10.

FAIR VALUE MEASUREMENT

Fair value is the exchange price that would be received for an asset if 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 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 beliefs about the assumptions that market participants would use in pricing an asset or liability.

United Community uses the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Available for sale securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2).

Impaired loans: At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for loan losses. For collateral dependent loans, fair value is commonly 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 historical knowledge, 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.

Other real estate owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly 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.

Appraisals for both collateral-dependent impaired loans and other real estate owned 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 Special Assets Department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with the independent data sources such as recent market data or industry-wide statistics. On an annual basis, the Company compares the actual selling price of collateral that has been sold to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value.

Mortgage servicing rights: On a quarterly basis, loan servicing rights are evaluated for impairment based upon the fair value of the rights as compared to carrying amount. If the carrying amount of an individual tranche exceeds fair value, impairment is recorded on that tranche so that the servicing asset is carried at fair value. Fair value is determined at a tranche level, based on market prices for comparable mortgage servicing contracts (Level 1), when available, or alternatively based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model utilizes assumptions that market participants would use in estimating future net servicing income and that can be validated against available market data (Level 2).

Loans held for sale: Loans held for sale are carried at the lower of cost or fair value, which is evaluated on a pool-level basis. The fair value of loans held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan or other observable market data, such as outstanding commitments from third party investors (Level 2).

Interest rate caps: The Company uses an independent third party that performs a market valuation analysis for interest rate caps. The methodology used consists of a discounted cash flow model, all future floating cash flows are projected and both floating and fixed cash flows are discounted to the valuation date. The yield curve utilized for discounting and projecting is developed externally and compared to available third party market quotes for reasonableness (Level 3).

Assets and Liabilities Measured on a Recurring Basis: Assets and liabilities measured at fair value on a recurring basis are summarized below:


			Fair Value Measurements at September 30, 2013 Using:
	September 30,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	2013		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Available for sale securities
US Treasury and government sponsored entities’ securities	$	229,763	$	—	$	229,763	$	—
Equity securities		396		396		—		—
Mortgage-backed GSE securities: residential		312,652		—		312,652		—
Interest rate caps		594		—		—		594


			Fair Value Measurements at December 31, 2012 Using:
	December 31, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
Assets:
Available for sale securities
US Treasury and government sponsored entities’ securities	$	163,692	$	—	$	163,692	$	—
Equity securities		313		313		—		—
Mortgage-backed GSE securities: residential		410,557		—		410,557		—
Interest rate caps		436		—		—		436

There were no transfers between Level 1 and Level 2 during 2013 or 2012.

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2013 and 2012:


	Interest Rate Caps
	Nine Months Ended September 30, 2013			Nine Months Ended September 30, 2012
	(Dollars in thousands)
Balance of recurring Level 3 assets at beginning of period	$	436		$	1,933
Total gains (losses) for the period
Included in other income		547			(1,077	)
Included in other comprehensive income		—			—
Purchases		—			—
Amortization		(389	)		(346	)
Sales		—			—

Balance of recurring Level 3 assets at end of period	$	594		$	510

There were no transfers between Level 2 and Level 3 during 2013 or 2012.

The following table presents quantitative information about recurring Level 3 fair value measurements at September 30, 2013:


	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range
	(Dollars in thousands)
Interest rate caps	$	594	Discounted cash flow	Discount rate	0.47%-1.5%

The fair value of interest rate caps was determined using proprietary models from third-party sources taking into account such factors as size of the transaction, the lack of a quoted market and the custom-tailored nature of the transaction. The fair value is inclusive of interest accruals, as applicable.

Assets and Liabilities Measured on a Non-Recurring Basis: Assets and liabilities measured at fair value on a non-recurring basis are summarized below:


			Fair Value Measurements at September 30, 2013 Using:
	September 30, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
Assets:
Impaired loans:
Permanent real estate loans	$	637	$	—	$	—	$	637
Construction loans		1,564		—		—		1,564
Mortgage servicing assets		387		—		387		—
Other real estate owned, net:
Permanent real estate		2,315		—		—		2,315
Construction		4,125		—		—		4,125

			Fair Value Measurements at December 31, 2012 Using:
	December 31, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
Assets:
Impaired loans:
Permanent real estate loans	$	6,166	$	—	$	—	$	6,166
Construction loans		3,489		—		—		3,489
Commercial loans		257		—		—		257
Mortgage servicing assets		4,920		—		4,920		—
Other real estate owned, net:
Permanent real estate		3,172		—		—		3,172
Construction		6,918		—		—		6,918

Impaired loans with specific allocations of the allowance for loan losses, carried at fair value, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a net carrying amount of $2.2 million at September 30, 2013, which includes a specific valuation allowance of $808,000. This resulted in an increase in the provision for loan losses of $307,000 during the three months ended September 30, 2013 and an increase in the provision for loan losses of $2.6 million during the nine months ended September 30, 2013. Impaired loans with specific allocations of the allowance for loan losses, carried at fair value, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $57.1 million at September 30, 2012, with a specific valuation allowance of $2.1 million. This resulted in a decrease of the provision for loan losses of $2.3 million during the three months ended September 30, 2012 and a decrease of the provision for loan losses of $794,000 during the nine months ended September 30, 2012. Impaired loans with specific allocations of the allowance for loan losses, carried at fair value, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a net carrying amount of $9.9 million at December 31, 2012, which includes a specific valuation allowance of $3.0 million. This resulted in an increase of the provision for loan losses of $27,000 during the twelve months ended December 31, 2012.

The significant unobservable (Level 3) inputs used in the fair value measurement of collateral for collateral dependent impaired loans included in the above table primarily relate to the adjustment between carrying value versus appraised value. During the reported periods, discounts applied to appraisals for estimated selling costs were 10%.

At September 30, 2013, mortgage servicing rights, carried at fair value, totaled $387,000, which is made up of the outstanding balance of $391,000, net of a valuation allowance of $4,000. At September 30, 2012, mortgage servicing rights, carried at fair value, totaled $4.2 million, which is made up of the outstanding balance of $6.2 million, net of a valuation allowance of $2.0 million. At December 31, 2012, mortgage servicing rights, carried at fair value, totaled $4.9 million, which is made up of the outstanding balance of $5.6 million, net of a valuation allowance of $680,000, resulting in a net recovery of $1.1 million for the year ended December 31, 2012. Mortgage servicing rights are valued by an independent third party that is active in purchasing and selling these instruments. The value reflects the characteristics of the underlying loans discounted at a market multiple.

At September 30, 2013, other real estate owned, carried at fair value, which is measured for impairment using the fair value of the property less estimated selling costs, had a net carrying amount of $6.4 million with a valuation allowance of $6.7 million. This resulted in additional expenses of $464,000 during the three months ended September 30, 2013 and additional expenses of $1.8 million during the nine months ended September 30, 2013. At September 30, 2012, other real estate owned had a net carrying amount of $18.5 million, with a valuation allowance of $6.9 million. This resulted in additional expenses of $1.3 million during the three months ended September 30, 2012, and additional expenses of $2.0 million during the nine months ended September 30, 2012. At December 31, 2012, other real estate owned had a net carrying amount of $10.1 million with a valuation allowance of $6.8 million. This resulted in additional expenses of $2.2 million during the twelve months ended December 31, 2012.

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at September 30, 2013:


	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Average)
			(Dollars in thousands)
Impaired loans:
Permanent real estate loans	$	637	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-56.90% (11.78%)

			Income approach	Adjustment for differences in net operating income Capitalization rate	3.95%-14.62% (9.41%)

Construction loans		1,564	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-25.00% (11.90%)
Foreclosed assets:

Permanent real estate		2,315	Sales comparison approach	Adjustment for differences between comparable sales	6.00%-46.53% (17.76%)

Construction		4,125	Sales comparison approach	Adjustment for differences between comparable sales	6.54%-26.63% (9.24%)

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at December 31, 2012:


	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Average)
			(Dollars in thousands)
Impaired loans:

Permanent real estate loans	$	6,166	Sales comparison approach	Adjustment for differences between comparable sales	12.07%-45.44% (28.75%)

			Income approach	Adjustment for differences in net operating income Capitalization rate	7.52%-10.73% (9.49%)

Construction loans		3,489	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-25.00% (9.83%)

			Income approach	Adjustment for differences in net operating income Capitalization rate	10.00%

Commercial loans		257	Sales comparison approach	Adjustment for differences between comparable sales	1.6%-24.18% (11.15%)

			Income approach	Adjustment for differences in net operating income Capitalization rate	8.5%-10% (9.25%)
Foreclosed assets:

Permanent real estate		3,172	Sales comparison approach	Adjustment for differences between comparable sales	3.60%-16.47% (10.20%)

Construction		6,918	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-47.24% (17.63%)

In accordance with U.S. GAAP, the carrying value and estimated fair values of financial instruments at September 30, 2013 and December 31, 2012, were as follows:


				Fair Value Measurements at September 30, 2013 Using:
	September 30, 2013 Carrying Value			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	86,130		$	86,130		$	—		$	—
Available for sale securities		542,811			396			542,415			—
Loans held for sale		2,894			—			2,947			—
Loans, net		1,009,029			—			—			1,021,206
FHLB stock		26,464			n/a			n/a			n/a
Accrued interest receivable		5,200			—			2,081			3,119
Interest rate caps		594			—			—			594
Liabilities:
Deposits:
Checking, savings and money market accounts		(900,444	)		(900,444	)		—			—
Certificates of deposit		(510,166	)		—			(519,632	)		—
FHLB advances		(50,000	)		—			(55,808	)		—
Repurchase agreements and other		(90,583	)		—			(99,292	)		—
Advance payments by borrowers for taxes and insurance		(12,126	)		—			(12,126	)		—
Accrued interest payable		(592	)		—			(592	)		—


				Fair Value Measurements at December 31, 2012 Using:
	December 31, 2012 Carrying Value			(Level 1)			(Level 2)			(Level 3)
	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	42,613		$	42,613		$	—		$	—
Available for sale securities		574,562			313			574,249			—
Loans held for sale		13,031			—			13,428			—
Loans, net		1,066,240			—			—			1,087,205
FHLB stock		26,464			n/a			n/a			n/a
Accrued interest receivable		6,238			—			2,380			3,858
Interest rate caps		436			—			—			436
Liabilities:
Deposits:
Checking, savings and money market accounts		(902,776	)		(902,776	)		—			—
Certificates of deposit		(559,298	)		—			(571,836	)		—
FHLB advances		(50,000	)		—			(57,077	)		—
Repurchase agreements and other		(90,598	)		—			(102,086	)		—
Advance payments by borrowers for taxes and insurance		(23,590	)		—			(23,590	)		—
Accrued interest payable		(563	)		—			(563	)		—

The methods and assumptions, not previously presented, 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) FHLB Stock

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

(c) 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.

(d) Deposits

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook 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 1 classification. The carrying amounts of variable rate, fixed-term money market accounts approximate their fair values at the reporting date resulting in a Level 1 classification. Fair values for fixed and variable rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of deposit to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

(e) Short-term Borrowings

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within 90 days, approximate their fair values resulting in a Level 2 classification.

(f) Other Borrowings

The fair values of Home Savings long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

(g) Accrued Interest Receivable/Payable

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

(h) 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.