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, 2015 and the six months ended June 30, 2016. 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 June 30, 2016 and December 31, 2015 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.


	June 30, 2016
(in thousands)	Level I		Level II		Level III		Total
Assets:
U.S. Government Agency securities	$	—	$	24,068	$	—	$	24,068
U.S. Sponsored Mortgage backed securities		—		44,923		—		44,923
Municipal securities		—		63,654		—		63,654
Equity and Other securities		686		5,513		—		6,199
Loans held for sale		—		131,671		—		131,671
Interest rate lock commitment		—		—		3,625		3,625
Interest rate swap		—		1,475		—		1,475
Interest rate cap		—		64		—		64
Liability:
Interest rate swap		—		1,475		—		1,475
Forward sales commitments		—		2,077		—		2,077


	December 31, 2015
(in thousands)	Level I		Level II		Level III		Total
Assets:
U.S. Government Agency securities	$	—	$	29,351	$	—	$	29,351
U.S. Sponsored Mortgage backed securities		—		33,714		—		33,714
Municipal securities		—		1,798		—		1,798
Equity and Other securities		—		5,393		—		5,393
Loans held for sale		—		102,623		—		102,623
Interest rate lock commitment		—		—		1,583		1,583
Interest rate swap		—		405		—		405
Interest rate cap		—		437		—		437
Liabilities:
Interest rate swap		—		405		—		405

The following table represents recurring level III assets:


	For the three months ended		For the three months ended		For the six months ended		For the six months ended
Interest Rate Lock Commitments	June 30, 2016		June 30, 2015		June 30, 2016		June 30, 2015
(in thousands)
Balance, beginning of period	$	2,769	$	1,790	$	1,583	$	1,020

Realized and unrealized gains (loss) included in earnings		856		(137)		2,042		633

Balance, end of period	$	3,625	$	1,653	$	3,625	$	1,653

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 2016 and 2015 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.

Assets measured at fair value on a nonrecurring basis as of June 30, 2016 and December 31, 2015 are included in the tables below:


	June 30, 2016
(in thousands)	Level I		Level II		Level III		Total
Assets:
Impaired loans	$	—	$	—	$	11,675	$	11,675
Other real estate owned		—		—		353		353


	December 31, 2015
(in thousands)	Level I		Level II		Level III		Total
Assets:
Impaired loans	$	—	$	—	$	14,362	$	14,362
Other real estate owned		—		—		239		239

The following tables present quantitative information about the Level 3 significant unobservable inputs for assets measured at fair value on a nonrecurring basis at June 30, 2016 and December 31, 2015.


	Quantitative Information about Level 3 Fair Value Measurements
			Valuation	Unobservable
(Dollars in thousands)	Fair Value		Technique	Input	Range
June 30, 2016:
Impaired loans	$	11,675	Appraisal of collateral (1)	Appraisal adjustments(2)	20% - 62%
				Liquidation expense (2)	5% - 10%

Other real estate owned	$	353	Appraisal of collateral (1)	Appraisal adjustments (2)	20% - 30%
				Liquidation expense (2)	5% - 10%


	Quantitative Information about Level 3 Fair Value Measurements
			Valuation	Unobservable
(Dollars in thousands)	Fair Value		Technique	Input	Range
December 31, 2015:
Impaired loans	$	14,362	Appraisal of collateral (1)	Appraisal adjustments (2)	20% - 62%
				Liquidation expense (2)	5% - 10%

Other real estate owned	$	239	Appraisal of collateral (1)	Appraisal adjustments (2)	20% - 30%
				Liquidation expense (2)	5% - 10%

(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% – 82% and 78% - 82% as of June 30, 2016 and December 31, 2015.

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.

Accrued interest receivable and payable and repurchase agreements: The carrying values of accrued interest receivable and payable and repurchase agreements 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)
June 30, 2016:
Financial assets:
Cash and cash equivalents	$	28,762	$	28,762	$	28,762	$	—	$	—
Certificates of deposits with other banks		13,150		13,394		—		13,394		—
Securities available-for-sale		138,844		138,844		—		138,844		—
Loans held for sale		131,671		131,671		—		131,671		—
Loans, net		1,078,415		1,072,011		—		—		1,072,011
Mortgage servicing rights		662		662		—		—		662
Interest rate lock commitment		3,625		3,625		—		—		3,625
Interest rate swap		1,475		1,475		—		1,475		—
Interest rate cap		64		64		—		64		—
Accrued interest receivable		3,974		3,974		—		754		3,220

Financial liabilities:
Deposits	$	1,067,242	$	1,081,195	$	—	$	1,081,195	$	—
Repurchase agreements		26,048		26,048		—		26,048		—
FHLB and other borrowings		213,008		213,015		—		213,015		—
Interest rate swap		1,475		1,475		—		1,475		—
Forward sales commitments		2,077		2,077		—		2,077		—
Accrued interest payable		720		720		—		720		—
Subordinated debt		33,524		32,172		—		32,172		—

December 31, 2015
Financial assets:
Cash and cash equivalents	$	29,133	$	29,133	$	29,133	$	—	$	—
Certificates of deposits with other banks		13,150		13,270		—		13,270		—
Securities available-for-sale		70,256		70,256		—		70,256		—
Securities held-to-maturity		52,859		54,470		—		54,470		—
Loans held for sale		102,623		102,623		—		102,623		—
Loans, net		1,024,164		1,034,832		—		—		1,034,832
Mortgage servicing rights		956		956		—		—		956
Interest rate lock commitment		1,583		1,583		—		—		1,583
Interest rate swap		405		405		—		405		—
Interest rate cap		437		437		—		437		—
Accrued interest receivable		3,356		3,356		—		723		2,633

Financial liabilities:
Deposits	$	1,012,314	$	1,015,521	$	—	$	1,015,521	$	—
Repurchase agreements		27,437		27,437		—		27,437		—
FHLB and other borrowings		183,198		183,211		—		183,211		—
Interest rate swap		405		405		—		405		—
Accrued interest payable		474		474		—		474		—
Subordinated debt		33,524		32,172		—		32,172		—

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.