Note 14. Fair Value of Financial Instruments

Relevant accounting guidance establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) of 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 assumptions about the assumptions that market participants would use in pricing an asset or liability.

The following table summarizes the Company's financial instruments that were measured at fair value on a recurring and nonrecurring basis at December 31, 2014.

($ in thousands)
Description of Financial Instruments	Fair Value at December 31, 2014		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Recurring
Securities available for sale:
Government-sponsored enterprise securities	$	27,521		—		27,521		—
Mortgage-backed securities		129,510		—		129,510		—
Corporate bonds		865		—		865		—
Equity securities		6,138		—		6,138		—
Total available for sale securities	$	164,034		—		164,034		—

Nonrecurring
Impaired loans – covered	$	5,220		—		—		5,220
Impaired loans – non-covered		20,512		—		—		20,512
Foreclosed real estate – covered		2,350		—		—		2,350
Foreclosed real estate – non-covered		9,771		—		—		9,771

The following table summarizes the Company's financial instruments that were measured at fair value on a recurring and nonrecurring basis at December 31, 2013.

($ in thousands)
Description of Financial Instruments	Fair Value at December 31, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Recurring
Securities available for sale:
Government-sponsored enterprise securities	$	18,245		—		18,245		—
Mortgage-backed securities		147,187		—		147,187		—
Corporate bonds		3,598		—		3,598		—
Equity securities		4,011		—		4,011		—
Total available for sale securities	$	173,041		—		173,041		—

Nonrecurring
Impaired loans – covered	$	15,284		—		—		15,284
Impaired loans – non-covered		13,020		—		—		13,020
Foreclosed real estate – covered		24,497		—		—		24,497
Foreclosed real estate – non-covered		12,251		—		—		12,251

The following is a description of the valuation methodologies used for instruments measured at fair value.

Securities Available for Sale — When quoted market prices are available in an active market, the securities are classified as Level 1 in the valuation hierarchy. If quoted market prices are not available, but fair values can be estimated by observing quoted prices of securities with similar characteristics, the securities are classified as Level 2 on the valuation hierarchy. Most of the fair values for the Company's Level 2 securities are determined by our third-party securities portfolio manager using matrix pricing. Matrix pricing 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. For the Company, Level 2 securities include mortgage-backed securities, collateralized mortgage obligations, government-sponsored enterprise securities, and corporate bonds. In cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.

The Company reviews the pricing methodologies utilized by the portfolio manager to ensure the fair value determination is consistent with the applicable accounting guidance and that the investments are properly classified in the fair value hierarchy. Further, the Company validates the fair values for a sample of securities in the portfolio by comparing the fair values provided by the portfolio manager to prices from other independent sources for the same or similar securities. The Company analyzes unusual or significant variances and conducts additional research with the portfolio manager, if necessary, and takes appropriate action based on its findings.

Impaired loans — Fair values for impaired loans in the above table are measured on a non-recurring basis and are based on the underlying collateral values securing the loans, adjusted for estimated selling costs, or the net present value of the cash flows expected to be received for such loans. Collateral may be in the form of real estate or business assets including equipment, inventory and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined using an income or market valuation approach based on an appraisal conducted by an independent, licensed third party appraiser (Level 3). The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable borrower's financial statements if not considered significant. Likewise, values for inventory and accounts receivable collateral are based on borrower financial statement balances or aging reports on a discounted basis as appropriate (Level 3). Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income (Loss).

Foreclosed real estate – Foreclosed real estate, consisting of properties obtained through foreclosure or in satisfaction of loans, is reported at the lower of cost or fair value. Fair value is measured on a non-recurring basis and is based upon independent market prices or current appraisals that are generally prepared using an income or market valuation approach and conducted by an independent, licensed third party appraiser, adjusted for estimated selling costs (Level 3). At the time of foreclosure, any excess of the loan balance over the fair value of the real estate held as collateral is treated as a charge against the allowance for loan losses. For any real estate valuations subsequent to foreclosure, any excess of the real estate recorded value over the fair value of the real estate is treated as a foreclosed real estate write-down on the Consolidated Statements of Income (Loss). In December 2012, the Company recorded a write-down of $10.6 million related to its non-covered foreclosed properties. This write-down reduced the carrying value of these properties by approximately 29% beyond their standard carrying value as described above. This write-down was recorded because of management's intent to dispose of these properties in an expedited manner and accept sales prices lower than prior practice.

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of December 31, 2014, the significant unobservable inputs used in the fair value measurements were as follows:

($ in thousands)

Description

Fair Value at December 31, 2014

Valuation Technique

Significant Unobservable Inputs

General Range of Significant Unobservable Input Values

Impaired loans – covered

5,220

Appraised value; PV of expected cash flows

Discounts to reflect current market conditions, ultimate collectability, and estimated costs to sell

0-10%

Impaired loans – non-covered

20,512

Appraised value; PV of expected cash flows

Discounts to reflect current market conditions, ultimate collectability, and estimated costs to sell

0-10%

Foreclosed real estate – covered

2,350

Appraised value; independent market prices

Discounts to reflect current market conditions and estimated costs to sell

0-10%

Foreclosed real estate – non-covered

9,771

Appraised value; independent market prices

Discounts to reflect current market conditions, abbreviated holding period and estimated costs to sell

0-40%

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of December 31, 2013, the significant unobservable inputs used in the fair value measurements were as follows:

($ in thousands)

Description

Fair Value at December 31, 2013

Valuation Technique

Significant Unobservable Inputs

General Range of Significant Unobservable Input Values

Impaired loans – covered

15,284

Appraised value

Discounts to reflect current market conditions, ultimate collectability, and estimated costs to sell

0-10%

Impaired loans – non-covered

13,020

Appraised value

Discounts to reflect current market conditions, ultimate collectability, and estimated costs to sell

0-37%

Foreclosed real estate – covered

24,497

Appraised value

Discounts to reflect current market conditions and estimated costs to sell

0-10%

Foreclosed real estate – non-covered

12,251

Appraised value

Discounts to reflect current market conditions, abbreviated holding period and estimated costs to sell

0-40%

Transfers of assets or liabilities between levels within the fair value hierarchy are recognized when an event or change in circumstances occurs. There were no transfers between Level 1 and Level 2 for assets or liabilities measured on a recurring basis during the years ended December 31, 2014 or 2013.

For the years ended December 31, 2014 and 2013, the increase (decrease) in the fair value of securities available for sale was $1,329,000 and ($5,311,000), respectively, which is included in other comprehensive income (net of tax expense (benefit) of $518,000 and ($2,072,000), respectively). Fair value measurement methods at December 31, 2014 and 2013 are consistent with those used in prior reporting periods.

As discussed in Note 1(p), the Company is required to disclose estimated fair values for its financial instruments.

Fair value estimates as of December 31, 2014 and 2013 and limitations thereon are set forth below for the Company's financial instruments. See Note 1(p) for a discussion of fair value methods and assumptions, as well as fair value information for off-balance sheet financial instruments.

		December 31, 2014				December 31, 2013
($ in thousands)	Level in Fair Value Hierarchy	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value

Cash and due from banks, noninterest-bearing	Level 1	$	81,068		81,068		83,881		83,881
Due from banks, interest-bearing	Level 1		171,248		171,248		136,644		136,644
Federal funds sold	Level 1		768		768		2,749		2,749
Securities available for sale	Level 2		164,034		164,034		173,041		173,041
Securities held to maturity	Level 2		178,687		182,411		53,995		56,700
Presold mortgages in process of settlement	Level 1		6,019		6,019		5,422		5,422
Total loans, net of allowance	Level 3		2,355,548		2,328,244		2,414,689		2,352,834
Accrued interest receivable	Level 1		8,920		8,920		9,649		9,649
FDIC indemnification asset	Level 3		22,569		21,856		48,622		47,032
Bank-owned life insurance	Level 1		55,421		55,421		44,040		44,040

Deposits	Level 2		2,695,906		2,696,153		2,751,019		2,752,375
Borrowings	Level 2		116,394		105,407		46,394		34,795
Accrued interest payable	Level 2		686		686		879		879

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no highly liquid market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities include net premises and equipment, intangible and other assets such as deferred income taxes, prepaid expense accounts, income taxes currently payable and other various accrued expenses. In addition, the income tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.