NOTE 6 – FAIR VALUE

ASC Topic 820 provides a framework for measuring and disclosing fair value under GAAP. ASC 820 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available-for-sale investment securities) or a nonrecurring basis (for example, impaired loans).

ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an 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. ASC 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The Fair Value Hierarchy

ASC 820‑10 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. In accordance with ASC 820‑10, these inputs are summarized in the three broad levels listed below:

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

Level 2 – Other significant observable inputs (including quoted prices in active markets for similar securities).

Level 3 – Significant unobservable inputs (including the Company’s own assumptions in determining the fair value of investments).

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value:

Investment Securities Available-for-Sale and Interest Rate Swaps. Investment securities available-for-sale and interest rate swap contracts are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage backed securities issued by government sponsored entities, municipal bonds and corporate debt securities, and interest rate swap contracts. Securities classified as Level 3 include asset-backed securities in illiquid markets.

The Bank may be required, from time to time, to measure certain other financial and non-financial assets and liabilities at fair value on a non-recurring basis in accordance with GAAP.

Loans. At March 31, 2019, these assets include 26 loans, excluding $349,000 of residential real estate, consumer and indirect loans, classified as impaired, which include nonaccrual, past due 90 days or more and still accruing, and a homogeneous pool of indirect loans all considered to be impaired loans, which are valued under Level 3 inputs. Loans which are deemed to be impaired ($2.8 million of loans with $255,000 of specific reserves as of March 31, 2019) and foreclosed real estate assets are primarily valued on a nonrecurring basis at the fair values of the underlying real estate collateral. The Company is predominantly a cash flow lender with real estate serving as collateral on a majority of loans ($2.4 million of the total impaired loans as of March 31, 2019). On a quarterly basis, the Company determines such fair values through a variety of data points and mostly rely on appraisals from independent appraisers. We obtain an appraisal on properties when they become impaired and have new appraisals at least every year. Typically, these appraisals do not include an inside inspection of the property as our loan documents do not require the borrower to allow access to the property. Therefore the most significant unobservable inputs is the details of the amenities included within the property and the condition of the property. Further, we cannot always accurately assess the amount of time it takes to gain ownership of our collateral through the foreclosure process and the damage, as well as potential looting, of the property further decreasing our value. Thus, in determining the fair values we discount the current independent appraisals, with a range from 0% to 16%, based on individual circumstances. The remaining impaired loans ($785,000 million with $255,000 of specific reserves as of March 31, 2019) include mobile homes, commercial, consumer, and indirect auto loans, which are valued based on the value of the underlying collateral.

The changes in the assets subject to fair value measurements are summarized below by level:


							Fair
(dollars in thousands)	Level 1		Level 2		Level 3		Value
March 31, 2019
Recurring:
Securities available for sale
Collateralized mortgage obligations	$	—	$	18,479	$	—	$	18,479
Agency mortgage-backed securities		—		26,597		—		26,597
Municipal securities		—		13,362		—		13,362
U.S. Government agency securities		—		1,988		—		1,988
U.S. Treasury securities		—		994		—		994
Interest rate swap		—		73		—		73

Non-recurring:
Maryland Financial Bank stock		—		—		5		5
Impaired loans		—		—		2,999		2,999
OREO		—		705		—		705
	$	—	$	62,198	$	3,004	$	65,202
December 31, 2018
Recurring:
Securities available for sale
Collateralized mortgage obligations	$	—	$	19,806	$	—	$	19,806
Agency mortgage-backed securities		—		24,987		—		24,987
Municipal securities		—		33,830		—		33,830
U.S. Government agency securities		—		1,959		—		1,959
U.S. Treasury securities		—		990		—		990
Interest rate swap		—		295		—		295

Non-recurring:
Maryland Financial Bank stock		—		—		5		5
Impaired loans		—		—		2,501		2,501
OREO				705				705
	$	—	$	82,572	$	2,506	$	85,078

The estimated fair values of the Company’s financial instruments at March 31, 2019 and December 31, 2018 are summarized below. The fair values of a significant portion of these financial instruments are estimates derived using present value techniques and may not be indicative of the net realizable or liquidation values. Also, the calculation of estimated fair values is based on market conditions at a specific point in time and may not reflect current or future fair values.


	March 31, 2019				December 31, 2018
(dollars in thousands)	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
Financial assets:
Cash and due from banks	$	2,341	$	2,341	$	2,605	$	2,605
Interest-bearing deposits in other financial institutions		14,194		14,194		12,468		12,468
Federal funds sold		62		62		881		881
Investment securities available for sale		61,420		61,420		81,572		81,572
Investments in restricted stock		1,439		1,439		2,481		2,481
Ground rents		146		146		143		143
Loans, less allowance for credit losses		296,812		293,507		296,579		293,175
Accrued interest receivable		1,110		1,110		1,198		1,198
Cash value of life insurance		7,900		7,900		7,860		7,860

Financial liabilities:
Deposits		331,613		309,010		322,453		307,271
Long-term borrowings		—		—		—		—
Short-term borrowings		25,000		25,004		55,000		55,851
Accrued interest payable		132		132		152		152
Unrecognized financial instruments:
Commitments to extend credit		24,664		24,664		19,905		19,905
Standby letters of credit		1,059		1,059		1,059		1,059

The following table presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments.


(dollars in thousands)
	Carrying		Fair
March 31, 2019	Amount		Value		Level 1		Level 2	Level 3

Financial instruments - Assets
Cash and cash equivalents	$	16,597	$	16,597	$	16,597	—	$	—
Loans receivable, net		296,812		293,507		—	—		293,507
Cash value of life insurance		7,900		7,900		—	7,900		—
Financial instruments - Liabilities
Deposits		331,613		309,010		—	309,010		—
Short-term debt		25,000		25,004		—	25,004		—

Fair values are based on quoted market prices for similar instruments or estimated using discounted cash flows. The discounts used are estimated using comparable market rates for similar types of instruments adjusted to be commensurate with the credit risk, overhead costs and optionality of such instruments.

The fair value of cash and due from banks, federal funds sold, investments in restricted stocks and accrued interest receivable are equal to the carrying amounts. The fair values of investment securities are determined using market quotations if available, or measured using pricing models or other model-based valuation techniques such as present value and future value cash flows. The fair value of loans receivable is estimated using discounted cash flow analysis. For cash surrender value of life insurance, the carrying value is a reasonable estimate of fair value. Cash surrender value of life insurance is reported in the Level 2 fair value category. The fair value of FHLB borrowings is estimated based upon discounted future cash flows using a discounted rate comparable to the current market rate for such borrowings. FHLB borrowings are reported in the Level 2 fair value category.

The fair value of non-interest bearing deposits, interest-bearing checking, savings, and money market deposit accounts, securities sold under agreements to repurchase, and accrued interest payable are equal to the carrying amounts. The fair value of fixed-maturity time deposits is estimated using discounted cash flow analysis.