15) Fair Value

Accounting guidance establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

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 other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data (for example, interest rates and yield curves observable at commonly quoted intervals, prepayment speeds, credit risks, and default rates).

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

Financial Assets and Liabilities Measured on a Recurring Basis

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 widely used in the industry 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 Company uses matrix pricing (Level 2 inputs) to establish the fair value of its securities available-for-sale.

The fair value of interest‑only (“I/O”) strip receivable assets is based on a valuation model used by a third party. The Company is able to compare the valuation model inputs and results to widely available published industry data for reasonableness (Level 2 inputs).


			Fair Value Measurements Using
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
	Balance		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets at December 31, 2018
Available-for-sale securities:
Agency mortgage-backed securities	$	302,854		—	$	302,854		—
U.S. Treasury		148,753		—		148,753		—
U.S. Government sponsored entities		7,436		—		7,436		—
I/O strip receivables		568		—		568		—
Assets at December 31, 2017
Available-for-sale securities:
Agency mortgage-backed securities	$	374,733		—	$	374,733		—
Trust preferred securities		17,119		—		17,119		—
I/O strip receivables		968		—		968		—

There were no transfers between Level 1 and Level 2 during the year for assets measured at fair value on a recurring basis.

Financial Assets and Liabilities Measured on a Non‑Recurring Basis

The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. The 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 usually significant and typically result in a Level 3 classification of the inputs for determining fair value.


			Fair Value Measurements Using
				Significant
			Quoted Prices in	Other	Significant
			Active Markets for	Observable	Unobservable
			Identical Assets	Inputs	Inputs
	Balance		(Level 1)	(Level 2)	(Level 3)
	(Dollars in thousands)
Assets at December 31, 2018
Impaired loans - held-for-investment:
Commercial	$	702	—	—	$	702
	$	702	—	—	$	702

Assets at December 31, 2017
Impaired loans - held-for-investment:
Commercial	$	242	—	—	$	242
Real estate:
Land and construction		119	—	—		119
	$	361	—	—	$	361

The following table shows the detail of the impaired loans held-for-investment and the impaired loans held-for-investment carried at fair value for the periods indicated:


	December 31, 2018		December 31, 2017
	(Dollars in thousands)
Impaired loans held-for-investment:
Book value of impaired loans held-for-investment carried at fair value	$	7,646	$	651
Book value of impaired loans held-for-investment carried at cost		7,494		2,123
Total impaired loans held-for-investment	$	15,140	$	2,774
Impaired loans held-for-investment carried at fair value:
Book value of impaired loans held-for-investment carried at fair value	$	7,646	$	651
Specific valuation allowance		(6,944)		(290)
Impaired loans held-for-investment carried at fair value, net	$	702	$	361

Impaired loans held‑for‑investment were $15,140,000 at December 31, 2018. In addition, these loans had a specific valuation allowance of $6,944,000 at December 31, 2018. Impaired loans held‑for‑investment totaling $7,646,000 at December 31, 2018 were carried at fair value as a result of partial charge‑offs and specific valuation allowances at year‑end. The remaining $7,494,000 of impaired loans were carried at cost at December 31, 2018, as the fair value of the collateral exceeded the cost basis of each respective loan. Partial charge‑offs and changes in specific valuation allowances during 2018 on impaired loans held‑for‑investment carried at fair value at December 31, 2018 resulted in an additional provision for loan losses of $7,042,000.

At December 31, 2018, there were no foreclosed assets.

Impaired loans held‑for‑investment were $2,774,000 at December 31, 2017. In addition, these loans had a specific valuation allowance of $290,000 at December 31, 2017. Impaired loans held‑for‑investment totaling $651,000 at December 31, 2017 were carried at fair value as a result of partial charge‑offs and specific valuation allowances at year‑end. The remaining $2,123,000 of impaired loans were carried at cost at December 31, 2017, as the fair value of the collateral exceeded the cost basis of each respective loan. Partial charge‑offs and changes in specific valuation allowances during 2017 on impaired loans held‑for‑investment carried at fair value at December 31, 2017 resulted in an additional provision for loan losses of $254,000.

At December 31, 2017, there were no foreclosed assets.

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis, at December 31, 2018 and 2017:


	December 31, 2018
			Valuation	Unobservable	Range
	Fair Value		Techniques	Inputs	(Weighted Average)
	(Dollars in thousands)
Impaired loans - held-for-investment:
Commercial	$	702	Market Approach	Discount adjustment for differences between comparable sales	0% to 1%


	December 31, 2017
			Valuation	Unobservable	Range
	Fair Value		Techniques	Inputs	(Weighted Average)
	(Dollars in thousands)
Impaired loans - held-for-investment:
Commercial	$	242	Market Approach	Discount adjustment for differences between comparable sales	Less than 1%
Real estate:
Land and construction		119	Market Approach	Discount adjustment for differences between comparable sales	Less than 1%

The Company obtains third party appraisals on its impaired loans held‑for‑investment and foreclosed assets to determine fair value. Generally, the third party appraisals apply the “market approach,” which is a valuation technique that uses prices and other relevant information generated by market transactions involving identical or comparable (that is, similar) assets, liabilities, or a group of assets and liabilities, such as a business. Adjustments are then made based on the type of property, age of appraisal, current status of property and other related factors to estimate the current value of collateral.

The carrying amounts and estimated fair values of financial instruments at December 31, 2018 are as follows:


			Estimated Fair Value
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Amounts		(Level 1)		(Level 2)		(Level 3)		Total
	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	164,568	$	164,568	$	—	$	—	$	164,568
Securities available-for-sale		459,043		—		459,043		—		459,043
Securities held-to-maturity		377,198		—		366,175		—		366,175
Loans (including loans held-for-sale), net		1,861,206		—		2,649		1,826,654		1,829,303
FHLB stock, FRB stock, and other
investments		25,216		—		—		—		N/A
Accrued interest receivable		9,577		—		2,871		6,706		9,577
I/O strips receivables		568		—		568		—		568
Liabilities:
Time deposits	$	147,560	$	—	$	147,916	$	—	$	147,916
Other deposits		2,489,972		—		2,489,972		—		2,489,972
Subordinated debt		39,369		—		38,969		—		38,969
Accrued interest payable		497		—		497		—		497

The carrying amounts and estimated fair values of financial instruments at December 31, 2017 are as follows:


			Estimated Fair Value
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Amounts		(Level 1)		(Level 2)		(Level 3)		Total
	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	316,222	$	316,222	$	—	$	—	$	316,222
Securities available-for-sale		391,852		—		391,852		—		391,852
Securities held-to-maturity		398,341		—		394,292		—		394,292
Loans (including loans held-for-sale), net		1,566,428		—		3,419		1,507,967		1,511,386
FHLB stock, FRB stock, and other
investments		17,911		—		—		—		N/A
Accrued interest receivable		7,985		—		2,423		5,562		7,985
I/O strips receivables		968		—		968		—		968
Liabilities:
Time deposits	$	194,561	$	—	$	194,844	$	—	$	194,844
Other deposits		2,288,428		—		2,288,428		—		2,288,428
Subordinated debt		39,183		—		40,384		—		40,384
Accrued interest payable		389		—		389		—		389

The methods utilized to estimate the fair value of financial instruments at December 31, 2017 did not necessarily represent an exit price. In accordance with our adoption of ASU 2016-01 in 2018, the methods utilized to measure the fair value of financial instruments at December 31, 2018 represent an approximation of exit price, however, an actual exit price may differ.