Note 17 - Fair Value Measurement

6 Months Ended

Jun. 30, 2017

17.

Fair Value Measurement.

Fair value is defined as the price that would be received on the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy prioritizes the inputs of valuation techniques used to measure fair value of nonfinancial assets and liabilities. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of the market observability of the fair value measurement. In order to determine the fair value, the Bank must determine the unit of account, highest and best use, principal market, and market participants. These determinations allow the Bank to define the inputs for fair value and level of hierarchy. Outlined below is the application of the fair value hierarchy to the Bank’s financial assets that are carried at fair value.

Level

inputs to the valuation methodology are quoted prices in active markets for identical assets or liabilities that the Bank has the ability to access at the measurement date. A quoted price in an active market provides the most reliable evidence of fair value and is used to measure fair value whenever available. The type of assets carried at Level

fair value generally includes investments such as U.S. Treasury and U.S. government agency securities.

Level

inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets and price quotations can vary substantially either over time or among market makers. The type of assets carried at Level

fair value generally includes securities and mortgage-backed securities issued by Government Sponsored Enterprises (“GSEs”), municipal bonds, corporate debt securities, mortgage loans held for sale and bank-owned life insurance.

Level

inputs to the valuation methodology are unobservable to the extent that observable inputs are

not

available. Unobservable inputs are developed based on the best information available in the circumstances and might include the Bank’s own assumptions. The Bank considers information about market participant assumptions that is reasonably available without undue cost and effort. The type of assets carried at Level

fair value generally include investments backed by non-traditional mortgage loans or certain state or local housing agency obligations, of which the Bank has

such assets or liabilities. Level

also includes impaired loans and other real estate owned.

Quoted market price for similar assets in active markets is the valuation technique for determining fair value of securities available-for-sale and held-to-maturity. Unrealized gains on available-for-sale securities are included in the “accumulated other comprehensive income” component of the Stockholders’ Equity section of the Consolidated Statements of Financial Condition. The estimated fair value of loans held for sale is based on commitments from investors within the secondary market for loans with similar characteristics. The Bank does

not

record loans held for investment at fair value on a recurring basis. However, when a loan is considered impaired, an impairment write down is taken based on the loan’s estimated fair value. The fair value of impaired loans is estimated using

one

of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those loans

not

requiring a write down represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans, and are

not

included below.

Assets measured at fair value on a recurring basis as of

June 30, 2017

and

December 31, 2016:

	Fair Value		Quoted Prices In Active Markets for Identical Assets		Significant Observable Inputs- Outputs		Significant Unobservable Inputs
	(In thousands)
Description	June 30, 2017		Level 1		Level 2		Level 3
Securities available-for-sale:
Government agencies	$	23,857	$	23,857	$	-	$	-
Mortgage-backed securities		87,483		-		87,483		-
Municipal securities		57,157		-		57,157		-
Corporate bonds		26,904		-		26,904		-
Mortgage loans held for sale		6,381		-		6,381		-
Bank-owned life insurance		18,351		-		18,351		-
Interest rate swap		64		-		64		-
Total June 30, 2016	$	220,197	$	23,857	$	196,340	$	-

Description	December 31, 2016		Level 1		Level 2		Level 3
Securities available-for-sale:
Government agencies	$	16,995	$	16,995	$	-	$	-
Mortgage-backed securities		95,116		-		95,116		-
Municipal securities		53,682		-		53,682		-
Corporate bonds		26,813		-		26,813		-
Mortgage loans held for sale		5,099		-		5,099		-
Bank-owned life insurance		18,080		-		18,080		-
Interest rate swap		121		-		121		-
Total December 31, 2015	$	215,906	$	16,995	$	198,911	$	-

Assets measured at fair value on a non-recurring basis as of

June 30, 2017

and

December 31, 2016:

	Fair Value		Quoted Prices In Active Markets for Identical Assets		Significant Observable Inputs- Outputs		Significant Unobservable Inputs
	(In thousands)
Description	June 30, 2017		Level 1		Level 2		Level 3
Impaired loans, net	$	8,603	$	-	$	-	$	8,603
Other real estate owned		2,438		-		-		2,438
Total June 30, 2016	$	11,041	$	-	$	-	$	11,041

Description	December 31, 2016		Level 1		Level 2		Level 3
Impaired loans, net	$	10,730	$	-	$	-	$	10,730
Other real estate owned		3,229		-		-		3,229
Total December 31, 2015	$	13,959	$	-	$	-	$	13,959

Impaired loans at

June 30, 2017

and

December 31, 2016

include

$7.8

million and

$9.9

million, respectively, of loans identified as impaired, even though an impairment analysis calculated pursuant to ASC

310

resulted in

allowance.

Impaired loans where a write down is taken based on fair value of collateral require classification in the fair value hierarchy. 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 non-recurring Level

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

observable market price, the Bank classifies the impaired loan as non-recurring Level

OREO is recorded at fair value upon transfer of a loan to foreclosed assets, based on the appraised market value of the property. OREO is reviewed quarterly and values are adjusted as determined appropriate. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When an appraised value is

not

available or management determines the fair value of the collateral is impaired below the appraised value and there is

observable market price, the Bank classifies the foreclosed asset as non-recurring Level

Fair value adjustments of

$57,624

and

$176,919,

respectively, were made to OREO during the

three

and

six

months ended

June 30, 2017,

compared to

$102,880

and

$110,170,

respectively, made during the

three

and

six

months ended

June 30, 2016.

liabilities were measured at fair value on a recurring or non-recurring basis as of

June 30, 2017

December 31, 2016.

- Definition

The entire disclosure for a company's election to apply the fair value option for measurement and reporting of eligible financial assets and liabilities (as defined), as well as certain other eligible items (as defined) included in the statement of financial position, whether such option is elected for a single eligible item or a group of similar eligible items and is in addition to other disclosures concerning fair value which the company may be required to provide. Such disclosure might be expected to include: (1) for items included in the statement of financial position: (a) the reasons for electing a fair value option for each eligible item or group of similar eligible items; (b) if the fair value option is elected for some but not all eligible items within a group of similar eligible items: (i) a description of those similar items and the reasons for partial election and (ii) information of how the group of similar items relates to individual balance sheet line items; (c) for each line item in the statement of financial position that includes an item or items for which the fair value option has been elected: (i) information of how each line item in the statement of financial position relates to major categories of assets and liabilities presented in accordance with other fair value disclosures and (ii) the aggregate carrying amount of ineligible items included in each line item in the balance sheet, if any; (d) the difference between the aggregate fair value and the aggregate unpaid principal balance (assuming contractual principal amounts and fair value option elected) of: (i) loans and long-term receivables (other than securities otherwise reported at fair value) and (ii) long-term debt instruments; (e) for loans held as assets for which the fair value option has been elected: (i) the aggregate fair value of loans that are 90 days or more past due, (ii) if the policy is to recognize interest income separately from other changes in fair value, the aggregate fair value of loans in nonaccrual status, and (iii) the difference between the aggregate fair value and the aggregate unpaid principal balance for loans that are 90 days or more past due, in nonaccrual status, or both; (f) for investments that would have been accounted for under the equity method if the entity had not chosen to apply the fair value option, the information required for such investments, if material either individually or in the aggregate; (2) for items included in the income statement: (a) the amounts of gains and losses from fair value changes included in earnings and in which line in the income statement those gains and losses are reported whether or not combined with gains and losses from items required to be accounted for at fair value; (b) a description of how interest and dividends are measured and where they are reported in the income statement; (c) for loans and other receivables held as assets: (i) the estimated amount of gains or losses included in earnings attributable to changes in instrument-specific credit risk and (ii) how the gains or losses attributable to changes in instrument-specific credit risk were determined; (d) for liabilities with fair values that have been significantly affected during the reporting period by changes in the instrument-specific credit risk: (i) the estimated amount of gains and losses from fair value changes included in earnings that are attributable to changes in the instrument-specific credit risk, (ii) qualitative information about the reasons for those changes, and (iii) how the gains and losses attributable to changes in instrument-specific credit risk were determined; and (3) certain other disclosures as required or determined to be provided.

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FIRST SOUTH BANCORP INC /VA/ 10-Q