NOTE 9 – FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an 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 Company 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 market prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use to price an asset or liability.

The Company used the following methods and significant assumptions to estimate fair value.

Securities and mortgage-backed securities. The fair value of securities available for sale is determined by obtaining quoted market prices on nationally recognized securities exchanges, if available (Level 1 inputs). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities. The fair value of mortgage-backed securities is determined through matrix pricing. This is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

Loans held for sale at fair value. The fair value of loans held for sale, which consists of single-family residential loans, is determined using quoted secondary market prices, adjusted for specific attributes of that loan or other observable data, such as outstanding commitments from third-party investors (Level 2 inputs).

Mortgage banking pipeline derivatives. The fair value of loan commitments is measured using current market rates for the associated mortgage loans (Level 2 inputs). The fair value of mandatory forward sales contracts is measured using secondary market pricing for similar product types (Level 2 inputs).

Impaired loans. The fair value of impaired loans with specific allocations of the allowance for loan losses is generally 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 as well as type and status of the property. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Other real estate owned. Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use 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 approach. 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. When the appraisals are received, Credit Administration reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. The Company currently utilizes a 9% discount for selling costs and it is applied to all properties, regardless of size. This discount is supported by the Company’s most recent analysis. Also, an additional 10% discount is applied to properties with appraisals performed greater than 12 months ago.

Loan 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 on 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 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).

Assets and liabilities measured at fair value on a recurring basis at March 31, 2013 and June 30, 2012, respectively, are summarized below:


	March 31, 2013			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Assets:
Securities available for sale:
FNMA structured note	$	—		$	—	$	—		$	—
Trust preferred securities		20,433,603			—		20,433,603			—
Mortgage-backed GSE securities		20,985,802			—		20,985,802			—
Loans held-for-sale		9,348,347			—		9,348,347			—
Interest rate-lock commitments		1,625,572			—		1,625,572			—
Liabilities:
Mandatory forward sales contracts		(77,959	)		—		(77,959	)		—


	June 30, 2012			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Assets:
Securities available for sale:
FNMA structured note	$	2,009,320		$	—	$	2,009,320		$	—
Trust preferred securities		21,261,762			—		21,261,762			—
Mortgage-backed GSE securities		15,386,963			—		15,386,963			—
Loans held-for-sale		25,062,786			—		25,062,786			—
Interest rate-lock commitments		1,773,453			—		1,773,453			—
Liabilities:
Mandatory forward sales contracts		(117,718	)		—		(117,718	)		—

There were no transfers between Level 1 and Level 2 in the period ended March 31, 2013 or June 30, 2012. The Company’s policy is to transfer assets or liabilities from one level to another when the methodology to obtain the fair value changes such that there are more or fewer unobservable inputs.

Assets measured at fair value on a nonrecurring basis at March 31, 2013 and June 30, 2012, respectively are summarized below:


	March 31, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans
1-4 Family	$	3,801,913	$	—	$	—	$	3,801,913
1-4 Family Construction		521,363		—		—		521,363
Multi-Family		—		—		—		—
Commercial Real Estate		4,384,564		—		—		4,384,564
Commercial Non-Real Estate		585,042		—		—		585,042
Land		3,152,861		—		—		3,152,861
Real estate owned
1-4 Family		2,381,281		—		—		2,381,281
Commercial Real Estate		1,893,521		—		—		1,893,521
Land		2,976,361		—		—		2,976,361
Impaired mortgage servicing rights		6,561,862		—		6,561,862		—


	June 30, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans
1-4 Family	$	4,033,385	$	—	$	—	$	4,033,385
1-4 Family Construction		660,862		—		—		660,862
Multi-Family		324,974		—		—		324,974
Commercial Real Estate		5,688,747		—		—		5,688,747
Commercial Non-Real Estate		238,229		—		—		238,229
Land		4,223,074		—		—		4,223,074
Real estate owned
1-4 Family		2,042,573		—		—		2,042,573
Commercial Real Estate		923,262		—		—		923,262
Land		2,914,174		—		—		2,914,174
Impaired mortgage servicing rights		6,499,157		—		6,499,157		—

Impaired loans that are measured for impairment using the fair value of the collateral for collateral dependent loans had a principal balance of $19.3 million after the application of impaired charge-offs of $6.1 million, with a specific valuation allowance of $0.8 million at March 31, 2013. At June 30, 2012, impaired loans that are measured for impairment using the fair value of the collateral for collateral dependent loans had a principal balance of $26.3 million after the application of impaired charge-offs of $9.7 million, with a specific valuation allowance of $1.4 million. There was no provision for loan losses related to changes in fair value of impaired loans for the three months ended March 31, 2013 compared to the provision of $2.0 million for the three months ended March 31, 2012. The provision for loan losses related to changes in the fair value of impaired loans was $0.6 million and $5.5 million for the nine months ended March 31, 2013 and 2012, respectively.

Tranches of mortgage servicing rights carried at fair value totaled $6.5 million, which is made up of the outstanding balance of $7.9 million, net of a valuation allowance of $1.4 million at March 31, 2013. During the nine months ended March 31, 2013 and 2012, the Company recognized an impairment charge of $0.5 million and $0.6 million, respectively. During the three months ended March 31, 2013 and 2012 the Company recognized recoveries of $0.2 million and $0.1 million respectively. Tranches of mortgage servicing rights carried at fair value totaled $6.5 million, which is made up of the outstanding balance of $7.3 million, net of a valuation allowance of $0.8 million at June 30, 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.

Other real estate owned which is maintained at fair value less costs to sell, had a net carrying amount of $7,251,163 and $7,733,578 at March 31, 2013, and June 30, 2012, respectively. The carrying amount of other real estate owned is not re-measured to fair value on a recurring basis, but is subject to fair value adjustments when the carrying amount exceeds the fair value, less estimated selling costs. For the nine months ended March 31, 2013, the Company recognized a net loss of $182,703 on the disposal of other real estate owned compared to the loss of $453,770 recognized for the nine months ended March 31, 2012. The Company also recorded a provision for other real estate owned losses of $1.0 and $1.3 million for the nine months ended March 31, 2013 and 2012, respectively. For the three months ended March 31, 2013 and 2012 the Company recognized a net loss of $0.1 million and $0.2 million respectively. The Company also recorded a provision for other real estate owned losses of $0.5 million and $0.4 million for the three months ended March 31, 2013 and 2012 respectively.

The direct write-downs recognized for the period are the result of obtaining updated appraisal valuations and reflect declining property values while holding the asset. The Company values all other real estate owned by obtaining updated appraisal valuations every twelve months. There have been no upward adjustments made in determining fair value.

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at March 31, 2013:


	Fair value at March 31, 2013		Valuation Techniques	Unobservable Inputs	Range and Weighted Average
Impaired loans	$	12,445,743	Appraisal value - sales comparison approach	Adjustment by management to reflect current conditions and selling costs	10-15% and 12%
Real estate owned		7,251,163	Appraisal value - sales comparison approach	Adjustment by mangagement to reflect current conditions and selling costs	9-10% and 10%

The Company has elected the fair value option for loans held for sale. These loans are intended for sale and are hedged with derivative instruments, and the Company believes that the fair value is the best indicator of the valuation 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 days or more past due or on nonaccrual as of March 31, 2013 and June 30, 2012.

As of March 31, 2013 and June 30, 2012, the aggregate fair value, contractual balance (including accrued interest), and gain or loss loans held for sale was as follows:


	March 31, 2013		June 30, 2012
Aggregate fair value	$	9,348,387	$	25,062,786
Contractual balance		9,070,294		24,324,044
Gain (loss)		278,093		738,742

The total amount of gains (losses) from changes in fair value included in earnings for the nine months ended March 31, 2013 and 2012 for loans held for sale were $(460,649) and $215,785 respectively.

The carrying amounts and estimated fair values of financial instruments at March 31, 2013 are as follows:


	Carrying			Fair Value Measurements at March 31, 2013
	Value			Level 1			Level 2			Level 3		Total
	(dollars in thousands)
Assets:
Cash and amounts due from financial institutions	$	19,869		$	19,869		$	—		$	—	$	19,869
Interest-bearing deposits		80,125			80,125			—			—		80,125
Securities available for sale		41,419			—			41,419			—		41,419
Loans receivable, net		547,216			—			—			563,543		563,543
Loans receivable held for sale, net		9,348			—			9,348			—		9,348
Federal Home Loan Bank stock		12,811			N/A			N/A			N/A		N/A
Accrued interest receivable		2,165			—			123			2,042		2,165
Commitments to make loans intended to be sold		1,626			—			1,626			—		1,626
Liabilities:
Demand deposits and savings		(297,912	)		(297,912	)		—			—		(297,912	)
Time deposits		(323,256	)		—			(325,192	)		—		(325,192	)
Notes payable		(966	)		—			(966	)		—		(966	)
Advances from the Federal Home Loan Bank		(35,000	)		—			(36,864	)		—		(36,864	)
Mandatory forward sale contract		(78	)		(78	)		—			—		(78	)
Accrued interest payable		(121	)		(33	)		(88	)				(121	)

The carrying amount and estimated fair values of financial instruments at June 30, 2012 were as follows:


				Fair Value Measurements at June 30, 2012
	Carrying Value			Level 1			Level 2			Level 3		Total
	(dollars in thousands)
Assets:
Cash and amounts due from financial institutions	$	5,841		$	5,841		$	—		$	—	$	5,841
Interest-bearing deposits		114,270			114,270			—			—		114,270
Securities available for sale		38,658			—			38,658			—		38,658
Loans receivable, net		541,628			—			—			569,603		569,603
Loans receivable held for sale, net		25,063			—			25,063			—		25,063
Federal Home Loan Bank stock		12,811			N/A			N/A			N/A		N/A
Accrued interest receivable		2,047			—			174			1,873		2,047
Commitments to make loans intended to be sold		1,773			—			1,773			—		1,773
Liabilities:
Demand deposits and savings		(271,412	)		(271,412	)		—			—		(271,412	)
Time deposits		(384,567	)		—			(385,872	)		—		(385,872	)
Notes payable		(1,046	)		—			(1,046	)		—		(1,046	)
Advances from the Federal Home Loan Bank		(35,000	)		—			(37,222	)		—		(37,222	)
Mandatory forward sale contract		(118	)		—			(118	)		—		(118	)
Accrued interest payable		(120	)		(112	)		(8	)		—		(120	)

The estimated fair value amounts were determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is involved in interpreting market data so as to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange and may not necessarily be the exit price. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

The Company used the following methods and assumptions to estimate fair value for items not described above:

Cash and amounts due from financial institutions, interest-bearing deposits, and federal funds sold. The carrying amounts are a reasonable estimate of fair value because of the short maturity of these instruments and therefore are classified as Level 1.

Loans receivable. For performing 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. For other performing loans receivable, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using discount rates based on secondary market sources adjusted to reflect differences in servicing and credit costs resulting in a Level 3 classification.

Federal Home Loan Bank stock. It was not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

Accrued interest receivable and accrued interest payable. The carrying amount is a reasonable estimate of the fair value. The fair value level classification is consistent with the related final instrument.

Demand deposits and time deposits. The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date resulting in a Level 1 classification. The fair value of fixed-maturity certificates of deposit is estimated using discounted cash flows and rates currently offered for deposits of similar remaining maturities resulting in a Level 2 classification.

Note payable. The carrying amount is a reasonable estimate of the fair value resulting in a Level 2 classification.

Federal Home Loan Bank Advance. The fair value of the Company’s FHLB debt is estimated based on the current rates offered to the Company for debt of the same remaining maturities resulting in a Level 2 classification.