NOTE (6) – Fair Value

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (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. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant observable inputs other than Level 1 prices such as 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.

Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate fair value:

The fair values of securities available-for-sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

The fair value of impaired loans that are collateral dependent is generally based upon the fair value of the collateral which is obtained from recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Assets acquired through or by transfer in lieu of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated every nine months. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Appraisals for collateral-dependent impaired loans and real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, an independent third-party licensed appraiser reviews the appraisals for accuracy and reasonableness, reviewing the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.

Assets Measured on a Recurring Basis

Assets measured at fair value on a recurring basis are summarized below:

	Fair Value Measurements at June 30, 2014
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
	(In thousands)
Assets:
Securities available-for-sale - residential mortgage-backed	$	-	$	16,872	$	-	$	16,872
Securities available-for-sale - U.S. Government and federal agency	-		1,942		-		1,942

	Fair Value Measurements 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)		Total
	(In thousands)
Assets:
Securities available-for-sale - residential mortgage-backed	$	-	$	9,397	$	-	$	9,397

There were no transfers between Level 1, Level 2, or Level 3 during the three and six months ended June 30, 2014 and 2013.

Assets Measured on a Non-Recurring Basis

The following table provides information regarding the carrying values of our assets measured at fair value on a non-recurring basis at the dates indicated. The fair value measurement for all of these assets falls within Level 3 of the fair value hierarchy.

	June 30, 2014		December 31, 2013
	(In thousands)
Assets:
Impaired loans carried at fair value of collateral:
One-to-four units	$	973	$	1,245
Five or more units	339		900
Commercial real estate	1,252		1,391
Church	5,721		9,024
Real estate owned:
Commercial real estate	-		151
Church	1,318		1,933

The following table provides information regarding (gains) losses recognized on assets measured at fair value on a non-recurring basis for the three and six months ended June 30, 2014 and 2013.

	Three Months Ended June 30,					Six Months Ended June 30,
	2014		2013				2014		2013
	(In thousands)
Non-performing loans receivable held-for-sale	$	-	$	(2	)		$	-	$	468
Impaired loans carried at fair value of collateral	141		366				298		400
Real estate owned	336		223				340		223
Total	$	477	$	587			$	638	$	1,091

The following tables present quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at June 30, 2014 and December 31, 2013:

	June 30, 2014
	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
	(Dollars in thousands)

Impaired loans – one-to-four units	$	973	Sales comparison approach	Adjustment for differences between the comparable sales	-10% to -1% (-6%)

Impaired loans – five or more units	339		Sales comparison approach	Adjustment for differences between the comparable sales	1%
			Income approach	Capitalization rate	8%

Impaired loans – commercial real estate	1,252		Sales comparison approach	Adjustment for differences between the comparable sales	-1% to 1% (-1%)
			Income approach	Capitalization rate	5% to 8% (7.17%)

Impaired loans – church	5,721		Sales comparison approach	Adjustment for differences between the comparable sales	-7% to 10% (1%)
			Income approach	Capitalization rate	7%

Real estate owned – church	1,318		Sales comparison approach	Adjustment for differences between the comparable sales	-1% to 7% (4%)

	December 31, 2013
	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
	(Dollars in thousands)

Impaired loans – one-to-four units	$	1,245	Sales comparison approach	Adjustment for differences between the comparable sales	-6% to 6% (-1%)

Impaired loans – five or more units	900		Sales comparison approach	Adjustment for differences between the comparable sales	-15% to 1% (-9%)

			Income approach	Capitalization rate	8% to 9% (8.59%)

Impaired loans – commercial real estate	1,391		Sales comparison approach	Adjustment for differences between the comparable sales	-1% to 0% (-1%)

			Income approach	Capitalization rate	4.5% to 8% (7.06%)

Impaired loans – church	9,024		Sales comparison approach	Adjustment for differences between the comparable sales	-21% to 9% (-1%)

			Income approach	Capitalization rate	6.75%

Real estate owned – commercial real estate	151		Sales comparison approach	Adjustment for differences between the comparable sales	3% (3%)

			Income approach	Capitalization rate	10%

Real estate owned – church	1,933		Sales comparison approach	Adjustment for differences between the comparable sales	-7% to 7% (0%)

Fair Values of Financial Instruments

The carrying amounts and estimated fair values of financial instruments, at June 30, 2014 and December 31, 2013 were as follows:

			Fair Value Measurements at June 30, 2014 Using
	Carrying Value		Level 1		Level 2		Level 3		Total
	(In thousands)
Financial Assets:
Cash and cash equivalents	$	34,636	$	34,636	$	-	$	-	$	34,636
Securities available-for-sale	18,814		-		18,814		-		18,814
Loans receivable held for investment	264,970		-		-		265,290		265,290
Federal Home Loan Bank stock	3,737		-		-		-		-
Accrued interest receivable	1,137		-		50		1,087		1,137
Financial Liabilities:
Deposits	$	(214,731)	$	-	$	(206,631)	$	-	$	(206,631)
Federal Home Loan Bank advances	(79,500)		-		(82,503)		-		(82,503)
Junior subordinated debentures	(6,000)		-		-		(2,277)		(2,277)
Senior debt	(2,849)		-		-		(2,082)		(2,082)
Accrued interest payable	(771)		-		(21)		(731)		(752)
Advance payments by borrowers for taxes and insurance	(814)		-		(814)		-		(814)

			Fair Value Measurements at December 31, 2013 Using
	Carrying Value		Level 1		Level 2		Level 3		Total
	(In thousands)
Financial Assets:
Cash and cash equivalents	$	58,196	$	58,196	$	-	$	-	$	58,196
Securities available-for-sale	9,397		-		9,397		-		9,397
Loans receivable held for investment	247,847		-		-		248,167		248,167
Federal Home Loan Bank stock	3,737		-		-		-		-
Accrued interest receivable	1,107		-		27		1,080		1,107
Financial Liabilities:
Deposits	$	(214,405)	$	-	$	(209,656)	$	-	$	(209,656)
Federal Home Loan Bank advances	(79,500)		-		(82,840)		-		(82,840)
Junior subordinated debentures	(6,000)		-		-		(2,167)		(2,167)
Senior debt	(2,923)		-		-		(1,429)		(1,429)
Accrued interest payable	(718)		-		(63)		(608)		(671)
Advance payments by borrowers for taxes and insurance	(776)		-		(776)		-		(776)

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

(a) Cash and Cash Equivalents

The carrying amounts of cash and cash equivalents approximate fair values and are classified as Level 1.

(b) Loans receivable held for investment

Fair values of loans are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

(c) FHLB Stock

It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

(d) Deposits and Advance Payments by Borrowers for Taxes and Insurance

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in Level 2 classification. Fair values for fixed rate certificates of deposit are estimated using discounted cash flow calculations that apply interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

(e) Federal Home Loan Bank Advances

The fair values of the Federal Home Loan Bank advances are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

(g) Junior Subordinated Debentures and Senior Debt

The fair values of the Company’s Debentures and senior debt are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

(h) Accrued Interest Receivable

The carrying amounts of accrued interest receivable approximate their fair value and are classified the same as the related asset.

(i) Accrued Interest Payable

The carrying amounts of accrued interest on deposits and Federal Home Loan Bank advances approximate their fair value. The carrying amounts of accrued interest on Debentures and senior debt are estimated by applying a discount similar to the related debt. The fair values of accrued interest are classified the same as the related liability.