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), using matrix pricing. Matrix pricing is a mathematical technique commonly used to price debt securities that are not actively traded, values debt securities without relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

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 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 conventional residential one-to four-family loans held for sale originated after January 1, 2016 and all permanent construction loans held for sale originated on or after January 1, 2015. The fair value of conventional loans held for sale is determined using the current 15 day forward contract price for either 15 or 30 year conventional mortgages (Level 2).

The fair value of the Company’s permanent construction loans held for sale is determined using the current 60 day forward contract price for 30 year conventional loans which is then adjusted by extrapolating this rate to the estimated time period remaining until construction is complete. The fair value is also adjusted for unobservable market data such as estimated fall out rates and the estimated time from origination to completion of construction (Level 3).

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).

Interest rate swaps: The fair values of interest rate swaps are based on valuation models using observable market data as of the measurement date (Level 2). Home Savings’ interest rate swaps are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of interest rate swaps are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rates, and volatility factors to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services.

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, 2018 Using:
				Quoted
				Prices in
				Active		Significant
				Markets for		Other			Significant
				Identical		Observable			Unobservable
	September 30,			Assets		Inputs			Inputs
	2018			(Level 1)		(Level 2)			(Level 3)
	(Dollars in thousands)
Assets:
Available for sale securities
U.S. Treasury and government sponsored entities' securities	$	119,288		$	—	$	119,288		$	—
States of the U.S. and political subdivisions		47,023			—		47,023			—
Mortgage-backed GSE securities: residential		75,795			—		75,795			—
Loans held for sale, at fair value		95,235			—		14,308			80,927
Purchased certificate of deposit option		459			—		459			—
Interest rate swaps		21			—		21			—
Liabilities
Written certificate of deposit option		(459	)		—		(459	)		—
Interest rate swaps		(25	)		—		(25	)		—

				Fair Value Measurements at December 31, 2017 Using:
				Quoted
				Prices in
				Active		Significant
				Markets for		Other			Significant
				Identical		Observable			Unobservable
	December 31,			Assets		Inputs			Inputs
	2017			(Level 1)		(Level 2)			(Level 3)
	(Dollars in thousands)
Assets:
Available for sale securities
U.S. Treasury and government sponsored entities' securities	$	123,817		$	—	$	123,817		$	—
States of the U.S. and political subdivisions		59,623			—		59,623			—
Mortgage-backed GSE securities: residential		87,121			—		87,121			—
Loans held for sale, at fair value		83,541			—		18,525			65,016
Purchased certificate of deposit option		809			—		809			—
Liabilities
Written certificate of deposit option		(809	)		—		(809	)		—

There were no transfers between Level 1 and Level 2 during the first nine months of 2018 or fiscal year 2017.

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 September 30, 2018 and 2017.

	Loans Held for Sale, At Fair Value
	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2018			2017			2018			2017
	(Dollars in thousands)
Balance of recurring Level 3 assets at beginning of period	$	76,690		$	69,995		$	65,016		$	53,761
Total gains (losses) for the period
Included in change in fair value of loans held for sale		(77	)		1,145			(2,216	)		3,557
Included in other comprehensive income		—			—			—			—
Originations/Draws on construction perm loans		32,581			28,864			94,908			80,109
Amortization		—			—			—			—
Sales		(28,267	)		(29,766	)		(76,781	)		(67,189	)
Balance of recurring Level 3 assets at end of period	$	80,927		$	70,238		$	80,927		$	70,238

The following table presents quantitative information about recurring Level 3 fair value measurements at September 30, 2018:

			Valuation	Unobservable
	Fair Value		Technique(s)	Input(s)	Range
Loans held for sale, at fair value	$	80,927	Comparable sales	Time discount	0.00-2.00%

The following table presents quantitative information about recurring Level 3 fair value measurements at December 31, 2017:

			Valuation	Unobservable
	Fair Value		Technique(s)	Input(s)	Range
Construction loans held for sale	$	65,016	Comparable sales	Time discount	0.00-1.96%

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 September 30, 2018 Using:
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	September 30,		Assets		Inputs		Inputs
	2018		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Impaired loans:
Commercial loans
Multifamily	$	247	$	—	$	—	$	247
Residential loans
One-to four-family residential		130		—		—		130
Consumer loans
Auto		16		—		—		16
Marine		38		—		—		38
Mortgage servicing rights		282		—		282		—
Other real estate owned, net
Commercial loans
Construction loans		197		—		—		197
Residential loans
One-to four-family residential		145		—		—		145

			Fair Value Measurements at December 31, 2017 Using:
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	December 31,		Assets		Inputs		Inputs
	2017		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Impaired loans:
Commercial loans
Multifamily	$	247	$	—	$	—	$	247
Nonresidential		2		—		—		2
Secured		40		—		—		40
Residential loans
One-to four-family residential		1,010		—		—		1,010
Consumer loans
Home Equity		89		—		—		89
Auto		13		—		—		13
Marine		169		—		—		169
Recreational vehicle		86		—		—		86
Mortgage servicing rights		382		—		382		—
Other real estate owned, net
Commercial loans
Construction loans		354		—		—		354
Residential loans
One-to four-family residential		82		—		—		82

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 $431,000 at September 30, 2018, that includes a specific valuation allowance of $488,000. This resulted in an increase of the provision for loan losses of $40,000 and $187,000 during the three and nine months ended September 30, 2018, respectively. 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 $1.2 million at September 30, 2017, which includes a specific valuation allowance of $42,000. This resulted in an increase in the provision for loan losses of $92,000 and $571,000 for the three and nine months ended September 30, 2017. 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 $1.7 million at December 31, 2017, that includes a specific valuation allowance of $491,000.

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 September 30, 2018, $282,000 in mortgage servicing rights were carried at fair value, resulting in a net valuation allowance of $26,000. At September 30, 2017, mortgage servicing rights carried at fair value totaled $125,000, resulting in a net valuation allowance of $15,000. Mortgage servicing rights are valued by an independent third party that is active in purchasing and selling these instruments. A net impairment reflected in other income totaled $6,000 and $17,000 for the three and nine months ended September 30, 2018, respectively. Net impairment reflected in other income totaled $10,000 and $15,000 for the three and nine months ended September 30, 2017. The value reflects the characteristics of the underlying loans.

At September 30, 2018, other real estate owned, carried at fair value, which is measured for impairment using the fair value of the property less estimated selling costs, and had a net carrying amount of $342,000, with a valuation allowance of $297,000. This resulted in expense of $49,000 and $82,000 during the three and nine months ended September 30, 2018. At September 30, 2017, other real estate owned, carried at fair value, which is measured for impairment using the fair value of the property less estimated selling costs, and had a net carrying amount of $580,000 with a valuation allowance of $423,000. This resulted in expense of $53,000 and $15,000 during the three and nine months ended September 30, 2017. At December 31, 2017, other real estate owned had a net carrying amount of $436,000, with a valuation allowance of $403,000.

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, 2018:

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
Impaired loans:
Commercial loans
Multifamily	$	247	Sales comparison approach	Adjustment for differences between comparable sales	0.00-35.00% (15.00%)
Residential loans
One-to four-family residential		130	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-10.77% (4.27%)
Consumer loans
Auto		16	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-17.85% (8.93%)
Marine		38	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-17.85% (8.93%)
Other real estate owned, net
Commercial loans
Construction loans		197	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-60.00% (57.67%)
Residential loans
One-to four-family residential		145	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-22.15% (16.36%)

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, 2017:

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
Impaired loans:
Commercial loans
Multifamily	$	247	Sales comparison approach	Adjustment for differences between comparable sales	0.00-35.00% (15.00%)
Nonresidential		2	Sales comparison approach	Adjustment for differences between comparable sales	0.00-35.00% (15.00%)
Secured		40	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-64.00% (16.00%)
Residential loans
One-to four-family residential		1,010	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-10.77% (4.27%)
Consumer loans
Home Equity		89	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-17.85% (8.93%)
Other real estate owned:
Commercial loans
Construction loans		354	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-52.90% (52.41%)
Residential loans
One-to four-family residential		82	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-13.43% (13.43%)

Auto and recreational vehicle loans were excluded from the table above as their value is considered immaterial.

The Company has elected the fair value option for newly originated residential mortgage and 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 September 30, 2018 and December 31, 2017.

	September 30, 2018		December 31, 2017
	(Dollars in thousands)
Aggregate fair value	$	95,235	$	83,541
Contractual balance		94,151		79,898
Gain		1,084		3,643

The total amount of gains and losses from changes in fair value included in earnings for the three and nine months ended September 30, 2018 and 2017 for loans held for sale, at fair value were:

	For the Three Months Ended					For the Nine Months Ended
	September 30, 2018			September 30, 2017		September 30, 2018			September 30, 2017
	(Dollars in thousands)
Interest income	$	—		$	—	$	—		$	—
Interest expense		—			—		—			—
Change in fair value		(362	)		1,088		(2,559	)		3,988
Total change in fair value	$	(362	)	$	1,088	$	(2,559	)	$	3,988

In accordance with U.S. GAAP, the carrying value and estimated fair values of financial instruments at September 30, 2018 and December 31, 2017, were as follows:

				Fair Value Measurements at September 30, 2018 Using:
	September 30,
	2018
	Carrying Value			(Level 1)			(Level 2)			(Level 3)
	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	54,265		$	54,265		$	—		$	—
Available for sale securities		242,106			—			242,106			—
Held to maturity securities		78,700			—			74,812			—
Loans held for sale, at fair value		95,235			—			14,308			80,927
Loans, net		2,148,942			—			—			2,117,982
FHLB stock		19,144		n/a			n/a			n/a
Accrued interest receivable		8,551			—			1,582			6,969
Purchased certificate of deposit option		459			—			459			—
Interest rate swaps		21			—			21			—
Liabilities:
Deposits:
Checking, savings and money market accounts		(1,313,932	)		(1,313,932	)		—			—
Certificates of deposit		(1,038,544	)		—			(1,034,803	)		—
FHLB advances		(95,025	)		—			(94,949	)		—
Repurchase agreements and other		(238	)		—			(224	)		—
Advance payments by borrowers for taxes and insurance		(16,494	)		(16,494	)		—			—
Accrued interest payable		(1,177	)		—			(1,177	)		—
Written certificate of deposit option		(459	)		—			(459	)		—
Interest rate swaps		(25	)		—			(25	)		—

				Fair Value Measurements at December 31, 2017 Using:
	December 31,
	2017
	Carrying Value			(Level 1)			(Level 2)			(Level 3)
	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	46,880		$	46,880		$	—		$	—
Available for sale securities		270,561			—			270,561			—
Held to maturity securities		82,911			—			82,126			—
Loans held for sale at lower of cost or market		211			—			217			—
Loans held for sale, at fair value		83,541			—			18,525			65,016
Loans, net		1,999,877			—			—			1,990,289
FHLB stock		19,324		n/a			n/a			n/a
Accrued interest receivable		8,190			—			2,244			5,946
Purchased certificate of deposit option		809			—			809			—
Liabilities:
Deposits:
Checking, savings and money market accounts		(1,251,398	)		(1,251,398	)		—			—
Certificates of deposit		(705,341	)		—			(705,238	)		—
FHLB advances		(356,536	)		—			(356,521	)		—
Repurchase agreements and other		(197	)		—			(190	)		—
Advance payments by borrowers for taxes and insurance		(25,038	)		(25,038	)		—			—
Accrued interest payable		(1,097	)		—			(1,097	)		—
Written certificate of deposit option		(809	)		—			(809	)		—

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 for held to maturity securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows.

(d) Loans

Beginning January 1, 2018, fair values of loans, excluding loans held for sale, are estimated based on the price received to sell the asset (exit price), considering the lifetime credit risk of the loan portfolio. For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based the weighted average next repricing date and weighted average index, resulting in a Level 3 classification. Fair values for other loans are estimated using the weighted average months to maturity and weighted average contractual interest rate, using weightings based on principal balances, 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 represent an exit price.

At December 31, 2017, fair values of loans, excluding loans held for sale, were estimated as follows: For variable rate, loans that reprice frequently and with no significant change in credit risk, fair values were based on carrying values resulting in a Level 3 classification. Fair values for other loans were estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similarly credit quality resulting in a Level 3 classification. Impaired loans were valued at the lower of cost or fair value. The methods utilized at December 31, 2017 to estimate fair value did not necessarily represent an exit price.

(e) 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.

(f) 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.

(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.