Note 17: Fair Value Measurements

Fair value is defined as 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. The fair value hierarchy established by the Company also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Three levels of inputs that may be used to measure fair value are:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the Company has the ability to access as of the measurement date.

Level 2: Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

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

Transfers between levels are deemed to have occurred at the end of the reporting period. For the year ended December 31, 2015, the Company transferred auction rate asset-backed securities from Level 3 to Level 2. For the year ended December 31, 2014 there were no significant transfers between levels.

The majority of securities (available-for-sale and held-to-maturity) are valued by external pricing services or dealer market participants and are classified in Level 2 of the fair value hierarchy. Both market and income valuation approaches are utilized. Quarterly, the Company evaluates the methodologies used by the external pricing services or dealer market participants to develop the fair values to determine whether the results of the valuations are representative of an exit price in the Company’s principal markets and an appropriate representation of fair value. The Company uses the following methods and significant assumptions to estimate fair value:

Government-sponsored agency debt securities are primarily priced using available market information through processes such as benchmark spreads, market valuations of like securities, like securities groupings and matrix pricing.

Other government-sponsored agency securities, MBS and some of the actively traded real estate mortgage investment conduits and collateralized mortgage obligations are priced using available market information including benchmark yields, prepayment speeds, spreads, volatility of similar securities and trade date.

State and political subdivisions are largely grouped by characteristics (e.g.., geographical data and source of revenue in trade dissemination systems). Because some securities are not traded daily and due to other grouping limitations, active market quotes are often obtained using benchmarking for like securities.

From December 31, 2013, to December 31, 2014, the Company utilized pricing data from a nationally recognized valuation firm providing specialized securities valuation services for auction rate asset-backed securities. Beginning March 31, 2015, these securities are priced using market spreads, cash flows, prepayment speeds, and loss analytics. Therefore, the valuations of auction rate asset-backed securities were transferred to Level 2 valuations.

During the third quarter of 2014, asset-backed collateralized loan obligations were acquired and priced using data from a pricing matrix supported by our bond accounting service provider and are therefore considered Level 2 valuations.

Once each quarter every security holding is priced by a pricing service independent of the regular and recurring pricing services used. The independent service provides a measurement to indicate if the price assigned by the regular service is within or outside of a reasonable range. Management reviews this report and applies judgment in adjusting calculations at quarter end related to securities pricing.

Residential mortgage loans eligible for sale in the secondary market are carried at fair market value. The fair value of loans held-for-sale is determined using quoted secondary market prices.

Lending related commitments to fund certain residential mortgage loans, e.g. residential mortgage loans with locked interest rates to be sold in the secondary market and forward commitments for the future delivery of mortgage loans to third party investors as well as forward commitments for future delivery of MBS are considered derivatives. Fair values are estimated based on observable changes in mortgage interest rates including prices for MBS from the date of the commitment and do not typically involve significant judgments by management.

The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income to derive the resultant value. The Company is able to compare the valuation model inputs, such as the discount rate, prepayment speeds, weighted average delinquency and foreclosure/bankruptcy rates to widely available published industry data for reasonableness.

Interest rate swap positions, both assets and liabilities, are based on valuation pricing models using an income approach reflecting readily observable market parameters such as interest rate yield curves.

The fair value of impaired loans with specific allocations of the allowance for loan losses is essentially based on recent real estate appraisals or the fair value of the collateralized asset. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are made in the appraisal process by the appraisers to reflect differences between the available comparable sales and income data. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Nonrecurring adjustments to certain commercial and residential real estate properties classified as OREO are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are based on third party appraisals of the property, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

Assets and Liabilities Measured at Fair Value on a Recurring Basis:

The tables below present the balance of assets and liabilities (dollars in thousands) at December 31, 2015, and December 31, 2014, respectively, measured by the Company at fair value on a recurring basis:


	December 31, 2015
	Level 1		Level 2		Level 3		Total
Assets:
Investment securities available-for-sale
U.S. Treasury	$	1,509	$	-	$	-	$	1,509
U.S. government agencies		-		1,556		-		1,556
U.S. government agencies mortgage-backed		-		1,996		-		1,996
States and political subdivisions		-		30,415		111		30,526
Corporate Bonds		-		29,400		-		29,400
Collateralized mortgage obligations		-		66,920		-		66,920
Asset-backed securities		-		231,908		-		231,908
Collateralized loan obligations		-		92,251		-		92,251
Loans held-for-sale		-		2,849		-		2,849
Mortgage servicing rights		-		-		5,847		5,847
Other assets (Interest rate swap agreements)		-		114		-		114
Other assets (Mortgage banking derivatives)		-		188		-		188
Total	$	1,509	$	457,597	$	5,958	$	465,064

Liabilities:
Other liabilities (Interest rate swap agreements)	$	-	$	745	$	-	$	745
Total	$	-	$	745	$	-	$	745


	December 31, 2014
	Level 1		Level 2		Level 3		Total
Assets:
Investment securities available-for-sale
U.S. Treasury	$	1,527	$	-	$	-	$	1,527
U.S. government agencies		-		1,624		-		1,624
States and political subdivisions		-		21,900		118		22,018
Corporate bonds		-		30,985		-		30,985
Collateralized mortgage obligations		-		63,627		-		63,627
Asset-backed securities		-		120,555		52,941		173,496
Collateralized loan obligations		-		92,209		-		92,209
Loans held-for-sale		-		5,072		-		5,072
Mortgage servicing rights		-		-		5,462		5,462
Other assets (Interest rate swap agreements net of swap credit valuation)		-		30		-		30
Other assets (Mortgage banking derivatives)		-		143		-		143
Total	$	1,527	$	336,145	$	58,521	$	396,193

Liabilities:
Other liabilities (Interest rate swap agreements)	$	-	$	30	$	-	$	30
Total	$	-	$	30	$	-	$	30

The changes in Level 3 assets and liabilities (dollars in thousands) measured at fair value on a recurring basis are as follows:


	Year ended December 31, 2015
	Investment securities available-for-sale
			States and		Mortgage
	Asset-		Political		Servicing
	backed		Subdivisions		Rights
Beginning balance January 1, 2015	$	52,941	$	118	$	5,462
Transfers out of Level 3		(24,917)		-		-
Total gains or losses
Included in earnings (or changes in net assets)		(28)		-		(466)
Included in other comprehensive income		(541)		-		-
Purchases, issuances, sales, and settlements
Issuances		-		-		1,526
Settlements		-		(7)		(675)
Sales		(27,455)		-		-
Ending balance December 31, 2015	$	-	$	111	$	5,847


	Year ended December 31, 2014
	Investment securities available-for-sale
			States and		Mortgage		Interest Rate
	Asset-		Political		Servicing		Swap
	backed		Subdivisions		Rights		Valuation
Beginning balance January 1, 2014	$	154,137	$	125	$	5,807	$	(6)
Total gains or losses
Included in earnings (or changes in net assets)		3,556		-		(1,214)		6
Included in other comprehensive income		(1,454)		-		-		-
Purchases, issuances, sales, and settlements
Purchases		63,704		-		-		-
Issuances		-		-		869		-
Settlements		-		(7)		-		-
Sales		(167,002)		-		-		-
Ending balance December 31, 2014	$	52,941	$	118	$	5,462	$	-

The following table and commentary presents quantitative (dollars in thousands) and qualitative information about Level 3 fair value measurements as of December 31, 2015:

Weighted

Measured at fair value

Unobservable

Average

on a recurring basis:

Fair Value

Valuation Methodology

Inputs

Range of Input

of Inputs

Mortgage Servicing rights

5,847

Discounted Cash Flow

Discount Rate

10.0-15.5%

10.2

Prepayment Speed

6.0-35.2%

10.1

The following table and commentary presents quantitative (dollars in thousands) and qualitative information about Level 3 fair value measurements as of December 31, 2014:


						Weighted
Measured at fair value				Unobservable		Average
on a recurring basis:	Fair Value		Valuation Methodology	Inputs	Range of Input	of Inputs

Mortgage Servicing rights	$	5,462	Discounted Cash Flow	Discount Rate	9.7-108.2%	10.2	%
				Prepayment Speed	5.0-78.4%	10.9	%

Asset-backed securities		52,941	Discounted Cash Flow	Credit Risk Premium	0.9-0.9%	0.9	%
			with comparable transaction yields	Liquidity Discount	3.5-3.7%	3.6	%

The $111,000 on the state and political subdivisions line at December 31, 2015, under Level 3 represents a security from a small, local municipality. Given the small dollar amount and size of the municipality involved, this is categorized as Level 3 based on the payment stream received by the Company from the municipality. That payment stream is otherwise an unobservable input.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis:

The Company may be required, from time to time, to measure certain other assets at fair value on a nonrecurring basis in accordance with GAAP. These assets consist of impaired loans and OREO. For assets measured at fair value on a nonrecurring basis at December 31, 2015, and December 31, 2014, respectively, the following tables provide the level of valuation assumptions used to determine each valuation and the carrying value of the related assets:


	December 31, 2015
	Level 1		Level 2		Level 3		Total
Impaired loans1	$	-	$	-	$	81	$	81
Other real estate owned, net2		-		-		19,141		19,141
Total	$	-	$	-	$	19,222	$	19,222

Represents carrying value and related write-downs of loans for which adjustments are substantially based on the appraised value of collateral for collateral-dependent loans, had a carrying amount of $115,000, with a valuation allowance of $34,000, resulting in a decrease of specific allocations within the allowance for loan losses of $243,000 for the year ending December 31, 2015.

OREO is measured at the lower of carrying or fair value less costs to sell, and had a net carrying amount of $19.1 million, which is made up of the outstanding balance of $34.9 million, net of a valuation allowance of $14.1 million and participations of $1.7 million, at December 31, 2015.


	December 31, 2014
	Level 1		Level 2		Level 3		Total
Impaired loans1	$	-	$	-	$	564	$	564
Other real estate owned, net2		-		-		31,982		31,982
Total	$	-	$	-	$	32,546	$	32,546

Represents carrying value and related write-downs of loans for which adjustments are substantially based on the appraised value of collateral for collateral-dependent loans, had a carrying amount of $842,000, with a valuation allowance of $278,000, resulting in a decrease of specific allocations within the provision for loan losses of $2.1 million for the year ending December 31, 2014.

OREO is measured at the lower of carrying or fair value less costs to sell, and had a net carrying amount of $32.0 million, which is made up of the outstanding balance of $53.0 million, net of a valuation allowance of $19.2 million and participations of $1.8 million, at December 31, 2014.

The Company also has assets that under certain conditions are subject to measurement at fair value on a nonrecurring basis. These assets include OREO and impaired loans. The Company has estimated the fair values of these assets based primarily on Level 3 inputs. OREO and impaired loans are generally valued using the fair value of collateral provided by third party appraisals. These valuations include assumptions related to cash flow projections, discount rates, and recent comparable sales. The numerical range of unobservable inputs for these valuation assumptions are not meaningful.