4. Fair Value Measurements

The Company follows the “Fair Value Measurement and Disclosures” topic of the FASB ASC, which establishes a framework for measuring fair value in U.S. GAAP and expands disclosures about fair value measurements. This standard applies whenever other standards require, or permit, assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, this standard establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy is as follows:

Level 1 inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.

Level 2 inputs - 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 assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

Management monitors the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another. In such instances, the transfer is reported at the beginning of the reporting period.

Management evaluates the significance of transfers between levels based upon the nature of the financial instrument and size of the transfer relative to total assets, total liabilities or total earnings.

Securities classified as available-for-sale are reported at fair value on a recurring basis utilizing Level 1, 2 and 3 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond's terms and conditions, among other things.

The Company does not record originated loans & leases at fair value on a recurring basis. However, from time to time, a loan or lease is considered impaired and an allowance for credit losses is established. Once a loan or lease is identified as individually impaired, management measures impairment in accordance with the “Receivable” topic of the FASB ASC. The fair value of impaired loans or leases is estimated using one of several methods, including collateral value when the loan is collateral dependent, market value of similar debt, enterprise value, and discounted cash flows. Impaired loans & leases not requiring an allowance represent loans & leases for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans & leases. Impaired loans & leases where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. The fair value of collateral dependent impaired loans is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including sales comparison, cost and the income approach. Adjustments are often made in the appraisal process by the appraisers to take into account differences between the comparable sales and income and other available data. Such adjustments can be significant and typically result in a Level 3 classification of the inputs for determining fair value. The valuation technique used for Level 3 nonrecurring impaired loans is primarily the sales comparison approach less selling costs of 10%.

Other Real Estate (“ORE”) is reported at fair value on a non-recurring basis. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including sales comparison, cost and the income approach. Adjustments are often made in the appraisal process by the appraisers to take into account differences between the comparable sales and income and other available data. Such adjustments can be significant and typically result in a Level 3 classification of the inputs for determining fair value. The valuation technique used for Level 3 nonrecurring ORE is primarily the sales comparison approach less selling costs of 10%.

The following tables present information about the Company’s assets measured at fair value on a recurring basis and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value for the periods indicated.

			Fair Value Measurements At March 31, 2019, Using
(in thousands)	Fair Value Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available-for-Sale Securities:
Government Agency & Government-Sponsored Entities	$	3,027	$	-	$	3,027	$	-
US Treasury Notes		164,674		164,674		-		-
US Govt SBA		14,412		-		14,412		-
Mortgage Backed Securities		304,020		-		304,020		-
Other		5,156		203		310		4,643
Total Assets Measured at Fair Value On a Recurring Basis	$	491,289	$	164,877	$	321,769	$	4,643

			Fair Value Measurements At December 31, 2018, Using
(in thousands)	Fair Value Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Available-for-Sale Securities:
Government Agency & Government-Sponsored Entities	$	3,039	$	-	$	3,039	$	-
US Treasury Notes		164,514		164,514		-		-
US Govt SBA		15,447		-		15,447		-
Mortgage Backed Securities		307,045		-		307,045		-
Other		5,351		202		310		4,839
Total Assets Measured at Fair Value On a Recurring Basis	$	495,396	$	164,716	$	325,841	$	4,839

			Fair Value Measurements At March 31, 2018, Using
(in thousands)	Fair Value Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available-for-Sale Securities:
Government Agency & Government-Sponsored Entities	$	3,095	$	-	$	3,095	$	-
US Treasury Notes		143,409		143,409		-		-
US Govt SBA		27,537		-		27,537		-
Mortgage Backed Securities		318,763		-		318,763		-
Other		3,010		200		310		2,500
Total Assets Measured at Fair Value On a Recurring Basis	$	495,814	$	143,609	$	349,705	$	2,500

Fair values for Level 2 available-for-sale investment securities are based on quoted market prices for similar securities. During the period ended March 31, 2019, there were no transfers in our out of level 1, 2, or 3.

Certain equity securities, categorized as Level 3 assets as of March 31, 2019 consisted of: (1) $3.0 million in limited liability companies (LLC) that invest in CRA qualified SBA loans; (2) $1.4 million in registered warrants issued by California reclamation districts; and (3) $200,000 in The Independent Bankers’ Bank stock. These securities are not readily tradeable, and are carried at cost, plus/minus observable price changes, less impairment. The significant unobservable data reflected in the fair value measurement include dealer quotes, projected prepayment speeds/average lives and credit information. There were no gains, losses or transfers in or out of level 3 during the three-month period ended March 31, 2019.

Level 3 Valuations

The following table presents a reconciliation of the level 3 fair value category measured at fair value on a recurring basis:

							Net Realized / Unrealized Gains (Losses)

(in thousands)	Balance at Beginning of Period		Purchases / Additions		Sales / Reductions		Realized		Unrealized		Balance at End of Period
Three months ended March 31, 2019
Available-for-sale debt securities:	$	1,593	$	479	$	675	$	-	$	-	$	1,397
Equity securities:	$	3,246	$	-	$	-	$	-	$	-	$	3,246
Total	$	4,839	$	479	$	675	$	-	$	-	$	4,643

The following tables present information about the Company’s other real estate and impaired loans or leases, classes of assets or liabilities that the Company carries at fair value on a non-recurring basis, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value for the periods indicated. Not all impaired loans or leases are carried at fair value. Impaired loans or leases are only included in the following tables when their fair value is based upon a current appraisal of the collateral, and if that appraisal results in a partial charge-off or the establishment of a specific reserve.

			Fair Value Measurements At March 31, 2019, Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets		Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	Total		(Level 1)		(Level 2)		(Level 3)
Impaired Loans
Commercial Real Estate	$	2,660	$	-	$	-	$	2,660
Residential 1st Mortgage		1,540		-		-		1,540
Home Equity Lines and Loans		69		-		-		69
Agricultural		102		-		-		102
Commercial		1,418		-		-		1,418
Total Impaired Loans		5,789		-		-		5,789
Other Real Estate
Real Estate Construction		873		-		-		873
Total Other Real Estate		873		-		-		873
Total Assets Measured at Fair Value On a Non-Recurring Basis	$	6,662	$	-	$	-	$	6,662

			Fair Value Measurements At December 31, 2018, Using
	Fair Value		Quoted Prices in ActiveMarkets for Identical Assets		Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	Total		(Level 1)		(Level 2)		(Level 3)
Impaired Loans:
Commercial Real Estate	$	2,658	$	-	$	-	$	2,658
Residential 1st Mortgage		1,550		-		-		1,550
Home Equity Lines and Loans		70		-		-		70
Commercial		1,454		-		-		1,454
Total Impaired Loans		5,732		-		-		5,732
Other Real Estate:
Real Estate Construction		873		-		-		873
Total Other Real Estate		873		-		-		873
Total Assets Measured at Fair Value On a Non-Recurring Basis	$	6,605	$	-	$	-	$	6,605

			Fair Value Measurements At March 31, 2018, Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets		Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	Total		(Level 1)		(Level 2)		(Level 3)
Impaired Loans
Commercial Real Estate	$	2,608	$	-	$	-	$	2,608
Residential 1st Mortgage		475		-		-		475
Home Equity Lines and Loans		74		-		-		74
Commercial		1,508		-		-		1,508
Total Impaired Loans		4,665		-		-		4,665
Other Real Estate
Real Estate Construction		873		-		-		873
Total Other Real Estate		873		-		-		873
Total Assets Measured at Fair Value On a Non-Recurring Basis	$	5,538	$	-	$	-	$	5,538

The Company’s property appraisals are primarily based on the sales comparison approach and the income approach methodologies, which consider recent sales of comparable properties, including their income generating characteristics, and then make adjustments to reflect the general assumptions that a market participant would make when analyzing the property for purchase. These adjustments may increase or decrease an appraised value and can vary significantly depending on the location, physical characteristics and income producing potential of each property. Additionally, the quality and volume of market information available at the time of the appraisal can vary from period to period and cause significant changes to the nature and magnitude of comparable sale adjustments. Given these variations, comparable sale adjustments are generally not a reliable indicator for how fair value will increase or decrease from period to period. Under certain circumstances, management discounts are applied based on specific characteristics of an individual property.

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at March 31, 2019:

(in thousands)	Fair Value		Valuation Technique	Unobservable Inputs	Range, Weighted Avg.
Impaired Loans
Commercial Real Estate	$	2,660	Income Approach	Capitalization Rate		3.25%, 3.25	%
Residential 1st Mortgage	$	1,540	Sales Comparison Approach	Adjustment for Difference Between Comparable Sales		1% - 4%, 2.85	%
Home Equity Lines and Loans	$	69	Sales Comparison Approach	Adjustment for Difference Between Comparable Sales		1% - 2%, 1.50	%
Agricultural	$	102	Income Approach	Capitalization Rate		5.10%, 5.10	%
Commercial	$	1,418	Income Approach	Capitalization Rate		3.25% - 8.70%, 3.40	%

Other Real Estate
Real Estate Construction	$	873	Sales Comparison Approach	Adjustment for Difference Between Comparable Sales		10%, 10	%