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Note 7 - Fair Value of Financial Instruments

3 Months Ended

Mar. 31, 2016

Fair Value Disclosures [Abstract]

Fair Value Disclosures [Text Block]

Note 7: Fair Value of Financial Instruments

Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective year-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each year-end.

The Company follows the guidance issued under ASC 820, Fair Value Measurement, which defines fair value, establishes a framework for measuring fair value under GAAP, and identifies required disclosures on fair value measurements.

ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC 820 are as follows:

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported with little or no market activity).

An asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2016 and December 31, 2015 were as follows:

(dollars in thousands)		Total				(Level 1) Quoted Prices in Active Markets for Identical Assets				(Level 2) Significant Other Observable Inputs				(Level 3) Significant Unobservable Inputs

March 31, 2016

Collateralized mortgage obligations		$	155,097			$	-			$	155,097			$	-
Agency mortgage-backed securities			9,962				-				9,962				-
Municipal securities			23,658				-				23,658				-
Corporate bonds			52,778				-				49,934				2,844
Asset-backed securities			16,799				-				16,799				-
Trust Preferred Securities			1,858				-				-				1,858
Other securities			117				-				117				-
Securities Available for Sale		$	260,269			$	-			$	255,567			$	4,702

SBA Servicing Assets		$	5,058											$	5,058

December 31, 2015

Collateralized mortgage obligations		$	178,145			$	-			$	178,145			$	-
Agency mortgage-backed securities			10,171				-				10,171				-
Municipal securities			23,344				-				23,344				-
Corporate bonds			54,129				-				51,295				2,834
Asset-backed securities			17,005				-				17,005				-
Trust Preferred Securities			1,883				-				-				1,883
Other securities			118				-				118				-
Securities Available for Sale		$	284,795			$	-			$	280,078			$	4,717

SBA Servicing Assets		$	4,886											$	4,886

The following table presents an analysis of the activity in the SBA servicing assets for the three months ended March 31, 2016 and 2015:

		Three Months Ended March 31,
(dollars in thousands)		2016				2015

Beginning balance		$	4,886			$	4,099
Additions			242				135
Fair value adjustments			(70	)			33
Ending balance		$	5,058			$	4,267

Fair value adjustments are recorded as loan advisory and servicing fees on the statement of income. Servicing fee income, not including fair value adjustments, totaled $434,000 and $417,000 for the three months ended March 31, 2016 and 2015, respectively.

The following table presents a reconciliation of the securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2016 and 2015:

		Three Months Ended March 31, 2016								Three Months Ended March 31, 2015
Level 3 Investments Only (dollars in thousands)		Trust Preferred Securities				Corporate Bonds				Trust Preferred Securities				Corporate Bonds
Balance, January 1^st		$	1,883			$	2,834			$	3,193			$	3,005
Unrealized (losses) gains			(24	)			10				(129	)			1
Paydowns			-				-				(19	)			-
Proceeds from sales			-				-				-				-
Realized (losses) gains			-				-				-				-
Impairment charges on Level 3			(1	)			-				(3	)			-
Balance, March 31^st		$	1,858			$	2,844			$	3,042			$	3,006

For assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2016 and December 31, 2015 were as follows:

(dollars in thousands)		Total				(Level 1) Quoted Prices in Active Markets for Identical Assets				(Level 2) Significant Other Observable Inputs				(Level 3) Significant Unobservable Inputs
March 31, 2016
Impaired loans		$	3,862			$	-			$	-			$	3,862
Other real estate owned			8,185				-				-				8,185

December 31, 2015
Impaired loans		$	5,734			$	-			$	-			$	5,734
Other real estate owned			10,034				-				-				10,034

The table below presents additional quantitative information about level 3 assets measured at fair value on a nonrecurring basis (dollars in thousands):

		Quantitative Information about Level 3 Fair Value Measurements

Asset Description		Fair Value			Valuation Technique		Unobservable Input		Range Weighted Average
March 31, 2016

Corporate bonds		$	2,844		Discounted Cash Flows		Discount Rate					(4.13%)

Trust preferred securities		$	1,858		Discounted Cash Flows		Discount Rate		7.38%	-	7.88%	(7.61%)

SBA servicing assets		$	5,058		Discounted Cash Flows		Conditional Prepayment Rate					(6.28%)

							Discount Rate					(10.00%)

Impaired loans		$	3,862		Appraised Value of Collateral (1)		Liquidation expenses (2)		12%	-	35%	(21%)				(3)

							Appraisal adjustment (2)					(9%)				(3)

Other real estate owned		$	8,185		Appraised Value of Collateral (1)		Liquidation expenses (2)		7%	-	19%	(7%)				(3)

							Appraisal adjustment (2)					(0%)

					Sales Price		Liquidation expenses (2)					(6%)				(3)

December 31, 2015

Corporate bonds		$	2,834		Discounted Cash Flows		Discount Rate					(4.11%)

Trust preferred securities		$	1,883		Discounted Cash Flows		Discount Rate		7.31%	-	7.81%	(7.77%)

SBA servicing assets		$	4,886		Discounted Cash Flows		Conditional Prepayment Rate					(6.27%)

							Discount Rate					(10.00%)

Impaired loans		$	5,734		Appraised Value of Collateral (1)		Liquidation expenses (2)		12%	-	78%	(20%)				(3)

Other real estate owned		$	10,034		Appraised Value of Collateral (1)		Liquidation expenses (2)		6%	-	30%	(10%)				(3)

							Appraisal adjustment (2)					(50%)

					Sales Price		Liquidation expenses (2)		7%	-	9%	(9%)				(3)

(1)

Fair value is generally determined through independent appraisals of the underlying collateral, which include Level 3 inputs that are not identifiable.

(2)

Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.

(3)

The range and weighted average of qualitative factors such as economic conditions and estimated liquidation expenses are presented as a percent of the appraised value.

The significant unobservable inputs for impaired loans and other real estate owned are the appraised value or an agreed upon sales price. These values are adjusted for estimated costs to sell which are incremental direct costs to transact a sale such as broker commissions, legal fees, closing costs and title transfer fees. The costs must be considered essential to the sale and would not have been incurred if the decision to sell had not been made. The costs to sell are based on costs associated with the Company’s actual sales of other real estate owned which are assessed annually.

Fair Value Assumptions

The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at March 31, 2016 and December 31, 2015.

Cash and Cash Equivalents (Carried at Cost)

The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets’ fair values.

Investment Securities

The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. For certain securities, which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments, are generally based on available market evidence (Level 3). In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Internal cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) were used to support fair values of certain Level 3 investments.

The types of instruments valued based on matrix pricing in active markets include all of the Company’s U.S. government and agency securities, corporate bonds, asset backed securities, and municipal obligations. Such instruments are generally classified within Level 2 of the fair value hierarchy. As required by ASC 820-10, the Company does not adjust the matrix pricing for such instruments.

Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, and may be adjusted to reflect illiquidity and/or non-transferability, with such adjustment generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. Subsequent to inception, management only changes Level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows. The Level 3 investment securities classified as available for sale are comprised of various issues of trust preferred securities and a single corporate bond.

The trust preferred securities are pools of similar securities that are grouped into an asset structure commonly referred to as collateralized debt obligations (“CDOs”) which consist of the debt instruments of various banks, diversified by the number of participants in the security as well as geographically. The secondary market for these securities has become inactive, and therefore these securities are classified as Level 3 securities. The fair value analysis does not reflect or represent the actual terms or prices at which any party could purchase the securities. There is currently a limited secondary market for the securities and there can be no assurance that any secondary market for the securities will expand.

An independent, third party pricing service is used to estimate the current fair market value of each CDO held in the investment securities portfolio. The calculations used to determine fair value are based on the attributes of the trust preferred securities, the financial condition of the issuers of the trust preferred securities, and market based assumptions. The INTEX CDO Deal Model Library was utilized to obtain information regarding the attributes of each security and its specific collateral as of March 31, 2016 and December 31, 2015. Financial information on the issuers was also obtained from Bloomberg, the FDIC, and SNL Financial. Both published and unpublished industry sources were utilized in estimating fair value. Such information includes loan prepayment speed assumptions, discount rates, default rates, and loss severity percentages. Due to the current state of the global capital and financial markets, the fair market valuation is subject to greater uncertainty that would otherwise exist.

The fair market valuation for each CDO was determined based on discounted cash flow analyses. The cash flows are primarily dependent on the estimated speeds at which the trust preferred securities are expected to prepay, the estimated rates at which the trust preferred securities are expected to defer payments, the estimated rates at which the trust preferred securities are expected to default, and the severity of the losses on securities that do default.

Increases (decreases) in actual or expected issuer defaults tend to decrease (increase) the fair value of the Company’s senior and mezzanine tranches of CDOs. The values of the Company’s mezzanine tranches of CDOs are also affected by expected future interest rates. However, due to the structure of each security, timing of cash flows, and secondary effects on the financial performance of the underlying issuers, the effects of changes in future interest rates on the fair value of the Company’s holdings are not quantifiably estimable.

Also included in Level 3 investment securities classified as available for sale is a single-issuer corporate bond transferred from Level 2 in 2010 that is not actively traded. Impairment would depend on the repayment ability of the underlying issuer, which is assessed through a detailed quarterly review of the issuer’s financial statements. The issuer is a “well capitalized” financial institution as defined by federal banking regulations and has demonstrated the ability to raise additional capital, when necessary, through the public capital markets. The fair value of this corporate bond is estimated by obtaining a price of a comparable floating rate debt instrument through Bloomberg.

Loans Held For Sale (Carried at Lower of Cost or Fair Value)

The fair values of loans held for sale is determined, when possible, using quoted secondary-market prices. If no such quoted prices exist, the fair value of a loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of that loan. The Company did not write down any loans held for sale during the three months ended March 31, 2016 and the year ended December 31, 2015.

Loans Receivable (Carried at Cost)

The fair values of loans receivable, excluding all nonaccrual loans and accruing loans deemed impaired with specific loan allowances, are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Due to the significant judgment involved in evaluating credit quality, loans are classified within Level 3 of the fair value hierarchy.

Impaired Loans (Carried at Lower of Cost or Fair Value)

Impaired loans are those that the Company has measured impairment based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements. The fair value consists of the loan balances less any valuation allowance. The valuation allowance amount is calculated as the difference between the recorded investment in a loan and the present value of expected future cash flows or it is calculated based on discounted collateral values if the loans are collateral dependent.

Other Real Estate Owned (Carried at Lower of Cost or Fair Value)

These assets are carried at the lower of cost or fair value. At March 31, 2016 and December 31, 2015, these assets are carried at current fair value and classified within Level 3 of the fair value hierarchy.

SBA Servicing Asset (Carried at Fair Value)

The SBA servicing asset is initially recorded when loans are sold and the servicing rights are retained and recorded on the balance sheet. An updated fair value is obtained from an independent third party on a quarterly basis and adjustments are presented as loan advisory and servicing fees on the statement of operations. The valuation begins with the projection of future cash flows for each asset based on their unique characteristics, the Company’s market-based assumptions for prepayment speeds and estimated losses and recoveries. The present value of the future cash flows are then calculated utilizing the Company’s market-based discount ratio assumptions. In all cases, the Company’s models expected payments for every loan for each quarterly period in order to create the most detailed cash flow stream possible.

The Company uses assumptions and estimates in determining the impairment of the SBA servicing asset. These assumptions include prepayment speeds and discount rates commensurate with the risks involved and comparable to assumptions used by participants to value and bid serving rights available for sale in the market. At March 31, 2016 and December 31, 2015, the sensitivity of the current fair value of the SBA loan servicing rights to immediate 10% and 20% adverse changes in key assumptions are included in the accompanying table.

(dollars in thousands)		March 31, 2016				December 31, 2015

SBA Servicing Asset

Fair Value of SBA Servicing Asset		$	5,058			$	4,886

Composition of SBA Loans Serviced for Others
Fixed-rate SBA loans			0	%			0	%
Adjustable-rate SBA loans			100	%			100	%
Total			100	%			100	%

Weighted Average Remaining Term (in years)		20.9				20.9

Prepayment Speed			6.28	%			6.27	%
Effect on fair value of a 10% increase		$	(155	)		$	(151	)
Effect on fair value of a 20% increase			(303	)			(296	)

Weighted Average Discount Rate			10.00	%			10.00	%
Effect on fair value of a 10% increase		$	(213	)		$	(206	)
Effect on fair value of a 20% increase			(409	)			(397	)

The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in value may not be linear. Also in this table, the effect of an adverse variation in a particular assumption on the value of the SBA servicing rights is calculated without changing any other assumption. While in reality, changes in one factor may magnify or counteract the effect of the change.

Restricted Stock (Carried at Cost)

The carrying amount of restricted stock approximates fair value, and considers the limited marketability of such securities. Restricted stock is classified within Level 2 of the fair value hierarchy.

Accrued Interest Receivable and Payable (Carried at Cost)

The carrying amounts of accrued interest receivable and accrued interest payable approximates fair value and are classified within Level 2 of the fair value hierarchy.

Deposit Liabilities (Carried at Cost)

The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits. Deposit liabilities are classified within Level 2 of the fair value hierarchy.

Short-term Borrowings (Carried at Cost)

Due to their short-term nature, the carrying amounts of short-term borrowings, which include overnight borrowings approximate their fair value. Short-term borrowings are classified within Level 2 of the fair value hierarchy.

Subordinated Debt (Carried at Cost)

Fair values of subordinated debt are estimated using discounted cash flow analysis, based on market rates currently offered on such debt with similar credit risk characteristics, terms and remaining maturity. Due to the significant judgment involved in developing the spreads used to value the subordinated debt, it is classified within Level 3 of the fair value hierarchy.

Off-Balance Sheet Financial Instruments (Disclosed at notional amounts)

Fair values for the Company’s off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing.

The estimated fair values of the Company’s financial instruments were as follows at March 31, 2016 and December 31, 2015:

		Fair Value Measurements at March 31, 2016
(dollars in thousands)		Carrying Amount				Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Balance Sheet Data
Financial assets:
Cash and cash equivalents		$	65,198			$	65,198			$	65,198			$	-			$	-
Investment securities available for sale			260,269				260,269				-				255,567				4,702
Investment securities held to maturity			178,628				181,306				-				181,306				-
Restricted stock			1,179				1,179				-				1,179				-
Loans held for sale			1,983				1,999				-				-				1,999
Loans receivable, net			890,088				870,274				-				-				870,274
SBA servicing assets			5,058				5,058				-				-				5,058
Accrued interest receivable			4,434				4,434				-				4,434				-

Financial liabilities:
Deposits
Demand, savings and money market		$	1,277,199			$	1,277,199			$	-			$	1,277,199			$	-
Time			60,408				60,340				-				60,340				-
Subordinated debt			22,476				19,186				-				-				19,186
Accrued interest payable			219				219				-				219				-

Off-Balance Sheet Data
Commitments to extend credit			-				-
Standby letters-of-credit			-				-

		Fair Value Measurements at December 31, 2015
(dollars in thousands)		Carrying Amount				Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Balance Sheet Data
Financial assets:
Cash and cash equivalents		$	27,139			$	27,139			$	27,139			$	-			$	-
Investment securities available for sale			284,795				284,795				-				280,078				4,717
Investment securities held to maturity			172,277				171,845				-				171,845				-
Restricted stock			3,059				3,059				-				3,059				-
Loans held for sale			3,653				3,831				-				-				3,831
Loans receivable, net			866,066				849,578				-				-				849,578
SBA servicing assets			4,886				4,886				-				-				4,886
Accrued interest receivable			4,216				4,216				-				4,216				-

Financial liabilities:
Deposits
Demand, savings and money market		$	1,181,720			$	1,181,720			$	-			$	1,181,720			$	-
Time			67,578				67,422				-				67,422				-
Short-term borrowings			47,000				47,000				-				47,000				-
Subordinated debt			22,476				18,972				-				-				18,972
Accrued interest payable			245				245				-				245				-

Off-Balance Sheet Data
Commitments to extend credit			-				-
Standby letters-of-credit			-				-

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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