Note 5: Disclosures about Fair Value of Assets and Liabilities

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs. There is a hierarchy of three levels of inputs that may be used to measure fair value:

Level 1 Quoted prices in active markets for identical assets or liabilities

Level 2 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 for substantially the full term of the assets or liabilities

Level 3 Unobservable inputs supported by little or no market activity and are significant to the fair value of the assets or liabilities

Recurring Measurements

The following tables present the fair value measurements of assets recognized in the accompanying balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at September 30, 2017 and December 31, 2016:


	Fair Value Measurements Using
			Quoted Prices in		Significant
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
	Fair		Assets		Inputs		Inputs
Assets	Value		(Level 1)		(Level 2)		(Level 3)
September 30, 2017	(In thousands)
Trading securities	$	121,360	$	—	$	121,360	$	—
Available-for-sale securities:
Treasury notes		997		997		—		—
Federal agencies		403,517		—		403,517		—
Mortgage-backed - Government-sponsored entity (GSE) - residential		26,067		—		26,067		—
Mortgage servicing rights		62,022		—		—		62,022
December 31, 2016
Trading securities	$	137,675	$	—	$	137,675	$	—
Available-for-sale securities:
Treasury notes		999		999		—		—
Federal agencies		288,993		—		288,993		—
Municipals		9,500		—		9,500		—
Mortgage-backed - Government-sponsored entity (GSE) - residential		26,382		—		26,382		—
Mortgage servicing rights		53,670		—		—		53,670

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy. There have been no significant changes in the valuation techniques during the nine months ended September 30, 2017 and the year ended December 31, 2016. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Trading and Available-for-Sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated by using quoted prices of securities with similar characteristics or independent asset pricing services and pricing models, the inputs of which are market-based or independently sourced market parameters, including, but not limited to, yield curves, interest rates, volatilities, prepayments, defaults, cumulative loss projections and cash flows. Such securities are classified in Level 2 of the valuation hierarchy including federal agencies, mortgage-backed securities, and Federal Housing Administration participation certificates. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.

Mortgage Servicing Rights

Mortgage servicing rights do not trade in an active, open market with readily observable prices. Accordingly, fair value is estimated using discounted cash flow models having significant inputs of discount rate, prepayment speed and default rate. Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the hierarchy.

The Chief Financial Officer’s (CFO) office contracts with a pricing specialist to generate fair value estimates on a quarterly basis. The CFO’s office challenges the reasonableness of the assumptions used and reviews the methodology to ensure the estimated fair value complies with accounting standards generally accepted in the United States.

Level 3 Reconciliation

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying balance sheets using significant unobservable (Level 3) inputs:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2017		2016		2017		2016
Mortgage servicing rights	(In thousands)
Balance, beginning of period	$	57,557	$	55,422	$	53,670	$	55,553
Additions
Purchased servicing		76		933		1,209		1,252
Originated servicing		2,939		2,379		7,775		3,349
Acquisition of Richmac		3,970		—		3,970		—
Subtractions
Paydowns		(1,083)		(1,798)		(3,813)		(3,218)
Changes in fair value due to changes in valuation inputs or assumptions used in the valuation model		(1,437)		—		(789)		—

Balance, end of period	$	62,022	$	56,936	$	62,022	$	56,936

Nonrecurring Measurements

The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at December 31, 2016. The Company had no assets measured at fair value on a nonrecurring basis at September 30, 2017.

Fair Value Measurements Using

Quoted Prices in

Significant

Active Markets

Other

Significant

for Identical

Observable

Unobservable

Fair

Assets

Inputs

Assets

Value

(Level 1)

(Level 2)

(Level 3)

(In thousands)

December 31, 2016

Impaired loans (collateral dependent)

225

—

225

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheet, as well as the general classification of such assets pursuant to the valuation hierarchy. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Collateral-Dependent Impaired Loans, Net of Allowance for Loan Losses

The estimated fair value of collateral-dependent impaired loans is based on the appraised fair value of the collateral, less estimated cost to sell. Collateral-dependent impaired loans are classified within Level 3 of the fair value hierarchy.

The Company considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect the fair value. Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary by the Bank’s Senior Credit Officer’s (SCO) office. Appraisals are reviewed for accuracy and consistency by the SCO’s office. Appraisers are selected from the list of approved appraisers maintained by management. The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral. These discounts and estimates are developed by the SCO’s office by comparison to historical results.

Unobservable (Level 3) Inputs:

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements other than goodwill.


			Valuation
	Fair Value		Technique	Unobservable Inputs	Range
	(In thousands)
At September 30, 2017:
Mortgage servicing rights	$	62,022	Discounted cash flow	Discount rate	8.0% - 15.0%
				Constant prepayment rate	1.1% - 35.8%
At December 31, 2016:
Collateral-dependent impaired loans	$	225	Market comparable properties	Marketability discount	40%
Mortgage servicing rights		53,670	Discounted cash flow	Discount rate	8.0% - 15.0%
				Constant prepayment rate	0% - 25%

Sensitivity of Significant Unobservable Inputs

The following is a discussion of the sensitivity of significant unobservable inputs, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement and of how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.

Mortgage Servicing Rights

The significant unobservable inputs used in the fair value measurement of the Company’s mortgage servicing rights are discount rates and constant prepayment rates. Significant increases or decreases in any of those inputs in isolation would result in a significantly different fair value measurement.

Fair Value of Financial Instruments

The following table presents the carrying amount and estimated fair values of the Company’s financial instruments not carried at fair value and the level within the fair value hierarchy in which the fair value measurements fall at September 30, 2017 and December 31, 2016.


			Fair Value Measurements Using
					Quoted Prices in		Significant
					Active Markets		Other		Significant
					for Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
Assets	Value		Value		(Level 1)		(Level 2)		(Level 3)
September 30, 2017			(In thousands)
Financial assets:
Cash and cash equivalents	$	566,810	$	566,810	$	566,810	$	—	$	—
Securities purchased under agreements to resell		7,080		7,080		—		7,080		—
FHLB stock		7,539		7,539		—		7,539		—
Loans held for sale		798,058		798,058		—		798,058		—
Loans, net		1,201,695		1,204,002		—		—		1,204,002
Interest receivable		7,196		7,196		—		7,196		—
Financial liabilities:
Deposits		2,901,464		2,901,331		2,511,551		389,780		—
Line of credit		25,000		25,000		—		25,000		—
Short-term subordinated debt		30,000		30,000		—		30,000		—
FHLB advances		1,624		1,645		—		1,645		—
Interest payable		2,364		2,364		—		2,364		—
December 31, 2016
Financial assets:
Cash and cash equivalents	$	445,701	$	445,701	$	445,701	$	—	$	—
Securities purchased under agreements to resell		5,392		5,392		—		5,392		—
FHLB stock		7,539		7,539		—		7,539		—
Loans held for sale		764,503		764,503		—		764,503		—
Loans, net		935,546		935,287		—		—		935,287
Interest receivable		5,368		5,368		—		5,368		—
Financial liabilities:
Deposits		2,428,621		2,428,478		2,262,378		166,100		—
Line of credit		25,000		25,000		—		25,000		—
Short-term subordinated debt		30,000		30,000		—		30,000		—
FHLB advances		2,006		2,031		—		2,031		—
Interest payable		1,791		1,791		—		1,791		—

The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying balance sheets at amounts other than fair value.

Cash and Cash Equivalents and Securities Purchased Under Agreement to Resell

The carrying amount approximates fair value.

Federal Home Loan Bank Stock

The fair value of Federal Home Loan Bank of Indianapolis (“FHLBI”) stock is based on the price at which it may be sold to the FHLBI.

Loans Held For Sale

The carrying amount approximates fair value due to the insignificant time between origination and date of sale.

Loans

Fair value is estimated by discounting the future cash flows using the market rates at which similar notes would be made to borrowers with similar credit ratings and for the same remaining maturities. The market rates used are based on current rates the Company would impose for similar loans and reflect a market participant assumption about risks associated with nonperformance, illiquidity, and the structure and term of the loans along with local economic and market conditions.

Interest Receivable and Payable

The carrying amount approximates fair value. The carrying amount is determined using the interest rate, balance and last payment date.

Deposits

The fair values of noninterest-bearing demand and savings accounts are equal to the amount payable on demand at the balance sheet date. Fair values for fixed-rate certificates and time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of expected monthly maturities on such time deposits.

Line of Credit and Short-term Subordinated Debt

The carrying amount approximates fair value.

Federal Home Loan Bank Advances

Fair value is estimated by discounting the future cash flows using rates of similar advances with similar maturities. These rates were obtained from current rates offered by the FHLBI.

Off-Balance Sheet Commitments

Commitments include commitments to purchase and originate mortgage loans, commitments to sell mortgage loans and standby letters of credit and are generally of a short-term nature. The fair value of such commitments are based on fees currently charged to similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments to extend credit and letters of credit is not presented in the previous table since the fair value is considered to be insignificant.