Fair Value of Financial Instruments

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach, and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. ASC Topic 825 requires disclosure of the fair value of financial assets and financial liabilities, including both those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis and a non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value, and for estimating the fair value of financial assets and financial liabilities not recorded at fair value, are discussed below.

In accordance with accounting guidance, the Company groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine 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 are described as follows:

Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2 - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, prepayment speeds, volatilities, etc.) or model-based valuation techniques where all significant assumptions are observable, either directly or indirectly, in the market.

Level 3 - Valuation is generated from model-based techniques where one or more significant inputs are not observable, either directly or indirectly, in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques may include use of matrix pricing, discounted cash flow models, and similar techniques.

Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the fair values presented. Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent limitations in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates presented herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction at December 31, 2015 and December 31, 2014.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Management maximizes the use of observable inputs and attempts to minimize the use of unobservable inputs when determining fair value measurements. The following is a description of both the general and specific valuation methodologies used for certain instruments measured at fair value, as well as the general classification of these instruments pursuant to the valuation hierarchy.

Cash and due from banks – The carrying amounts of cash and short-term instruments approximate fair value due to the liquidity of these instruments.

Securities Available for Sale – AFS securities are generally valued based upon quotes obtained from an independent third-party pricing service, which uses evaluated pricing applications and model processes. Observable market inputs, such as, benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data are considered as part of the evaluation. The inputs are related directly to the security being evaluated, or indirectly to a similarly situated security. Market assumptions and market data are utilized in the valuation models. The Company reviews the market prices provided by the third-party pricing service for reasonableness based on the Company’s understanding of the market place and credit issues related to the securities. The Company has not made any adjustments to the market quotes provided by them and, accordingly, the Company categorized its investment portfolio within Level 2 of the fair value hierarchy.

FHLB, FRB, Other Stock – The carrying value approximates the fair value based upon the redemption provisions of the stock.

Loans Held for Investment – The fair value of loans, other than loans on nonaccrual status, was estimated by discounting the remaining contractual cash flows using the estimated current rate at which similar loans would be made to borrowers with similar credit risk characteristics and for the same remaining maturities, reduced by deferred net loan origination fees and the allocable portion of the allowance for loan losses. Accordingly, in determining the estimated current rate for discounting purposes, no adjustment has been made for any change in borrowers’ credit risks since the origination of such loans. Rather, the allocable portion of the allowance for loan losses is considered to provide for such changes in estimating fair value. As a result, this fair value is not necessarily the value which would be derived using an exit price. These loans are included within Level 3 of the fair value hierarchy.

Loans Held for Sale – The fair values of LHFS are based on quoted market prices, where available, or are determined by discounting estimated cash flows using interest rates approximating the Corporation’s current origination rates for similar loans adjusted to reflect the inherent credit risk. The borrower-specific credit risk is embedded within the quoted market prices or is implied by considering loan performance when selecting comparables.

Impaired loans and OREO – Impaired loans and OREO assets are recorded at the fair value less estimated costs to sell at the time of foreclosure. The fair value of impaired loans and OREO assets are generally based on recent real estate appraisals adjusted for estimated selling costs. 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 appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

Deposit Accounts and Short-term Borrowings — The amounts payable to depositors for demand, savings, and money market accounts, and short-term borrowings are considered to approximate fair value. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities using a discounted cash flow calculation. Interest-bearing deposits and borrowings are included within Level 2 of the fair value hierarchy.

Term FHLB Advances and Other Long-term Borrowings— The fair value of long term borrowings is determined using rates currently available for similar borrowings with similar credit risk and for the remaining maturities and are classified as Level 2.

Subordinated Debentures – The fair value of subordinated debentures is estimated by discounting the balance by the current three-month LIBOR rate plus the current market spread. The fair value is determined based on the maturity date as the Company does not currently have intentions to call the debenture and is classified as Level 2.

Estimated fair values are disclosed for financial instruments for which it is practicable to estimate fair value. These estimates are made at a specific point in time based on relevant market data and information about the financial instruments. These estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.

The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2015 and 2014.



	At December 31, 2015
	Carrying Amount		Level 1		Level 2		Level 3		Estimated Fair Value
	(in thousands)
Assets:
Cash and cash equivalents	$	78,417	$	78,417	$	—	$	—	$	78,417
Securities available for sale	280,273		—		280,273		—		280,273
Federal Reserve Bank and FHLB stock, at cost	22,292		—		22,292		—		22,292
Loans held for sale, net	8,565		—		9,507		—		9,507
Loans held for investment, net	2,236,998		—		—		2,244,936		2,244,936
Accrued interest receivable	9,315		9,315		—		—		9,315
Liabilities:
Deposit accounts	2,195,123		1,674,148		521,291		—		2,195,439
FHLB advances	148,000		—		148,036		—		148,036
Other borrowings	48,125		—		49,156		—		49,156
Subordinated debentures	70,310		—		68,675		—		68,675
Accrued interest payable	206		206		—		—		206

	At December 31, 2014
	Carrying Amount		Level 1		Level 2		Level 3		Estimated Fair Value
	(in thousands)
Assets:
Cash and cash equivalents	$	110,925	$	110,925	$	—	$	—	$	110,925
Securities available for sale	201,638		—		201,638		—		201,638
Federal Reserve Bank and FHLB stock, at cost	17,067		—		17,067		—		17,067
Loans held for investment, net	1,616,422		—		—		2,116,719		2,116,719
Accrued interest receivable	7,131		7,131		—		—		7,131
Liabilities:
Deposit accounts	1,630,826		1,216,847		519,898		—		1,736,745
FHLB advances	70,000		—		70,025		—		70,025
Other borrowings	46,643		—		48,312		—		48,312
Subordinated debentures	70,310		—		33,456		—		33,456
Accrued interest payable	209		209		—		—		209

A loan is considered impaired when it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement. Impairment is measured based on the fair value of the underlying collateral or the discounted expected future cash flows. The Company measures impairment on all non-accrual loans for which it has reduced the principal balance to the value of the underlying collateral less the anticipated selling cost. As such, the Company records impaired loans as non-recurring Level 3 when the fair value of the underlying collateral is based on an observable market price or current appraised value. When current market prices are not available or the Company determines that the fair value of the underlying collateral is further impaired below appraised values, the Company records impaired loans as Level 3. At December 31, 2015, substantially all the Company’s impaired loans were evaluated based on the fair value of their underlying collateral based upon the most recent appraisal available to management.

The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

The following fair value hierarchy tables present information about the Company’s assets measured at fair value on a recurring basis at the dates indicated:



	At December 31, 2015
	Fair Value Measurement Using
	Level 1		Level 2		Level 3		Securities at Fair Value
	(in thousands)
Investment securities available for sale:
Municipal bonds	$	—	$	130,245	$	—	$	130,245
Collateralized mortgage obligation	$	—	$	24,543	$	—	$	24,543
Mortgage-backed securities	$	—	$	125,485	$	—	$	125,485
Total securities available for sale:	$	—	$	280,273	$	—	$	280,273

	At December 31, 2014
	Fair Value Measurement Using
	Level 1		Level 2		Level 3		Securities at Fair Value
	(in thousands)
Investment securities available for sale:
Municipal bonds	$	—	$	89,661	$	—	$	89,661
Collateralized mortgage obligation	$	—	$	6,862	$	—	$	6,862
Mortgage-backed securities	$	—	$	105,115	$	—	$	105,115
Total securities available for sale:	$	—	$	201,638	$	—	$	201,638

The following table provides a summary of the financial instruments the Company measures at fair value on a non-recurring basis at the dates indicated:



	At December 31, 2015
	Fair Value Measurement Using
	Level 1		Level 2		Level 3		Assets at Fair Value
	(in thousands)
Assets
Collateral dependent impaired loans	$	—	$	—	$	1,322	$	1,322
Other real estate owned	—		—		1,161		1,161
Total assets	$	—	$	—	$	2,483	$	2,483




	At December 31, 2014
	Fair Value Measurement Using
	Level 1		Level 2		Level 3		Assets at Fair Value
	(in thousands)
Assets
Collateral dependent impaired loans	$	—	$	—	$	921	$	921
Other real estate owned	—		—		1,037		1,037
Total assets	$	—	$	—	$	1,958	$	1,958

The following table presents quantitative information about level 3 of fair value measurements for financial instruments measured at fair value on a non-recurring basis at the dates indicated:



	December 31, 2015
					Range
	Fair Value		Valuation Technique	Unobservable Inputs	Rate		Maturity (years)	Unobservable Inputs
Collateral dependent impaired loans:
Business loans:
Commercial and industrial	$	313	Collateral valuation	Management adjustment to reflect current conditions and selling costs	7.50	%	6	0-10
Franchise	168		Collateral valuation	Management adjustment to reflect current conditions and selling costs	5.70% - 6.70%		7 - 8	0-10
Commercial owner occupied	536		Collateral valuation	Management adjustment to reflect current conditions and selling costs	7.75	%	7	0-10
Real estate loans:
Commercial non-owner occupied	214		Collateral valuation	Management adjustment to reflect current conditions and selling costs	6.75	%	2 - 12	0-15
One-to-four family	70		Collateral valuation	Management adjustment to reflect current conditions and selling costs	9.00% - 15.00%		5 - 16	0-10
Land	21		Collateral valuation	Management adjustment to reflect current conditions and selling costs	13.00	%	15	0-10
Total collateral dependent impaired loans	$	1,322
Other real estate owned
One-to-four family	$	—	Collateral valuation	Management adjustment to reflect current conditions and selling costs	—		—	0-10
Land	1,161		Collateral valuation	Management adjustment to reflect current conditions and selling costs	—		—	0-10
Total other real estate owned	$	1,161



	At December 31, 2014
					Range
	Fair Value		Valuation Technique	Unobservable Inputs	Rate		Maturity (years)	Unobservable Inputs
Collateral dependent impaired loans:
Business loans:
Commercial owner occupied	$	388	Collateral valuation	Management adjustment to reflect current conditions and selling costs	6.75	%	7	0-10
Real estate loans:
Commercial non-owner occupied	479		Collateral valuation	Management adjustment to reflect current conditions and selling costs	7.00% - 7.50%		2 - 12	0-15
One-to-four family	54		Collateral valuation	Management adjustment to reflect current conditions and selling costs	8.00% - 15.00%		5 - 16	0-10
Total collateral dependent impaired loans	$	921
Other real estate owned
One-to-four family	$	285	Collateral valuation	Management adjustment to reflect current conditions and selling costs	—		—	0-10
Land	752		Collateral valuation	Management adjustment to reflect current conditions and selling costs	—		—	0-10
Total other real estate owned	$	1,037