13.	FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company follows the provisions of ASC Topic 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.

Fair Value Hierarchy

The assumptions used in the estimation of the fair value of the Company’s financial instruments are detailed below. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of the Company, but rather represent a good-faith estimate of the increase or decrease in value of financial instruments held by the Company since purchase, origination or issuance.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants at the measurement date. In determining fair value, the Company uses various methods, including market, income and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated or generally unobservable inputs. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, the Company is required to provide the following information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:

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Level 1 – Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange or NASDAQ. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

•

Level 2 – Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third-party pricing services for identical or similar assets or liabilities.

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Level 3 – Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer or broker-traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.

The Company rarely transfers assets and liabilities measured at fair value between Level 1 and Level 2 measurements. Trading account assets and securities available-for-sale may be periodically transferred to or from Level 3 valuation based on management’s conclusion regarding the best method of pricing for an individual security. Such transfers are accounted for as if they occurred at the beginning of a reporting period. There were no such transfers during the periods ended September 30, 2014 or December 31, 2013.

Fair Value Measurements on a Recurring Basis

Available-for-Sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include exchange traded equities. Level 2 securities include U.S. treasury and agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset-backed and other securities. Level 2 fair values are obtained from quoted prices of securities with similar characteristics. In certain cases, where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.

Interest Rate Cap Derivative Agreements

Interest rate cap agreements were included in other assets at fair value on the Company’s balance sheet as of September 30, 2014. The interest rate caps qualify as derivatives but are not designated as hedging instruments. Accordingly, changes in fair value are included in results of operations. The fair value of these agreements are based on information obtained from third party financial institutions. This information is periodically evaluated by the Company and, as necessary, corroborated against other third party valuations. The Company classified these derivative assets within Level 2 of the valuation hierarchy.

The following table presents assets measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013. There were no liabilities measured at fair value on a recurring basis for either period presented.


	Fair Value Measurements as of September 30, 2014 Using
	Totals At September 30, 2014		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in Thousands)
Investment securities, available-for-sale
Mortgage-backed securities:
Residential	$	123,767	$	—	$	123,767	$	—
Commercial		34,346		—		34,346		—
Obligations of states and political subdivisions		16,899		—		16,899		—
U.S. treasury securities		3,946		—		3,946		—
Obligations of U.S. government sponsored agencies		388		—		388		—
Other assets – derivatives		105		—		105		—


	Fair Value Measurements as of December 31, 2013 Using
	Totals At December 31, 2013		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in Thousands)
Investment securities, available-for-sale
Mortgage-backed securities:
Residential	$	83,434	$	—	$	83,434	$	—
Commercial		30,465		—		30,465		—
Obligations of states and political subdivisions		17,027		—		17,027		—
U.S. treasury securities		3,827		—		3,827		—
Obligations of U.S. government sponsored agencies		1,001		—		1,001		—

Fair Value Measurements on a Non-recurring Basis

Impaired Loans

Estimates of fair value for impaired loans are determined based on a variety of information, including the use of available appraisals, estimates of market value by licensed appraisers or local real estate brokers and the knowledge and experience of the Company’s management related to the assessment of collateral associated with loans. Management takes into consideration the type, location and occupancy of the collateral, as well as current economic conditions in the area in which the collateral is located, in assessing estimates of fair value.

Loan impairment is reported when full payment under the loan terms is not expected. 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. A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance. If these allocations cause the allowance for loan losses to increase, such increase is reported as a component of the provision for loan losses. When an impaired loan is determined to be collateral dependent, the fair value is determined through the utilization of a third-party appraisal. It is the policy of the Company to update appraisals every 18-24 months. The types of collateral influence the frequency of obtaining updated appraisals. Management knows the market trends of collateral values well and monitors trends in sales and valuations in all of the various categories of collateral. These trends influence how often new appraisals are obtained within the 18-24 month timeframe. An example would be loans collateralized by residential subdivision lots. The values of this type of collateral have been volatile in recent years, and, therefore, appraisals are generally updated at the lower end of the timeframe (i.e., closer to 18 months), while timberland appraisals, which have been less volatile in recent years, would be updated closer to the upper end of the timeframe (i.e., closer to 24 months). Any observed trend indicating significant changes in valuations would require updated appraisals. If a loan is evaluated for impairment under ASC Topic 310-10-35, Accounting by Creditors for Impairment of a Loan, and the appraisal is outdated, a new appraisal is ordered. If the new appraisal is not received in sufficient time to assess any required impairment to meet financial reporting obligations, the old appraisal may be adjusted to reflect values observed in similar properties. After a new appraisal is obtained, the analysis is updated to reflect the new valuation. Loan losses are charged against the allowance when management believes that the uncollectibility of a loan is confirmed. Loans determined to be uncollectible and that were written down to appraised value totaled $1.1 million and $8.3 million, net of specific allowances for fair-value impairment, as of September 30, 2014 and December 31, 2013, respectively. This valuation was derived using Level 3 inputs, consisting of appraisals of underlying collateral or discounted cash flow analysis.

Foreclosed Assets

Certain foreclosed assets, upon initial recognition, are remeasured at fair value through a charge-off to the allowance for loan losses based upon the fair value of the foreclosed asset. Estimates of fair values for foreclosed assets are determined based on a variety of information, including the use of available appraisals, estimates of market value by licensed appraisers or local real estate brokers and the knowledge and experience of the Company’s management related to the assessment of the values of foreclosed properties. Management takes into consideration the type, location and occupancy of the property, as well as current economic conditions in the area in which the property is located, in assessing estimates of fair value.

The fair value of a foreclosed asset, upon initial recognition, is estimated using Level 2 inputs based on observable market data or Level 3 inputs based on customized discounting criteria and/or market data. Foreclosed assets measured at fair value upon initial recognition totaled $4.5 million and $2.2 million (utilizing Level 3 valuation inputs) during the nine months ended September 30, 2014 and 2013, respectively. In connection with the measurement and initial recognition of the foregoing foreclosed assets, the Company recognized charge-offs of the allowance for loan losses totaling approximately $0.4 million for both the nine-month periods ended September 30, 2014 and 2013, respectively. Other foreclosed assets totaling $1.3 million and $3.4 million (utilizing Level 3 valuation inputs) were remeasured at fair value during the nine months ended September 30, 2014 and 2013, respectively. The remeasurement resulted in $0.2 million in write downs of other real estate owned during the nine months ended September 30, 2014 and $0.5 million in write downs of other real estate owned during the nine months ended September 30, 2013.

Fair Value of Financial Instruments

ASC Topic 825, Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:

Cash, due from banks and federal funds sold: The carrying amount of cash, due from banks and federal funds sold approximates fair value.

Federal Home Loan Bank (“FHLB”) stock: Based on the redemption provision of the FHLB, the stock has no quoted market value and is carried at cost.

Investment securities: Fair values of investment securities are based on quoted market prices where available. If quoted market prices are not available, estimated fair values are based on market prices of comparable instruments.

Derivative instruments: The fair value of derivative instruments is based on information obtained from a third party financial institution. This information is periodically evaluated by the Company and, as necessary, corroborated against other third party information.

Accrued interest receivable and payable: The carrying amount of accrued interest approximates fair value.

Loans, net: For variable-rate loans, fair values are based on carrying values. Fixed-rate commercial loans, other installment loans and certain real estate mortgage loans are valued using discounted cash flows. The discount rate used to determine the present value of these loans is based on interest rates currently being charged by the Company on comparable loans as to credit risk and term.

Demand and savings deposits: The fair values of demand deposits are equal to the carrying value of such deposits. Demand deposits include non-interest bearing demand deposits, savings accounts, NOW accounts and money market demand accounts.

Time deposits: The fair values of relatively short-term time deposits are equal to their carrying values. Discounted cash flows are used to value long-term time deposits. The discount rate used is based on interest rates currently being offered by the Company on comparable deposits as to amount and term.

Short-term borrowings: These borrowings may consist of federal funds purchased, securities sold under agreements to repurchase and the floating rate borrowings from the FHLB account. Due to the short-term nature of these borrowings, fair values approximate carrying values.

Long-term debt: The fair value of this debt is estimated using discounted cash flows based on the Company’s current incremental borrowing rate for similar types of borrowing arrangements as of September 30, 2014 and December 31, 2013.

Off-balance sheet instruments: The carrying amount of commitments to extend credit and standby letters of credit approximates fair value. The carrying amount of the off-balance sheet financial instruments is based on fees currently charged to enter into such agreements.

The estimated fair value and related carrying or notional amounts, as well as the level within the fair value hierarchy, of the Company’s financial instruments as of September 30, 2014 and December 31, 2013, were as follows:


	September 30, 2014
	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
	(Dollars in Thousands)
Assets:
Cash and cash equivalents	$	34,531	$	34,531	$	34,531	$	—	$	—
Investment securities available-for-sale		179,346		179,346		—		179,346		—
Investment securities held-to-maturity		36,524		36,091		—		36,091		—
Federal Home Loan Bank stock		738		738		—		—		738
Loans, net of allowance for loan losses		265,170		264,393		—		—		264,393
Other assets – derivatives		105		105		—		105		—
Liabilities:
Deposits		474,518		474,412		—		474,412		—
Short-term borrowings		755		755		—		755		—
Long-term debt		5,000		5,009		—		5,009		—


	December 31, 2013
	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
	(Dollars in Thousands)
Assets:
Cash and cash equivalents	$	47,720	$	47,720	$	47,720	$	—	$	—
Investment securities available-for-sale		135,754		135,754		—		135,754		—
Investment securities held-to-maturity		35,050		33,365		—		33,365		—
Federal Home Loan Bank stock		906		906		—		—		906
Loans, net of allowance for loan losses		300,927		303,291		—		—		303,291
Liabilities:
Deposits		484,279		484,957		—		484,957		—
Short-term borrowings		1,231		1,231		—		1,231		—
Long-term debt		5,000		5,011		—		5,011		—