(14) Fair Value of Financial Instruments

In accordance with the Fair Value Measurements and Disclosures topic of the FASB ASC, the Company groups its financial assets and liabilities valued at fair value into three levels based on the markets in which the financial assets and liabilities are traded and the reliability of the assumptions used to determine fair value as follows:

· Level 1 — Valuation is based upon quoted prices (unadjusted) for identical assets or liabilities traded in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

· Level 2 — Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

· Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect management’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of discounted cash flow models and similar techniques that require the use of significant judgment or estimation.

In accordance with the Fair Value Measurements and Disclosures topic, the Company bases its fair values on the price that it would expect to receive if an asset were sold or the price that it would expect to pay to transfer a liability in an orderly transaction between market participants at the measurement date. Also as required, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when developing fair value measurements.

The Company uses fair value measurements to determine fair value disclosures. Investment securities held for sale and derivatives are recorded at fair value on a recurring basis. From time to time, the Company may be required to record other financial assets at fair value on a nonrecurring basis, such as loans held for sale, impaired loans and investments, and mortgage servicing assets. These nonrecurring fair value adjustments typically involve application of the lower of cost or fair value accounting or write-downs of individual assets.

Cash and Cash Equivalents, Accrued Interest Receivable and Accrued Interest Payable. The carrying amount approximates fair value because of the short maturity of these instruments.

Investment Securities. The estimated fair values of U.S. government-sponsored mortgage-backed securities are considered Level 2 inputs because the valuation for investment securities utilized pricing models that varied based on asset class and included trade, bid and other observable market information.

The trust preferred securities represent investments in a pool of debt obligations issued primarily by holding companies for Federal Deposit Insurance Corporation-insured financial institutions. The trust preferred securities market is considered to be inactive as only six transactions have occurred over the past 54 months in the same tranche of securities we own and no new issues of pooled trust preferred securities have occurred since 2007. The fair value of our trust preferred securities was determined using a discounted cash flow model. Our model used a discount rate equal to three-month LIBOR plus 20.00%.

The discounted cash flow analysis includes a review of all issuers within the pool. The fair value of the trust preferred securities are classified as Level 3 inputs because they are based on discounted cash flow models.

FHLB Stock. FHLB stock, which is redeemable for cash at par value, is reported at its par value.

FRB Stock. FRB stock, which is redeemable for cash at par value, is reported at its par value.

Loans. The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The fair value of loans is not based on the concept of exit price.

Loans Held for Sale. The fair value of loans held for sale is determined based on the prices quoted in the secondary market for similar loans.

Deposits. The fair value of checking and Super NOW savings accounts, passbook accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting future cash flows using the rates currently offered for deposits with similar remaining maturities.

Advances From the FHLB and Securities Sold Under Agreements to Repurchase. Fair value is estimated by discounting future cash flows using the rates currently offered to the Company for debt with similar remaining maturities.

Interest Rate Contracts. The Company may enter into interest rate lock commitments with borrowers on loans intended to be sold. To manage interest rate risk on the lock commitments, the Company may also enter into forward loan sale commitments. The interest rate lock commitments and forward loan sale commitments are treated as derivatives and are recorded at their fair value determined by referring to prices quoted in the secondary market for similar contracts. Interest rate contracts that are classified as assets are included with prepaid expenses and other assets on the consolidated balance sheet while interest rate contracts that are classified as liabilities are included with accounts payable and accrued expenses.

The estimated fair values of the Company’s financial instruments are as follows:


	Carrying				Fair Value Measurements Using
(Dollars in thousands)	Amount		Fair Value		Level 1		Level 2		Level 3
June 30, 2016
Assets
Cash and cash equivalents	$	63,878	$	63,878	$	63,878	$	—	$	—
Investment securities held to maturity		455,991		474,058		—		473,066		992
Loans held for sale		353		370		—		370		—
Loans receivable, net		1,259,339		1,306,902		—		—		1,306,902
FHLB stock		4,945		4,945		—		4,945		—
FRB stock		3,062		3,062		—		3,062		—
Accrued interest receivable		4,812		4,812		6		1,205		3,601
Interest rate contracts		142		142		—		142		—

Liabilities
Deposits		1,469,754		1,471,549		—		1,244,651		226,898
Advances from the Federal Home Loan Bank		69,000		70,032		—		70,032		—
Securities sold under agreements to repurchase		55,000		55,808		—		55,808		—
Accrued interest payable		245		245		—		2		243
Interest rate contracts		111		111		—		111		—

December 31, 2015
Assets
Cash and cash equivalents	$	65,919	$	65,919	$	65,919	$	—	$	—
Investment securities held to maturity		493,059		497,982		—		497,066		916
Loans held for sale		2,139		2,205		—		2,205		—
Loans receivable, net		1,188,649		1,208,300		—		—		1,208,300
FHLB stock		4,790		4,790		—		4,790		—
FRB stock		3,022		3,022		—		3,022		—
Accrued interest receivable		4,684		4,684		5		1,310		3,369
Interest rate contracts		71		71		—		71		—

Liabilities
Deposits		1,445,103		1,445,484		—		1,221,069		224,415
Advances from the Federal Home Loan Bank		69,000		69,191		—		69,191		—
Securities sold under agreements to repurchase		55,000		55,280		—		55,280		—
Accrued interest payable		237		237		—		—		237
Interest rate contracts		77		77		—		77		—

At June 30, 2016 and December 31, 2015, neither the commitment fees received on commitments to extend credit nor the fair value thereof was material to the consolidated financial statements of the Company.

The table below presents the balance of assets and liabilities measured at fair value on a recurring basis:


(Dollars in thousands)	Level 1		Level 2		Level 3		Total

June 30, 2016
Interest rate contracts — assets	$	—	$	142	$	—	$	142
Interest rate contracts — liabilities		—		(111)		—		(111)

December 31, 2015
Interest rate contracts — assets	$	—	$	71	$	—	$	71
Interest rate contracts — liabilities		—		(77)		—		(77)

The fair value of interest rate contracts was determined by referring to prices quoted in the secondary market for similar contracts.

The table below presents the balance of assets measured at fair value on a nonrecurring basis as of June 30, 2016 and December 31, 2015 and the related gains and losses for the six months ended June 30, 2016 and the year ended December 31, 2015:


									Total Gains
(Dollars in thousands)	Level 1		Level 2		Level 3		Total		(Losses)

June 30, 2016
Trust preferred securities	$	—	$	—	$	992	$	992	$	76
Mortgage servicing assets		—		—		341		341		(49)

December 31, 2015
Trust preferred securities	$	—	$	—	$	916	$	916	$	226

The fair value of trust preferred securities is determined using a discounted cash flow model. The assumptions used in the discounted cash flow model are discussed above. Gains and losses on trust preferred securities that are credit related are included in net other-than-temporary impairment losses in the consolidated statements of income. Gains and losses on trust preferred securities that are not credit related are included in other comprehensive income in the consolidated statements of comprehensive income. Mortgage servicing assets are valued using a discounted cash flow model. Assumptions used in the model include mortgage prepayment speeds, discount rates and cost of servicing. Losses on mortgage servicing assets are included in service fees on loan and deposit accounts in the consolidated statements of income.

The table below presents the significant unobservable inputs for Level 3 nonrecurring fair value measurements:


				Unobservable
(Dollars in thousands)	Fair Value		Valuation Technique	Input	Value

June 30, 2016:
Trust preferred securities	$	992	Discounted cash flow	Discount rate		Three-month LIBOR plus 20.00%
Mortgage servicing assets		341	Discounted cash flow	Discount rate		10.50%
				Prepayment speed (PSA)		166.3 – 361.3
				Annual cost to service (per loan, in dollars)	$	65
December 31, 2015:
Trust preferred securities	$	916	Discounted cash flow	Discount rate		Three-month LIBOR plus 20.00%