NOTE 2: FAIR VALUE MEASUREMENTS

Assets Measured at Fair Value on a Recurring Basis

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. Current 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. 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 the Company's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

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, 2017:
Investment securities available for sale:
US Treasury securities	$	495	$	495	$	—	$	—
Agency mortgage-backed securities		432,448		—		432,448		—
Beneficial interest – FHLMC securitizations		38,559		—		—		38,559
Total assets at fair value on a recurring basis	$	471,502	$	495	$	432,448	$	38,559

December 31, 2016:
Investment securities available for sale:
US Treasury securities	$	297	$	297	$	—	$	—
Agency mortgage-backed securities		468,909		—		468,909		—
Beneficial interest – FHLMC securitizations		40,372		—		—		40,372
Total assets at fair value on a recurring basis	$	509,578	$	297	$	468,909	$	40,372

The decrease in level 3 assets from December 31, 2016 was due to beneficial interest – FHLMC securitization maturities.

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. 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.

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. When a market is illiquid or there is a lack of transparency around the inputs to valuation, the securities are classified as Level 3 and reliance is placed upon internally developed models, and management judgment and evaluation for valuation. 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 beneficial interests – FHLMC securitization. Significant assumptions in the valuation of these Level 3 securities as of September 30, 2017 included a prepayment rate of 15% and discount rates ranging from 4.0% to 10%.

Federal Home Loan Bank Stock. The Bank is a member of the Federal Home Loan Bank (the “FHLB”). As a member, we are required to own stock of the FHLB, the amount of which is based primarily on the level of our borrowings from this institution. The fair value of that stock is equal to the carrying amount, is classified as restricted securities and is 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, other than impaired 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.

Loans Held For Sale. Loans held for sale are accounted for at the lower of amortized cost or fair value. The fair value of loans held for sale is generally based on observable market prices from other loans in the secondary market that have similar collateral, credit, and interest rate characteristics. If quoted market prices are not readily available, the Company may consider other observable market data such as dealer quotes for similar loans or forward sale commitments. In certain cases, the fair value may be based on a discounted cash flow model.

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 $421 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 $25 million holding company line of credit 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.

Assets Measured at Fair Value on a Nonrecurring Basis

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”, at the fair value of the loan’s collateral (if the loan is collateral dependent) less estimated selling costs. 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 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 Level 3. The total collateral dependent impaired Level 3 loans were $14.4 million and $9.0 million at September 30, 2017 and December 31, 2016, respectively. There were no specific reserves related to these loans at September 30, 2017 and December 31, 2016.

Real Estate Owned. The fair value of real estate owned is based on external appraised values that include adjustments for estimated selling costs and assumptions of market conditions that are not directly observable, resulting in a Level 3 classification. As of September 30, 2017 and December 31, 2016, the fair value of real estate owned was $1.4 million and $1.7 million, respectively.

The carrying amounts and estimated fair values of financial instruments are as follows as of:

	Carrying		Fair Value Measurement Level
(dollars in thousands)	Value		1		2		3		Total
September 30, 2017:
Assets:
Cash and cash equivalents	$	123,210	$	123,210	$	—	$	—	$	123,210
Securities AFS		471,502		495		432,448		38,559		471,502
Loans		3,239,374		—		—		3,381,237		3,381,237
Loans held for sale		153,405		—		—		155,246		155,246
Investment in FHLB stock		17,250		—		17,250		—		17,250

Liabilities:
Deposits		3,268,726		2,385,687		883,359		—		3,269,046
Borrowings		421,000		—		406,000		15,000		421,000

December 31, 2016:
Assets:
Cash and cash equivalents	$	597,946	$	597,946	$	—	$	—	$	597,946
Securities AFS		509,578		297		468,909		40,372		509,578
Loans, net		2,540,309		—		—		2,529,360		2,529,360
Loans held for sale		250,942		—		—		253,953		253,953
Investment in FHLB stock		33,750		—		33,750		—		33,750

Liabilities:
Deposits		2,426,795		1,797,329		629,594		—		2,426,923
Borrowings		1,250,000		—		1,250,000		—		1,250,000