2. Fair Value Measurements

Assets Measured at Fair Value on a Recurring Basis

The following tables show the recorded amounts of assets and liabilities measured at fair value on a recurring basis as of:

			Fair Value Measurement Level
	Total		Level 1		Level 2		Level 3
(dollars in thousands)
September 30, 2014:
Investment securities available for sale
US Treasury securities	$	300	$	—	$	300	$	—
FNMA and FHLB Agency notes		10,173		—		10,173		—
Agency mortgage-backed securities		124,287		—		124,287		—
Total assets at fair value on a recurring basis	$	134,760	$	—	$	134,760	$	—

December 31, 2013:
Investment securities available for sale
US Treasury securities	$	300	$	—	$	300	$	—
FNMA and FHLB Agency notes		9,780		—		9,780		—
Agency mortgage-backed securities		49,031		—		49,031		—
Total assets at fair value on a recurring basis	$	59,111	$	—	$	59,111	$	—

Assets Measured at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market or that were recognized at a fair value below cost at the end of the period.

Information regarding assets measured at fair value on a nonrecurring basis is set forth in the table below as of:

	September 30, 2014
(dollars in thousands)	Total		Level 1		Level 2		Level 3
Assets at Fair Value:
Impaired Loans	$	3,136	$	—	$	—	$	3,136
REO		334		—		334		—
Total	$	3,470	$	—	$	334	$	3,136

REO with a carrying value of $1.8 million was foreclosed on during the first nine months of 2014. REO with carrying values of $3.2 million were disposed during the first nine months of 2014. There were no other significant transfers in or out of assets measured at fair value on a nonrecurring basis during the first nine months of 2014.

The following table provides quantitative information about the Company’s nonrecurring Level 3 fair value measurements as of:

(dollars in thousands)

Valuation Technique

Unobservable
Input

Estimate
Used

Fair Value

June 30, 2014:

Impaired Loans

Third party appraisal

Selling costs

9.0%

3,136

December 31, 2013:

REO

Third party appraisal

Selling costs

9.0%

375

Fair Value of Financial Instruments

We have elected to use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available for sale are measured at fair value on a recurring basis. Additionally, from time to time, we may be required to measure at fair value other assets on a nonrecurring basis, such as loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Fair value estimates are made at a discrete point in time based on relevant market information and other information about the financial instruments. Because no active market exists for a significant portion of our financial instruments, fair value estimates are based in large part on judgments we make primarily regarding current economic conditions, risk characteristics of various financial instruments, prepayment rates, and future expected loss experience. These estimates are subjective in nature and invariably involve some inherent uncertainties. Additionally, unexpected changes in events or circumstances can occur that could require us to make changes to our assumptions and which, in turn, could significantly affect and require us to make changes to our previous estimates of fair value.

In addition, the fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of existing and anticipated future customer relationships and the value of assets and liabilities that are not considered financial instruments, such as premises and equipment and other real estate owned.

The following methods and assumptions were used to estimate the fair value of financial instruments.

Cash and Cash Equivalents. The fair value of cash and cash equivalents approximates its carrying value.

Interest-Bearing Deposits with Financial Institutions. The fair values of interest-bearing deposits maturing within ninety days approximate their carrying values.

Investment Securities Available for Sale. Investment securities available-for-sale are measured at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as level 3 include asset-backed securities in less liquid markets.

Federal Home Loan Bank and Federal Reserve Bank Stock. The Bank is a member of the Federal Home Loan Bank (the “FHLB”) and the Federal Reserve Bank of San Francisco (the “FRB”). As members, we are required to own stock of the FHLB and the FRB, the amount of which is based primarily on the level of our borrowings from those institutions. We also have the right to acquire additional shares of stock in either or both of the FHLB and the FRB; however, to date, we have not done so. The fair values of that stock are equal to their respective carrying amounts, are classified as restricted securities and are periodically evaluated for impairment based on our assessment of the ultimate recoverability of our investments in that stock. Any cash or stock dividends paid to us on such stock are reported as income.

Loans . The fair value for loans with variable interest rates is the carrying amount. The fair value of fixed rate loans is derived by calculating the discounted value of future cash flows expected to be received by the various homogeneous categories of loans. All loans have been adjusted to reflect changes in credit risk.

Impaired Loans. ASC 820-10 applies to loans measured for impairment in accordance with ASC 310-10, “Accounting by Creditors for Impairment of a Loan”, including impaired loans measured at an observable market price (if available), and at the fair value of the loan’s collateral (if the loan is collateral dependent) less selling cost. The fair value of an impaired loan is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. When the fair value of the collateral is based on an observable market price or a current appraised value, we measure the impaired loan at nonrecurring Level 2. When an appraised value is not available, or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price or a discounted cash flow has been used to determine the fair value, we measure the impaired loan at nonrecurring Level 3.

Foreclosed Assets. Foreclosed assets are adjusted to the lower of cost or fair value, less estimated costs to sell, at the time the loans are transferred to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value, less estimated costs to sell. Fair value is determined on the basis of independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, we measure the foreclosed asset at nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we measure the foreclosed asset at nonrecurring Level 3.

Deposits. The fair value of demand deposits, savings deposits, and money market deposits is defined as the amounts payable on demand at quarter-end. The fair value of fixed maturity certificates of deposit is estimated based on the discounted value of the future cash flows expected to be paid on the deposits.

Borrowings . The fair value of $208 million in borrowings is the carrying value of overnight FHLB advances that approximate fair value because of the short-term maturity of this instrument, resulting in a Level 2 classification. The fair value of term borrowings is derived by calculating the discounted value of future cash flows expected to be paid out by the Company. The $20.7 million term loan is a variable rate loan for which the rate adjusts quarterly, and as such, its fair value is based on its carrying value resulting in a Level 3 classification.

The following table sets forth the estimated fair values and related carrying amounts of our financial instruments as of:

	Carrying		Fair Value Measurement Level
(dollars in thousands)	Value		1		2		3		Total
September 30, 2014:
Assets:
Cash and cash equivalents	$	28,842	$	28,842	$	—	$	—	$	28,842
Securities AFS		134,760		—		134,760		—		134,760
Loans		1,091,625		—		—		1,138,059		1,138,059
Investment in FHLB stock		9,776		9,776		—		—		9,776

Liabilities:
Deposits		951,164		685,448		265,626		—		951,074
Borrowings		228,682		-		208,000		20,682		228,682

December 31, 2013:
Assets:
Cash and cash equivalents	$	56,954	$	56,954	$	—	$	—	$	56,954
Securities AFS		59,111		—		59,111		—		59,111
Loans		893,730		—		—		933,695		933,695
Investment in FHLB stock		6,721		6,721		—		—		6,721

Liabilities:
Deposits		802,037		556,171		245,920		—		802,091
Borrowings		141,063		—		134,000		7,063		141,063