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. ASC 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 agencies, municipal securities, mortgage and asset-backed securities 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 also 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. 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. Rating agency and industry research reports as well as default and deferral activity are reviewed and incorporated into the calculation. The Company did not own any securities classified within Level 3 of the hierarchy as of September 30, 2016 or December 31, 2015.

Loans Held-for-Sale (mandatory pricing agreements)

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 values 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 September 30, 2016 and December 31, 2015.



				September 30, 2016 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 agencies	$	85,990		$	—		$	85,990	$	—
Municipal securities	97,501			—			97,501		—
Mortgage-backed securities	246,085			—			246,085		—
Asset-backed securities	19,496			—			19,496		—
Corporate securities	18,880			—			18,880		—
Other securities	3,026			3,026			—		—
Total available-for-sale securities	470,978			3,026			467,952		—
Loans held-for-sale (mandatory pricing agreements)	31,196			—			31,196		—
Forward contracts	(465		)	(465		)	—		—
IRLCs	2,032			—			—		2,032



			December 31, 2015 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 agencies	$	37,750	$	—	$	37,750	$	—
Municipal securities	21,469		—		21,469		—
Mortgage-backed securities	113,052		—		113,052		—
Asset-backed securities	19,361		—		19,361		—
Corporate securities	19,087		—		19,087		—
Other securities	2,979		2,979		—		—
Total available-for-sale securities	213,698		2,979		210,719		—
Loans held-for-sale (mandatory pricing agreements)	24,065		—		24,065		—
Forward contracts	30		30		—		—
IRLCs	582		—		—		582

The following tables reconcile the beginning and ending balances of recurring fair value measurements recognized in the accompanying condensed consolidated balance sheets using significant unobservable (Level 3) inputs for the three and nine month periods ended September 30, 2016 and September 30, 2015.



	Three Months Ended
	Interest Rate Lock Commitments
Balance, July 1, 2016	$	1,724
Total realized gains
Included in net income	308
Balance, September 30, 2016	$	2,032

Balance, July 1, 2015	$	623
Total realized gains
Included in net income	284
Balance, September 30, 2015	$	907



	Nine Months Ended
	Interest Rate Lock Commitments
Balance, January 1, 2016	$	582
Total realized gains
Included in net income	1,450
Balance, September 30, 2016	$	2,032

Balance, January 1, 2015	$	521
Total realized gains
Included in net income	386
Balance, September 30, 2015	$	907

The following describes valuation methodologies and inputs used for assets measured at fair value on a nonrecurring basis, as well as the general classification of such assets pursuant to the valuation hierarchy.

Impaired Loans

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. The amount of the impairment may be determined based on the fair value of the underlying collateral, less costs to sell, the estimated present value of future cash flows or the loan’s observable market price.

If the impaired loan is identified as collateral dependent, the fair value of the underlying collateral, less costs to sell, is used to measure impairment. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value. If the impaired loan is not collateral dependent, the Company utilizes a discounted cash flow analysis to measure impairment.

Impaired loans with a specific valuation allowance based on the value of the underlying collateral or a discounted cash flow analysis are classified as Level 3 assets.

There were no impaired loans that were measured at fair value on a nonrecurring basis at September 30, 2016 or December 31, 2015.

Significant Unobservable (Level 3) Inputs

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



	Fair Value at September 30, 2016	Valuation Technique	Significant Unobservable Inputs	Range
IRLCs	2,032	Discounted cash flow	Loan closing rates	41% - 99%



	Fair Value at December 31, 2015		Valuation Technique	Significant Unobservable Inputs	Range
IRLCs	$	582	Discounted cash flow	Loan closing rates	43% - 100%

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.

Interest-Bearing Time Deposits

The fair value of these financial instruments approximates carrying value.

Loans Held-for-Sale (best efforts pricing agreements)

The fair value of these loans approximates carrying value.

Loans

The fair value of loans 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 of Indianapolis Stock

The fair value approximates carrying value.

Deposits

The fair value of noninterest-bearing and interest-bearing demand deposits, savings and money market accounts approximates carrying value. The fair value of fixed maturity certificates of deposit and brokered deposits are estimated using rates currently offered for deposits of similar remaining maturities.

Advances from Federal Home Loan Bank

The fair value of fixed rate advances is estimated using rates currently available for advances with similar remaining maturities. The carrying value of variable rate advances approximates fair value.

Subordinated Debt

The fair value of the Company’s publicly traded subordinated debt is obtained from quoted market prices. The fair value of the Company’s remaining subordinated debt is estimated using discounted cash flow analysis, based on current borrowing rates for similar types of debt instruments.

Accrued Interest Payable

The fair value of these financial instruments approximates carrying value.

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 September 30, 2016 and December 31, 2015.

The following tables summarize the carrying value and estimated fair value of all financial assets and liabilities at September 30, 2016 and December 31, 2015.



			September 30, 2016 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	$	67,825	$	67,825	$	—	$	—
Interest-bearing time deposits	250		250		—		—
Securities held-to-maturity	5,500		—		5,578		—
Loans held-for-sale (best efforts pricing agreements)	1,275		—		1,275
Loans	1,198,932		—		—		1,209,791
Accrued interest receivable	5,848		5,848		—		—
Federal Home Loan Bank of Indianapolis stock	8,595		—		8,595		—
Deposits	1,493,601		510,055		—		971,679
Advances from Federal Home Loan Bank	147,978		—		146,334		—
Subordinated debt	36,541		25,000		13,542		—
Accrued interest payable	125		125		—		—



			December 31, 2015 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	$	25,152	$	25,152	$	—	$	—
Interest-bearing time deposits	1,000		1,000		—		—
Loans held-for-sale (best efforts pricing agreements)	12,453		—		12,453		—
Loans	953,859		—		—		967,303
Accrued interest receivable	4,105		4,105		—		—
Federal Home Loan Bank of Indianapolis stock	8,595		—		8,595		—
Deposits	956,054		472,481		—		478,360
Advances from Federal Home Loan Bank	190,957		—		188,126		—
Subordinated debt	12,724		—		13,212		—
Accrued interest payable	117		117		—		—