Note 24: Fair Values of Financial Instruments

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs. There is a hierarchy of three levels of inputs that may be used to measure fair value:

Level 1Quoted prices in active markets for identical assets or liabilities

Level 2Observable 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 for substantially the full term of the assets or liabilities

Level 3Unobservable inputs supported by little or no market activity and are significant to the fair value of the assets or liabilities

Items Measured at Fair Value on a Recurring Basis

Following is a description of the valuation methodologies and inputs used for instruments measured at fair value on a recurring basis and recognized in the accompanying comparative balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Available-for-Sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. The Company uses a third-party provider to provide market prices on its securities. Prices are evaluated by a third party. Level 1 securities include marketable equity securities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include mortgage-backed, collateralized mortgage obligations, municipal, federal agency and certain corporate obligation securities. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include certain corporate obligation securities.

Third party vendors compile prices from various sources and may apply such techniques as matrix pricing to determine the value of identical or similar investment securities (Level 2). Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather relying on investment securities relationship to other benchmark quoted investment securities. Any investment security not valued based upon the methods above are considered Level 3.

The following table presents the fair value measurements of assets measured at fair value on a recurring basis and level within the ASC 820 fair value hierarchy in which the fair value measurements fall:



			Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
December 31, 2014
Mortgage-backed securities
Government sponsored agencies	$	113,290	$	-	$	113,290	$	-
Collateralized mortgage obligations
Government sponsored agencies		97,759		-		97,759		-
Federal agencies		4		-		4		-
Municipal obligations		29,252		-		29,252		-
Corporate obligations		20,501		-		17,979		2,522
Available-for-sale securities	$	260,806	$	-	$	258,284	$	2,522



			Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
December 31, 2013
Mortgage-backed securities
Government sponsored agencies	$	103,517	$	-	$	103,517	$	-
Collateralized mortgage obligations
Government sponsored agencies		107,578		-		107,578		-
Federal agencies		4,774		-		4,774		-
Municipal obligations		27,338		-		27,338		-
Corporate obligations		21,141		-		17,805		3,336
Available-for-sale securities	$	264,348	$	-	$	261,012	$	3,336

The following is a reconciliation of the beginning and ending balances for the years ended December 31, 2014, 2013 and 2012 of recurring fair value measurements recognized in the accompanying balance sheets using significant unobservable (Level 3) inputs:



		2014		2013		2012
Beginning balance	$	3,336	$	2,475	$	2,454
Total realized and unrealized gains (losses)
Included in net income		(68)		-		-
Included in other comprehensive income (loss)		2,098		897		30
Sales		(2,826)		-		-
Settlements		(18)		(36)		(9)
Ending balance	$	2,522	$	3,336	$	2,475
Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets still held at the reporting date	$	0	$	0	$	0

Items Measured at Fair Value on a Non-Recurring Basis

From time to time, certain assets may be recorded at fair value on a non-recurring basis. These non-recurring fair value adjustments typically are a result of the application of lower of cost or fair value accounting or a write-down occurring during the period. The following is a description of the valuation methodologies used for certain assets that are recorded at fair value.

Impaired Loans (Collateral Dependent)

Loans for which it is probable that the Bank will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral dependent loans.

If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.

Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.

Other Real Estate Owned

The fair value of real estate is generally determined based on appraisals by qualified licensed appraisers. The appraisers typically determine the value of the real estate by utilizing an income or market valuation approach. If an appraisal is not available, the fair value may be determined by using a cash flow analysis.

Other real estate owned is classified within Level 3 of the fair value hierarchy.

Mortgage-Servicing Rights

We initially measure our mortgage servicing rights at fair value, and amortize them over the period of estimated net servicing income. They are periodically assessed for impairment based on fair value at the reporting date. Mortgage-servicing rights do not trade in an active market with readily observable prices. Accordingly, the fair value is estimated based on a valuation model which calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, market discount rates, cost to service, float earnings rates and other ancillary income, including late fees. The fair value measurements are classified as Level 3.

The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the ASC 820 fair value hierarchy in which the fair value measurements fall:



			Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
December 31, 2014
Other real estate owned	$	1,280	$	-	$	-	$	1,280



			Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
December 31, 2013
Impaired loans	$	925	$	-	$	-	$	925
Other real estate owned		1,677		-		-		1,677
Mortgage-servicing rights		2,106		-		-		2,106

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements.



December 31, 2014	Fair Value		Valuation Technique	Unobservable Inputs	Range
Trust Preferred Securities	$	2,522	Discounted cash flow	Discount rate	8.0	%
				Constant prepayment rate	2.0	%
				Cumulative projected prepayments	40.0	%
				Probability of default	1.7 - 1.8	%
				Projected cures given deferral	0 - 15.0	%
				Loss severity	34.2 - 39.8	%
Other real estate owned	$	1,280	Third party valuations	Discount to reflect realizable value less estimated selling costs	24.4 - 36.7	%



December 31, 2013	Fair Value		Valuation Technique	Unobservable Inputs	Range
Trust Preferred Securities	$	3,336	Discounted cash flow	Discount rate	10.0 - 17.0	%
				Constant prepayment rate	2.0	%
				Cumulative projected prepayments	40.0	%
				Probability of default	1.5 - 2.7	%
				Projected cures given deferral	0 - 15.0	%
				Loss severity	46.9 - 73.7	%
Impaired loans (collateral dependent)	$	925	Third party valuations	Discount to reflect realizable value	7.3 - 78.3	%
Other real estate owned	$	1,677	Third party valuations	Discount to reflect realizable value less estimated selling costs	0 - 25.0	%
Mortgage-servicing rights	$	2,106	Third party valuations	Prepayment speeds	105 - 700	%
				Discount rates	10.0	%
				Servicing fee	0.25	%

The following methods and assumptions were used to estimate the fair value of all other financial instruments recognized in the accompanying balance sheets at amounts other than fair value:

Cash and Cash Equivalents - The fair value of cash and cash-equivalents approximates carrying value.

Loans Held For Sale - Fair values are based on quoted market prices.

Loans - The fair value for loans is estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.

FHLB Stock - Fair value of FHLB stock is based on the price at which it may be resold to the FHLB.

Interest Receivable/Payable - The fair values of interest receivable/payable approximate carrying values.

Deposits - The fair values of noninterest-bearing, interest-bearing demand and savings accounts are equal to the amount payable on demand at the balance sheet date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on such time deposits.

FHLB Advances - The fair value of these borrowings is estimated using a discounted cash flow calculation, based on current rates for similar debt for periods comparable to the remaining terms to maturity of these advances.

Other Borrowings - The fair value of these borrowings is estimated using discounted cash flow analyses using interest rates for similar financial instruments.

Off-Balance Sheet Commitments - Commitments include commitments to purchase and originate mortgage loans, commitments to sell mortgage loans, and standby letters of credit and are generally of a short-term nature. The fair values of such commitments 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 these instruments is insignificant.

The estimated fair values of the Company’s financial instruments not carried at fair value in the consolidated balance sheets as of the dates noted below are as follows:



					Fair Value Measurements Using
December 31, 2014		Carrying Amount		Fair Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	29,575	$	29,575	$	29,575	$	-	$	-
Loans held for sale		6,140		6,220		-		6,220		-
Loans, net		1,003,518		1,006,233		-		-		1,006,233
FHLB stock		11,964		11,964		-		11,964		-
Interest receivable		3,730		3,730		-		3,730		-
Liabilities
Deposits		1,079,320		1,050,295		648,314		-		401,981
FHLB advances		192,442		191,995		-		191,995		-
Other borrowings		10,174		10,283		-		10,283		-
Interest payable		223		223		-		223		-



					Fair Value Measurements Using
December 31, 2013		Carrying Amount		Fair Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	25,285	$	25,285	$	25,285	$	-	$	-
Loans held for sale		1,888		1,905		-		1,905		-
Loans, net		965,966		935,414		-		-		935,414
FHLB stock		14,391		14,391		-		14,391		-
Interest receivable		3,775		3,775		-		3,775		-
Liabilities
Deposits		1,113,084		1,068,422		593,457		-		474,965
FHLB advances		142,928		141,526		-		141,526		-
Other borrowings		10,890		11,148		-		11,148		-
Interest payable		157		157		-		157		-