9.	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. Real estate owned properties are individually evaluated at least annually for additional impairment and adjusted accordingly.

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 Home Savings. 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. In addition to the Special Assets Department review, a third party independent review is also performed. On an annual basis, Home Savings 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. At the time a property is acquired and classified as real estate owned, the fair value is determined utilizing the most appropriate method. A fair value in excess of $250,000 will be supported by an appraisal. After determination of fair value, each property will be recorded at the lower of cost (i.e., recorded investment in the loan) or the estimated net realizable value on the date of transfer to real estate owned. In determining net realizable value, reductions to fair market value may be taken for estimated costs of sale, conditions that must be remedied immediately upon acquisition, and other factors that negatively impact the marketability and prompt sale of the property.

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, 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).

Loans held for sale, at fair value: The Company elected the fair value option for all permanent construction loans held for sale originated on or after January 1, 2015. As noted above, the fair value of the Company’s construction perm loans held for sale was determined based on quoted prices for similar loans in active markets. The fair value of permanent construction loans held for sale is determined, based on the committed loan amount, using quoted prices for similar assets, adjusted for specific attributes of that loan and other unobservable market data, such as time it takes to complete the project (Level 3).

Interest rate caps: Home Savings 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 built by obtaining publicly available third party market quotes from Reuters, which handle up to 30-year swap maturities (Level 3). Assumptions used in the valuation of interest rate caps are back-tested for reasonableness on a quarterly basis using an independent source along with a third party service.

Purchased and written certificate of deposit option: Home Savings periodically enters into written and purchased option derivative instruments to facilitate the Power CD. The written and purchased options are mirror derivative instruments which are carried at fair value on the consolidated balance sheets. Home Savings uses an independent third party that performs a market valuation analysis for purchased and written certificate of deposit options. (Level 2)

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 March 31, 2015 Using:
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	March 31,		Assets		Inputs		Inputs
	2015		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Available for sale securities
U.S. Treasury and government sponsored entities’ securities	$	226,893	$	—	$	226,893	$	—
Mortgage-backed GSE securities: residential		265,519		—		265,519		—
Loans held for sale, at fair value		1,608		—		—		1,608
Interest rate caps		126		—		—		126
Purchased certificate of deposit option		935		—		935		—
Liabilities
Written certificate of deposit option		935		—		935		—

			Fair Value Measurements at December 31, 2014 Using:
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	December 31,		Assets		Inputs		Inputs
	2014		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Available for sale securities
U.S. Treasury and government sponsored entities’ securities	$	227,957	$	—	$	227,957	$	—
Mortgage-backed GSE securities: residential		271,833		—		271,833		—
Interest rate caps		180		—		—		180
Purchased certificate of deposit option		930		—		930		—
Liabilities
Written certificate of deposit option		930		—		930		—

There were no transfers between Level 1 and Level 2 during 2015 or 2014.

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 three months ended March 31, 2015 and 2014:

	Loans Held for Sale, At Fair Value
	For the Three Months Ended March 31,
	2015
	(Dollars in thousands)
Balance of recurring Level 3 assets at beginning of period	$	—
Total gains (losses) for the period
Included in mortgage banking income		561
Included in other comprehensive income		—
Originations		1,047
Amortization		—
Sales		—
Balance of recurring Level 3 assets at end of period	$	1,608

	Interest Rate Caps
	For the Three Months Ended March 31,
	2015			2014
	(Dollars in thousands)
Balance of recurring Level 3 assets at beginning of period	$	180		$	546
Total gains (losses) for the period
Included in other income		75			2
Included in other comprehensive income		—			—
Purchases		—			—
Amortization		(129	)		(129	)
Sales		—			—
Balance of recurring Level 3 assets at end of period	$	126		$	419

There were no transfers between Level 2 and Level 3 during 2015 or 2014.

The following table presents quantitative information about recurring Level 3 fair value measurements at March 31, 2015:

			Valuation	Unobservable
	Fair Value		Technique(s)	Input(s)	Range
Loans held for sale, at fair value	$	1,608	Comparable sales	Time discount	0.00-1.50%
Interest rate caps		126	Discounted cash flow	Discount rate	0.49-1.18%

The following table presents quantitative information about recurring Level 3 fair value measurements at December 31, 2014:

			Valuation	Unobservable
	Fair Value		Technique(s)	Input(s)	Range
Interest rate caps	$	180	Discounted cash flow	Discount rate	0.49-1.18%

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.

The fair value of loans held for sale, at fair value was determined using pricing from a quoted market, discounted for the length of time to the completion of the construction project.

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 March 31, 2015 Using:
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	March 31,		Assets		Inputs		Inputs
	2015		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Impaired loans:
Commercial loans	$	3,828	$	—	$	—	$	3,828
Residential loans		406		—		—		406
Consumer loans		276		—		—		276
Mortgage servicing rights		1,457		—		1,457		—
Other real estate owned, net
Permanent real estate loans		626		—		—		626
Construction loans		1,013		—		—		1,013

			Fair Value Measurements at December 31, 2014 Using:
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	December 31,		Assets		Inputs		Inputs
	2014		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Impaired loans:
Commercial loans	$	3,803	$	—	$	—	$	3,803
Residential loans		765		—		—		765
Consumer loans		260		—		—		260
Mortgage servicing rights		1,138		—		1,138		—
Other real estate owned, net
Permanent real estate loans		640		—		—		640
Construction loans		1,286		—		—		1,286

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 $4.5 million at March 31, 2015, that includes a specific valuation allowance of $678,000. This resulted in a decrease of the provision for loan losses of $35,000 during the three months ended March 31, 2015. 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 $2.7 million at March 31, 2014, which includes a specific valuation allowance of $959,000. This resulted in an increase in the provision for loan losses of $469,000 during the three months ended March 31, 2014. 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 $4.8 million at December 31, 2014, that includes a specific valuation allowance of $713,000.

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 values versus appraised value. During the reported periods, discounts applied to appraisals for estimated selling costs were 10%.

At March 31, 2015, mortgage servicing rights carried at fair value were $1.5 million, resulting in a net valuation allowance of $219,000 for the three months ended March 31, 2015. At March 31, 2014, mortgage servicing rights, carried at fair value, totaled $103,000, which is made up of the outstanding balance of $104,000, net of a valuation allowance of $1,000. At December 31, 2014, mortgage servicing rights carried at fair value were $1.1 million, resulting in a net loss of $58,000 for the year ended December 31, 2014. 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 March 31, 2015, 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 gross carrying amount of $2.9 million, with a valuation allowance of $1.2 million. This resulted in additional expenses of $80,000 during the three months ended March 31, 2015. At March 31, 2014, 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 $3.4 million with a valuation allowance of $3.6 million. This resulted in additional expenses of $292,000 during the three months ended March 31, 2014. At December 31, 2014, other real estate owned had a net carrying amount of $1.9 million, with a valuation allowance of $1.4 million.

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, 2015:

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
Impaired loans:
Commercial loans	$	3,828	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-20.00% (10.00%)
Residential loans		406	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-10.77% (10.00%)
Consumer loans		276	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-17.85% (17.85%)
Foreclosed assets:
Permanent real estate loans		626	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-40.50% (10.93%)
Construction loans		1,013	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-53.10% (18.76%)

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, 2014:

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
Impaired loans:
Commercial loans	$	3,803	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-20.00% (10.00%)
Residential loans		765	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-11.80% (3.70%)
Consumer loans		260	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-10.00% (5.00%)
Foreclosed assets:
Permanent real estate loans		640	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-51.10% (26.83%)
Construction loans		1,286	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-58.10% (22.20%)

The Company has elected the fair value option for newly originated permanent construction loans held for sale. These loans are intended for sale and the Company believes that fair value is the best indicator of the resolution of these loans. Interest income is recorded based on the contractual terms of the loan and in accordance with the Company’s policy on loans held for investment. None of these loans are 90 or more days past due nor on nonaccrual status as of March 31, 2015.

	March 31, 2015
	(Dollars in thousands)
Aggregate fair value	$	1,608
Contractual balance		1,047
Gain (loss)		561

The total amount of gains and losses from changes in fair value included in earnings for the three months ended March 31, 2015 for loans held for sale, at fair value were:

	March 31, 2015
	(Dollars in thousands)
Interest income	$	—
Interest expense		—
Change in fair value		561
Total change in fair value	$	561

In accordance with U.S. GAAP, the carrying value and estimated fair values of financial instruments at March 31, 2015 and December 31, 2014, were as follows:

				Fair Value Measurements at March 31, 2015 Using:
	March 31,
	2015
	Carrying Value			(Level 1)			(Level 2)			(Level 3)
	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	41,665		$	41,665		$	—		$	—
Available for sale securities		492,412			—			492,412			—
Loans held for sale		29,635			—			31,353			—
Loans held for sale, at fair value		1,608			—			—			1,608
Loans, net		1,168,434			—			—			1,186,655
FHLB stock		18,068		n/a			n/a			n/a
Accrued interest receivable		5,208			—			1,819			3,389
Interest rate caps		126			—			—			126
Purchased certificate of deposit option		935			—			935			—
Liabilities:
Deposits:
Checking, savings and money market accounts		(977,167	)		(977,167	)		—			—
Certificates of deposit		(429,577	)		—			(435,845	)		—
FHLB advances		(152,389	)		—			(152,491	)		—
Repurchase agreements and other		(30,552	)		—			(32,466	)		—
Advance payments by borrowers for taxes and		(14,529	)		(14,529	)		—			—
insurance
Accrued interest payable		(219	)		—			(219	)		—
Written certificate of deposit option		(935	)		—			(935	)		—

				Fair Value Measurements at December 31, 2014 Using:
	December 31,
	2014
	Carrying Value			(Level 1)			(Level 2)			(Level 3)
	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	32,980		$	32,980		$	—		$	—
Available for sale securities		499,790			—			499,790			—
Loans held for sale		20,730			—			21,528			—
Loans, net		1,148,093			—			—			1,167,372
FHLB stock		18,068		n/a			n/a			n/a
Accrued interest receivable		5,763			—			2,374			3,389
Interest rate caps		180			—			—			180
Purchased certificate of deposit option		930			—			930			—
Liabilities:
Deposits:
Checking, savings and money market accounts		(912,536	)		(912,536	)		—			—
Certificates of deposit		(435,300	)		—			(442,268	)		—
FHLB advances		(186,194	)		—			(186,290	)		—
Repurchase agreements and other		(30,558	)		—			(32,817	)		—
Advance payments by borrowers for taxes and		(19,904	)		(19,904	)		—			—
insurance
Accrued interest payable		(185	)		—			(185	)		—
Written certificate of deposit option		(930	)		—			(930	)		—

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.

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; and 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.

(d) Deposits

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, 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) Other Borrowings

Short-term borrowings, generally maturing within 90 days, approximate their fair values resulting in a Level 2 classification. 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.

(f) 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.

(g) 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.