NOTE 16 - FAIR VALUE

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:	Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2:	Significant other 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.

Level 3:	Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

There were no transfers between levels during 2018 or 2017. The Company used the following methods and significant assumptions to estimate fair value:

Investment Securities: The 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 calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

Interest Rate Locks and Forward Delivery Commitments: Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the commitment related to the loan is locked. The fair value estimate is based on valuation models using market data from secondary market loan sales and direct contacts with third party investors as of the measurement date (Level 3).

Derivative instruments are carried at fair value in the Company’s financial statements. Changes in the fair value of a derivative instrument are accounted for within the consolidated statements of income.

The following presents assets measured on a recurring basis at December 31, 2018 and December 31, 2017 (in thousands):


	Quoted
	Prices in		Significant
	Active Markets		Other		Significant
	for Identical		Observable		Unobservable
	Assets		Inputs		Inputs		Reported
December 31, 2018	(Level 1)		(Level 2)		(Level 3)		Balance
Investment securities available-for-sale:
U.S. Treasury debt	$	250	$	—	$	—	$	250
GNMA mortgage-backed securities – residential		—		34,002		—		34,002
FNMA mortgage-backed securities – residential		—		3,870		—		3,870
Securities issued by U.S. government sponsored entities and agencies		—		4,302		—		4,302
Corporate CMO and MBS		—		1,271		—		1,271
SBIC		—		1,206		—		1,206
Total securities available-for-sale	$	250	$	44,651	$	—	$	44,901
Equity securities not available-for-sale	$	693	$	—	$	—	$	693
Interest rate lock and forward delivery commitments	$	—	$	890	$	—	$	890


	Quoted
	Prices in		Significant
	Active Markets		Other		Significant
	for Identical		Observable		Unobservable
	Assets		Inputs		Inputs		Reported
December 31, 2017	(Level 1)		(Level 2)		(Level 3)		Balance
Investment securities available-for-sale:
U.S. Treasury debt	$	249	$	—	$	—	$	249
GNMA mortgage-backed securities – residential		—		40,836		—		40,836
FNMA mortgage-backed securities – residential		—		4,399		—		4,399
Securities issued by U.S. government sponsored entities and agencies		—		5,054		—		5,054
Corporate CMO and MBS		—		1,479		—		1,479
SBIC		—		930		—		930
Equity mutual fund		703		—		—		703
Total securities available-for-sale	$	952	$	52,698	$	—	$	53,650
Interest rate lock and forward delivery commitments	$	—	$	665	$	—	$	665

Mutual funds and U.S. Treasury debt are reported at fair value utilizing Level 1 inputs. The remaining portfolio of securities are reported at fair value with Level 2 inputs provided by a pricing service. As of December 31, 2018 and December 31, 2017, the majority of the securities had credit support provided by the Federal Home Loan Mortgage Corporation, GNMA, the Federal National Mortgage Association or the Small Business Administration. Factors used to value the securities by the pricing service include: benchmark yields, reported trades, interest spreads, prepayments, and other market research. In addition, ratings and collateral quality are considered.

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. They 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 which are updated no less frequently than on an annual basis. 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 comparable sales and income data available. Such adjustments can be significant and typically result in Level 3 classifications of the inputs for determining fair value. Other real estate owned is evaluated monthly for additional impairment and adjusted accordingly.

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent 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 can be significant and typically result in Level 3 classifications of the inputs for determining fair value. Impaired loans are evaluated monthly for additional impairment and adjusted accordingly.

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 overall resulting fair value in comparison with independent data sources such as recent market data or industry‑wide statistics.

The following presents assets measured on a nonrecurring basis as of December 31, 2018 and December 31, 2017 (in thousands):


	Quoted
	Prices in		Significant
	Active Markets		Other		Significant
	for Identical		Observable		Unobservable
	Assets		Inputs		Inputs		Reported
December 31, 2018	(Level 1)		(Level 2)		(Level 3)		Balance
Other real estate owned:
Commercial properties	$	—	$	—	$	658	$	658
Total other real estate owned	$	—	$	—	$	658	$	658

Total impaired loans:
Commercial and industrial		—		—		795		795
Total impaired loans	$	—	$	—	$	795	$	795


	Quoted
	Prices in		Significant
	Active Markets		Other		Significant
	for Identical		Observable		Unobservable
	Assets		Inputs		Inputs		Reported
December 31, 2017	(Level 1)		(Level 2)		(Level 3)		Balance
Other real estate owned:
Commercial properties	$	—	$	—	$	658	$	658
Total other real estate owned	$	—	$	—	$	658	$	658

Total impaired loans:
Commercial and industrial	$	—	$	—	$	1,113	$	1,113
Total impaired loans	$	—	$	—	$	1,113	$	1,113

The sales comparison approach was utilized for estimating the fair value of non‑recurring assets.

At December 31, 2018, other real estate owned remained unchanged from December 31, 2017. As of December 31, 2017, other real estate owned at fair value had a carrying amount of $0.7 million, which is the cost basis of $2.4 million net of a valuation allowance of $1.7 million.

At December 31, 2018, total impaired loans at the fair value of the collateral for collateral dependent loans had carrying values of $1.7 million with valuation allowances of $0.9 million and were classified as Level 3. As of December 31, 2017, impaired loans measured for impairment using the fair value of the collateral for collateral dependent loans had carrying values of $1.8 million with valuation allowances of $0.7 million and were classified as Level 3. Impaired loans valued using a discounted cash flow analyses were not deemed to be at fair value at December 31, 2018 and December 31, 2017.

Impaired loans accounted for provisions for loan losses of $0.2 million and $0.7 million for the years ended December 31, 2018 and December 31, 2017.

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring, the significant unobservable inputs used in the fair value measurements were as follows (in thousands):

Quantitative Information about Level 3 Fair Value Measurements at December 31, 2018

Valuation

Significant

Range

Fair Value

Technique

Unobservable Input

(Weighted Average)

Other real estate owned:

Commercial properties

658

Appraisal Value

Discount

50% (50%)

Commission and Cost to Sell

1% - 10% (7%)

Total impaired loans:

Commercial and industrial

795

Discounted Cash Flow

Discount Rate

9% (9%)

Quantitative Information about Level 3 Fair Value Measurements at December 31, 2017

Valuation

Significant

Range

Fair Value

Technique

Unobservable Input

(Weighted Average)

Other real estate owned:

Commercial properties

658

Appraisal Value

Discount

50% (50%)

Commission and Cost to Sell

1% - 10% (7%)

Total impaired loans:

Commercial and industrial

1,113

Discounted Cash Flow

Discount Rate

9% (9%)

The following presents carrying amounts and estimated fair values for financial instruments as of December 31, 2018 and December 31, 2017 (in thousands):


	Carrying		Fair Value Measurements Using:
December 31, 2018	Amount		Level 1		Level 2		Level 3
Assets:
Cash and cash equivalents	$	73,357	$	73,357	$	—	$	—
Securities available-for-sale		44,901		250		44,651		—
Loans, net		886,515		—		—		868,828
Mortgage loans held for sale		14,832		—		14,832		—
Accrued interest receivable		2,844		—		2,844		—
Other assets		693		693		—		—
Liabilities:
Deposits	$	937,758	$	—	$	940,039	$	—
Borrowings:
FHLB Topeka Borrowings – fixed rate		15,000		—		14,833		—
2016 Subordinated notes – fixed-to-floating rate		6,560		—		—		6,434
Accrued interest payable		231		—		231		—


	Carrying		Fair Value Measurements Using:
December 31, 2017	Amount		Level 1		Level 2		Level 3
Assets:
Cash and cash equivalents	$	9,502	$	9,502	$	—	$	—
Securities available-for-sale		53,650		952		52,698		—
Loans, net		806,402		—		—		822,392
Mortgage loans held for sale		22,940		—		22,940		—
Correspondent bank stock		1,555		N/A		N/A		N/A
Accrued interest receivable		2,421		—		2,421		—
Promissory notes, net		5,792		—		—		5,792
Liabilities:
Deposits	$	816,117	$	—	$	821,059	$	—
Borrowings:
FHLB Topeka Borrowings – fixed rate		28,563		—		29,108		—
2016 Subordinated notes – fixed-to-floating rate		6,560		—		—		6,893
2012 Subordinated notes – fixed rate		6,875		—		—		7,129
Accrued interest payable		197		—		197		—

The fair value estimates presented and discussed above are based on pertinent information available to management as of the dates specified. The estimated fair value amounts are based on the exit price notion set forth by ASU 2016‑01 effective January 1, 2018 on a prospective basis. The estimated fair values carried at cost at December 31, 2017 were based on an entry price notion. Although management is not aware of any factors that would significantly affect the estimated fair values, such amounts have not been comprehensively revalued for purposes of these consolidated financial statements since the balance sheet dates. Therefore, current estimates of fair value may differ significantly from the amounts presented herein.

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

Cash and Cash Equivalents and Restricted Cash: The carrying amounts of cash and cash equivalents and restricted cash approximate fair values as maturities are less than 90 days and balances are generally in accounts bearing current market interest rates.

Loans, net: The fair values for all fixed-rate and variable-rate performing loans were estimated by discounting the projected cash flows of such loans at December 31, 2018 and 2017. Principal and interest cash flows were projected based on the contractual terms of the loans, including maturity, contractual amortization and adjustments for prepayments and expected losses, where appropriate. A discount rate was developed based on the relative risk of the cash flows, taking into account the loan type, maturity and a required return on capital.

Mortgage Loans Held for Sale: The fair value of mortgage loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

Correspondent Bank Stock: The fair value of FHLB stock and Bankers' Bank of the West stock due to restrictions placed on their transferability is not readily determinable.

Accrued Interest Receivable and Payable: The carrying amounts of accrued interest approximate fair value due to their short-term nature.

Deposits: The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amounts payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting dates. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Borrowings:

Variable Rate Borrowings: The carrying amounts of borrowings with variable rates approximate their fair values since the interest rates change to reflect current market borrowing rates for similar instruments and borrowers with similar credit ratings.

Fixed Rate Borrowings: Borrowings with fixed rates are valued using inputs such as discounted cash flows and current interest rates for similar instruments and borrowers with similar credit ratings.