FAIR VALUE MEASUREMENTS

9 Months Ended

Sep. 30, 2015

14.	FAIR VALUE MEASUREMENTS

Fair value is the exchange price that would be received for 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. A fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. An asset or liability’s placement in the hierarchy is based on the lowest level of input that is significant to the fair value estimate. There are 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; 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 reporting entity’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:

Securities: The fair values of securities are obtained from a third party who utilizes quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing (Level 2 inputs), which is a mathematical technique used widely 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.

Servicing Rights: The fair value of SBA servicing rights is obtained from a third party using assumptions provided by the Company. The individual servicing rights are valued individually taking into consideration the original term to maturity, the current age of the loan and the remaining term to maturity. The valuation methodology utilized for the servicing rights begins with projecting future cash flows for each servicing asset, based on its unique characteristics and market-based assumptions for prepayment speeds. The present value of the future cash flows are then calculated utilizing a market-based discount rate assumption. These inputs are generally observable in the marketplace resulting in a Level 2 classification.

Impaired Loans: The method used to determine the valuation of impaired loans depends on the anticipated source of repayment. Collateral dependent impaired loans with specific allocations of the allowance for loan losses are measured using the fair value of the collateral which is generally based on recent real estate appraisals or internal evaluations. Management may add discounts to third party appraisals. The appraisals are generally obtained annually and are performed by qualified licensed appraisers approved by the Board of Directors. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. The comparable sales approach evaluates the sales price of similar properties in the same market area. This approach is inherently subjective due to the wide range of comparable sale dates. The income approach considers net operating income generated by the property and the investor’s required return. This approach utilizes various inputs including lease rates and cap rates which are subject to judgment. Such adjustments can be significant and result in a Level 3 classification of the inputs for determining fair value.

Non-real estate collateral may be valued using appraisals, independent valuation tools, net book value per the borrower’s financial statements, or aging reports. To determine the fair value, these values are adjusted or discounted based on several factors, including but not limited to: the Bank’s historical losses within that particular asset category; knowledge of the collateral, including age and condition; and changes in market conditions from the time of the valuation, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Foreclosed Assets: Commercial and residential real estate properties classified as foreclosed assets are measured at fair value, less costs to sell. Fair values are generally based on recent real estate appraisals or internal evaluations. Management may add discounts to third party appraisals. The appraisals are generally obtained annually and are performed by qualified licensed appraisers approved by the Board of Directors. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. The comparable sales approach evaluates the sales price of similar properties in the same market area. This approach is inherently subjective due to the wide range of comparable sale dates. The income approach considers net operating income generated by the property and the investor’s required return. This approach utilizes various inputs including lease rates and cap rates which are subject to judgment. Adjustments of the carrying amount utilizing this process result in a Level 3 classification.

Assets measured at fair value on a recurring basis are summarized below as of September 30, 2015 and December 31, 2014:

			Fair Value Measurements Using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
September 30, 2015
Available for sale securities:
US Treasury	$	2,021,562	$	2,021,562	$	0	$	0
US Government and federal agency		11,131,198		0		11,131,198		0
Municipals		711,541		0		711,541		0
Mortgage-backed and collateralized mortgage obligations– residential		11,177,673		0		11,177,673		0
Total	$	25,041,974	$	2,021,562	$	23,020,412	$	0

Servicing assets	$	33,279	$	0	$	33,279	$	0

December 31, 2014
Available for sale securities:
US Treasury	$	2,025,703	$	2,025,703	$	0	$	0
US Government and federal agency		15,203,950		0		15,203,950		0
Municipals		1,064,465		0		1,064,465		0
Mortgage-backed and collateralized mortgage obligations– residential		13,397,251		0		13,397,251		0
Total	$	31,691,369	$	2,025,703	$	29,665,666	$	0

Servicing assets	$	33,279	$	0	$	33,279	$	0

There were no transfers between levels during the third quarter of 2015 or 2014.

Assets measured at fair value on a non-recurring basis are summarized below for the periods ended September 30, 2015 and December 31, 2014:

			Quoted Prices in		Significant
			Active Markets for		Other Observable		Significant
			Identical Assets		Inputs		Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
September 30, 2015
Impaired loans¹:	$	1,165,453	$	0	$	0	$	1,165,453
Foreclosed assets:		1,036,535		0		0		1,036,535
Total	$	2,201,988	$	0	$	0	$	2,201,988

			Quoted Prices in		Significant
			Active Markets for		Other Observable		Significant
			Identical Assets		Inputs		Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
December 31, 2014
Impaired loans¹:	$	1,596,474	$	0	$	0	$	1,596,474
Foreclosed assets:		1,913,093		0		0		1,913,093
Total	$	3,509,567	$	0	$	0	$	3,509,567

¹ Collateral dependent

The following tables present information as of September 30, 2015 and December 31, 2014 about significant unobservable inputs related to the Bank’s Level 3 financial assets, by class, measured on a non-recurring basis:

			Valuation	Significant Unobservable	Range
September 30, 2015	Fair Value		Technique	Inputs	of Inputs

Impaired loans	$	836,203	Sales comparison approach	Adjustments for differences between comparable sales	(14)-19	%
			Income approach	Capitalization rate	9.5	%

Foreclosed assets	$	0	N/A	N/A	N/A%

			Valuation	Significant Unobservable	Range
December 31, 2014	Fair Value		Technique	Inputs	of Inputs

Impaired loans	$	1,294,790	Sales comparison approach	Adjustments for differences between comparable sales	(25)-25	%
			Income approach	Capitalization rate	10	%

Foreclosed assets	$	1,056,514	Sales comparison approach	Adjustments for differences between comparable sales	(30)-25	%

The carrying amounts and estimated fair values of financial instruments not previously presented above are as follows:

			Fair Value Measurements
			at September 30, 2015
	Carrying
	Amount		Level 1		Level 2		Level 3		Total

	(in thousands)
Financial assets
Cash and cash equivalents	$	26,935	$	26,935	$	0	$	0	$	26,935
Loans held for sale		0		0		0		0		0
Loans, net (including impaired)		121,899		0		0		119,535		119,535
FHLB stock		301		N/A		N/A		N/A		N/A
Accrued interest receivable		386		7		100		279		386

Financial liabilities
Deposits		170,986		0		163,726		0		163,726
Federal funds purchased and repurchase agreements		4,874		0		4,874		0		4,874
Subordinated debentures		4,500		0		0		1,125		1,125
Notes payable		1,280		0		0		1,280		1,280
Derivative liability		427		0		0		427		427
Accrued interest payable		706		0		26		190		216

			Fair Value Measurements
			at December 31, 2014
	Carrying
	Amount		Level 1		Level 2		Level 3		Total

	(in thousands)
Financial assets
Cash and cash equivalents	$	7,936	$	7,936	$	0	$	0	$	7,936
Loans held for sale		148		0		152		0		152
Loans, net (including impaired)		127,809		0		0		124,712		124,712
FHLB stock		388		N/A		N/A		N/A		N/A
Accrued interest receivable		418		6		102		310		418

Financial liabilities
Deposits		161,305		0		155,659		0		155,659
Federal funds purchased and repurchase agreements		8,611		0		8,611		0		8,611
Subordinated debentures		4,500		0		0		1,125		1,125
Notes payable		1,280		0		0		1,280		1,280
Derivative liability		0		0		0		0		0
Accrued interest payable		615		0		26		167		193

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

(a) Cash and cash equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.

(b) Loans

Fair values of loans, excluding loans held for sale, 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.

The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

(c) FHLB stock

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

(d) Deposits

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, 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 a Level 2 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies 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 funds purchased and repurchase agreements

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.

(f) Subordinated debentures and Notes payable

The fair values of the Company’s subordinated debentures and notes payable are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements and consideration of the Company’s liquidity, resulting in a Level 3 classification.

(g) Derivative Liability

The fair value of the Company’s derivative liability is estimated based on the probability of the utilization of the beneficial conversion feature and an estimate of the value of the beneficial conversion right, resulting in a Level 3 classification.

(h) Accrued interest receivable/payable

The carrying amounts of accrued interest approximate fair value resulting in a Level 1, 2, or 3 classification, depending on the associated asset or liability.

(i) Off-balance sheet instruments

Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.

- 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.

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