Fair Value Measurements

GAAP establishes a hierarchy for determining fair value measurements that includes three levels and is based upon the valuation techniques used to measure assets and liabilities. The three levels are as follows:


•	Level 1: Inputs that are quoted unadjusted prices in active markets - that the Company has the ability to access at the measurement date - for identical assets or liabilities.

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Level 2: Inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity including quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, and inputs derived principally from, or corroborated by, observable market data by correlation or other means.


•	Level 3: Inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s assets and liabilities carried at fair value. Where available, fair value is based upon quoted market prices. Significant balances of the Bank’s financial assets and liabilities do not have quoted market prices. In such circumstances, fair value is based upon internal or third party models that primarily use, as inputs, observable market-based parameters, such as yields and discount rates of comparable instruments of like duration or credit quality. Valuation adjustments may be made to model results with respect to various assets or liabilities. These adjustments may include amounts to reflect counterparty credit quality and the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes that the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain assets and liabilities could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and, therefore, estimates of fair value after the condensed consolidated balance sheet date may differ significantly from the amounts presented herein.

The following is a description of the valuation methodologies used for assets measured at fair value on a recurring or nonrecurring basis, as well as the general classification of such assets pursuant to valuation hierarchy:

Investment securities available-for-sale: Where quoted prices for identical assets are available in an active market, investment securities available-for-sale are classified within level 1 of the hierarchy. If quoted market prices for identical securities are not available, then fair values are estimated by independent sources using pricing models and/or quoted prices of investment securities with similar characteristics or discounted cash flows. The Company has categorized its investment securities available-for-sale as level 2, since a majority of such securities are MBS which are mainly priced in this latter manner.

Interest rate swap derivatives: The fair value of the interest rate lock commitments and forward sales commitments are estimated using quoted or published market prices for similar instruments, adjusted for factors such as pull-through rate assumptions based on historical information, where appropriate. The fair value of the interest rate swaps is determined using a discounted cash flow technique with values provided by third party swap dealers or consultants. The Company has determined that the majority of the inputs used to value its interest rate swap derivatives fall within Level 2.

Impaired loans: In accordance with GAAP, loans are measured for impairment using one of three methods: an observable market price (if available), the present value of expected future cash flows discounted at the loan’s effective interest rate, or at the fair value of the loan’s collateral (if collateral dependent). Estimated fair value of the loan’s collateral is determined by appraisals or independent valuations which are then adjusted for the estimated costs related to liquidation of the collateral. Management’s ongoing review of appraisal information may result in additional discounts or adjustments to valuation based upon more recent market sales activity or more current appraisal information derived from properties of similar type and/or locale. A significant portion of the Bank’s impaired loans are measured using the estimated fair market value of the collateral less the estimated costs to sell. The Company has categorized all its loans impaired during the calendar year utilizing fair value metrics as level 3. Loans that were impaired during the calendar year based on the present value of expected future cash flows discounted at the loans’ effective interest rates are not included in the table below as the loans’ effective interest rates are not based on current market rates.

OREO: The Company’s OREO is measured at estimated fair value less estimated costs to sell. Fair value is generally determined based on third-party appraisals of fair value in an orderly sale. Historically, appraisals have considered comparable sales of like assets in reaching a conclusion as to fair value. Since many recent real estate sales could be termed “distressed sales”, and since a preponderance have been short-sale or foreclosure related, this has directly impacted appraisal valuation estimates. Estimated costs to sell OREO are based on standard market factors. The valuation of OREO is subject to significant external and internal judgment. Management periodically reviews OREO to determine whether the property continues to be carried at the lower of its recorded book value or estimated fair value, net of estimated costs to sell. The Company has categorized its OREO as level 3.

The Company’s only financial assets measured at fair value on a recurring basis at March 31, 2017 and December 31, 2016 were as follows (dollars in thousands):



	Level 1		Level 2		Level 3
March 31, 2017
Assets:
Investment securities available-for-sale	$	—	$	469,720	$	—
Interest rate swap derivatives	—		3,053		—
Total assets	$	—	$	472,773	$	—

Liabilities:
Interest rate swap derivatives	$	—	$	3,053	$	—

December 31, 2016
Assets:
Investment securities available-for-sale	$	—	$	494,819	$	—
Interest rate swap derivatives	—		5,239		—
Total assets	$	—	$	500,058	$	—

Liabilities:
Interest rate swap derivatives	—		5,239		—

Certain assets are measured at fair value on a nonrecurring basis (e.g., the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments when there is evidence of impairment). The following table represents the assets measured at fair value on a nonrecurring basis by the Company at March 31, 2017 and December 31, 2016 (dollars in thousands):



	Level 1		Level 2		Level 3
March 31, 2017
Impaired loans	$	—	$	—	$	140
Other real estate owned	—		—		50
	$	—	$	—	$	190

December 31, 2016
Impaired loans	$	—	$	—	$	66
Other real estate owned	—		—		1,677
	$	—	$	—	$	1,743

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, 2017 and December 31, 2016 (dollars in thousands):



	March 31, 2017
	Fair Value Estimate		Valuation Techniques	Unobservable Input
Impaired loans	$	140	Market approach	Appraised value less selling costs of 5% to 10% Additional discounts of 5% to 90% to appraised value to reflect liquidation value
Other real estate owned	$	50	Market approach	Appraised value less selling costs of 5% to 10%

	December 31, 2016
	Fair Value Estimate		Valuation Techniques	Unobservable Input
Impaired loans	$	66	Market approach	Appraised value less selling costs of 5% to 10% Additional discounts of 70% to 100% to appraised value to reflect liquidation value
Other real estate owned	$	1,677	Market approach	Appraised value less selling costs of 5% to 10%

The Company did not change the methodology used to determine fair value for any assets or liabilities during the three months ended March 31, 2017 or during 2016. In addition, for any given class of assets, the Company did not have any transfers between level 1, level 2, or level 3 during the three months ended March 31, 2017 or during 2016.

The following disclosures are made in accordance with the provisions of GAAP, which requires the disclosure of fair value information about financial instruments where it is practicable to estimate that value.

In cases where quoted market values are not available, the Company primarily uses present value techniques to estimate the fair value of its financial instruments. Valuation methods require considerable judgment, and the resulting estimates of fair value can be significantly affected by the assumptions made and methods used. Accordingly, the estimates provided herein do not necessarily indicate amounts which could be realized in a current market exchange.

In addition, as the Company normally intends to hold the majority of its financial instruments until maturity, it does not expect to realize many of the estimated amounts disclosed. The disclosures also do not include estimated fair value amounts for items which are not defined as financial instruments but which may have significant value. The Company does not believe that it would be practicable to estimate a representational fair value for these types of items as of March 31, 2017 and December 31, 2016.

Because GAAP excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements, any aggregation of the fair value amounts presented would not represent the underlying value of the Company.

The Company uses the following methods and assumptions to estimate the fair value of its financial instruments:

Cash and cash equivalents: The carrying amount approximates the estimated fair value of these instruments.

Investment securities: See above description.

FHLB stock: The carrying amount approximates the estimated fair value of this investment.

Loans: The estimated fair value of non-impaired loans is calculated by discounting the contractual cash flows of the loans using March 31, 2017 and December 31, 2016 origination rates. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated. Estimated fair values for impaired loans are determined using an observable market price (if available) or the fair value of the loan’s collateral (if collateral dependent) as described above. Observable market prices for community bank loans are not generally available given the non-homogenous characteristics of such loans.

BOLI: The carrying amount of both the separate and general account BOLI approximates the estimated fair value of these instruments. Fair values of insurance policies owned are based on the insurance contracts’ cash surrender values.

MSRs: The estimated fair value of MSRs is calculated by discounting the expected future contractual cash flows. Factors considered in the estimated fair value calculation include prepayment speed forecasts, market discount rates, earning rates, servicing costs, acquisition costs, ancillary income, and borrower rates.

Deposits: The estimated fair value of demand deposits, consisting of checking, interest bearing demand, and savings deposit accounts, is represented by the amounts payable on demand. At the reporting date, the estimated fair value of time deposits is calculated by discounting the scheduled cash flows using the March 31, 2017 and December 31, 2016 rates offered on those instruments.

Other borrowings: The fair value of other borrowings (including federal funds purchased, if any) is estimated using discounted cash flow analysis based on the Bank’s March 31, 2017 and December 31, 2016 incremental borrowing rates for similar types of borrowing arrangements.

Loan commitments and standby letters of credit: The majority of the Bank’s commitments to extend credit have variable interest rates and “escape” clauses if the customer’s credit quality deteriorates. Therefore, the fair values of these items are not significant and are not included in the following table.

The estimated fair values of the Company’s significant on-balance sheet financial instruments at March 31, 2017 and December 31, 2016 were approximately as follows (dollars in thousands):



		March 31, 2017				December 31, 2016
	Level in Fair Value Hierarchy	Carrying value		Estimated fair value		Carrying value		Estimated fair value
Financial assets:
Cash and cash equivalents	Level 1	$	157,268	$	157,268	$	72,577	$	72,577
Investment securities:
Available-for-sale	Level 2	469,720		469,720		494,819		494,819
Held-to-maturity	Level 2	139,196		141,594		140,557		142,272
FHLB stock	Level 2	3,838		3,838		3,268		3,268
Loans held-for-sale	Level 2	4,066		4,066		8,651		8,651
Loans, net	Level 3	2,088,174		2,078,424		2,077,358		2,064,937
BOLI	Level 3	56,869		56,869		56,957		56,957
MSRs	Level 3	2,423		3,701		2,348		3,321
Interest rate swap derivatives	Level 2	3,053		3,053		5,239		5,239

Financial liabilities:
Deposits	Level 2	2,714,781		2,713,431		2,661,813		2,661,045
Interest rate swap derivatives	Level 2	3,053		3,053		5,239		5,239