Fair Value of Financial Instruments and Fair Value Measurement

Accounting standards define fair value as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accounting standards also establish a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The applicable standard describes three levels of inputs that may be used to measure fair value: 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, and 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. The Company evaluates fair value measurement inputs on an ongoing basis in order to determine if there is a change of sufficient significance to warrant a transfer between levels. For example, changes in market activity or the addition of new unobservable inputs could, in the Company’s judgment, cause a transfer to either a higher or lower level. For the three months ended March 31, 2015, there were no transfers between levels.

At March 31, 2015, the Company holds, as part of its investment portfolio, available for sale securities reported at fair value consisting of municipal securities, collateralized loan obligations, mortgage-backed securities and collateralized mortgage obligations. The fair value of the majority of these securities is determined using widely accepted valuation techniques including matrix pricing and broker-quote based applications. Inputs include benchmark yields, reported trades, issuer spreads, prepayment speeds and other relevant items. These are inputs used by a third-party pricing service used by the Company. To validate the appropriateness of the valuations provided by the third party, the Company regularly updates its understanding of the inputs used and compares valuations to an additional third party source.

All of the Company’s available for sale securities fall into Level 2 of the fair value hierarchy. These securities are priced via independent service providers. In obtaining such valuation information, the Company has evaluated the valuation methodologies used to develop the fair values.

The Company also holds assets available for sale reported at fair value and included in other assets on the Company's balance sheet, consisting of three former branches, a parcel of land adjacent to a current branch and a parcel of land initially acquired as a proposed branch site. These assets are included in other assets on the Company's condensed consolidated statements of financial condition. The fair value of these assets is determined using current appraisals adjusted at management’s discretion to reflect any decline in the fair value of the properties since the time the appraisal was performed. Appraisal values are reviewed and monitored internally and fair value is reassessed at least quarterly or more frequently when circumstances occur that indicate a change in fair value. All of the Company’s assets held for sale fall into level 3 of the fair value hierarchy.

Assets and Liabilities Measured on a Recurring Basis:

Assets and liabilities measured at fair value on a recurring basis are summarized below.



	March 31, 2015
	Estimated fair value		Quoted prices in active markets for identical assets (Level 1 inputs)		Quoted prices for similar assets (Level 2 inputs)		Significant unobservable inputs (Level 3 inputs)
Assets:
Investment securities available for sale:
Collateralized loan obligations	$	24,329,386	$	—	$	24,329,386	$	—
Mortgage-backed securities:
FHLMC certificates	40,546,762		—		40,546,762		—
FNMA certificates	105,984,755		—		105,984,755		—
GNMA certificates	1,646,637		—		1,646,637		—
Collateralized mortgage obligations:
FHLMC	44,890		—		44,890		—
FNMA	71,917		—		71,917		—
Private-label mortgage securities:
Investment grade	1,167,623		—		1,167,623		—
Split rating ₍₁₎	1,031,106		—		1,031,106		—
Non-investment grade	8,158,450		—		8,158,450		—
Total investment securities available for sale	182,981,526		—		182,981,526		—
Assets held for sale	1,744,584		—		—		1,744,584
Total recurring assets at fair value	$	184,726,110	$	—	$	182,981,526	$	1,744,584

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(1)	Bonds with split ratings represent securities with both investment and non-investment grades.



	September 30, 2014
	Estimated fair value		Quoted prices in active markets for identical assets (Level 1 inputs)		Quoted prices for similar assets (Level 2 inputs)		Significant unobservable inputs (Level 3 inputs)
Assets:
Investment securities available for sale:
Tax free municipals	$	13,457,203	$	—	$	13,457,203	$	—
Mortgage–backed securities:
FHLMC certificates	44,025,928		—		44,025,928		—
FNMA certificates	118,278,377		—		118,278,377		—
GNMA certificates	1,697,844		—		1,697,844		—
Collateralized mortgage obligations:
FHLMC	53,496		—		53,496		—
FNMA	80,156		—		80,156		—
Private-label mortgage securities:
Investment grade	1,446,858		—		1,446,858		—
Split rating ₍₁₎	1,094,107		—		1,094,107		—
Non-investment grade	8,609,304		—		8,609,304		—
Total investment securities available for sale	188,743,273		—		188,743,273		—
Assets held for sale	1,744,584		—		—		1,744,584
Total recurring assets at fair value	$	190,487,857	$	—	$	188,743,273	$	1,744,584

__________________________________


(1)	Bonds with split ratings represent securities with both investment and non-investment grades.

When a determination is made to classify a financial instrument within Level 3 of the valuation hierarchy, the determination is based upon the significance of the unobservable factors to the overall fair value measurement. However, since Level 3 financial instruments typically include, in addition to the unobservable or Level 3 components, observable components (that is, components that are actively quoted and can be validated to external sources), the losses below include changes in fair value due in part to observable factors that are part of the valuation methodology.

A reconciliation of the beginning and ending balances of Level 3 assets and liabilities recorded at fair value on a recurring basis is as follows:



	Six Months Ended March 31, 2015		Year Ended September 30, 2014
Fair value, beginning balance	$	1,744,584	$	1,744,584
Purchases	—		—
Sales	—		—
Transfers in and/or out of level 3	—		—
Fair value, ending balance	$	1,744,584	$	1,744,584

Assets and Liabilities Measured on a Nonrecurring Basis:

Assets and liabilities measured at fair value on a nonrecurring basis are summarized below.



			Fair value measurements using:
	Estimated fair value		Quoted prices in active markets for identical assets (Level 1 inputs)		Quoted prices for similar assets (Level 2 inputs)		Significant unobservable inputs (Level 3 inputs)
March 31, 2015
Impaired loans:
Not covered under loss share	$	2,579,119	$	—	$	—	$	2,579,119
Other real estate owned:
Not covered under loss share	1,144,112		—		—		1,144,112
Covered under loss share	3,343,384		—		—		3,343,384
September 30, 2014
Impaired loans:
Not covered under loss share	3,174,410		—		—		3,174,410
Other real estate owned:
Not covered under loss share	1,757,864		—		—		1,757,864
Covered under loss share	5,557,927		—		—		5,557,927

Loans considered impaired are loans for which, based on current information and events, it is probable that the creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are subject to nonrecurring fair value adjustments to reflect write-downs that are based on the market price or current appraised value of the collateral, adjusted to reflect local market conditions or other economic factors. After evaluating the underlying collateral, the fair value of the impaired loans is determined by allocating specific reserves from the allowance for loan and lease losses to the loans. Thus, the fair value reflects the loan balance, which is net of partial charge-offs. Certain collateral-dependent impaired loans are reported at the fair value of the underlying collateral. Impairment is measured based on the fair value of the collateral, which is typically derived from appraisals that take into consideration prices in observed transactions involving similar assets and similar locations. Each appraisal is updated on an annual basis, either through a new appraisal or through the Company’s comprehensive internal review process. Appraised values are reviewed and monitored internally and fair value is re-assessed at least quarterly or more frequently when circumstances occur that indicate a change in fair value. The fair value of impaired loans that are not collateral dependent is measured using a discounted cash flow analysis considered to be a Level 3 input.

Other real estate owned (“OREO”) is initially accounted for at fair value, less estimated costs to dispose of the property. Any excess of the recorded investment over fair value, less costs to dispose, is charged to the allowance for loan and lease losses at the time of foreclosure. A provision is charged to earnings for subsequent losses on other real estate owned when market conditions indicate such losses have occurred. The ability of the Company to recover the carrying value of other real estate owned is based upon future sales of the real estate. The ability to affect such sales is subject to market conditions and other factors beyond the Company's control, and future declines in the value of the real estate would result in a charge to earnings. The recognition of sales and gain on sales is dependent upon whether the nature and terms of the sales, including possible future involvement of the Company, if any, meet certain defined requirements. If those requirements are not met, sale and gain recognition is deferred. OREO represents real property taken by the Company either through foreclosure or through a deed in lieu thereof from the borrower. The fair value of OREO is based on property appraisals adjusted at management’s discretion to reflect a further decline in the fair value of properties since the time the appraisal analysis was performed. It has been the Company’s experience that appraisals may become outdated due to the volatile real-estate environment. Appraised values are reviewed and monitored internally and fair value is re-assessed at least quarterly or more frequently when circumstances occur that indicate a change in fair value. Therefore, the inputs used to determine the fair value of OREO and repossessed assets fall within Level 3. The Company may include within OREO other repossessed assets received as partial satisfaction of a loan. These assets are not material and do not typically have readily determinable market values and are considered Level 3 inputs.

The following table provides information describing the valuation processes used to determine recurring and nonrecurring fair value measurements categorized within Level 3 of the fair value hierarchy at March 31, 2015:



	Quantitative Information about Level 3 Fair Value Measurements
	Fair Value		Valuation Technique	Unobservable Input	General Range (Discount)			Weighted Average Discount
Impaired Loans	$	2,579,119	Property appraisals	Management discount for property type and recent market volatility	19%	—	50%	31%
OREO	$	4,487,496	Property appraisals	Management discount for property type and recent market volatility	20%	—	47%	29%
Assets Held for Sale	$	1,744,584	Valuation analysis	Management discount for property type and recent market volatility	0%	—	50%	34%

Accounting standards require disclosures of fair value information about financial instruments, whether or not recognized in the Statement of Condition, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair value is based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Also, the fair value estimates presented herein are based on pertinent information available to Management as of March 31, 2015 and September 30, 2014.

The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:

CASH AND CASH EQUIVALENTS – The carrying amount approximates fair value because of the short maturity of these instruments.

INVESTMENTS AVAILABLE FOR SALE AND FHLB STOCK – The fair value of investment securities and mortgage-backed securities and collateralized mortgage obligations available for sale is estimated based on bid quotations received from securities dealers. The FHLB stock is considered a restricted stock and is carried at cost which approximates its fair value.

LOANS RECEIVABLE – Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type. The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit risk inherent in the loan. The estimate of maturity is based on the Company’s historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of the current economic and lending conditions.

Fair value for significant nonperforming loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are determined using available market information and specific borrower information. In prior periods, the Company affected estimated fair value by a liquidation discount of 5.5%. Due to the continued stabilization of the whole loan market, this liquidation discount was discontinued during the year ended September 30, 2014.

LOANS HELD FOR SALE – Loans held for sale are carried at the lower of cost or market value. The fair values of loans held for sale are based on commitments on hand from investors within the secondary market for loans with similar characteristics.

CASH SURRENDER VALUE OF LIFE INSURANCE – The Company’s cash surrender value of bank owned life insurance approximates its fair value.

FDIC RECEIVABLE FOR LOSS SHARING AGREEMENTS – Fair value is estimated based on discounted future cash flows using current discount rates for instruments with similar risk and cash flow volatility.

ASSETS HELD FOR SALE – The fair value of assets held for sale by the Company is generally based on the most recent appraisals of the asset or other market information as it becomes available to management.

DEPOSITS – The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, money market and checking accounts, is equal to the amount payable on demand. The fair value of time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.

BORROWINGS – The fair value of the Company’s Federal Home Loan Bank advances is estimated based on the discounted value of contractual cash flows. The fair value of securities sold under agreements to repurchase approximates the carrying amount because of the short maturity of these borrowings. The discount rate is estimated using rates quoted for the same or similar issues or the current rates offered to the Company for debt of the same remaining maturities.

ACCRUED INTEREST AND DIVIDENDS RECEIVABLE AND PAYABLE – The carrying amount of accrued interest and dividends receivable on loans and investments and payable on borrowings and deposits approximate their fair values.

COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT – The value of these unrecognized financial instruments is estimated based on the fee income associated with the commitments which, in the absence of credit exposure, is considered to approximate their settlement value. Since no significant credit exposure existed, and because such fee income is not material to the Company's financial statements at March 31, 2015 and at September 30, 2014, the fair value of these commitments is not presented.

Many of the Company's assets and liabilities are short-term financial instruments whose carrying amounts reported in the Statement of Condition approximate fair value. These items include cash and due from banks, interest-bearing bank balances, federal funds sold, other short-term borrowings and accrued interest receivable and payable balances. The estimated fair value of the Company’s remaining on-balance sheet financial instruments as of March 31, 2015 and September 30, 2014 is summarized below:



	March 31, 2015
					Estimated Fair Value
	Carrying Value		Total Estimated Fair Value		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets:
Cash and cash equivalents	$	64,563,841	$	64,563,841	$	64,563,841	$	—	$	—
Investments available for sale	182,981,526		182,981,526		—		182,981,526		—
FHLB stock	3,005,600		3,005,600		—		3,005,600		—
Loans receivable, net	656,212,122		654,262,331		—		—		654,262,331
Loans held for sale	2,700,613		2,755,616		—		2,755,616		—
FDIC receivable for loss sharing arrangements	6,749,359		5,932,365		—		—		5,932,365
Assets held for sale	1,744,584		1,744,584		—		—		1,744,584
Accrued interest and dividends receivable	2,594,483		2,594,483		—		495,737		2,098,746
Financial liabilities:
Deposits	$	736,802,784	$	737,511,630	$	—	$	737,511,630	$	—
FHLB advances	50,000,000		54,061,552		—		54,061,552		—
Accrued interest payable	198,293		198,293		—		198,293		—



	September 30, 2014
					Estimated Fair Value
	Carrying Value		Total Estimated Fair Value		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets:
Cash and cash equivalents	$	99,462,953	$	99,462,953	$	99,462,953	$	—	$	—
Investments available for sale	188,743,273		188,743,273		—		188,743,273		—
FHLB stock	3,442,900		3,442,900		—		3,442,900		—
Loans receivable, net	606,366,713		607,754,670		—		—		607,754,670
Loans held for sale	2,054,722		2,090,469		—		2,090,469		—
FDIC receivable for loss sharing arrangements	10,531,809		7,658,896		—		—		7,658,896
Assets held for sale	1,744,584		1,744,584		—		—		1,744,584
Accrued interest and dividends receivable	2,459,347		2,459,347		—		538,043		1,921,304
Financial liabilities:
Deposits	$	717,192,200	$	718,935,248	$	—	$	718,935,248	$	—
FHLB advances	55,000,000		59,391,540		—		59,391,540		—
Accrued interest payable	182,198		182,198		—		182,198		—