FAIR VALUE

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

Marketable Securities: The fair values for marketable securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

Loans Held For Sale: Loans held for sale are carried at the lower of cost or fair value, which is evaluated on a pool-level basis. The fair value of loans held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan or other observable market data, such as outstanding commitments from third party investors (Level 2).

Derivative Instruments: The fair values of derivatives are based on valuation models using observable market data as of the measurement date (Level 2).

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on the present value of estimated future cash flows using the loan's existing rate or, if repayment is expected solely from the collateral, the fair value of collateral, less costs to sell, is determined using 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. Such adjustments are usually significant (Level 3). Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business (Level 3). Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. 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. Real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly (Level 3).

The following tables summarize quantitative disclosures about the fair value measurements for each category of financial assets (liabilities) carried at fair value:



As of March 31, 2017	Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Other Unobservable Inputs (Level 3)
Assets (liabilities) at fair value on a recurring basis:
Available for sale securities
Mortgage-backed securities	$	79,545		$	—	$	79,545		$	—
Collateralized mortgage obligations	102,467			—		102,467			—
Municipal securities	7,278			—		7,278			—
Corporate bonds	25,173			—		25,173			—
Derivative instruments	(661		)	—		(661		)	—

Assets at fair value on a nonrecurring basis:
Impaired loans	9,921			—		—			9,921
Other real estate owned	1,637			—		—			1,637



As of December 31, 2016	Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Other Unobservable Inputs (Level 3)
Assets (liabilities) at fair value on a recurring basis:
Available for sale securities
Mortgage-backed securities	$	59,690		$	—	$	59,690		$	—
Collateralized mortgage obligations	65,133			—		65,133			—
Corporate bonds	24,883			—		24,883			—
U.S. treasury securities	—			—		—			—
Derivative instruments	(695		)	—		(695		)	—

Assets at fair value on a nonrecurring basis:
Impaired loans	6,065			—		—			6,065
Other real estate owned	1,692			—		—			1,692

There were no transfers between Level 2 and Level 3 during 2017 or 2016.

Nonfinancial Assets and Nonfinancial Liabilities

Nonfinancial assets measured at fair value on a nonrecurring basis during the three months ended March 31, 2017 and 2016 include certain foreclosed assets which, upon initial recognition, were remeasured and reported at fair value through a charge-off to the allowance for loan losses and certain foreclosed assets which, subsequent to their initial recognition, were remeasured at fair value through a write-down included in current earnings. The fair value of a foreclosed asset is estimated using Level 2 inputs based on observable market data or Level 3 inputs based on customized discounting criteria.

The following table presents foreclosed assets that were remeasured and recorded at fair value as of:



	March 31, 2017			December 31, 2016			March 31, 2016
Foreclosed assets remeasured at initial recognition:
Carrying value of foreclosed assets prior to remeasurement	$	87		$	78		$	134
Charge-offs recognized in the allowance for loan losses	(78		)	(11		)	(14		)
Fair value of foreclosed assets remeasured at initial recognition	$	9		$	67		$	120

Foreclosed assets remeasured subsequent to initial recognition:
Carrying value of foreclosed assets prior to remeasurement	$	—		$	170		$	—
Write-downs included in collection and other real estate owned expense	—			(69		)	—
Fair value of foreclosed assets remeasured subsequent to initial recognition	$	—		$	101		$	—

The following tables present quantitative information about nonrecurring Level 3 fair value measurements as of:



	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
March 31, 2017
Impaired loans	$	9,921	Fair value of collateral - sales comparison approach	Selling costs or other normal adjustments: Real estate Equipment	10%-20% (16%) 10%-20% (14%)
Other real estate owned	$	1,637	Appraisal value of collateral	Selling costs or other normal adjustments	10%-20% (16%)



	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
December 31, 2016
Impaired loans	$	6,065	Fair value of collateral - sales comparison approach	Selling costs or other normal adjustments: Real estate Equipment	10%-20% (16%) 40%-50% (42%)
Other real estate owned	$	1,692	Appraisal value of collateral	Selling costs or other normal adjustments	10%-20% (16%)

The carrying amounts and estimated fair values of financial instruments, not previously in this note, as of March 31, 2017 and December 31, 2016 are as follows:



	Fair value measurements as of March 31, 2017 using:
	Carrying Amount		Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
Financial assets:
Cash, due from banks, federal funds sold and interest-bearing deposits	$	143,757	$	115,751	$	28,006	$	—	$	143,757
Marketable securities held to maturity	185,837		—		184,412		—		184,412
Loans, net	1,241,215		—		—		1,246,011		1,246,011
Accrued interest receivable	6,304		—		6,304		—		6,304
Nonmarketable equity securities	7,285		—		7,285		—		7,285
Cash surrender value of life insurance	17,922		—		17,922		—		17,922
Financial liabilities:
Deposits	$	1,671,171	$	1,335,456	$	336,371	$	—	$	1,671,827
Securities sold under repurchase agreements	12,663		—		12,663		—		12,663
Accrued interest payable	1,010		—		1,010		—		1,010
Other debt	18,929		—		18,929		—		18,929
Federal Home Loan Bank advances	25,165		—		25,163		—		25,163
Subordinated debentures	19,310		—		16,852		—		16,852



	Fair value measurements as of December 31, 2016 using:
	Carrying Amount		Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
Financial assets:
Cash, due from banks, federal funds sold and interest-bearing deposits	$	127,543	$	100,205	$	27,338	$	—	$	127,543
Marketable securities held to maturity	189,371		—		186,155		—		186,155
Loans, net	1,233,651		—		—		1,235,306		1,235,306
Accrued interest receivable	7,419		—		7,419		—		7,419
Nonmarketable equity securities	10,500		—		10,500		—		10,500
Cash surrender value of life insurance	17,804		—		17,804		—		17,804
Financial liabilities:
Deposits	$	1,576,791	$	1,234,875	$	342,615	$	—	$	1,577,490
Securities sold under repurchase agreements	10,859		—		10,859		—		10,859
Accrued interest payable	889		—		889		—		889
Other debt	18,286		—		18,286		—		18,286
Federal Home Loan Bank advances	55,170		—		55,160		—		55,160
Subordinated debentures	19,310		—		16,809		—		16,809

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values (Level 1).

Loans, net

The fair value of fixed-rate loans and variable-rate loans that reprice on an infrequent basis is estimated by discounting future cash flows using the current interest rates at which similar loans with similar terms would be made to borrowers of similar credit quality (Level 3).

Cash Surrender Value of Life Insurance

The carrying amounts of bank-owned life insurance approximate their fair value.

Nonmarketable Equity Securities

It is not practical to determine the fair value of Independent Bankers Financial Corporation, Federal Home Loan Bank, Federal Reserve Bank and other stock due to restrictions placed on its transferability.

Deposits and Securities Sold Under Repurchase Agreements

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) (Level 1). The fair values of deposit liabilities with defined maturities are estimated by discounting future cash flows using interest rates currently offered for deposits of similar remaining maturities (Level 2).

Other Borrowings

The fair value of borrowings, consisting of lines of credit, Federal Home Loan Bank advances and Subordinated debentures is estimated by discounting future cash flows using currently available rates for similar financing (Level 2).

Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate their fair values (Level 2).

Off-balance Sheet Instruments

Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.