Fair Value Measurements

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. There are three levels of inputs that may be used to measure fair values:

Level 1:

Valuations for assets and liabilities traded in active exchange markets, or interest in open-end mutual funds that allow the Company to sell its ownership interest back to the fund at net asset value on a daily basis. Valuations are obtained from readily available pricing sources for market transactions involving identical assets, liabilities, or funds.

Level 2:

Valuations for assets and liabilities traded in less active dealer, or broker markets, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active or valuations using methodologies with observable inputs.

Level 3:

Valuations for assets and liabilities that are derived from other valuation methodologies, such as option pricing models, discounted cash flow models and similar techniques using unobservable inputs, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.

(a) Recurring and Nonrecurring Basis

The Company used the following methods and significant assumptions to estimate fair value of certain assets on a recurring and nonrecurring basis:

Investment Securities Available for Sale and Held to Maturity:

The fair value of all investment securities are based upon the assumptions market participants would use in pricing the security. If available, investment securities are determined by quoted market prices (Level 1). For investment securities where quoted market prices are not available, fair values are calculated based on market prices on similar securities (Level 2). Level 2 includes U.S. Treasury, U.S. government and agency debt securities, municipal securities, corporate securities and mortgage-backed securities and collateralized mortgage obligations-residential. For investment securities where quoted prices or market prices of similar securities are not available, fair values are calculated by using observable and unobservable inputs such as discounted cash flows or other market indicators (Level 3). Security valuations are obtained from third party pricing services for comparable assets or liabilities.

Impaired Loans:

At the time a loan is considered impaired, its impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, a loan’s observable market prices, or fair market value of the collateral if the loan is collateral-dependent. Impaired loans for which impairment is measured using the discounted cash flow approach are not considered to be measured at fair value because the loan’s effective interest rate is not a fair value input, and for the purposes of fair value disclosures, the fair value of these loans are measured commensurate with non-impaired loans. Generally, the Company utilizes the fair market value of the collateral, which is commonly based on recent real estate appraisals, to measure impairment. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business (Level 3). Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned:

Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in Level 3 classification of the inputs for determining fair value.

Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers for commercial properties or certified residential appraisers for residential properties whose qualifications and licenses have been reviewed and verified by the Company. Once received, the Company reviews the assumptions and approaches utilized in the appraisal as well as the resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. On a quarterly basis, the Company compares the actual selling price of collateral that has been liquidated to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value.

The following table summarizes the balances of assets measured at fair value on a recurring basis at September 30, 2013 and December 31, 2012.



	September 30, 2013
	Total		Level 1		Level 2		Level 3
	(In thousands)
Investment securities available for sale:
U.S. Treasury and U.S. Government-sponsored agencies	$	6,071	$	—	$	6,071	$	—
Municipal securities	50,387		—		50,387		—
Mortgage backed securities and collateralized mortgage obligations—residential:
U.S Government-sponsored agencies	110,768		—		110,768		—
Total	$	167,226	$	—	$	167,226	$	—



	December 31, 2012
	Total		Level 1		Level 2		Level 3
	(In thousands)
Investment securities available for sale:
U.S. Treasury and U.S. Government-sponsored agencies	$	11,035	$	—	$	11,035	$	—
Municipal securities	47,360		—		47,360		—
Mortgage backed securities and collateralized mortgage obligations—residential:
U.S Government-sponsored agencies	85,898		—		85,898		—
Total	$	144,293	$	—	$	144,293	$	—

There were no transfers between Level 1 and Level 2 during the three or nine months ended September 30, 2013 or 2012.

The Company may be required to measure certain financial assets and liabilities at fair value on a nonrecurring basis. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets.

The tables below represent assets measured at fair value on a nonrecurring basis at September 30, 2013 and December 31, 2012 and the net losses (gains) recorded in earnings during the three and nine months ended September 30, 2013 and 2012.



	Basis (1)		Fair Value at September 30, 2013
	Basis (1)		Total		Level 1		Level 2		Level 3		Net Losses (Gains) Recorded in Earnings During the Three Months Ended September 30, 2013			Net Losses (Gains) Recorded in Earnings During the Nine Months Ended September 30, 2013
	(In thousands)
Impaired originated loans:
Commercial business	$	11,476	$	7,364	$	—	$	—	$	7,364	$	664		$	2,482
One-to-four family residential	359		359		—		—		359		—			(18		)
Real estate construction and land development	4,396		4,396		—		—		4,396		—			(764		)
Consumer	39		—		—		—		—		32			39
Total impaired originated loans	16,270		12,119		—		—		12,119		696			1,739
Purchased other impaired loans:
Commercial business	5,887		4,558		—		—		4,558		1,082			1,378
One-to-four family residential	455		420		—		—		420		(4		)	(17		)
Consumer	10		7		—		—		7		—			31
Total purchased other impaired loans	6,352		4,985		—		—		4,985		1,078			1,392
Investment securities held to maturity:
Mortgage back securities and collateralized mortgage obligations—residential:
Private residential collateralized mortgage obligations	16		13		—		13		—		—			26
Other real estate owned	1,537		1,190		—		—		1,190		45			45
Total	$	24,175	$	18,307	$	—	$	13	$	18,294	$	1,819		$	3,202



	Basis (1)		Fair Value at December 31, 2012
	Basis (1)		Total		Level 1		Level 2		Level 3		Net Losses (Gains) Recorded in Earnings During the Three Months Ended September 30, 2012			Net Losses (Gains) Recorded in Earnings During the Nine Months Ended September 30, 2012
	(In thousands)
Impaired originated loans:
Commercial business	$	11,781	$	9,028	$	—	$	—	$	9,028	$	1,041		$	1,361
One-to-four family residential	811		764		—		—		764		(23		)	75
Real estate construction and land development	6,077		4,628		—		—		4,628		(62		)	447
Consumer	109		—		—		—		—		—			—
Total impaired originated loans	18,778		14,420		—		—		14,420		956			1,883
Purchased other impaired loans:
Commercial business	781		742		—		—		742		23			23
One-to-four family residential	527		422		—		—		422		—			—
Consumer	163		6		—		—		6		(2		)	(2		)
Total purchased other impaired loans	1,471		1,170		—		—		1,170		21			21
Investment securities held to maturity:
Mortgage back securities and collateralized mortgage obligations – residential:
Private residential collateralized mortgage obligations	117		113		—		113		—		—			60
Other real estate owned	3,042		2,391		—		—		2,391		—			310
Total	$	23,408	$	18,094	$	—	$	113	$	17,981	$	977		$	2,274


(1)	Basis represents the unpaid principal balance of impaired originated and purchased other impaired loans, amortized cost of investment securities held to maturity, and carrying value at ownership date of other real estate owned.

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2013 and December 31, 2012.



	September 30, 2013
	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range of Inputs; Weighted Average
	(Dollars in thousands)
Impaired originated loans	$	12,119	Market approach	Adjustment for differences between the comparable sales	(35.1%) - 11.1%; (1.7%)
Purchased other impaired loans	$	4,985	Market approach	Adjustment for differences between the comparable sales	(5.0%) - 0.0%; (2.5%)
Other real estate owned	$	1,190	Market approach	Adjustment for differences between the comparable sales	(47.7)% - 5.0%; (22.6%)



	December 31, 2012
	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range of Inputs; Weighted Average
	(Dollars in thousands)
Impaired originated loans	$	14,420	Market approach	Adjustment for differences between the comparable sales	(35.1)% - 22.0%; (2.0%)
Purchased other impaired loans	$	1,170	Market approach	Adjustment for differences between the comparable sales	(5.0%) - 0.0%; (2.5%)
Other real estate owned	$	2,391	Market approach	Adjustment for differences between the comparable sales	(47.7%) - 5.0%; (27.6%)

(b) Fair Value of Financial Instruments

Because broadly traded markets do not exist for most of the Company’s financial instruments, the fair value calculations attempt to incorporate the effect of current market conditions at a specific time. These determinations are subjective in nature, involve uncertainties and matters of significant judgment and do not include tax ramifications; therefore, the results cannot be determined with precision, substantiated by comparison to independent markets and may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results. For all of these reasons, the aggregation of the fair value calculations presented herein do not represent, and should not be construed to represent, the underlying value of the Company.

The tables below present the carrying value amount of the Company’s financial instruments and their corresponding estimated fair values at the dates indicated.



	September 30, 2013
	Carrying Value		Fair Value Total		Fair Value Measurements Using:
	Carrying Value		Fair Value Total		Level 1		Level 2		Level 3
	(In thousands)
Financial Assets:
Cash and cash equivalents	$	135,123	$	135,123	$	135,123	$	—	$	—
Other interest earning deposits	17,415		17,525		—		17,525		—
Investment securities available for sale	167,226		167,226		—		167,226		—
Investment securities held to maturity	35,113		35,509		—		35,509		—
FHLB stock	5,795		N/A		N/A		—		—
Loans receivable, net of allowance	1,208,082		1,199,552		—		—		1,199,552
Accrued interest receivable	5,658		5,658		17		1,309		4,332
Financial Liabilities:
Deposits:
Noninterest deposits, NOW accounts, money market accounts, savings accounts	1,105,867		1,105,867		1,105,867		—		—
Certificate of deposit accounts	320,118		320,443		—		320,443		—
Total deposits	$	1,425,985	$	1,426,310	$	1,105,867	$	320,443	$	—
Securities sold under agreement to repurchase	$	22,655	$	22,655	$	22,655	$	—	$	—
Accrued interest payable	$	155	$	155	$	16	$	139	$	—



	December 31, 2012
	Carrying Value		Fair Value Total		Fair Value Measurements Using:
	Carrying Value		Fair Value Total		Level 1		Level 2		Level 3
	(In thousands)
Financial Assets:
Cash and cash equivalents	$	104,268	$	104,268	$	104,268	$	—	$	—
Other interest earning deposits	2,818		2,818		—		2,818		—
Investment securities available for sale	144,293		144,293		—		144,293		—
Investment securities held to maturity	10,099		11,010		—		11,010		—
FHLB stock	5,495		N/A		N/A		—		—
Loans held for sale	1,676		1,676		—		—		1,676
Loans receivable, net of allowance	998,344		1,012,880		—		—		1,012,880
Accrued interest receivable	4,821		4,821		6		717		4,098
Financial Liabilities:
Deposits:
Noninterest deposits, NOW accounts, money market accounts, savings accounts	829,044		829,044		829,044		—		—
Certificate of deposit accounts	288,927		290,484		—		290,484		—
Total deposits	$	1,117,971	$	1,119,528	$	829,044	$	290,484	$	—
Securities sold under agreement to repurchase	$	16,021	$	16,021	$	16,021	$	—	$	—
Accrued interest payable	$	106	$	106	$	19	$	87	$	—

The methods and assumptions, not previously presented, used to estimate fair value are described as follows:

Cash and Cash Equivalents:

The fair value of financial instruments that are short-term or reprice frequently and that have little or no risk are considered to have a fair value equal to carrying value (Level 1).

Other Interest Earning Deposits:

These deposits with other banks have maturities greater than three months. The fair value is calculated based upon market prices for similar deposits (Level 2).

FHLB Stock:

FHLB of Seattle stock is not publicly traded, as such, it is not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability.

Loans Receivable and Loans Held for Sale:

Except for impaired loans discussed previously, fair value is based on discounted cash flows using current market rates applied to the estimated life (Level 3). While these methodologies are permitted under U.S. GAAP, they are not based on the exit price concept of the fair value required under ASC 820-10, Fair Value Measurements and Disclosures, and generally produces a higher value.

Accrued Interest Receivable/Payable:

The fair value of accrued interest receivable/payable balances are determined using inputs and fair value measurements commensurate with the asset from which the accrued interest is generated. The carrying amounts of accrued interest approximate fair value (Level 1, Level 2, and Level 3).

Deposits:

For deposits with no contractual maturity, the fair value is assumed to equal the carrying value (Level 1). The fair value of fixed maturity deposits is based on discounted cash flows using the difference between the deposit rate and the rates offered by the Company for deposits of similar remaining maturities (Level 2).

Securities Sold Under Agreement to Repurchase:

Securities sold under agreement to repurchase are short-term in nature, repricing on a daily basis. Fair value financial instruments that are short-term or reprice frequently and that have little or no risk are considered to have a fair value equal to carrying value (Level 1).

Off-Balance Sheet Financial Instruments:

The majority of our commitments to extend credit, standby letters of credit and commitments to sell mortgage loans carry current market interest rates if converted to loans. As such, no premium or discount was ascribed to these commitments (Level 1). They are excluded from the preceding tables.