Note 16—Fair Value Measurements and Fair Values of Financial Instruments

 

The Corporation uses its best judgment in estimating the fair value of the Corporation’s assets and liabilities; however, there are inherent weaknesses in any estimation technique.  Therefore, the fair value estimates herein are not necessarily indicative of the amounts that could be realized in sales transactions on the dates indicated.  The estimated fair value amounts have been measured as of their respective period-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates.  As such, the estimated fair values subsequent to the respective reporting dates may be different than the amounts reported at each period end.

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date.  GAAP establishes a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:

 

Level 1:  Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets.  A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

 

Level 2:  Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets;  inputs to the valuation methodology include quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs to the  valuation methodology that utilize model-based techniques for which all significant assumptions are observable in the market.

 

Level 3:  Inputs to the valuation methodology are unobservable and significant to the fair value measurement;  inputs to the valuation methodology that utilize model-based techniques for which significant assumptions are not observable in the market; or inputs to the valuation methodology that require significant management judgment or estimation, some of which may be internally developed.

 

Since management maximizes the use of observable inputs and minimizes the use of unobservable inputs when determining fair value, an asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.  Management reviews and updates the fair value hierarchy classifications on a quarterly basis.

 

Assets Measured at Fair Value on a Recurring Basis

 

Securities Available for Sale

 

The fair values of investment securities were measured using information from a third-party pricing service. The pricing service uses quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique, used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. At least annually, the Corporation reviews a random sample of the pricing information received from the third-party pricing service by comparing it to price quotes from third-party brokers. Historically, price deviations have been immaterial.

 

 

Assets Measured at Fair Value on a Nonrecurring Basis

 

Impaired Loans

Impaired loans are those that are accounted for under FASB ASC Topic 310, in which the Corporation has measured impairment generally based on the fair value of the loan’s collateral.  Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds.  These loans are included as Level 3 fair values, based on the lowest level of input that is significant to the fair value measurements.  At December 31, 2014, the fair value consists of loan balances of $3,058,000, net of valuation allowances of $2,512,000 and charge-offs of $26,000, compared to loan balances of $8,669,000, net of valuation allowances of $1,720,000 and charge-offs of $291,000, at December 31, 2013. 

 

Foreclosed Real Estate

Other real estate property acquired through foreclosure is initially recorded at fair value of the property at the transfer date less estimated selling cost. Subsequently, other real estate owned is carried at the lower of its carrying value or the fair value less estimated selling cost.  Fair value is usually determined based upon an independent third-party appraisal of the property or occasionally upon a recent sales offer.  At December 31, 2014, the fair value of foreclosed real estate with a valuation allowance or charge-off was $1,198,000, which is net of valuation allowances of $1,687,000 and no charge-offs.  At December 31, 2013, the fair value of foreclosed real estate with a valuation allowance or charge-off was $3,098,000, which is net of valuation allowances of $3,954,000 and charge-offs of $100,000. 

 

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Corporation has utilized Level 3 inputs to determine fair value:

 

 

Disclosures about Fair Value of Financial Instruments

The following methods and assumptions were used to estimate the fair values of the Corporation’s financial instruments as of December 31, 2014 and 2013. 

 

Cash and Cash Equivalents

The carrying amount is a reasonable estimate of fair value.

 

Securities Available for Sale

The fair value of securities available for sale is determined in accordance with the methods described under FASB ASC Topic 820 as described above.

 

Restricted Investment in Bank Stocks

The carrying amount of restricted investment in bank stocks is a reasonable estimate of fair value.  The Corporation is required to maintain minimum investment balances in these stocks, which are not actively traded and, therefore, have no readily determinable market value.

 

Loans Held for Sale

The fair value of loans held for sale is determined, when possible, using quoted secondary-market prices.  If no such quoted prices exist, the fair value of a loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of that loan.  

 

Loans, net 

The fair value of loans, excluding all impaired loans, is estimated using discounted cash flow analyses using the current interest rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  Loans were first segregated by type such as commercial, real estate, and consumer, and were then further segmented into fixed and variable rate.  Projected future cash flows are calculated based upon contractual maturity or call dates.  For variable rate loans that reprice frequently and have no significant change in credit risk, fair value is based on carrying value. 

 

Interest Receivable

The carrying value of interest receivable is a reasonable estimate of fair value.

 

Deposits

The fair value of demand deposits, savings accounts and money market deposits is the amount payable on demand at the reporting date.  The fair values of time deposits are estimated using a discounted cash flow analyses.  The discount rates used are based on rates currently offered for deposits with similar remaining maturities.  The fair values of variable rate time deposits that reprice frequently are based on carrying value.  The fair values of time deposit liabilities do not take into consideration the value of the Corporation’s long-term relationships with depositors, which may have significant value.

 

Short-term Borrowings

For theses short-term instruments, the carrying amount is a reasonable estimate of fair value.

 

Long-term Debt 

Long-term debt includes FHLBP advances (Level 2) and junior subordinated debt (Level 3).  The fair value of FHLBP advances are estimated using discounted cash flow analysis, based on quoted prices for new FHLBP advances with similar credit risk characteristics, terms and remaining maturity.  These prices are obtained from this active market and represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.  The fair value of junior subordinated debt is estimated using discounted cash flow analysis, based on market rates and spread characteristics of similar debt with similar credit risk characteristics, terms and remaining maturity.

 

Interest Payable

The carrying value of interest payable is a reasonable estimate of fair value.

 

Off-Balance Sheet Instruments

Off-balance sheet instruments consist of lending commitments and letters of credit are based on fees currently charged in the market to enter into similar arrangements, taking into account the remaining terms of the agreements and counterparties’ credit standing.  These amounts were not considered material.

 

The following presents the carrying amount and estimated fair value of the Corporation’s financial instruments as of December 31, 2014 and 2013.