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:

Trading securities: The fair values of trading securities are determined by obtaining quoted prices from a counterparty who makes a market in the securities (Level 1 inputs). For securities where quoted prices are not available, fair value is calculated based on the market price of similar securities discounted for the price that certain bidders are willing to pay for the securities (Level 2).

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 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, 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: Home Savings periodically enters into interest rate swap agreements with its commercial customers who desire a fixed rate loan term that is longer than Home Savings is willing to extend. Home Savings then enters into a reciprocal swap agreement with a 3^rd party that offsets the interest rate risk from the interest rate swap extended to the customer. The interest rate swaps are derivative instruments which are carried at fair value on the consolidated balance sheet. Home Savings uses an independent third party that performs a market valuation analysis for both swap positions (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 September 30, 2019 Using:
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	September 30,		Assets		Inputs		Inputs
	2019		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Trading securities	$	734	$	267	$	467	$	—
Available for sale securities
U.S. Treasury and agency securities		61,435		—		61,435		—
States and municipalities		36,493		—		36,493		—
Corporate debt securities		13,353		—		13,353		—
Collateralized mortgage obligations		54,744		—		54,744		—
Mortgage-backed securities		148,996		—		148,996		—
Loans held for sale, at fair value		113,593		—		24,366		89,227
Purchased certificate of deposit option		239		—		239		—
Interest rate swaps		372		—		372		—
Liabilities
Written certificate of deposit option		239		—		239		—
Interest rate swaps		421		—		421		—

			Fair Value Measurements at December 31, 2018 Using:
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	December 31,		Assets		Inputs		Inputs
	2018		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Trading securities	$	364	$	364		—		—
Available for sale securities
U.S. Treasury and agency securities		95,581		—		95,581		—
States and municipalities		47,746		—		47,746		—
Corporate debt securities		2,004		—		2,004		—
Collateralized mortgage obligations		22,108		—		22,108		—
Mortgage-backed securities		74,204		—		74,204		—
Loans held for sale, at fair value		91,472		—		11,221		80,251
Purchased certificate of deposit option		261		—		261		—
Interest rate swaps		56		—		56		—
Liabilities
Written certificate of deposit option		261		—		261		—
Interest rate swaps		62		—		62		—

There were no transfers between Level 1 and Level 2 during the three and nine months ended September 30, 2019 and 2018.

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, 2019 and 2018.

	Loans Held for Sale, At Fair Value
	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2019			2018			2019			2018
	(Dollars in thousands)
Balance of recurring Level 3 assets at beginning of period	$	69,565		$	76,690		$	80,251		$	65,016
Total gains (losses) for the period
Included in change in fair value of loans held for sale		626			(77	)		3,275			(2,216	)
Included in other comprehensive income					—						—
Originations/Draws on construction perm loans		38,114			32,581			91,845			94,908
Amortization		—			—			—			—
Sales		(19,078	)		(28,267	)		(86,144	)		(76,781	)
Balance of recurring Level 3 assets at end of period	$	89,227		$	80,927		$	89,227		$	80,927

The following table presents quantitative information about recurring Level 3 fair value measurements at September 30, 2019:

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, 2019 Using:
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	September 30,		Assets		Inputs		Inputs
	2019		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Impaired loans:
Commercial loans
Secured Commercial		668		—		—		668
Residential loans
One-to four-family residential		467		—		—		467
Consumer loans
Home Equity		19		—		—		19
Auto		14		—		—		14
Marine		105		—		—		105
Recreational vehicle		66		—		—		66
Mortgage servicing rights		3,018		—		3,018		—
Other real estate owned, net
Commercial loans
Construction loans		58		—		—		58
Residential loans
One-to four-family residential		113		—		—		113

			Fair Value Measurements at December 31, 2018 Using:
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	December 31,		Assets		Inputs		Inputs
	2018		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Impaired loans:
Commercial loans
Secured	$	419	$	—	$	—	$	419
Residential loans
One-to four-family residential		540		—		—		540
Consumer loans
Auto		8		—		—		8
Mortgage servicing rights		2,990		—		2,990		—
Other real estate owned, net
Commercial loans
Auto		181		—		—		181
Residential loans
One-to four-family residential		121		—		—		121

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 $1.3 million at September 30, 2019, that includes a specific valuation allowance of $85,000. This resulted in a decrease of the provision for loan losses of $12,000 and $110,000 during the three and nine months ended September 30, 2019, 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 $431,000 at September 30, 2018, which includes a specific valuation allowance of $488,000. This resulted in an increase in the provision for loan losses of $40,000 and $187,000 for the three and nine months ended September 30, 2018. 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 $967,000 at December 31, 2018, that includes a specific valuation allowance of $69,000.

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, 2019, mortgage servicing rights carried at fair value totaled $3.0 million with a valuation allowance of $1.9 million. At September 30, 2018, $282,000 of mortgage servicing rights were carried at fair value, resulting in a net valuation allowance of $26,000. Mortgage servicing rights are valued by an independent third party that is active in purchasing and selling these instruments. Net impairment reflected in mortgage servicing rights valuation totaled $336,000 and $1.8 million for the three and nine months ended September 30, 2019, respectively. Net impairment reflected in mortgage service rights valuation totaled $6,000 and $17,000 for the three and nine months ended September 30, 2018, respectively. The value reflects the characteristics of the underlying loans.

At September 30, 2019, 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 $171,000, with a valuation allowance of $170,000. This resulted in expense of $26,000 and $62,000 during the three and nine months ended September 30, 2019, respectively. 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, 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, respectively. At December 31, 2018, other real estate owned had a net carrying amount of $302,000, with a valuation allowance of $308,000.

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, 2019:

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
Impaired loans:
Commercial loans
Secured Commercial		668	Sales comparison approach	Adjustment for differences between comparable sales	0.00-35.00% (15.00%)
Residential loans
One-to four-family residential		467	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-10.77% (4.27%)
Consumer loans
Home Equity		19	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-17.85% (8.93%)
Auto		14	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-17.85% (8.93%)
Marine		105	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-17.85% (8.93%)
Recreational vehicle		66	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-17.85% (8.93%)
Other real estate owned, net
Commercial loans
Construction loans		58	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-50.00% (45.85%)
Residential loans
One-to four-family residential		113	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-14.22% (14.22%)

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, 2018:

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
Impaired loans:
Commercial loans
Secured		419	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-64.00% (16.00%)
Residential loans
One-to four-family residential		540	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-10.77% (4.27%)
Other real estate owned:
Commercial loans
Construction loans		181	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-52.90% (52.41%)
Residential loans
One-to four-family residential		121	Sales comparison approach	Adjustment for differences between comparable sales	0.00%-13.43% (13.43%)

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, 2019 and December 31, 2018.

The total amount of gains and losses from changes in fair value included in earnings for the three and nine months ended September 30, 2019 and 2018 for loans held for sale, at fair value were:

In accordance with U.S. GAAP, the carrying value and estimated fair values of financial instruments at September 30, 2019 and December 31, 2018, were as follows:

				Fair Value Measurements at September 30, 2019 Using:
	September 30,
	2019
	Carrying Value			(Level 1)			(Level 2)			(Level 3)
	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	64,869		$	64,869		$	—		$	—
Trading securities		734			267			467			—
Available for sale securities		315,021			—			315,021			—
Loans held for sale, at fair value		113,593			—			24,366			89,227
Loans, net		2,248,507			—			—			2,244,746
Purchased certificate of deposit option		239			—			239			—
Interest rate swaps		372			—			372			—
Liabilities:
Deposits:
Checking, savings and money market accounts		(1,496,470	)		(1,496,470	)		—			—
Certificates of deposit		(609,288	)		—			(610,997	)		—
FHLB advances		(422,000	)		—			(422,000	)		—
Written certificate of deposit option		(239	)		—			(239	)		—
Interest rate swaps		(421	)		—			(421	)		—

				Fair Value Measurements at December 31, 2018 Using:
	December 31,
	2018
	Carrying Value			(Level 1)			(Level 2)			(Level 3)
	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	60,985		$	60,985		$	—		$	—
Trading securities		364			364			—			—
Available for sale securities		241,643			—			241,643			—
Held to maturity securities		77,491			—			71,206			3,869
Loans held for sale, at fair value		91,472			—			11,221			80,251
Loans, net		2,176,842			—			—			2,138,319
Purchased certificate of deposit option		261			—			261			—
Interest rate swaps		56						56			—
Liabilities:
Deposits:
Checking, savings and money market accounts		(1,305,439	)		(1,305,439	)		—			—
Certificates of deposit		(907,781	)		—			(904,198	)		—
FHLB advances		(243,000	)		—			(243,000	)		—
Repurchase agreements and other		(224	)		—			(213	)		—
Written certificate of deposit option		(261	)		—			(261	)		—
Interest rate swaps		(62	)		—			(62	)		—