NOTE 12 - 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 the three months ended March 31, 2019 or 2018. 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 2).

Derivative instruments are carried at fair value in the Company’s financial statements. The accounting for 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 March 31, 2019 and December 31, 2018 (in thousands):


	Quoted
	Prices in		Significant
	Active Markets		Other		Significant
	for Identical		Observable		Unobservable
	Assets		Inputs		Inputs		Reported
March 31, 2019	(Level 1)		(Level 2)		(Level 3)		Balance
Investment securities available-for-sale:
U.S. Treasury debt	$	253	$	—	$	—	$	253
GNMA		—		39,423		—		39,423
FNMA		—		3,746		—		3,746
Securities issued by US. Government sponsored entities and agencies		—		4,400		—		4,400
Corporate CMO and MBS		—		5,788		—		5,788
Total securities available-for-sale	$	253	$	53,357	$	—	$	53,610
Equity securities	$	702	$	—	$	—	$	702
Interest rate lock and forward delivery commitments	$	—	$	1,525	$	—	$	1,525


	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		—		34,002		—		34,002
FNMA		—		3,870		—		3,870
Securities issued by US. Government sponsored entities and agencies		—		4,302				4,302
Corporate CMO and MBS		—		1,271		—		1,271
Total securities available-for-sale	$	250	$	43,445	$	—	$	43,695
Equity securities	$	693	$	—	$	—	$	693
Interest rate lock and forward delivery commitments	$	—	$	890	$	—	$	890

Equity securities 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 March 31, 2019 and December 31, 2018, the majority of the securities have credit support provided by the Federal Home Loan Mortgage Corporation, GNMA, and the Federal National Mortgage Association. 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.

As of March 31, 2019, equity securities have been recorded at fair value within the other assets line item in the consolidated balance sheet with changes recorded in the other line item in the consolidated statement of income (in thousands).

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 quarterly 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 March 31, 2019 and December 31, 2018 (in thousands):


	Quoted
	Prices in		Significant
	Active Markets		Other		Significant
	for Identical		Observable		Unobservable
	Assets		Inputs		Inputs		Reported
March 31, 2019	(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		—		—		495		495
Total impaired loans	$	—	$	—	$	495	$	495


	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

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

At March 31, 2019, other real estate owned remained unchanged from December 31, 2018 and 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 March 31, 2019, total impaired loans measured for impairment using the fair value of the collateral for collateral dependent loans had carrying values of $1.4 million with valuation allowances of $0.9 million and were classified as Level 3. As of December 31, 2018, impaired loans measured for impairment using 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. Impaired loans valued using a discounted cash flow analyses were not deemed to be at fair value at March 31, 2019 and December 31, 2018.

Impaired loans accounted for provisions for loan losses of $0 for each of the three month periods ended March 31, 2019 and 2018.

The following presents carrying amounts and estimated fair values for financial instruments as of March 31, 2019 and December 31, 2018 (in thousands):


	Carrying		Fair Value Measurements Using:
March 31, 2019	Amount		Level 1		Level 2		Level 3
Assets:
Cash and cash equivalents	$	69,766	$	69,766	$	—	$	—
Securities available-for-sale		53,610		253		53,357		—
Loans, net		923,545		—		—		905,205
Mortgage loans held for sale		19,778		—		19,778		—
Accrued interest receivable		3,053		—		3,053		—
Other assets		702		702		—		—
Liabilities:
Deposits	$	978,101	$	—	$	980,258	$	—
Borrowings:
FHLB Topeka Borrowings – fixed rate		20,361		—		20,249		—
2016 Subordinated notes – fixed-to-floating rate		6,560		—		—		6,325
Accrued interest payable		329		—		329		—


	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		43,695		250		43,445		—
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		—

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.