Note 4. Fair Value Measurement for Financial and Non-Financial Assets and Liabilities

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. The fair value inputs of the instruments are classified and disclosed in one of the following three categories pursuant to ASC 820:

Level 1 — Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. The quoted price shall not be adjusted for any type of blockage factor (i.e., size of the position relative to trading volume).

Level 2 — Pricing inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Fair value is determined through the use of models or other valuation methodologies, including the use of pricing matrices. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability.

Level 3 — Pricing inputs are inputs unobservable for the asset or liability. Unobservable inputs shall be used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date. The inputs into the determination of fair value require significant management judgment or estimation.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

The Company uses the following methods and assumptions in estimating our fair value disclosures for financial instruments. Financial assets and liabilities recorded at fair value on a recurring and non-recurring basis are listed as follows:

Cash and cash equivalents — The carrying value of our cash and cash equivalents is approximately equal to the fair value resulting in a Level 1 classification.

Federal funds sold — The carrying value of federal funds sold is approximately equal to the fair value resulting in a Level 1 classification.

Deposits held at other financial institutions — The carrying value of deposits held at other financial institutions is approximately equal to the fair value resulting in a Level 1 classification.

Investment securities — Investments securities are recorded at fair value pursuant to ASC 320-10 “Investments - Debt and Equity Securities.” Fair value measurements are based upon quoted prices for similar assets, if available (Level 1). If quoted prices are not available, fair values are measured using matrix pricing models, or other model-based valuation techniques requiring observable inputs other than quoted prices such as yield curves, prepayment speeds, and default rates (Level 2). Our existing investment security holdings as of March 31, 2014 are measured using matrix pricing models in lieu of direct price quotes and is recorded based on recurring Level 2 measurement inputs. Level 3 measurement inputs are not utilized to measure fair value for any of our investment securities.

Loans — The fair value of variable rate loans that have no significant changes in credit risk are based on the carrying values. The fair values of other loans are estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar risk characteristics. The aforementioned fair value techniques result in a Level 3 classification. See below for impaired loans.

Loans held-for-sale (excluding impaired loans held-for-sale) — Small Business Administration (“SBA”) loans or mortgage loans that are held-for-sale are reported at the lower of cost or fair value. Fair value is determined based on quotes, bids, or indications directly from potential purchasing party. We record SBA and mortgage loans held-for-sale as non-recurring Level 2 measurement inputs.

Impaired loans — At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans are carried at fair value generally having had a charge-off through the allowance for loan losses or a specific valuation allowance. The fair value of impaired loans that are not collateral dependent is measured based on the present value of estimated cash flows. For collateral dependent loans, 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 to adjust for differences between the comparable sales and income data available. Such adjustments may be significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may also 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, based on changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and are adjusted accordingly.

Indications of value for both collateral-dependent impaired loans and other real estate owned are obtained from third party providers or the Company’s internal Appraisal Department. All indications of value are reviewed for reasonableness by a member of the Appraisal Department for the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value via comparison with independent data sources such as recent market data or industry-wide statistics.

Other real estate owned — OREO is measured at fair value less estimated costs to sell when acquired, establishing a new cost basis. 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 to adjust for differences between the comparable sales and income data available. The Company records OREO as non-recurring with Level 3 measurement inputs.

Servicing assets — SBA and residential real estate loan servicing assets represent the value associated with servicing SBA and residential real estate loans that have been sold. The fair value for servicing assets is determined through discounted cash flow analysis and utilizes discount rates, prepayment speeds, and delinquency rate assumptions as inputs. All of these assumptions require a significant degree of management estimation and judgment. The fair market valuation is performed on a quarterly basis for servicing assets. The Company classifies loan servicing assets as recurring with Level 3 measurement inputs.

FHLB stock — It is not practical to determine the fair value of Federal Home Loan Bank (“FHLB”) stock due to the restrictions placed on the stock’s transferability.

Accrued interest receivable — The carrying amount of accrued interest receivable approximates its fair value due to the short-term nature of this asset resulting in a Level 2 or 3 classification which is consistent with its underlying asset.

FDIC loss-share indemnification asset — The fair value of the Federal Deposit Insurance Corporation (“FDIC”) loss-share indemnification asset is estimated by discounting the estimated future cash flows using current market rates for financial instruments with similar characteristics resulting in a Level 3 classification.

Due from customer on acceptances — The carrying value of due from customers on acceptances is approximately equal to the fair value resulting in a Level 1 classification.

Non-interest bearings deposits — The carrying value of our non-interest bearings deposits is approximately equal to the fair value resulting in a Level 1 classification.

Interest bearings deposits — The fair value of money market and savings accounts is estimated to be the amount that is payable on demand as of the reporting date resulting in Level 2 classification. Fair value for fixed-rate time deposits is estimated using a discounted cash flow analysis which utilizes current interest rates offered on deposits of similar maturities resulting in a Level 2 classification.

Junior subordinated debentures — The fair value for junior subordinated debentures is derived from a discounted cash flow analysis based on current rates that are given for securities with similar risk characteristics, resulting in a Level 2 classification.

Short-term FHLB advances — The carrying value of our short-term FHLB advances is approximately equal to the fair value as the borrowings are usually variable rate and are renewed daily. As such, these liabilities have a Level 1 classification.

Long-term FHLB advances — The fair value for long-term FHLB advances is derived from a discounted cash flow analysis based on current rates that are given for borrowings with similar risk characteristics, resulting in a Level 2 classification.

Accrued Interest payable — The carrying amount of accrued interest payable approximates its fair value due to the short-term nature if this liability resulting in a Level 1 or 2 classification consistent with its underlying liabilities.

The table below summarizes the valuation measurements of our financial assets and liabilities in accordance with ASC 820-10 fair value hierarchy levels at March 31, 2014 and December 31, 2013:

Assets and Liabilities Measured at Fair Value on a Recurring Basis
(Dollars in Thousands)

	Fair Value Measurements Using:
As of March 31, 2014	Total Fair Value		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Investments:
Securities of government sponsored enterprises	$	59,950	$	—	$	59,950	$	—
Mortgage-backed securities (residential)	89,325		—		89,325		—
Collateralized mortgage obligations (residential)	127,814		—		127,814		—
Corporate securities	39,242		—		39,242		—
Municipal bonds	26,107		—		26,107		—
Servicing assets	17,536		—		—		17,536

	Fair Value Measurements Using:
As of December 31, 2013	Total Fair Value		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Investments:
Securities of government sponsored enterprises	$	60,789	$	—	$	60,789	$	—
Mortgage-backed securities (residential)	90,869		—		90,869		—
Collateralized mortgage obligations (residential)	135,653		—		135,653		—
Corporate securities	39,530		—		39,530		—
Municipal bonds	25,596		—		25,596		—
Servicing assets	16,108		—		—		16,108

Financial instruments measured for fair value on a recurring basis, which were part of the asset or liability balances that were deemed to have Level 3 fair value inputs when determining valuation, are identified in the table below by category with a summary of changes in fair value for periods indicated:

(Dollars in Thousands)	At January 1, 2014		Net Realized Gains in Net Income		Unrealized Gains in Other Comprehensive Income (Loss)		Net Purchases, Sales and Settlements		Transfers In or Out of Level 3		At March 31, 2014		Net Cumulative Unrealized Loss in Accumulated Other Comprehensive Income (Loss)
Servicing assets	$	16,108	$	563	$	—	$	865	$	—	$	17,536	$	—

(Dollars in Thousands)	At January 1, 2013		Net Realized Gains in Net Income		Unrealized Gains in Other Comprehensive Income (Loss)		Net Purchases, Sales and Settlements		Transfers In or Out of Level 3		At March 31, 2013		Net Cumulative Unrealized Loss in Accumulated Other Comprehensive Income (Loss)
Servicing assets	$	9,610	$	107	$	—	$	704	$	—	$	10,421	$	—

We had no transfers of financial instruments between Level 1, 2, or 3 during the quarters ended March 31, 2014 and December 31, 2013.

The following tables represent the aggregated balance of assets measured at fair value on a non-recurring basis at March 31, 2014 and December 31, 2013, and the total losses resulting from these fair value adjustments for the three months ended March 31, 2014 and December 31, 2013:

As of March 31, 2014

(Dollars in Thousands)	Level 1		Level 2		Level 3		Total		Net Realized Losses
Collateral Dependent Impaired Loans:
Commercial Real Estate	$	—	$	—	$	5,191	$	5,191	$	(81	)
Residential Real Estate	—		—		449		449		—
OREO:
Commercial Real Estate	—		—		8,434		8,434		(11		)
Residential Real Estate	—		—		535		535		—
Total	$	—	$	—	$	14,609	$	14,609	$	(92	)

As of December 31, 2013

(Dollars in Thousands)	Level 1		Level 2		Level 3		Total		Net Realized (Losses)/ Gains
Collateral Dependent Impaired Loans:
Construction	$	—	$	—	$	—	$	—	$	—
Commercial Real Estate	—		—		9,330		9,330		(6,134		)
Residential Real Estate	—		—		649		649		(72		)
OREO:
Commercial Real Estate	—		—		4,866		4,866		(26		)
Impaired Loans Held-For-Sale:
Commercial Real Estate	—		—		800		800		(769		)
Total	$	—	$	—	$	15,645	$	15,645	$	(7,001	)

Quantitative information about the significant unobservable inputs (level 3) used in the fair value measurement for asset and liabilities measured on a recurring and non-recurring basis at March 31, 2014 and March 31, 2013 are presented in the tables below:

As of March 31, 2014

(Dollars in Thousands)	Fair Value		Valuation Technique	Significant Unobservable Inputs	Range *
Servicing assets	$	17,536	Discounted cash flow	Discount rate Constant prepayment rate	4.5% - 7.8% 9.0% - 9.6%
Collateral dependent impaired loans:
Commercial Real Estate	5,191		Sales comparison approach	Adjustment for difference between comparable sales and expected sales amounts	64.06%
Residential Real Estate	449		Sales comparison approach	Adjustment for difference between comparable sales and expected sales amounts	19.24%*
OREO:
Commercial Real Estate	8,434		Sales comparison approach	Adjustment for difference between comparable sales and expected sales amounts	29.01%*
Residential Real Estate	535		Sales comparison approach	Adjustment for difference between comparable sales and expected sales amounts	10.23%*

As of December 31, 2013

(Dollars in Thousands)	Fair Value		Valuation Technique	Significant Unobservable Inputs	Range
Servicing assets	$	16,108	Discounted cash flow	Discount rate Constant prepayment rate	4.5% - 7.8% 10.1% - 10.9%
Collateral dependent impaired loans:
Commercial Real Estate	9,330		Sales Comparison Approach	Adjustment for difference between comparable sales and expected sales amounts	54.64%*
Residential Real Estate	649		Sales Comparison Approach	Adjustment for difference between comparable sales and expected sales amounts	50.08%*
OREO:
Commercial Real Estate	4,866		Sales Comparison Approach	Adjustment for difference between comparable sales and expected sales amounts	15.08%*
Impaired Loans Held-For-Sale:
Commercial Real Estate	800		Sales comparison approach	Adjustment for difference between comparable sales and expected sales amounts	63.91%*

* Represents weighted average percentage

The fair value estimates presented herein are based on pertinent information available to management at March 31, 2014 and December 31, 2013. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and therefore, current estimates of fair value may differ significantly from the amounts presented herein.

The fair value of OREO and collateral-dependent impaired loans, including those that are held-for-sale, are based on third-party property appraisals. The majority of the appraisals utilize a single valuation approach or a combination of approaches including a market approach, where prices and other relevant information generated by market transactions involving identical or comparable properties are used to determine fair value. Appraisals may also utilize an income approach, such as the discounted cash flow method, to estimate future income and profits or cash flows. Appraisals may include an ‘as is’ sales comparison approach and an ‘upon completion’ valuation approach. Adjustments are routinely made in the appraisal process by third-party appraisers to adjust for differences between the comparable sales and income data. Adjustments also result from the consideration of relevant economic and demographic factors with the potential to affect property values. Also, prospective values are based on the market conditions which exist at the date of inspection combined with informed forecasts based on current trends in supply and demand for the property types under appraisal.

The fair value of servicing assets is measured using discounted cash flow valuation. This method requires generating cash flow projections over multiple interest rate scenarios and discounting those cash flows at a risk adjusted rate. As such, increases or decreases in cash flow inputs, including changes to the discount rate and constant prepayment rate will have a corresponding impact to the fair value of these assets.

The table below is a summary of fair value estimates at March 31, 2014 and December 31, 2013, for financial instruments, as defined by ASC 825-10 “Financial Instruments”, including those financial instruments for which the Company did not elect fair value option.

		March 31, 2014				December 31, 2013
	Fair Value	Carrying		Estimated		Carrying		Estimated
(Dollars in Thousands)	Level	Amount		Fair Value		Amount		Fair Value
Assets:
Cash and cash equivalents	Level 1	$	160,999	$	160,999	$	124,064	$	124,064
Federal funds sold	Level 1	7,301		7,301		46,590		46,590
Deposits held in other financial institutions		21,006		21,006		21,019		21,019
Investment securities available-for-sale	Level 2	342,438		342,438		352,437		352,437
Investment securities held-to-maturity	Level 2	32		34		35		37
Loans receivable, net of allowance	Level 3	2,818,175		2,821,415		2,763,279		2,752,556
Loans held-for-sale	Level 2	27,791		31,220		47,557		52,169
FHLB stock	N/A	15,983		N/A		15,983		N/A
Accrued interest receivable	Level 2/3	8,293		8,293		8,350		8,350
FDIC loss-share indemnification asset	Level 3	2,169		2,169		4,856		4,856
Due from customer on acceptances	Level 1	889		889		1,517		1,517

Liabilities:
Non-interest bearing deposits	Level 1	$	869,598	$	869,598	$	832,152	$	832,152
Interest-bearing deposits	Level 2	2,053,611		2,009,008		2,039,358		1,993,563
Junior subordinated debentures	Level 2	71,610		65,717		71,550		66,186
Short-term FHLB advances	Level 1	140,000		140,000		180,000		180,000
Long-term FHLB advances	Level 2	10,292		10,186		10,325		10,238
Accrued interest payable	Level 1/2	2,462		2,462		2,418		2,418
Bank acceptances outstanding	Level 1	889		889		1,517		1,517