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, 2015.

($ in thousands)
Description of Financial Instruments	Fair Value at December 31, 2015		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	$	18,972		—		18,972		—
Mortgage-backed securities		121,553		—		121,553		—
Corporate bonds		24,946		—		24,946		—
Equity securities		143		—		143		—
Total available for sale securities	$	165,614		—		165,614		—

Nonrecurring
Impaired loans – covered	$	2,588		—		—		2,588
Impaired loans – non-covered		18,057		—		—		18,057
Foreclosed real estate – covered		806		—		—		806
Foreclosed real estate – non-covered		9,188		—		—		9,188

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		122		—		122		—
Total available for sale securities	$	158,018		—		158,018		—

Nonrecurring
Impaired loans – covered	$	3,991		—		—		3,991
Impaired loans – non-covered		18,035		—		—		18,035
Foreclosed real estate – covered		2,350		—		—		2,350
Foreclosed real estate – non-covered		9,771		—		—		9,771

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 bond accounting provider 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 bond accounting provider 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 bond accounting provider 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.

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.

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of December 31, 2015, the significant unobservable inputs used in the fair value measurements were as follows:

($ in thousands)

Description

Fair Value at
December 31, 2015

Valuation
Technique

Significant Unobservable
Inputs

General Range
of Significant Unobservable
Input Values

Impaired loans – covered

2,588

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

18,057

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

806

Appraised value; List or contract price

Discounts to reflect current market conditions and estimated costs to sell

0-10%

Foreclosed real estate – non-covered

9,188

Appraised value; List or contract price

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

0-10%

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

3,991

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

18,035

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; List or contract price

Discounts to reflect current market conditions and estimated costs to sell

0-10%

Foreclosed real estate – non-covered

9,771

Appraised value; List or contract price

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

0-10%

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, 2015 or 2014.

For the years ended December 31, 2015 and 2014, the increase (decrease) in the fair value of securities available for sale was ($473,000) and $1,329,000, respectively, which is included in other comprehensive income (net of tax expense (benefit) of ($184,000) and $518,000, respectively). Fair value measurement methods at December 31, 2015 and 2014 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, 2015 and 2014 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, 2015				December 31, 2014
($ 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	$	53,285	$	53,285		81,068		81,068
Due from banks, interest-bearing	Level 1		213,426		213,426		171,248		171,248
Federal funds sold	Level 1		557		557		768		768
Securities available for sale	Level 2		165,614		165,614		158,018		158,018
Securities held to maturity	Level 2		154,610		157,146		178,687		182,411
Presold mortgages in process of settlement	Level 1		4,323		4,323		6,019		6,019
Total loans, net of allowance	Level 3		2,490,343		2,484,059		2,355,548		2,328,244
Accrued interest receivable	Level 1		9,166		9,166		8,920		8,920
FDIC indemnification asset	Level 3		8,439		8,256		22,569		21,856
Bank-owned life insurance	Level 1		72,086		72,086		55,421		55,421

Deposits	Level 2		2,811,285		2,809,828		2,695,906		2,696,153
Borrowings	Level 2		186,394		178,468		116,394		105,407
Accrued interest payable	Level 2		585		585		686		686

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.