted secondary market prices for similar loans and are classified as Level 2.

 

The carrying amounts of accrued interest receivable and payable are considered to approximate fair value.

 

The estimated fair value of deposits with no stated maturity, such as non-interest-bearing demand deposits, savings, money market accounts, and checking accounts, is equal to the amount payable on demand. The fair value of interest-bearing time deposits is based on the discounted value of contractual cash flows of such deposits. The discount rate is tied to the FHLB yield curve plus an appropriate servicing spread. Fair value measurements based on discounted cash flows are classified as Level 2. These fair values do not incorporate the value of core deposit intangibles which may be associated with the deposit base.

 

The fair value of advances from the FHLB, subordinated debentures, and other borrowings is estimated using current yield curves for similar borrowings adjusted for the Company’s current credit spread and classified as Level 2.

 

The Company’s derivative financial instruments consist of interest rate lock commitments and forward commitments for the future delivery of these mortgage loans. The fair values of these derivatives are based on quoted prices for similar loans in the secondary market. The market prices are adjusted by a factor, based on the Company’s historical data and its judgment about future economic trends, which considers the likelihood that a commitment will ultimately result in a closed loan. These instruments are classified as Level 2. The amounts are included in other assets or other liabilities on the consolidated balance sheets and gains on sale of loans, net in the consolidated statements of earnings.

 

Off-Balance-Sheet Financial Instruments

 

The fair value of letters of credit and commitments to extend credit is based on the fees currently charged to enter into similar agreements. The aggregate of these fees is not material.

 

Transfers

 

The Company did not transfer any assets or liabilities among levels during the six months ended June 30, 2017 or during the year ended December 31, 2016.

 

Valuation Methods for Instruments Measured at Fair Value on a Recurring Basis

 

The following table represents the Company’s financial instruments that are measured at fair value on a recurring basis at June 30, 2017 and December 31, 2016, allocated to the appropriate fair value hierarchy:

  

(Dollars in thousands)         As of June 30, 2017        
          Fair value hierarchy        
    Total     Level 1     Level 2     Level 3  
Assets:                                
Available-for-sale investment securities:                                
U. S. treasury securities   $ 5,016     $ 5,016     $ -     $ -  
U. S. federal agency obligations     21,382       -       21,382       -  
Municipal obligations, tax exempt     179,243       -       179,243       -  
Municipal obligations, taxable     62,778       -       62,778       -  
Agency mortgage-backed securities     111,840       -       111,840       -  
Certificates of deposit     9,224       -       9,224       -  
Common stocks     359       359       -       -  
Loans held for sale     9,758       -       9,758       -  
Derivative financial instruments     711       -       711       -  
Liabililty:                                
Derivative financial instruments     (28 )     -       (28 )     -  

 

(Dollars in thousands)         As of December 31, 2016        
          Fair value hierarchy        
      Total       Level 1       Level 2       Level 3  
Assets:                                
Available-for-sale investment securities:                                
U. S. treasury securities   $ 6,015     $ 6,015     $ -     $ -  
U. S. federal agency obligations     27,139       -       27,139       -  
Municipal obligations, tax exempt     161,662       -       161,662       -  
Municipal obligations, taxable     71,563       -       71,563       -  
Agency mortgage-backed securities     108,376       -       108,376       -  
Certificates of deposit     9,700       -       9,700       -  
Common stocks     1,108       1,108       -       -  
Loans held for sale     5,517       -       5,517       -  
Derivative financial instruments     662       -       662       -  

 

Changes in the fair value of available-for-sale securities are included in other comprehensive income to the extent the changes are not considered other-than-temporary impairments. Other-than-temporary impairment tests are performed on a quarterly basis and any decline in the fair value of an individual security below its cost that is deemed to be other-than-temporary results in a write-down of that security’s cost basis.

 

The aggregate fair value, contractual balance (including accrued interest), and gain on loans held for sale were as follows:

 

    As of     As of  
(Dollars in thousands)   June 30, 2017     December 31, 2016  
Aggregate fair value   $ 9,758     $ 5,517  
Contractual balance     9,553       5,480  
Gain   $ 205     $ 37  

 

The total amount of gains from changes in fair value of loans held for sale included in earnings were as follows:

 

    Three months ended     Six months ended  
    June 30,     June 30,  
(Dollars in thousands)   2017     2016     2017     2016  
Interest income   $ 79     $ 210     $ 124     $ 315  
Change in fair value     60       (63 )     169       (67 )
Total change in fair value   $ 139     $ 147     $ 293     $ 248  

 

Valuation Methods for Instruments Measured at Fair Value on a Non-recurring Basis

 

The Company does not value its loan portfolio at fair value. Collateral-dependent impaired loans are generally carried at the lower of cost or fair value of the collateral, less estimated selling costs. Collateral values are determined based on appraisals performed by qualified licensed appraisers hired by the Company and then further adjusted if warranted based on relevant facts and circumstances. The appraisals may utilize a single valuation approach or a combination of approaches including the comparable sales and income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Impaired loans are reviewed and evaluated at least quarterly for additional impairment and adjusted accordingly, based on the same factors identified above. The carrying value of the Company’s impaired loans was $6.4 million and $6.7 million, with an allocated allowance of $275,000 and $274,000, at June 30, 2017 and December 31, 2016, respectively.

 

The following table represents the Company’s financial instruments that are measured at fair value on a non-recurring basis as of June 30, 2017 and December 31, 2016 allocated to the appropriate fair value hierarchy:

 

(Dollars in thousands)      
          As of June 30, 2017     Total  
          Fair value hierarchy     gains  
    Total     Level 1     Level 2     Level 3     (losses)  
Assets:                                        
Impaired loans:                                        
Commercial   $ 177     $ -     $ -     $ 177     $ 11  
Agriculture     670       -       -       670       (60 )
Real estate owned:                                        
One-to-four family residential real estate     302       -       -       302       (67 )

  

          As of December 31, 2016     Total  
          Fair value hierarchy     (losses)/  
    Total     Level 1     Level 2     Level 3     gains  
Assets:                                        
Impaired loans:                                        
Commercial real estate   $ 219     $ -     $ -     $ 219     $ (81 )
Commercial     222       -       -       222       (87 )
Agriculture     645       -       -       645       (89 )
Real estate owned:                                        
One-to-four family residential real estate     142       -       -       142       (34 )

 

The following table presents quantitative information about Level 3 fair value measurements for impaired loans measured at fair value on a non-recurring basis as of June 30, 2017 and December 31, 2016.

 

(Dollars in thousands)                    
    Fair value     Valuation technique   Unobservable inputs   Range  
As of June 30, 2017                        
Impaired loans:                        
Commercial     177      Sales comparison    Adjustment to comparable sales     0%-50%  
Agriculture     670      Sales comparison    Adjustment to appraised value     10%-50%  
Real estate owned:                        
One-to-four family residential real estate     302      Sales comparison    Adjustment to appraised value     10%  
                         
As of December 31, 2016                        
Impaired loans:                        
Commercial real estate   $ 219      Sales comparison    Adjustment to appraised value     2%-15%  
Commercial     222      Sales comparison    Adjustment to comparable sales     7%-80%  
Agriculture     645      Sales comparison    Adjustment to appraised value     8%-80%  
Real estate owned:                        
One-to-four family residential real estate     142      Sales comparison    Adjustment to appraised value     10%