19.	FAIR VALUE MEASUREMENTS

The Company follows the provisions of ASC Topic 820, Fair Value Measurements, 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. Level 1 also includes equity securities in banks that are publicly traded. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

 

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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 years ended December 31, 2013 or 2012.

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.

The following table presents the balances of available-for-sale securities measured at fair value on a recurring basis as of December 31, 2013 and 2012.

 

		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)
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 as of December 31, 2012 Using
		Totals At December 31, 2012				Quoted Prices in Active Markets For Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
		(Dollars in Thousands)
Mortgage-backed securities:
Residential		$	49,264			$	—			$	49,264			$	—
Commercial			28,289				—				28,289				—
Obligations of states and political subdivisions			14,981				—				14,981				—
U.S. treasury securities			80				—				80				—

Fair Value Measurements on a Non-recurring Basis

Impaired Loans

Estimates of fair value 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 values of properties in the Company’s market areas. 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. Accordingly, fair value estimates for impaired loans are classified as Level 3.

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. Based on experience, current appraisals are discounted 9% for estimated costs associated with foreclosures and costs to sell. 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 uncollectability of a loan is confirmed. Loans, net of specific allowances, subject to this evaluation amounted to $11.4 million and $15.0 million as of December 31, 2013 and 2012, respectively. This valuation would be considered Level 3, consisting of appraisals of underlying collateral and discounted cash flow analysis.

 

Foreclosed Assets

Estimates of fair values 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 values of properties in the Company’s market areas. 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. Accordingly, the fair value estimates for foreclosed real estate are classified as Level 3.

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. Foreclosed assets measured at fair value upon initial recognition totaled $0.5 million and $2.1 million (utilizing Level 3 valuation inputs) as of December 31, 2013 and 2012, 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 $0.5 million and $0.4 million as of December 31, 2013 and 2012, respectively. Foreclosed assets totaling $5.3 million and $9.3 million (utilizing Level 3 valuation inputs) were remeasured at fair value as of December 31, 2013 and 2012, respectively, resulting in impairment loss of $1.3 million and $3.6 million on other real estate owned as of December 31, 2013 and 2012, respectively.

The following table presents the balances of impaired loans and foreclosed assets measured at fair value on a non-recurring basis as of December 31, 2013 and 2012.

 

		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)
Impaired loans		$	11,358			$	—			$	—			$	11,358
Foreclosed property and other real estate			5,832				—				—				5,832

 

		Fair Value Measurements as of December 31, 2012  Using
		Totals At December 31, 2012				Quoted Prices in Active Markets For Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
		(Dollars in Thousands)
Impaired loans		$	14,956			$	—			$	—			$	14,956
Foreclosed property and other real estate			11,368				—				—				11,368

Non-Recurring Fair Value Measurements Using Significant Unobservable Inputs:

The following table presents information regarding assets and liabilities measured at fair value using significant unobservable inputs (Level 3) as of December 31, 2013. The table includes the valuation techniques and the significant unobservable inputs utilized. The range of each unobservable input, as well as the weighted average within the range utilized as of December 31, 2013, are both included. Following the table is a description of the valuation technique and the sensitivity of the technique to changes in the significant unobservable input.

 

		Level 3 Significant Unobservable Input Assumptions
		Fair Value December 31, 2013		Valuation Technique		Unobservable Input		Quantitative Range of  Unobservable Inputs (Weighted- Average)
		(Dollars in Thousands)
Non-recurring fair value measurements:
Impaired loans		$11,358		Multiple data points, including discount to appraised value of collateral based on recent market activity		Appraisal compatibility adjustment (discount)		9%—30% (11.6%)
Foreclosed property and other real estate		$5,832		Discount to appraised value of property based on recent market activity for sales of similar properties		Appraisal compatibility adjustment (discount)		9%—10% (9.3%)

Impaired loans

Impaired loans are valued based on multiple data points indicating the fair value for each loan. The primary data point for non-performing loans is the appraisal value of the underlying collateral to which a discount is applied. Management establishes this discount or comparability adjustment based on recent sales of similar property types. As liquidity in the market increases or decreases, the comparability adjustment and the resulting asset valuation are impacted.

Foreclosed property and other real estate

Foreclosed property and other real estate under a binding contract for sale are valued based on contract price. If no sales contract is pending for a specific property, management establishes a comparability adjustment to the appraised value based on historical activity considering proceeds for properties sold versus the corresponding appraised value. Increases or decreases in realization for properties sold impact the comparability adjustment for similar assets remaining on the balance sheet.

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”): Based on the redemption provision of the FHLB, the stock has no quoted market value and is carried at cost.

Securities: Fair values of 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.

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 December 31, 2013 and 2012.

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 December 31, 2013 and 2012, are as follows:

 

		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				—

 

		December 31, 2012
		Carrying Amount				Estimated Fair Value				Level 1				Level 2				Level 3
		(Dollars in Thousands)
Assets:
Cash and cash equivalents		$	54,126			$	54,126			$	54,126			$	—			$	—
Investment securities available-for-sale			92,614				92,614				—				92,614				—
Investment securities held-to-maturity			21,136				21,185				—				21,185				—
Federal funds sold			5,000				5,000				5,000				—				—
Federal Home Loan Bank stock			936				936				—				936				—
Loans, net of allowance for loan losses			337,400				339,230				—				—				339,230
Liabilities:
Deposits			489,034				490,596				—				490,596				—
Short-term borrowings			638				638				—				638				—