FAIR VALUES OF FINANCIAL INSTRUMENTS

9 Months Ended

Sep. 30, 2016

NOTE 8 – FAIR VALUES OF FINANCIAL INSTRUMENTS

Fair value is defined as the exchange price that would be received to sell 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. Accounting guidance also establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under this guidance are described below.

Level 1 - Valuation is based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets and liabilities.

Level 2 - Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on 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 for substantially the full term of the asset or liability.

Level 3 - Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Accordingly, investment securities available for sale and loans held for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record other assets at fair value on a nonrecurring basis, such as impaired loans and other real estate owned. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or writedowns of individual assets.

The following describes the valuation techniques used to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements.

Investment securities available for sale - 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 the 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 or traded by dealers or brokers in active over-the-counter markets. Level 2 securities include securities issued by government sponsored entities, mortgage backed securities, and municipal bonds. Level 3 securities include those with unobservable inputs. Transfers between levels can occur due to changes in the observability of significant inputs.

Loans held for sale - Loans held for sale are carried at fair value. These loans currently consist of one-to-four-family residential loans originated for sale in the secondary market. Fair va lu e is based on the committed market rates or the price secondary markets are currently offering for similar loans using observable market data.

The following are assets and liabilities that were accounted for or disclosed at fair value on a recurring basis:

	(Dollars in thousands)
			Fair Value Measurements Using
			Quoted Prices in		Significant
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
			Assets/Liabilities		Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
September 30, 2016
Assets:
Securities available for sale:
U.S. government securities	$	-	$	-	$	-	$	-
U.S. government federal agencies		2,248		-		2,248		-
State and local governments		2,927		-		2,927		-
Mortgage backed securities		3,854		-		3,854		-
Total securities available for sale	$	9,029	$	-	$	9,029	$	-
Loans held for sale	$	229	$	-	$	229	$	-

December 31, 2015
Assets:
Securities available for sale:
U.S. government securities	$	1,005	$	1,005	$	-	$	-
U.S. government federal agencies		6,535		-		6,535		-
State and local governments		1,783		-		1,783		-
Mortgage backed securities		4,690		-		4,690		-
Total securities available for sale	$	14,013	$	1,005	$	13,008	$	-

The following describes the valuation techniques used to measure certain financial assets and liabilities recorded at fair value on a nonrecurring basis in the financial statements.

Impaired loans - The Bank does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses may need to be established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment. As of September 30, 2016, the fair value of substantially all of the impaired loans was estimated based on the fair value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Bank records the impaired loan as nonrecurring Level 3. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.

Other real estate owned (OREO) - OREO consists of real estate acquired in foreclosure or other settlement of loans. Such assets are carried on the consolidated balance sheet at the lower of the investment in the real estate or its fair value less estimated selling costs. The fair value of OREO is determined on a nonrecurring basis generally utilizing current appraisals performed by an independent, licensed appraiser applying an income or market value approach using observable market data (Level 2). However, if a current appraisal is not available, the original appraised value is discounted, as appropriate, to compensate for the estimated depreciation in the value of the real estate since the date of its original appraisal. Such discounts are generally estimated based upon management’s knowledge of sales of similar property within the applicable market area and its knowledge of other real estate market-related data, as well as general economic trends (Level 3). Upon foreclosure, any fair value adjustment is charged against the allowance for loan losses. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense in the consolidated statements of income.

The following are assets and liabilities that were accounted for or disclosed at fair value on a nonrecurring basis:

			(Dollars in thousands)
			Fair Value Measurements Using
			Quoted Prices in		Significant
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
			Assets/Liabilities		Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
September 30, 2016
Assets:
Impaired loans
Commercial mortgage	$	3,691	$	-	$	-	$	3,691
Commercial other		699		-		-		699
Residential real estate		662		-		-		662
Consumer equity		96		-		-		96
Consumer auto		37		-		-		37
Total impaired loans		5,185		-		-		5,185

Other real estate owned
Residential		22		-		-		22
Commercial		-		-		-		-
Total other real estate owned	$	22	$	-	$	-	$	22

December 31, 2015
Assets:
Impaired loans
Commercial mortgage	$	2,171	$	-	$	-	$	2,171
Commercial other		38		-		-		38
Residential real estate		679		-		-		679
Consumer equity		-		-		-		-
Consumer auto		89		-		-		89
Total impaired loans	$	2,977	$	-	$	-	$	2,977

Other real estate owned
Residential		15		-		-		15
Commercial		223		-		-		223
Total other real estate owned	$	238	$	-	$	-	$	238

The quantitative information about Level 3 fair value measurements for financial assets and liabilities measured at fair value on a nonrecurring basis is as follows:

	(Dollars in thousands)
	Fair Value		Valuation Technique	Significant Unobservable Input	Range
September 30, 2016
Impaired loans
Commercial mortgage	$	3,691	Appraisal of Collateral	Appraisal Adjustment	Up to 11%
Commercial other		699	Appraisal of Collateral	Appraisal Adjustment	Up to 3%
Residential real estate		662	Appraisal of Collateral	Appraisal Adjustment	Up to 4%
Consumer:
Equity		96	Appraisal of Collateral	Appraisal Adjustment	Up to 15%
Auto		37	Appraisal of Collateral	Appraisal Adjustment	*

Other real estate owned
Residential		22	Appraisal of Property	Appraisal Adjustment	*
Commercial		-	Appraisal of Property	Appraisal Adjustment	*

December 31, 2015
Impaired loans
Commercial mortgage	$	2,171	Appraisal of Collateral	Appraisal Adjustment	Up to 6%
Commercial other		38	Appraisal of Collateral	Appraisal Adjustment	*
Residential real estate		679	Appraisal of Collateral	Appraisal Adjustment	Up to 6%
Consumer:
Equity		-	Appraisal of Collateral	Appraisal Adjustment	*
Auto		89	Appraisal of Collateral	Appraisal Adjustment	*

Other real estate owned
Residential		15	Appraisal of Property	Appraisal Adjustment	*
Commercial		223	Appraisal of Property	Appraisal Adjustment	Up to 45%
			* There are no related allowances for these classifications

The following methods and assumptions were used to estimate the fair value disclosures for other financial instruments as of September 30, 2016 and December 31, 2015:

Cash and cash equivalents - The fair value of cash and cash equivalents is estimated to approximate the carrying amounts.

Other investment securities - Other investment securities consist of restricted equity securities in the Federal Home Loan Bank (FHLB) and are carried at cost. Because there is no market, the carrying values of restricted equity securities approximate fair values based on the redemption provisions of the FHLB.

Loans - The fair value of loans is calculated by discounting estimated cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The estimated cash flows do not anticipate prepayments.

Management has made estimates of fair value discount rates that it believes to be reasonable. However, because there is no market for many of these financial instruments, management has no basis to determine whether the fair value presented for loans would be indicative of the value negotiated in an actual sale.

Accrued interest receivable and payable - The carrying amounts of accrued interest approximate fair value.

Bank owned life insurance - The fair value of bank owned life insurance approximates the cash surrender value of the policies.

Deposits - The fair value of deposits with no stated maturity, such as noninterest bearing and interest bearing demand deposits, regular savings, and certain types of money market accounts, is equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.

Borrowed funds - The carrying amounts of borrowed funds which mature within 90 days approximate their fair values. The fair values of other borrowed funds are estimated using discounted cash flow analysis that applies interest rates currently offered on similar instruments.

Off-balance sheet instruments - The fair values of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of agreements and the present credit standing of the counterparties. The amounts of fees currently charged on commitments to extend credit and standby letters of credit are deemed insignificant, and therefore, the estimated fair values and carrying values are not shown.

The estimated fair value of the financial instruments is as follows:

					Fair Value Measurements Using
					Quoted
	(Dollars in thousands)				Prices in
					Active		Significant
					Markets		Other		Significant
					for Identical		Observable		Unobservable
	Carrying		Fair		Assets/Liabilities		Inputs		Inputs
	Amount		Value		(Level 1)		(Level 2)		(Level 3)
September 30, 2016
Financial assets:
Cash and cash equivalents	$	10,041	$	10,041	$	-	$	10,041	$	-
Investment securities		9,029		9,029		-		9,029		-
Other investment securities		859		859		-		-		859
Loans held for sale		229		229		-		229		-
Loans, net		147,935		154,492		-		-		154,492
Accrued interest receivable		277		277		-		-		277
Bank owned life insurance		3,403		3,403		-		3,403		-

Financial liabilities:
Noninterest-bearing deposits	$	31,859	$	31,859	$	-	$	31,859	$	-
Interest-bearing deposits		126,463		127,885		-		127,885		-
Borrowed funds		2,203		2,203		-		2,203		-
Accrued interest payable		560		560		-		-		560

December 31, 2015
Financial assets:
Cash and cash equivalents	$	9,371	$	9,371	$	-	$	9,371	$	-
Securities available for sale		14,013		14,013		1,005		13,008		-
Other investment securities		859		859		-		-		859
Net loans		147,153		149,355		-		-		149,355
Accrued interest receivable		285		285		-		-		285
Bank owned life insurance		3,320		3,320		-		3,320		-

Financial liabilities:
Noninterest bearing deposits	$	26,116	$	26,116	$	-	$	26,116	$	-
Interest bearing deposits		136,209		137,174		-		137,174		-
Borrowed funds		2,569		2,569		-		2,569		-
Accrued interest payable		759		759		-		-		759

The carrying amounts in the preceding table are included in the consolidated balance sheets under the applicable captions. No derivatives were held by the Company for trading purposes.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

+ References + Details

Citizens Independent Bancorp, Inc. 10-Q