(7)Fair Value Measurements

The Bank uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of an asset or liability is the price which a seller would receive in an orderly transaction between market participants (an exit price). Assets and liabilities are placed in a fair value hierarchy based on fair value measurements using three levels of inputs: (Level 1) quoted market prices in active markets for identical assets or liabilities; (Level 2) significant other observable inputs, including quoted prices for similar items in active markets, quoted prices for identical or similar items in markets that are not active, inputs such as interest rates and yield curves, volatilities, prepayment speeds, credit risks and default rates which provide a reasonable basis for fair value determination or inputs derived principally from observed market data; (Level 3) significant unobservable inputs for situations in which there is little, if any, market activity for the asset or liability. Unobservable inputs must reflect reasonable assumptions that market participants would use in pricing the asset or liability, which are developed on the basis of the best information available under the circumstances.

The following tables summarize significant assets and liabilities carried at fair value and placement in the fair value hierarchy at the dates specified:

	September 30, 2014
(Dollars in thousands)	Level 1		Level 2		Level 3
Assets measured on a recurring basis:
Derivative loan commitments	$	—	$	—	$	120
Liabilities measured on a recurring basis:
Forward loan sale commitments	—		—		8
Assets measured on a non-recurring basis:
Impaired loans (collateral dependent)	—		—		1,379
Foreclosed real estate	—		—		735
Real estate held for sale	—		1,887		3,831

	December 31, 2013
(Dollars in thousands)	Level 1		Level 2		Level 3
Assets measured on a recurring basis:
Forward loan sale commitments	$	—	$	—	$	248
Liabilities measured on a recurring basis:
Derivative loan commitments	—		—		4
Assets measured on a non-recurring basis:
Impaired loans (collateral dependent)	—		—		987
Foreclosed real estate	—		—		1,170
Real estate held for sale	—		—		3,515

The Bank did not have cause to transfer any assets between the fair value measurement levels during the three and nine months ended September 30, 2014 or the year ended December 31, 2013, other than the transfer of one property classified as real estate held for sale, which was transferred out of level 3 to level 2 as a result of entering into a Purchase & Sale Agreement as described below.

Impaired loan balances in the table above represent those collateral dependent impaired loans where management has estimated the credit loss by comparing the loan’s carrying value against the expected realizable fair value of the collateral (appraised value or internal analysis less estimated cost to sell, adjusted as necessary for changes in relevant valuation factors subsequent to the measurement date). Certain inputs used in these assessments, and possible subsequent adjustments, are not always observable, and therefore, collateral dependent impaired loans are categorized as Level 3 within the fair value hierarchy. A specific allowance or partial charge-off is recorded to the collateral dependent impaired loan for the amount of management’s estimated credit loss. Losses on collateral dependent impaired loans for the three months ended September 30, 2014 and 2013, totaled $157,000 and $91,000, respectively and $257,000 and $220,000 for the nine months ended September 30, 2014 and 2013 respectively. The losses represent the amount of write-downs during the period on assets held at period end.

Real estate acquired by the Bank through foreclosure proceedings or the acceptance of a deed in lieu of foreclosure is classified as foreclosed real estate. When property is acquired, it is recorded at the estimated fair value of the property acquired, less estimated costs to sell. The estimated fair value is based on market appraisals and the Bank’s internal analysis. Certain inputs used in appraisals or the Bank’s internal analysis, are not always observable, and therefore, foreclosed real estate may be categorized as Level 3 within the fair value hierarchy. Losses on foreclosed real estate for assets held at period end for the three months ended September 30, 2014 and 2013 totaled $91,000 and $11,000, respectively, and $129,000 and $230,000 for the nine months ended September 30, 2014 and 2013, respectively. The Bank sold a foreclosed property on July 1, 2014, and received net proceeds of $1.1 million. A write-down of $40,000 had been recorded on this property upon entering into the Purchase & Sale Agreement in the second quarter of 2014.

Write-downs on real estate held for sale during the three and nine months ended September 30, 2014 and 2013 totaled $706,000 and $393,000, and $1.1 million and $482,000 respectively. On May 31, 2014, the Bank entered into a Purchase & Sale Agreement to sell a property classified as real estate held for sale for a net sales price of $1.8 million resulting in a $393,000 impairment loss. The sale, closed on October 30, 2014, and was financed by the Bank. The borrower provided a sufficient down payment in accordance with Accounting Standards Codification Topic 360. The loan was made at market terms. During the third quarter of 2014, the Bank reclassified its prior corporate headquarters into real estate held for sale and recorded an impairment loss of $706,000, based upon a current appraised value, less estimated cost to sell.

Derivatives fair value methodology

Fair value changes in mortgage banking derivatives (interest rate lock commitments and commitments to sell fixed-rate residential mortgages) subsequent to inception are estimated using anticipated market prices based on pricing indications provided from syndicate banks and consideration of pull-through and fallout rates. The fair value of the mortgage banking derivatives are considered to be Level 3 assets.

The table below presents for the three and nine months ended September 30, 2014 and 2013, the change in Level 3 assets and liabilities that are measured on a recurring basis:

	Derivative Loan Commitments and Forward Loan Sale Commitments
	Three months ended September 30,
(Dollars in thousands)	2014			2013
Balance at beginning of period	$	96		$	1,370
Total realized and unrealized gains (losses) included in net income	(103		)	(198		)
Settlements and closed loans	119			(1,093		)
Balance at end of period	$	112		$	79
Total unrealized gains (losses) relating to instruments still held at period end	$	112		$	79

	Derivative Loan Commitments and Forward Loan Sale Commitments
	Nine months ended September 30,
(Dollars in thousands)	2014			2013
Balance at beginning of period	$	244		$	201
Total realized and unrealized gains included in net income	95			(81		)
Settlements and closed loans	(227		)	(41		)
Balance at end of period	$	112		$	79
Total unrealized gains relating to instruments still held at period end	$	112		$	79

The following tables present additional quantitative information about assets and liabilities measured at fair value on a recurring and non-recurring basis for which the Bank utilized Level 3 inputs (significant unobservable inputs for situations in which there is little, if any, market activity for the asset or liability) to determine fair value:

September 30, 2014

(Dollars in thousands)	Fair Value		Valuation Technique	Unobservable Input	Unobservable Input Value or Range
Assets measured on a recurring basis:

Derivative loan commitments	$	120	Investor pricing	Pull-through rate	82.5-100%
				Pricing spreads	99.14-107.96%
Liabilities measured on a recurring basis:

Forward loan sale commitments	8		Investor pricing	Pull-through rate	82.5-100%
				Pricing spreads	99.13-108.35%
Assets measured on a non-recurring basis:

Impaired loans (collateral dependent)	1,379		Appraisal of collateral	Collateral discounts/selling costs	5% - 30%

Foreclosed real estate	735		Appraisal of collateral	Collateral discounts/selling costs	5% - 30%

Real estate held for sale	3,831		Appraisal of collateral	Selling costs	5-6%

December 31, 2013

Assets measured on a recurring basis:

Forward loan sale commitments	$	248	Investor pricing	Pull-through rate	82.5-100%
				Pricing spreads	94.55-106.16%
Liabilities measured on a recurring basis:

Derivative loan commitments	4		Investor pricing	Pull-through rate	82.5-100%
				Pricing spreads	95.28-106.16%
Assets measured on a non-recurring basis:

Impaired loans (collateral dependent)	987		Appraisal of collateral	Collateral discounts/selling costs	5% - 30%

Foreclosed real estate	1,170		Appraisal of collateral	Collateral discounts/selling costs	5% - 30%

Real estate held for sale	3,515		Appraisal of collateral	Selling costs	5%

Estimated Fair Values of Assets and Liabilities

In addition to disclosures regarding the measurement of assets and liabilities carried at fair value on the balance sheet, the Corporation is also required to disclose fair value information about financial instruments for which it is practicable to estimate that value, whether or not recognized on the balance sheet. In cases where quoted fair values are not available, fair values are based upon estimates using various valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. The following methods and assumptions were used by the Corporation in estimating fair values of its financial instruments.

The following methods and assumptions were used by the Corporation in estimating fair value disclosures:

Cash and cash equivalents — The carrying amounts of cash and cash equivalents approximate fair values based on the short-term nature of the assets.

Certificates of deposit — The carrying value of certificates of deposit is deemed to approximate fair value, based on both the current interest rate and the maturity date.

Federal Home Loan Bank stock — The carrying value of Federal Home Loan Bank stock is deemed to approximate fair value, based on the redemption provisions of the Federal Home Loan Bank.

Loans, net — For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash flow analyses, using market interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Loans held for sale — Fair values of loans held for sale are based on prevailing market rates for loans with similar characteristics.

Deposits — The fair values of deposits with no stated maturity, such as demand deposits, savings, club and money market accounts, are equal to the amount payable on demand at the reporting date. Fair values for term certificates are estimated using a discounted cash flow calculation that applies market interest rates currently being offered for deposits of similar remaining maturities.

Borrowed funds — The fair values of the Bank’s FHLB advances are estimated using discounted cash flow analyses based on the current incremental borrowing rates in the market for similar types of borrowing arrangements.

Accrued interest — The carrying amounts of accrued interest approximate fair value.

Off-balance sheet credit-related instruments — Fair values for off-balance-sheet, credit related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.

The estimates of fair value of financial instruments were based on information available at September 30, 2014 and December 31, 2013 and are not indicative of the fair market value of those instruments as of the date of this report. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Corporation’s entire holdings of a particular financial instrument. The fair value of the Corporation’s time deposit liabilities do not take into consideration the value of the Corporation’s long-term relationships with depositors, which may have significant value.

Because no active market exists for a portion of the Corporation’s financial instruments, fair value estimates were based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates were based on existing on- and off-balance sheet financial instruments without an attempt to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments, including premises and equipment and foreclosed real estate, and real estate held for sale.

The carrying values, estimated fair values and placement in the fair value hierarchy of the Corporation’s financial instruments(1) for which fair value is only disclosed but not recognized on the balance sheet at the dates indicated are summarized as follows:

	September 30, 2014 (unaudited)				Fair value measurement
(Dollars in thousands)	Carrying Amount		Fair Value		Level 1 inputs		Level 2 Inputs		Level 3 Inputs
Financial assets:
Loans, net	$	367,667	$	369,931	$	—	$	—	$	369,931
Loans held for sale	13,596		13,638		—		—		13,638
FHLB stock	2,363		2,363		—		—		2,363
Financial liabilities:
Certificates of deposit	119,793		121,793		—		121,793		—
Borrowed funds	33,300		33,314		—		33,314		—

	December 31, 2013				Fair value measurement
(Dollars in thousands)	Carrying Amount		Fair Value		Level 1 inputs		Level 2 Inputs		Level 3 Inputs
Financial assets:
Loans, net	$	328,576	$	327,618	$	—	$	—	$	327,618
Loans held for sale	8,648		8,690		—		—		8,690
FHLB stock	2,694		2,694		—		—		2,694
Financial liabilities:
Certificates of deposit	125,410		127,528		—		127,528		—
Borrowed funds	28,000		28,021		—		28,021		—

(1)

Excluded from this table are certain financial instruments that approximate fair value, as they were short-term in nature or payable on demand. These include cash and cash equivalents, certificates of deposit, accrued interest receivable, non-term deposit accounts, and accrued interest payable.