NOTE 11 - Fair Value Disclosures

Fair value is the exchange price that would be received for an asset or 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 values:

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 company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The methods of determining the fair value of assets and liabilities presented in this note are consistent with our methodologies disclosed in our annual financial statements.

Assets measured at fair value on a recurring basis are summarized in the table below. There were no liabilities measured at fair value on a recurring basis at September 30, 2014 and December 31, 2013.

	Fair Value Measurements Using						Total
September 30, 2014:	Level 1		Level 2		Level 3		Fair Value
Securities available for sale
U.S. Government agency obligations	$	—	$	90,737	$	—	$	90,737
Mortgage-backed securities-residential		—		30,713		—		30,713
Asset backed securities		—		18,795		—		18,795
State and municipal		—		4,603		3,495		8,098
Corporate bonds		—		16,931		—		16,931
SBA pooled securities		—		215		—		215
	$	—	$	161,994	$	3,495	$	165,489
Loans held for sale
Mortgages		—		7,295		—		7,295
	$	—	$	7,295	$	—	$	7,295

	Fair Value Measurements Using						Total
December 31, 2013:	Level 1		Level 2		Level 3		Fair Value
Securities available for sale
U.S. Government agency obligations	$	—	$	95,834	$	—	$	95,834
Mortgage-backed securities-residential		—		36,285		—		36,285
Asset backed securities		—		18,839		—		18,839
State and municipal		—		5,423		3,582		9,005
Corporate bonds		—		20,843		—		20,843
SBA pooled securities		—		248		—		248
Trust preferred		—		3,600		—		3,600
	$	—	$	181,072	$	3,582	$	184,654
Loans held for sale
Mortgages		—		5,393		—		5,393
	$	—	$	5,393	$	—	$	5,393

There were no transfers between levels during 2014 or 2013.

At September 30, 2014, the Company classified $3,495 of municipal securities as level 3. These municipal securities are bond issues for municipal government entities located in northwestern Illinois and are privately placed, non-rated bonds without CUSIP numbers. The municipal securities are valued by an independent third party using matrix pricing according to the municipal bond index that most closely matches the bond issue. Fair values for each maturity of the bond issue are then calculated based on the index yield at the appropriate point on the yield curve. The Company does not make any internal adjustments to the third party bond valuations. The only activity related to the above level 3 securities during the nine months ended September 30, 2014 was associated with immaterial contractual payments and changes in fair value that were recorded in other comprehensive income.

Assets measured at fair value on a non-recurring basis are summarized in the table below. There were no liabilities measured at fair value on a non-recurring basis at September 30, 2014 and December 31, 2013.

	Fair Value Measurements Using						Total
September 30, 2014:	Level 1		Level 2		Level 3		Fair Value
Impaired loans
1-4 family residential properties	$	—	$	—	$	321	$	321
Commercial		—		—		732		732
Factored receivables		—		—		141		141
Other real estate owned⁽¹⁾:
1-4 family residential properties		—		—		97		97
Commercial		—		—		391		391
Construction, land development, land		—		—		870		870
	$	—	$	—	$	2,552	$	2,552

	Fair Value Measurements Using						Total
December 31, 2013:	Level 1		Level 2		Level 3		Fair Value
Impaired loans
1-4 family residential properties	$	—	$	—	$	106	$	106
Commercial		—		—		200		200
Factored receivables		—		—		345		345
Other real estate owned⁽¹⁾:
1-4 family residential properties		—		—		367		367
Commercial		—		—		653		653
Construction, land development, land		—		—		—		—
	$	—	$	—	$	1,671	$	1,671

	September 30, 2014				December 31, 2013
Provision recorded for loans classified as impaired	$	699			$	14
Valuation adjustments recorded on other real estate owned	$	363			$	144

⁽¹⁾ Represents the fair value of OREO that was adjusted subsequent to its initial classification as OREO

Impaired Loans with Specific Allocation of ALLL: A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due pursuant to the contractual terms of the loan agreement. Impairment is measured by estimating the fair value of the loan based on the present value of expected cash flows, the market price of the loan, or the underlying fair value of the loan’s collateral. Fair value of the impaired loan’s collateral is determined by third party appraisals, which are then adjusted for the estimated selling and closing costs related to liquidation of the collateral. Unobservable inputs for estimated selling and closing costs range from 5% to 8% of the value of the underlying collateral.

OREO: OREO is comprised of real estate acquired in partial or full satisfaction of loans. OREO is recorded at its estimated fair value less estimated selling and closing costs at the date of transfer, with any excess of the related loan balance over the fair value less expected selling costs is charged to the ALLL. Subsequent changes in fair value are reported as adjustments to the carrying amount and are recorded against earnings. The Company outsources the valuation of OREO with material balances to third party appraisers. For this asset class, the actual valuation methods (income, sales comparable, or cost) vary based on the status of the project or property. For example, land is generally based on the sales comparable method while construction is based on the income and/or sales comparable methods. The unobservable inputs may vary depending on the individual assets with no one of the three methods being the predominant approach. The Company reviews the third party appraisal for appropriateness and adjusts the value downward to consider selling and closing costs, which typically range from 5% to 8% of the appraised value.

The estimated fair values of the Company’s financial instruments at September 30, 2014 and December 31, 2013 were as follows:

	September 30, 2014
	Carrying		Fair Value Measurements Using						Total
	Amount		Level 1		Level 2		Level 3		Fair Value
Financial assets:
Cash and cash equivalents	$	75,625	$	75,625	$	—	$	—	$	75,625
Securities - Held to maturity		745		—		750		—		750
Loans, net		969,819		—		—		977,509		977,509
FHLB and Federal Reserve Bank stock		5,826	N/A		N/A		N/A		N/A
Accrued interest receivable		4,127		—		4,127		—		4,127

Financial liabilities:
Deposits		1,105,624		—		1,109,111		—		1,109,111
Customer repurchase agreements		15,644		—		15,644		—		15,644
Federal Home Loan Bank advances		—		—		—		—		—
Senior secured note		11,630		—		11,434		—		11,434
Junior subordinated debentures		24,359		—		24,359		—		24,359
Accrued interest payable		901		—		901		—		901


	December 31, 2013
	Carrying		Fair Value Measurements Using						Total
	Amount		Level 1		Level 2		Level 3		Fair Value
Financial assets:
Cash and cash equivalents	$	85,797	$	85,797	$	—	$	—	$	85,797
Securities - Held to maturity		743		—		745		—		745
Loans, net		877,454		—		—		884,307		884,307
FHLB and Federal Reserve Bank stock		5,802	N/A		N/A		N/A		N/A
Accrued interest receivable		3,748		—		3,748		—		3,748

Financial liabilities:
Deposits		1,044,854		—		1,046,226		—		1,046,226
Customer repurchase agreements		11,330		—		11,329		—		11,329
Federal Home Loan Bank advances		21,000		—		21,000		—		21,000
Senior secured note		12,573		—		12,379		—		12,379
Junior subordinated debentures		24,171		—		24,171		—		24,171
Accrued interest payable		2,426		—		2,426		—		2,426