(8)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.

Effective January 1, 2015, the Bank elected the fair value option pursuant to Accounting Standards Codification (“ASC”) 825, “Financial Instruments” for certain closed mortgage loans intended for sale and transferred the placement of loans held for sale to Level 2 in the fair value hierarchy. ASC 825 allows for the irrevocable option to elect fair value accounting for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis that may otherwise not be required to be measured at fair value under other accounting standards. The Bank elected the fair value option for certain residential real estate mortgage loans held for sale pursuant to forward sale commitments in order to better match changes in fair values for the loans with changes in the fair value of the forward loan sale contracts used to economically hedge them. The aggregate fair value of loans held for sale, the contractual balance of loans held for sale and the gain on loans held for sale totaled $23.5 million, $22.4 million and $1.1 million at June 30, 2016. The aggregate fair value of loans held for sale, the contractual balance of loans held for sale and the gain on loans held for sale totaled $19.0 million, $18.3 million and $684,000 at December 31, 2015. The change in fair value of loans held for sale reported as a component of net gains on sale of loans and other mortgage banking income was $561,000 and $(189,000) for the three months ended June 30, 2016 and 2015, respectively, and $404,000 and $(129,000) for the six months ended June 30, 2016 and 2015, respectively.

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

	June 30, 2016
(Dollars in thousands)	(Level 1)		(Level 2)		(Level 3)
Assets measured on a recurring basis:
Loans held for sale	$	—	$	23,499	$	—
Derivative loan commitments	—		—		1,002
Liabilities measured on a recurring basis:
Forward loan sale commitments:
Best efforts contracts	—		—		554
Mandatory delivery contracts	—		13		—
TBA securities	—		226		—
Assets measured on a non-recurring basis:
Impaired loans (collateral dependent)	—		—		816
Foreclosed real estate	—		—		907

	December 31, 2015
(Dollars in thousands)	(Level 1)		(Level 2)		(Level 3)
Assets measured on a recurring basis:
Loans held for sale	$	—	$	18,952	$	—
Derivative loan commitments	—		—		217
Forward sale mandatory delivery contracts	—		3		—
Liabilities measured on a recurring basis:
Forward loan sale commitments:
Best efforts contracts	—		—		175
TBA securities	—		5		—
Assets measured on a non-recurring basis:
Impaired loans (collateral dependent)	—		—		1,084
Foreclosed real estate	—		—		710
Real estate held for sale	—		3,305		—

The Bank did not have cause to transfer any assets between the fair value measurement levels during the three and six months ended June 30, 2016 or the year ended December 31, 2015.

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. The provision to the allowance for loan losses related to collateral dependent impaired loans recorded at fair value for the three and six months ended June 30, 2016 and 2015, totaled $22,000 and $(8,000) and $23,000 and $100,000, respectively. The carrying value of impaired loans recorded at fair value is $816,000, net of $20,000 in charge-offs and specific reserves of $38,000 at June 30, 2016. The carrying value of impaired loans recorded at fair value was $1.1 million, net of $28,000 in charge-offs and $15,000 in specific reserves at December 31, 2015.

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 generally 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. There were no losses on sales of foreclosed real estate for the three months ended June 30, 2016 and 2015, respectively. There were $14,000 and no losses on foreclosed real estate held at period end for the six months ended June 30, 2016 and 2015, respectively. There was one property acquired through foreclosure during the three and six months ended June 30, 2016 with a carrying value of $211,000.

When real estate is determined to be held for sale, it is recorded at the lower of estimated fair value less estimated cost to sell. The fair value less costs to sell is determined based on current appraisals that utilize prices in observed transactions involving similar assets or estimated selling price less costs to sell. There were no write-downs on real estate held for sale during the three and six months ended June 30, 2016 and $195,000 of write-downs on real estate held for sale during the three and six months ended June 30, 2015. The Bank recorded a loss of $11,000 upon the sale of its two real estate held for sale properties during the three and six months ended June 30, 2016.

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 six months ended June 30, 2016 and 2015, 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 June 30,
(Dollars in thousands)	2016			2015

Balance at beginning of period	$	354		$	122
Gains on new commitments during the period	466			374
Gain (losses) arising during the period	(18		)	32
Reclassifications of realized gains (losses) on settled commitments	(354		)	(110		)

Balance at end of period	448			418

	Derivative Loan Commitments and Forward Loan Sale Commitments
	Six months ended June 30,
(Dollars in thousands)	2016			2015
Balance at beginning of period	$	42		$	2
Gains on new commitments during the period	841			415
Gain (losses) arising during the period	(18		)	2
Reclassifications of realized gains (losses) on settled commitments	(417		)	(1		)

Balance at end of period	448			418

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:

June 30, 2016

(Dollars in thousands)	Fair Value			Valuation Technique	Unobservable Input	Unobservable Input Value or Range
Assets measured on a recurring basis:
Derivative loan commitments	$	1,002		Investor pricing	Pull-through rate	76.2% – 100	%
Liabilities measured on a recurring basis:
Forward loan sale commitments	(554		)	Investor pricing	Pull-through rate	82.5% – 100	%
Assets measured on a non-recurring basis:
Impaired loans (collateral dependent)	816			Discounted appraisal	Collateral discounts	5 – 30	%
Foreclosed real estate	907			Discounted appraisal	Collateral discounts	5 – 30	%

December 31, 2015

(Dollars in thousands)	Fair Value			Valuation Technique	Unobservable Input	Unobservable Input Value or Range
Assets measured on a recurring basis:
Derivative commitments	$	217		Investor pricing	Pull-through rate	79.6% – 100	%
Liabilities measured on a recurring basis:
Forward loan sale commitments	(175		)	Investor pricing	Pull-through rate	82.5% – 100	%
Assets measured on a non-recurring basis:
Impaired loans (collateral dependent)	1,084			Discounted appraisals	Collateral discounts	5 – 30	%
Foreclosed real estate	710			Discounted appraisals	Collateral discounts	5 – 30	%

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 — It is not practical to determine the fair value of Federal Home Loan Bank stock due to restrictions placed on its transferability.

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 June 30, 2016 and December 31, 2015 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:

	June 30, 2016				Fair value measurement
(Dollars in thousands)	Carrying Amount		Fair Value		Level 1 inputs		Level 2 Inputs		Level 3 Inputs
Financial assets:
Loans, net	$	504,311	$	513,306	$	—	$	—	$	513,306
FHLB stock	6,500		N/A		—		—		N/A
Financial liabilities:
Certificates of deposit	114,636		114,885		—		114,885		—
Borrowed funds	138,850		138,845		—		138,845		—

	December 31, 2015				Fair value measurement
(Dollars in thousands)	Carrying Amount		Fair Value		Level 1 inputs		Level 2 Inputs		Level 3 Inputs
Financial assets:
Loans, net	$	467,023	$	471,245	$	—	$	—	$	471,245
FHLB stock	5,283		N/A		—		—		N/A
Financial liabilities:
Certificates of deposit	109,038		109,423		—		109,423		—
Borrowed funds	115,500		115,495		—		115,495		—

(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. The respective carrying values of cash and cash equivalents, certificates of deposit and non-term deposit accounts would all be considered to be classified within Level 1 of their fair value hierarchy. The $1.5 million and $1.4 million carrying value of accrued interest receivable on loans would generally be considered Level 3 in the fair value hierarchy and the carrying value of accrued interest payable of $38,000 and $24,000 at June 30, 2016 and December 31, 2015, respectively would be considered Level 2.