Note 6 – Fair Value of Financial Instruments

The following summarizes the methods and significant assumptions used by the Company in estimating its fair value disclosures for financial instruments.

Level I: Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

Level II: Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.

Level III: Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

Assets Measured on a Recurring Basis

As required by accounting standards, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company classified investments in government securities as Level 2 instruments and valued them using the market approach. The following measurements are made on a recurring basis.

Available-for-sale investment securities - Available-for-sale investment securities are recorded 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. 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 and private label entities, municipal bonds and corporate debt securities. There have been no changes in valuation techniques for the year ended December 31, 2014. Valuation techniques are consistent with techniques used in prior periods.

Loans held for sale — Loans held for sale are carried at fair value. These loans currently consist of one-to-four-family residential loans originated for sale in the secondary market. Fair value is based on the committed market rates or the price secondary markets are currently offering for similar loans using observable market data.

Interest rate lock commitment - For mortgage interest rate locks, the fair value is based on either (i) the price of the underlying loans obtained from an investor for loans that will be delivered on a best efforts basis or (ii) the observable price for individual loans traded in the secondary market for loans that will be delivered on a mandatory basis less (iii) expected costs to deliver the interest rate locks, any expected “pull through rate” is applied to this calculation to estimate the derivative value.

Interest rate cap - The fair value of the interest rate cap is determined at the end of each quarter by using Bloomberg Finance which values the interest rate cap using observable inputs from forward and futures yield curves as well as standard market volatility.

Interest rate swap – Interest rate swaps are recorded at fair value based on third party vendors who compile prices from various sources and may determine fair value of identical or similar instruments by using pricing models that consider observable market data.

Forward sales commitments – Forward sales commitments are considered derivatives and are recorded at fair value, based on (i) committed sales prices from investors for commitments to sell mortgage loans or (ii) observable market data inputs for commitments to sell mortgage backed securities. A majority of the interest rate locks and loans held for sale are committed on a best efforts basis.

The following tables present the assets and liabilities reported on the consolidated statements of financial condition at their fair value on a recurring basis as of September 30, 2015 and December 31, 2014 by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.


	September 30, 2015
(in thousands)	Level I		Level II		Level III		Total
Assets:
U.S. Government Agency securities	$	—	$	32,090	$	—	$	32,090
U.S. Sponsored Mortgage backed securities		—		34,712		—		34,712
Municipal securities		—		459		—		459
Equity and Other securities		88		809		—		897
Loans held for sale		—		73,047		—		73,047
Interest rate lock commitment		—		—		1,758		1,758
Interest rate swap		—		580		—		580
Interest rate cap		—		443		—		443
Liability:
Interest rate swap		—		580		—		580
Forward sales commitments		—		417		—		417


	December 31, 2014
(in thousands)	Level I		Level II		Level III		Total
Assets:
U.S. Government Agency securities	$	—	$	37,534	$	—	$	37,534
U.S. Sponsored Mortgage backed securities		—		29,932		—		29,932
Equity and Other securities		77		670		—		747
Loans held for sale		—		69,527		—		69,527
Interest rate lock commitment		—		—		1,020		1,020
Interest rate cap		—		1,423		—		1,423
Liability:
Forward sales commitments		—		431		—		431

The following table represents recurring level III assets:


	For the three months ended		For the three months ended		For the nine months ended		For the nine months ended
(in thousands)	September 30, 2015		September 30, 2014		September 30, 2015		September 30, 2014

Balance, beginning of period	$	1,653	$	3,210	$	1,020	$	2,271

Realized and unrealized gains (loss) included in earnings		105		(391)		738		548

Balance, end of period	$	1,758	$	2,819	$	1,758	$	2,819

Assets Measured on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain financial assets, financial liabilities, non-financial assets and non-financial liabilities at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market value that were recognized at fair value below cost at the end of the period. Certain non-financial assets measured at fair value on a non-recurring basis include foreclosed assets (upon initial recognition or subsequent impairment), non-financial assets and non-financial liabilities measured at fair value in the second step of a goodwill impairment test, and intangible assets and other non-financial long-lived assets measured at fair value for impairment assessment. Non-financial assets measured at fair value on a nonrecurring basis during 2015 and 2014 include certain foreclosed assets which, upon initial recognition, were remeasured and reported at fair value through a charge-off to the allowance for possible loan losses and certain foreclosed assets which, subsequent to their initial recognition, were remeasured at fair value through a write-down included in other non-interest expense.

Impaired Loans - Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. Collateral values are estimated using Level 2 inputs based on observable market data or Level 3 inputs based on customized discounting criteria. For a majority of impaired real estate related loans, the Company obtains a current external appraisal. Other valuation techniques are used as well, including internal valuations, comparable property analysis and contractual sales information.

Other Real Estate owned — Other real estate owned, which is obtained through the Bank’s foreclosure process is valued utilizing the appraised collateral value. Collateral values are estimated using Level 2 inputs based on observable market data or Level 3 inputs based on customized discounting criteria. At the time, the foreclosure is completed, the Company obtains a current external appraisal.

Mortgage Servicing Rights – Mortgage servicing rights (“MSRs”) do not trade in an active, open market with readily observable prices. While sales of MSRs do occur, the precise terms and conditions typically are not readily available.

Assets measured at fair value on a nonrecurring basis as of September 30, 2015 and December 31, 2014 are included in the tables below:


	September 30, 2015
(in thousands)	Level I		Level II		Level III		Total
Assets:
Impaired loans	$	—	$	—	$	11,989	$	11,989
Other real estate owned		—		—		274		274
Mortgage servicing rights		—		—		1,155		1,155


	December 31, 2014
(in thousands)	Level I		Level II		Level III		Total
Assets:
Impaired loans	$	—	$	—	$	14,091	$	14,091
Other real estate owned		—		—		575		575
Mortgage servicing rights		—		—		1,423		1,423

The following tables present quantitative information about the Level 3 significant unobservable inputs for assets measured at fair value on a nonrecurring basis at September 30, 2015 and December 31, 2014.


	Quantitative Information about Level 3 Fair Value Measurements
			Valuation	Unobservable
(Dollars in thousands)	Fair Value		Technique	Input	Range
September 30, 2015:
Impaired loans	$	11,989	Appraisal of collateral (1)	Appraisal adjustments(2)	20% - 30%
				Liquidation expense (2)	5% - 10%

Other real estate owned	$	274	Appraisal of collateral (1)	Appraisal adjustments (2)	20% - 30%
				Liquidation expense (2)	5% - 10%

Mortgage servicing rights	$	1,155	Discounted cash flows	Constant prepayment rate	12%
				Cost of service	0.25%
				Discount rate	12%


	Quantitative Information about Level 3 Fair Value Measurements
			Valuation	Unobservable
(Dollars in thousands)	Fair Value		Technique	Input	Range
December 31, 2014:
Impaired loans	$	14,091	Appraisal of collateral (1)	Appraisal adjustments (2)	20% - 30%
				Liquidation expense (2)	5% - 10%

Other real estate owned	$	575	Appraisal of collateral (1)	Appraisal adjustments (2)	20% - 30%
				Liquidation expense (2)	5% - 10%

Mortgage servicing rights	$	1,423	Discounted cash flows	Constant prepayment rate	12%
				Cost of service	0.25%
				Discount rate	12%

(1)

Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level 3 inputs which are not observable.

(2)

Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

The following summarizes the methods and significant assumptions used by the Company in estimating its fair value disclosures for financial instruments.

Cash and cash equivalents: The carrying amounts for cash and cash equivalents approximate fair value because they have original maturities of 90 days or less and do not present unanticipated credit concerns.

Certificates of deposits: The fair values for certificates of deposits are computed based on scheduled future cash flows of principal and interest, discounted at interest rates currently offered for certificates of deposits with similar terms of investors. No prepayments of principal are assumed.

Securities: Fair values of securities are based on quoted market prices, where available. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable securities.

Loans held for sale: Loans held for sale are reported at fair value. These loans currently consist of one-to-four-family residential loans originated for sale in the secondary market. Fair value is based on committed market rates or the price secondary markets are currently offering for similar loans using observable market data. (Level II)

Loans: The fair values for loans are computed based on scheduled future cash flows of principal and interest, discounted at interest rates currently offered for loans with similar terms of borrowers of similar credit quality. No prepayments of principal are assumed.

Mortgage servicing rights: The carrying value of mortgage servicing rights approximates their fair value.

Interest rate lock commitment: For mortgage interest rate locks, the fair value is based on either (i) the price of the underlying loans obtained from an investor for loans that will be delivered on a best efforts basis or (ii) the observable price for individual loans traded in the secondary market for loans that will be delivered on a mandatory basis less (iii) expected costs to deliver the interest rate locks, any expected “pull through rate” is applied to this calculation to estimate the derivative value. The “pull through rate” range from 78% – 80% and 77% - 81% as of September 30, 2015 and December 31, 2014.

Interest rate cap: The fair value of the interest rate cap is determined at the end of each quarter by using Bloomberg Finance which values the interest rate cap using observable inputs from forward and futures yield curves as well as standard market volatility.

Accrued interest receivable and payable and repurchase agreements: The carrying values of accrued interest receivable and payable approximate their fair values.

Deposits: The fair values of demand deposits (i.e., non-interest bearing checking, NOW and money market), savings accounts and other variable rate deposits approximate their carrying values. Fair values of fixed maturity deposits are estimated using a discounted cash flow methodology at rates currently offered for deposits with similar remaining maturities. Any intangible value of long-term relationships with depositors is not considered in estimating the fair values disclosed.

Forward Sales Commitments: Forward sales commitments are used to mitigate interest rate risk for residential mortgage loans held for sale and interest rate locks and manage expected funding percentages. These instruments are considered derivatives and are recorded at fair value, based on (i) committed sales prices from investors for commitments to sell mortgage loans or (ii) observable market data inputs for commitments to sell mortgage backed securities.

FHLB and other borrowings: The fair values for loans are computed based on scheduled future cash flows of principal and interest, discounted at interest rates currently offered for loans with similar terms of borrowers of similar credit quality. No prepayments of principal are assumed.

Subordinated debt: The fair values for debt are computed based on scheduled future cash flows of principal and interest, discounted at interest rates currently offered for debt with similar terms of borrowers of similar credit quality. No prepayments of principal are assumed.

Off-balance sheet instruments: The fair values of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of agreements and the present credit standing of the counterparties. The amounts of fees currently charged on commitments and standby letters of credit are deemed insignificant, and therefore, the estimated fair values and carrying values are not shown.

The carrying values and estimated fair values of the Company’s financial instruments are summarized as follows (in thousands):

Fair Value Measurements at:


					Quoted Prices in		Significant		Significant
					Active Markets For		Other		Unobservable
	Carrying		Estimated		Identical Assets		Observable		Inputs
	Value		Fair Value		(Level 1)		Inputs (Level 2)		(Level 3)
September 30, 2015:
Financial assets:
Cash and cash equivalents	$	25,135	$	25,135	$	25,135	$	—	$	—
Certificates of deposits with other banks		13,150		13,341		—		13,341		—
Securities available-for-sale		68,158		68,158		88		68,070		—
Securities held-to-maturity		52,969		53,923		—		53,923		—
Loans held for sale		73,047		73,047		—		73,047		—
Loans, net		994,833		1,000,857		—		—		1,000,857
Mortgage servicing rights		1,155		1,155		—		—		1,155
Interest rate lock commitment		1,758		1,758		—		—		1,758
Interest rate swap		580		580		—		580		—
Interest rate cap		443		443		—		443		—
Accrued interest receivable		3,250		3,250		—		800		2,450

Financial liabilities:
Deposits	$	1,018,255	$	1,019,968	$	—	$	1,019,968	$	—
Repurchase agreements		26,562		26,562		—		26,562		—
FHLB and other borrowings		102,468		102,476		—		102,476		—
Interest rate swap		580		580		—		580		—
Forward sales commitments		417		417		—		417		—
Accrued interest payable		458		458		—		458		—
Subordinated debt		33,524		31,172		—		31,172		—

December 31, 2014
Financial assets:
Cash and cash equivalents	$	30,077	$	30,077	$	30,077	$	—	$	—
Certificates of deposits with other banks		11,907		12,035		—		12,035		—
Securities available-for-sale		68,213		68,213		77		68,136		—
Securities held-to-maturity		54,538		55,871		—		55,871		—
Loans held for sale		69,527		69,527		—		69,527		—
Loans, net		792,074		803,036		—		—		803,036
Mortgage servicing rights		1,423		1,423		—		—		1,423
Interest rate lock commitment		1,020		1,020		—		—		1,020
Interest rate cap		1,423		1,423		—		1,423		—
Accrued interest receivable		2,387		2,387		—		728		1,659

Financial liabilities:
Deposits	$	823,227	$	824,078	$	—	$	824,078	$	—
Repurchase agreements		32,673		32,673		—		32,673		—
FHLB and other borrowings		101,287		101,338		—		101,338		—
Forward sales commitments		431		431		—		431		—
Accrued interest payable		376		376		—		376		—
Subordinated debt		33,524		31,172		—		31,172		—

Fair value estimates are made at a specific point in time, based on relevant market information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on-and-off balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments.