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Fair Value of Financial Instruments

3 Months Ended

Mar. 31, 2019

Note 14. Fair Value of Financial Instruments

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (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. There are three levels of inputs that may be used to measure fair values:

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 company’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 Available for Sale: The fair values of investment securities are determined by matrix pricing, which is a mathematical technique used 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). Management obtains the fair values of investment securities on a monthly basis from a third-party pricing service.

Other Investment: The Company has equity investment with readily determinable fair value. The fair value for the equity investment with readily determinable fair value is obtained from unadjusted quoted prices in active markets on the date of measurement and classified as Level 1.

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. 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 independent 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. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s judgment, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

OREO: OREO is reported at fair value at the time the asset was transferred to OREO. The fair value of OREO was estimated using appraised value and classified as a Level 3 nonrecurring fair value measurement. OREO is reviewed on quarterly basis for additional impairment and adjusted to lower of cost or market.

Appraisals for collateral-dependent impaired loans are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, a member of the credit department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.

Assets and liabilities measured at fair value on a recurring basis as of March 31, 2019 and December 31, 2018 are summarized below:

			Fair Value Measuring Using
			Quoted		Significant Other		Significant
			Prices in		Observable		Unobservable
	Total		Active Markets		Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
As of March 31, 2019:
U.S. Government sponsored agency securities	$	6,940	$	—	$	6,940	$	—
Mortgage-backed securities - residential		13,700		—		13,700		—
Collateralized mortgage obligations		33,476		—		33,476		—
Other investments:
Mutual fund - CRA qualified		2,534		2,534		—		—

As of December 31, 2018:
U.S. Government sponsored agency securities	$	6,906	$	—	$	6,906	$	—
Mortgage-backed securities - residential		14,129		—		14,129		—
Collateralized mortgage obligations		34,301		—		34,301		—
Other investments:
Mutual fund - CRA qualified		2,488		2,488		—		—

There were no transfers between Level 1 and Level 2 in the three months ended March 31, 2019 or 2018. There were no other assets or liabilities, except OREO measured at fair value on a non-recurring basis as of March 31, 2019 or December 31, 2018. OREO is reported at fair value. The value was based on third party appraisal, which the Company classifies as a Level 3 nonrecurring fair value measurement.

Financial Instruments: The carrying amounts and estimated fair values of financial instruments not carried at fair value as of March 31, 2019 are as follows:

	Carrying Amount		Level 1		Level 2		Level 3		Value
As of March 31, 2019:	(Dollars in thousands)
Financial Assets:
Cash and cash equivalents	$	65,796	$	65,796	$	—	$	—	$	65,796
Loans held for sale		246		—		264		—		264
Loans receivable, net		903,445		—		—		916,455		916,455
Accrued interest receivable		3,368		14		234		3,120		3,368
Financial Liabilities:
Deposit	$	929,402	$	—	$	927,423	$	—	$	927,423
Accrued interest payable		2,178		—		2,178		—		2,178

The carrying amounts and estimated fair values of financial instruments not carried at fair value at December 31, 2018 are as follows:

	Carrying Amount		Level 1		Level 2		Level 3		Value
As of December 31, 2018:	(Dollars in thousands)
Financial Assets:
Cash and cash equivalents	$	77,726	$	77,726	$	—	$	—	$	77,726
Loans held for sale		752		—		806		—		806
Loans receivable, net		865,423		—		—		862,394		862,394
Accrued interest receivable		3,068		44		240		2,784		3,068
Financial Liabilities:
Deposit	$	905,176	$	—	$	904,466	$	—	$	904,466
Accrued interest payable		1,715		—		1,715		—		1,715

- 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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