Note 14 - Fair Values

9 Months Ended

Sep. 30, 2016

NOTE 14. FAIR VALUES

The following table presents estimated fair values of our financial instruments as of September 30, 2016 and December 31, 2015, whether or not recognized or recorded at fair value in the Consolidated Balance Sheets. The table indicates the fair value hierarchy of the valuation techniques we utilized to determine such fair value.

Non-financial assets and non-financial liabilities defined by the FASB ASC 820, Fair Value Measurement, such as Bank premises and equipment, deferred taxes and other liabilities are excluded from the table. In addition, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements of FASB ASC 825, Financial Instruments, such as bank-owned life insurance policies.

(Amounts in thousands)	Carrying		Fair Value Measurements Using
September 30, 2016	Amounts		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents	$	85,130	$	85,130	$	—	$	—
Securities available-for-sale	$	156,440	$	—	$	156,440	$	—
Securities held-to-maturity	$	31,771	$	—	$	33,388	$	—
Net loans	$	768,325	$	—	$	—	$	775,640
Federal Home Loan Bank of San Francisco stock	$	4,465	$	4,465	$	—	$	—
Financial liabilities
Deposits	$	975,493	$	—	$	976,983	$	—
Term debt	$	19,124	$	—	$	19,124	$	—
Junior subordinated debenture	$	10,310	$	—	$	8,751	$	—

(Amounts in thousands)	Carrying		Fair Value Measurements Using
December 31, 2015	Amounts		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents	$	51,192	$	51,192	$	—	$	—
Securities available-for-sale	$	159,030	$	—	$	159,030	$	—
Securities held-to-maturity	$	35,899	$	—	$	36,645	$	—
Net loans	$	706,329	$	—	$	—	$	711,528
Federal Home Loan Bank of San Francisco stock	$	4,465	$	4,465	$	—	$	—
Financial liabilities
Deposits	$	803,735	$	—	$	804,490	$	—
Term debt	$	94,694	$	—	$	94,694	$	—
Junior subordinated debenture	$	10,310	$	—	$	5,402	$	—
Derivatives	$	2,369	$	—	$	2,369	$	—

Fair Value Hierarchy

Level 1

valuations utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access.

Level 2

valuations utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 valuations include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

Level 3

valuations are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety.

We maximize the use of observable inputs and minimizes the use of unobservable inputs when developing fair value measurements. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practical to estimate that value:

Cash and cash equivalents

– The carrying amounts reported in the Consolidated Balance Sheets for cash and cash equivalents are a reasonable estimate of fair value. The carrying amount is a reasonable estimate of fair value because of the relatively short term between the origination of the instrument and its expected realization. Therefore, we believe the measurement of fair value of cash and cash equivalents is derived from Level 1 inputs.

Securities

– Investment securities fair values are based on quoted market prices, where available, and are classified as Level 1. If quoted market prices are not available, fair values are estimated using quoted market prices or matrix pricing, which is a mathematical technique, used widely by the industry that relies on the securities relationship to other benchmark securities, and are classified as Level 2.

Net Loans

– For variable rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying values. For fixed rate loans, projected cash flows are discounted back to their present value based on specific risk adjusted spreads to the U.S. Treasury Yield Curve, with the rate determined based on the timing of the cash flows. The ALLL is considered to be a reasonable estimate of loan discount for credit quality concerns. Given that there are commercial loans with specific terms that are not readily available; we believe the fair value of loans is derived from Level 3 inputs.

Federal Home Loan Bank of San Francisco stock

– The carrying value of Federal Home Loan Bank of San Francisco stock approximates fair value as the shares can only be redeemed by the issuing institution at par. We measure the fair value of Federal Home Loan Bank of San Francisco stock using Level 1 inputs.

Deposits

– We measure fair value of maturing deposits using Level 2 inputs. The fair values of deposits were derived by discounting their expected future cash flows based on the Federal Home Loan Bank of San Francisco yield curves, and maturities. We obtained Federal Home Loan Bank of San Francisco yield curve rates as of the measurement date, and believe these inputs fall under Level 2 of the fair value hierarchy. Deposits with no defined maturities, the fair values are the amounts payable on demand at the respective reporting date.

Term Debt

– For variable rate term debt, the carrying value approximates fair value. The fair value of fixed rate term debt is estimated by discounting the future cash flows using market rates at the reporting date, of which similar debt would be issued with similar credit ratings as ours and similar remaining maturities. We measure the fair value of term debt using Level 2 inputs.

Junior subordinated debenture

– The fair value of the subordinated debenture is estimated by discounting the future cash flows using market rates at the reporting date, of which similar debentures would be issued with similar credit ratings as ours and similar remaining maturities. At September 30, 2016, future cash flows were discounted at 3.44%. We measure the fair value of subordinated debentures using Level 2 inputs.

Commitments

– Loan commitments and standby letters of credit generate ongoing fees, which are recognized over the term of the commitment period. In situations where the borrower’s credit quality has declined, we record a reserve for these unfunded commitments. Given the uncertainty in the likelihood and timing of a commitment being drawn upon, a reasonable estimate of the fair value of these commitments is the carrying value of the related unamortized loan fees plus the reserve, which is not material. As such, no disclosures are made on the fair value of commitments.

We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Available-for-sale securities and derivatives are recorded at fair value on a recurring basis. From time to time, we may be required to record at fair value other assets on a nonrecurring basis, such as collateral dependent impaired loans and certain other assets including OREO or goodwill. These nonrecurring fair value adjustments involve the application of lower of cost or fair value accounting or write-downs of individual assets.

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

The following table presents information about our assets and liabilities measured at fair value on a recurring basis, and indicate the fair value hierarchy of the valuation techniques we utilized to determine such fair value, as of September 30, 2016 and December 31, 2015.

(Amounts in thousands)	Fair Value at September 30, 2016
Recurring Basis	Total		Level 1		Level 2		Level 3
Available-for-sale securities
U.S. government and agencies	$	—	$	—	$	—	$	—
Obligations of states and political subdivisions		59,952		—		59,952		—
Residential mortgage backed securities and collateralized mortgage obligations		54,046		—		54,046		—
Corporate securities		16,346		—		16,346		—
Commercial mortgage backed securities		16,254		—		16,254		—
Other investment securities (1)		9,842		—		9,842		—
Total assets measured at fair value	$	156,440	$	—	$	156,440	$	—

(1)

Principally consists of residential mortgage backed securities issued by both by governmental and nongovernmental agencies, and SBA pool securities.

(Amounts in thousands)	Fair Value at December 31, 2015
Recurring Basis	Total		Level 1		Level 2		Level 3
Available-for-sale securities
U.S. government and agencies	$	3,943	$	—	$	3,943	$	—
Obligations of states and political subdivisions		61,104		—		61,104		—
Residential mortgage backed securities and collateralized mortgage obligations		32,137		—		32,137		—
Corporate securities		33,778		—		33,778		—
Commercial mortgage backed securities		12,769		—		12,769		—
Other investment securities (1)		15,299		—		15,299		—
Total assets measured at fair value	$	159,030	$	—	$	159,030	$	—
Derivatives – interest rate swaps	$	2,369	$	—	$	2,369	$	—
Total liabilities measured at fair value	$	2,369	$	—	$	2,369	$	—

(1)

Principally consists of residential mortgage backed securities issued by both by governmental and nongovernmental agencies, and SBA pool securities.

Recurring Items

Debt Securities

– The available-for-sale securities amount in the recurring fair value table above represents securities that have been adjusted to their fair values. For these securities, we obtain fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions among other things. We have determined that the source of these fair values falls within Level 2 of the fair value hierarchy.

Forward starting interest rate swaps

– The valuation of our interest rate swaps was obtained from third party pricing services. The fair values of the interest rate swaps were determined by using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis was based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves. We have determined that the source of these derivatives’ fair values falls within Level 2 of the fair value hierarchy.

Transfers Between Fair Value Hierarchy Levels

Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstance that caused the transfer. There were no transfers between levels of the fair value hierarchy during the nine months ended September 30, 2016 or the year ended December 31, 2015.

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. These adjustments to fair value generally result from the application of lower of cost or fair value accounting or write-downs of individual assets due to impairment. The following tables present information about our assets and liabilities at September 30, 2016 and December 31, 2015 measured at fair value on a nonrecurring basis for which a nonrecurring change in fair value has been recorded during the reporting period.

The amounts disclosed below present the fair values at the time the nonrecurring fair value measurements were made, and not necessarily the fair values as of the date reported upon.

(Amounts in thousands)	Fair Value at September 30, 2016
Nonrecurring basis	Total		Level 1		Level 2		Level 3
Collateral dependent impaired loans	$	1,686	$	—	$	—	$	1,686
Other real estate owned		207		—		—		207
Total assets measured at fair value	$	1,893	$	—	$	—	$	1,893

(Amounts in thousands)	Fair Value at December 31, 2015
Nonrecurring basis	Total		Level 1		Level 2		Level 3
Collateral dependent impaired loans	$	707	$	—	$	—	$	707
Other real estate owned		743		—		—		743
Total assets measured at fair value	$	1,450	$	—	$	—	$	1,450

The following table presents the losses resulting from nonrecurring fair value adjustments for the three and nine months ended September 30, 2016 and 2015 for assets that are included on the balance sheet at period end.

(Amounts in thousands)	Three Months Ended September 30,				Nine Months Ended September 30,
Fair value adjustments	2016		2015		2016		2015
Collateral dependent impaired loans	$	15	$	199	$	1,068	$	744
Other real estate owned		—		—		71		108
Total	$	15	$	199	$	1,139	$	852

During the nine months ended September 30, 2016, collateral dependent impaired loans with a carrying amount of $2.8 million outstanding at period end were written down to their fair value of $1.7 million, resulting in a $1.1 million adjustment to the ALLL.

During the nine months ended September 30, 2016, two OREO properties with an aggregate carrying value of $278 thousand outstanding at period end were written down to their fair value of $207 thousand, resulting in a $71 thousand adjustment to the ALLL.

The loan amounts above represent impaired, collateral dependent loans that have been adjusted to fair value during the respective reporting period. When we identify a collateral dependent loan as impaired, we measure the impairment using the current fair value of the collateral, less selling costs. Depending on the characteristics of a loan, the fair value of collateral is generally estimated by obtaining external appraisals. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we recognize this impairment and adjust the carrying value of the loan to fair value through the ALLL.

The loss represents charge offs or impairments on collateral dependent loans for fair value adjustments based on the fair value of collateral. The carrying value of loans fully charged off is zero. When the fair value of the collateral is based on a current appraised value, or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we record the impaired loan as nonrecurring Level 3.

The OREO amount above represents impaired real estate that has been adjusted to fair value during the respective reporting period. The loss represents impairments on OREO for fair value adjustments based on the fair value of the real estate. The determination of fair value is based on recent appraisals of the foreclosed properties, which take into account recent sales prices adjusted for unobservable inputs, such as opinions provided by local real estate brokers and other real estate experts. OREO fair values are adjusted for estimated selling costs between 8% and 15%. We record OREO as a nonrecurring Level 3.

Limitations

– Fair value estimates are made at a specific point in time, based on relevant market information and other information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time our entire holdings of a particular financial instrument. Because no market exists for a significant portion of our financial instruments, fair value estimates are 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, involve uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

Fair value estimates are based on current on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial assets or liabilities include deferred tax assets and liabilities, and property, plant and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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