Note 5 – Fair Value Measurements

The Company accounts for fair value measurements in accordance with FASB ASC 820, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. FASB ASC 820 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. FASB ASC 820 also 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.

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

The carrying value of certain financial assets and liabilities is impacted by the application of fair value measurements, either directly or indirectly. In certain cases, an asset or liability is measured and reported at fair value on a recurring basis, such as available-for-sale investment securities. In other cases, management must rely on estimates or judgments to determine if an asset or liability not measured at fair value warrants an impairment write-down or whether a valuation reserve should be established. Given the inherent volatility, the use of fair value measurements may have a significant impact on the carrying value of assets or liabilities, or result in material changes to the financial statements, from period to period.

Fair value is defined as the price that would be received to sell an asset or transfer a liability between market participants at the balance sheet date. When possible, the Company looks to active and observable markets to price identical assets or liabilities. When identical assets and liabilities are not traded in active markets, the Company looks to observable market data for similar assets and liabilities. However, certain assets and liabilities are not traded in observable markets and the Company must use other valuation methods to develop a fair value.

The following methods, assumptions, and valuation techniques were used by the Company to measure different financial assets and liabilities at fair value and in estimating its fair value disclosures for financial instruments.

Cash and Cash Equivalents: The carrying amounts reported in the consolidated statements of financial condition for cash and cash equivalents is deemed to approximate fair value and are classified as Level 1 of the fair value hierarchy.

Available for Sale Investment Securities: Fair values for investment securities are determined by quoted market prices if available (Level 1). For securities where quoted prices are not available, fair values are estimated based on market prices of similar securities. For securities where quoted prices or market prices of similar securities are not available, fair values are estimated using matrix pricing, which is a mathematical technique widely used in the industry to value investment securities without relying exclusively on quoted prices for the specific investment securities but rather relying on the investment securities’ relationship to other benchmark quoted investment securities (Level 2). Any investment securities not valued based upon the methods above is considered Level 3.

The Company utilizes information provided by a third-party investment securities portfolio manager in analyzing the investment securities portfolio in accordance with the fair value hierarchy of the Fair Value Topic. The portfolio manager’s evaluation of investment security portfolio pricing is performed using a combination of prices and data from other sources, along with internally developed matrix pricing models. The third-party’s month-end pricing process includes a series of quality assurance activities where prices are compared to recent market conditions, previous evaluation prices, and between the various pricing services. These processes produce a series of quality assurance reports on which price exceptions are identified, reviewed and where appropriate, securities are re-priced. In the event of a materially different price, the third party will report the variance and review the pricing methodology in detail. The results of the quality assurance process are incorporated into the selection of pricing providers by the third party.

Loans: For fixed rate loans and for variable rate loans with infrequent re-pricing or re-pricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. For loans held on balance sheet, the discounted fair value is further reduced by the amount of reserves held against the loan portfolios. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price and due to the significant judgment involved in evaluating credit quality, loans are classified within Level 3 classification.

Federal Home Loan Bank Stock: The carrying amount presented in the consolidated statements of financial condition is deemed to approximate fair value, and is classified as a Level 2 instrument.

Accrued Interest Receivable and Payable: The fair value for accrued interest approximates its carrying amounts due to the short duration before collection. The valuation is a Level 3 classification which is consistent with its underlying asset or liability.

Deposits: The fair values of deposits with no stated maturity, such as money market demand deposits, savings and NOW accounts have been analyzed by management and assigned estimated maturities and cash flows which are then discounted to derive a value. The fair value of fixed-rate certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The Company classifies the estimated fair value of deposit liabilities as Level 2 in the fair value hierarchy.

Advances from the Federal Home Loan Bank: The fair value of these advances is estimated using the rates currently offered for similar advances of similar remaining maturities (Level 2).

Commitments to Extend Credit: For fixed-rate and adjustable-rate loan commitments, the fair value estimate considers the difference between current levels of interest rates and committed rates. At June 30, 2015 and December 31, 2014, the fair value of loan commitments was not material.

Based on the foregoing methods and assumptions, the carrying value and fair value of the Company’s financial instruments are as follows at June 30, 2015 and December 31, 2014 (in thousands):

	At June 30, 2015
	Carrying
	Amount		Fair Value		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents	$	47,393	$	47,393	$	47,393	$	—	$	—
Securities available-for-sale		78,975		78,975		—		78,975		—
Loans (net of allowance)		378,000		379,316		—		—		379,316
FHLB stock		3,250		3,250		—		3,250		—
Accrued interest receivable		1,461		1,461		—		—		1,461

Financial liabilities
Non-interest-bearing deposits	$	118,114	$	118,114		—	$	118,114		—
Interest-bearing deposits		352,411		352,474		—		352,474		—
FHLB advances		4,719		4,719		—		4,719		—
Accrued interest payable		66		66		—		—		66

	At December 31, 2014
	Carrying
	Amount		Fair Value		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents	$	21,274	$	21,274	$	21,274	$	—	$	—
Securities available-for-sale		75,909		75,909		—		75,909		—
Loans (net of allowance)		381,208		381,224		—		—		381,224
FHLB stock		3,250		3,250				3,250		—
Accrued interest receivable		1,234		1,234		—		—		1,234

Financial liabilities
Non-interest-bearing deposits	$	111,022	$	111,022	$	—	$	111,022	$	—
Interest-bearing deposits		342,170		342,318		—		342,318		—
FHLB advances		11,808		11,808		—		11,808		—
Accrued interest payable		36		36		—		—		36

The following table presents the fair value measurements of assets recognized in the accompanying 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 June 30, 2015 and December 31, 2014 (in thousands):

	At June 30, 2015
			Fair Value Measurements Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)

U.S. Government and agency obligations	$	14,393	$	—	$	14,393	$	—
Corporate bonds		4,972		—		4,972		—
State and municipal obligations		22,476		—		22,476		—
Collateralized mortgage obligations		20,272		—		20,272		—
Mortgage-backed securities		16,862		—		16,862		—
Total	$	78,975	$	—	$	78,975	$	—

	At December 31, 2014
			Fair Value Measurements Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)

U.S. Government and agency obligations	$	11,545	$	—	$	11,545	$	—
Corporate bonds		4,987		—		4,987		—
State and municipal obligations		21,657		—		21,657		—
Collateralized mortgage obligations		19,580		—		19,580		—
Mortgage-backed securities		18,140		—		18,140		—
Total	$	75,909	$	—	$	75,909	$	—

The following is a description of the valuation methodologies used for instruments measured at fair value on a non-recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Impaired loans

At June 30, 2015 and December 31, 2014, impaired loans consisted primarily of loans secured by non-residential and commercial real estate. Management has determined fair value measurements on impaired loans primarily through evaluations of appraisals performed.

Real Estate Owned

Real estate acquired through, or in lieu of, loan foreclosure is held for sale and initially recorded at fair value (based on current appraised value) at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated costs to sell. Management has determined fair value measurements on real estate owned primarily through evaluations of appraisals performed.

The following table presents the fair value measurements of assets measured at fair value on a non-recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2015 and December 31, 2014 (in thousands).

At June 30, 2015

Fair Value Measurements Using

Quoted Prices

in Active

Significant

Markets for

Other

Significant

Identical

Observable

Unobservable

Fair

Assets

Inputs

Value

(Level 1)

(Level 2)

(Level 3)

Impaired loans

11,838

—

11,838

Real estate owned

807

—

807

At December 31, 2014

Fair Value Measurements Using

Quoted Prices

in Active

Significant

Markets for

Other

Significant

Identical

Observable

Unobservable

Fair

Assets

Inputs

Value

(Level 1)

(Level 2)

(Level 3)

Impaired loans

12,173

—

12,173

Real estate owned

1,111

—

1,111