Fair Value of Financial Instruments

ASC Topic 820, Fair Value Measurement, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Topic 820 also specifies 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 standard describes three levels of inputs that may be used to measure fair value:


Level 1	Quoted prices in active markets for identical assets or liabilities


Level 2	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 for substantially the full term of the assets or liabilities


Level 3	Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying condensed consolidated balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.

Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include highly liquid mutual funds. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows.

Level 2 securities include U.S. Government-sponsored enterprises, mortgage and asset-backed securities and obligations of state, municipals and certain corporate securities. Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather relying on the investment securities’ relationship to other benchmark quoted investment securities.

In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include certain other securities. Fair values are calculated using discounted cash flows. Discounted cash flows are calculated based off of the anticipated future cash flows updated to incorporate loss severities and volatility. Rating agency and industry research reports as well as default and deferral activity are reviewed and incorporated into the calculation.

Loans Held-for-Sale

The fair value of loans held-for-sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan (Level 2).

Forward Contracts

The fair values of forward contracts on to-be-announced securities are determined using quoted prices in active markets, or benchmarked thereto (Level 1).

Interest Rate Lock Commitments

The fair value of interest rate lock commitments (“IRLCs”) are determined using the projected sale price of individual loans based on changes in market interest rates, projected pull-through rates (the probability that an IRLC will ultimately result in an originated loan), the reduction in the value of the applicant’s option due to the passage of time, and the remaining origination costs to be incurred based on management’s estimate of market costs (Level 3).

The following tables present the fair value measurements of assets and liabilities recognized in the accompanying condensed consolidated balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at March 31, 2014 and December 31, 2013:



			March 31, 2014 Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. Government-sponsored enterprises	$	55,874	$	—	$	55,874	$	—
Mortgage-backed and asset-backed securities - government-sponsored enterprises	144,048		—		144,048		—
Mortgage-backed and asset-backed securities - private labeled	1,167		—		1,167		—
Other securities	3,780		1,969		—		1,811
Total available for sale securities	204,869		1,969		201,089		1,811
Loans held-for-sale (mandatory pricing agreements)	14,621		—		14,621		—
Forward contracts	32		32		—		—
Interest rate lock commitments	170		—		—		170



			December 31, 2013 Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. Government-sponsored enterprises	$	56,277	$	—	$	56,277	$	—
Municipals	46,323		—		46,323		—
Mortgage-backed and asset-backed securities - government-sponsored enterprises	73,941		—		73,941		—
Mortgage-backed and asset-backed securities - private labeled	1,232		—		1,232		—
Other securities	3,636		1,963		—		1,673
Total available for sale securities	181,409		1,963		177,773		1,673
Loans held-for-sale (mandatory pricing agreements)	24,254		—		24,254		—
Forward contracts	227		227		—		—
Interest rate lock commitments	79		—		—		79

ASC Topic 825, Financial Instruments, permits entities to measure recognized financial assets and financial liabilities using either historical cost or the fair value option at specified election dates. During 2013, the Company began using derivative financial instruments to manage exposure to interest rate risk in its mortgage banking business. These derivative financial instruments are recorded at fair value with changes in fair value reflected in noninterest income on the condensed consolidated statements of income.

To mitigate the volatility reported in earnings caused by measuring related assets and liabilities differently, the Company has elected the fair value option for the hedged item, mortgage loans held-for-sale under mandatory pricing agreements that were originated on or after April 1, 2013. The Company continues to record mortgage loans held-for-sale under best-efforts pricing agreements at the lower of cost or fair value. Prior to April 1, 2013, all mortgage loans held-for-sale were carried at the lower of cost or fair value.

The following table presents the fair value and aggregate principal balance of loans held-for-sale under the fair value option:



	March 31, 2014						December 31, 2013
	Aggregate Value		Gain		Fair Value		Aggregate Value		Loss			Fair Value
Loans held-for-sale	$	14,424	$	197	$	14,621	$	24,258	$	(4	)	$	24,254

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying condensed consolidated balance sheets using significant unobservable (Level 3) inputs:



	Securities Available for Sale		Interest Rate Lock Commitments
Balance, January 1, 2014	$	1,673	$	79
Total realized and unrealized gains
Included in net income	—		91
Included in other comprehensive income	138		—
Balance, March 31, 2014	$	1,811	$	170

Balance, January 1, 2013	$	840	$	—
Total realized and unrealized gains
Included in net income	—		—
Included in other comprehensive income	328		—
Balance, March 31, 2013	$	1,168	$	—

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying condensed consolidated balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.

Impaired Loans (Collateral Dependent)

Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral, less costs to sell, for collateral dependent loans.

If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.

Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.

The following tables present the fair value measurements of impaired loans recognized in the accompanying condensed consolidated balance sheets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fell at March 31, 2014 and December 31, 2013:



			March 31, 2014 Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans	$	89	$	—	$	—	$	89



			December 31, 2013 Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans	$	137	$	—	$	—	$	137

Unobservable (Level 3) Inputs

The following tables present quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements other than goodwill.



	Fair Value at March 31, 2014		Valuation Technique	Unobservable Inputs	Range
Other securities	$	1,811	Discounted cash flow	Discount margin Cumulative default % Loss given default % Cumulative prepayment %	5.25% - 10.75% 2% - 100% 85% - 100% 0% - 100%
Collateral dependent impaired loans	$	89	Fair value of collateral	Discount for type of property and current market conditions	0% - 42%
IRLCs	$	170	Discounted cash flow	Loan closing rates	52% - 94%



	Fair Value at December 31, 2013		Valuation Technique	Unobservable Inputs	Range
Other securities	$	1,673	Discounted cash flow	Discount margin Cumulative default % Loss given default % Cumulative prepayment %	6% - 12.5% 2% - 100% 85% – 100% 0% - 100%
Collateral dependent impaired loans	$	137	Fair value of collateral	Discount for type of property and current market conditions	0% - 54%
IRLCs	$	79	Discounted cash flow	Loan closing rates	53% - 97%

The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying condensed consolidated balance sheets at amounts other than fair value:

Cash and Cash Equivalents

For these instruments, the carrying amount is a reasonable estimate of fair value.

Loans Held-for-Sale

The fair value of these financial instruments approximates carrying value.

Interest-Bearing Time Deposits

The fair value of these financial instruments approximates carrying value.

Loans Receivable

The fair value of loans receivable is estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and remaining maturities.

Accrued Interest Receivable

The fair value of these financial instruments approximates carrying value.

Federal Home Loan Bank Stock

The carrying amount approximates fair value.

Deposits

The fair value of noninterest-bearing demand deposits and savings and NOW accounts is the amount payable as of the reporting date. The fair value of fixed maturity certificates of deposit is estimated using rates currently offered for deposits of similar remaining maturities.

FHLB Advances

The fair value of fixed rate advances is estimated using rates currently offered for similar remaining maturities.

Accrued Interest Payable

The fair value of these financial instruments approximates carrying value.

Subordinated Debt

The fair value of our subordinated debt is estimated using discounted cash flow analysis, based on our current incremental borrowing rates for similar type of borrowing arrangements.

Commitments

The fair value of commitments to extend credit are based on fees currently charged to enter into similar agreements with similar maturities and interest rates. The Company determined that the fair value of commitments was zero based on the contractual value of outstanding commitments at each of March 31, 2014 and December 31, 2013.

The following schedule includes the carrying value and estimated fair value of all financial assets and liabilities at March 31, 2014 and December 31, 2013:



	March 31, 2014 Fair Value Measurements Using
	Carrying Amount		Quoted Prices In Active Market for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash and cash equivalents	$	57,460	$	57,460	$	—	$	—
Interest-bearing time deposits	2,500		2,500		—		—
Loans held-for-sale (best efforts pricing agreements)	2,652		—		2,652		—
Loans receivable – net	526,861		—		—		527,097
Accrued interest receivable	2,662		2,662		—		—
FHLB stock	2,943		—		2,943		—
Deposits	727,652		386,982		—		345,452
FHLB advances	21,819		—		23,247		—
Accrued interest payable	83		83		—		—
Subordinated debt	2,809		—		2,959		—



	December 31, 2013 Fair Value Measurements Using
	Carrying Amount		Quoted Prices In Active Market for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash and cash equivalents	$	53,690	$	53,690	$	—	$	—
Interest-bearing time deposits	2,500		2,500		—		—
Loans held-for-sale (best efforts pricing agreements)	4,356		—		4,356		—
Loans receivable - net	495,727		—		—		500,447
Accrued interest receivable	2,904		2,904		—		—
FHLB stock	2,943		—		2,943		—
Deposits	673,095		362,634		—		315,179
FHLB advances	31,793		—		33,415		—
Accrued interest payable	102		102		—		—
Subordinated debt	2,789		—		2,978		—