Note 16 - Fair Value Measurements

12 Months Ended

Dec. 31, 2022

Notes to Financial Statements

Fair Value Disclosures [Text Block]

Note 16. FAIR VALUE MEASUREMENTS

In determining fair value, FNCB uses various valuation approaches, including market, income and cost approaches. Accounting standards establish a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability, which are developed based on market data obtained from sources independent of FNCB. Unobservable inputs reflect FNCB’s knowledge about the assumptions the market participants would use in pricing an asset or liability, which are developed based on the best information available in the circumstances.

The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). A financial 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. The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

● Level 1 valuation is based upon unadjusted quoted market prices for identical instruments traded in active markets;

● Level 2 valuation is based upon quoted market prices for similar instruments traded in active markets, quoted market prices for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by market data; and

● Level 3 valuation is derived from other valuation methodologies including discounted cash flow models and similar techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in determining fair value.

A description of the valuation methodologies used for assets recorded at fair value, and for estimating fair value of financial instruments not recorded at fair value, is set forth below.

Available-for-Sale Debt Securities

The estimated fair values for FNCB’s investments in obligations of the U.S. government, obligations of state and political subdivisions, government-sponsored agency CMOs and mortgage-backed securities, private collateralized mortgage obligations, asset-backed securities, negotiable certificates of deposit and certain corporate debt securities are obtained by FNCB from a nationally-recognized pricing service. This pricing service develops estimated fair values by analyzing like securities and applying available market information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing (Level 2 inputs), to prepare valuations. Matrix pricing is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities. The fair value measurements consider observable data that may include, among other things, 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, and are based on market data obtained from sources independent from FNCB. The Level 2 investments in FNCB’s portfolio are priced using those inputs that, based on the analysis prepared by the pricing service, reflect the assumptions that market participants would use to price the assets. Management has determined that the Level 2 designation is appropriate for these securities because, as with most fixed-income securities, those in FNCB’s portfolio are not exchange-traded, and such non-exchange-traded fixed income securities are typically priced by correlation to observed market data. FNCB has reviewed the pricing service’s methodology to confirm its understanding that such methodology results in a valuation based on quoted market prices for similar instruments traded in active markets, quoted markets for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which the significant assumptions can be corroborated by market data as appropriate to a Level 2 designation.

For those securities for which the inputs used by an independent pricing service were derived from unobservable market information, FNCB evaluated the appropriateness and quality of each price.  Management reviewed the volume and level of activity for all classes of securities and attempted to identify transactions which may not be orderly or reflective of a significant level of activity and volume.  For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing service may be adjusted, as necessary, to estimate fair value (fair values based on Level 3 inputs).  If applicable, the adjustment to fair value was derived based on present value cash flow model projections obtained from third party providers using assumptions similar to those incorporated by market participants.

At  December 31, 2022, FNCB owned 29 corporate debt securities with an aggregate amortized cost and fair value of $33.6 million and $30.7 million, respectively. The market for six of the 29 corporate debt securities at  December 31, 2022 was not active and markets for similar securities are also not active. FNCB obtained valuations for these securities from a third-party service provider that prepared the valuations using a market approach that incorporates identifying a population of transactions for similar instruments and an evaluation to capture credit risk associated with these bonds.  Management takes measures to validate the service provider’s analysis and is actively involved in the valuation process, including reviewing and verifying the population and evaluation of credit risk. Managment believes this approach to be a conservative approach as it takes into consideration securities that have longer maturities or longer call dates, issuers with smaller asset sizes, and securities with smaller issue amounts. These factors are typically considered to be factors that would add credit spread to a bond, thus resulting in a higher yield.  Management believes the valuation results from this market approach to be consistent with pricing and data for similar deals at December 31, 2022. FNCB considers the inputs used in the market approach to be observable Level 3 inputs because, while inputs are based on actual transactions, the relative number of transactions in the population is small and subjective assumptions are used in considering factors considered to incorporate credit spreads into price determination. Management will continue to monitor the market for these securities to assess the market activity and the availability of observable inputs and will continue to apply these controls and procedures to the valuations received from FNCB's third-party service provider.

Equity Securities

The estimated fair values of equity securities are determined by obtaining quoted prices on nationally recognized exchanges (Level 1 inputs).

Derivative Contracts

FNCB's derivative liabilities are reported at fair value utilizing Level 2 inputs. Values of these instruments are obtained through an independent pricing source utilizing information which may include market observed quotations for swaps, LIBOR rates, forward rates and rate volatility.  Derivative contracts create exposure to interest rate movements a swell as risks from the potential of non-performance of the counterparty.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following tables present the financial assets and liabilities that are measured at fair value on a recurring basis at  December 31, 2022 and 2021, and the fair value hierarchy of the respective valuation techniques utilized to determine the fair value:

	Fair Value Measurements at December 31, 2022
			Quoted Prices		Significant		Significant
			in Active Markets		Observable		Unobservable
			for Identical Assets		Inputs		Inputs
(in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
Financial assets:
Available-for-sale debt securities:
U.S. Treasury securities	$	32,134	$	-	$	32,134	$	-
Obligations of state and political subdivisions		220,782		-		220,782		-
U.S. government/government-sponsored agencies:
Collateralized mortgage obligations - residential		80,407		-		80,407		-
Collateralized mortgage obligations - commercial		3,329		-		3,329		-
Mortgage-backed securities		20,663		-		20,663		-
Private collateralized mortgage obligations		72,507		-		72,507		-
Corporate debt securities		30,672		-		22,736		7,936
Asset-backed securities		14,941		-		14,941		-
Negotiable certificates of deposit		656		-		656		-
Total available-for-sale debt securities		476,091		-		468,155		7,936
Equity securities, at fair value		7,717		7,717		-		-
Derivative assets		2,104		-		2,104		-
Total financial assets	$	485,912	$	7,717	$	470,259	$	7,936
Financial liabilities:
Derivative liabilities	$	931	$	-	$	931	$	-
Total financial liabilities	$	931	$	-	$	931	$	-

	Fair Value Measurements at December 31, 2021
			Quoted Prices		Significant		Significant
			in Active Markets		Observable		Unobservable
			for Identical Assets		Inputs		Inputs
(in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
Financial assets:
Available-for-sale debt securities:
U.S. Treasury securities	$	36,355	$	-	$	36,355	$	-
Obligations of state and political subdivisions		244,372		-		244,372		-
U.S. government/government-sponsored agencies:
Collateralized mortgage obligations - residential		100,710		-		100,710		-
Collateralized mortgage obligations - commercial		3,727		-		3,727		-
Mortgage-backed securities		25,506		-		25,506		-
Private collateralized mortgage obligations		67,165		-		67,165		-
Corporate debt securities		32,063		-		19,718		12,345
Asset-backed securities		11,932		-		11,932		-
Negotiable certificates of deposit		736		-		736		-
Total available-for-sale debt securities		522,566		-		510,221		12,345
Equity Securities, at fair value		4,922		4,922		-		-
Derivative assets		363		-		363		-
Total financial assets	$	527,851	$	4,922	$	510,584	$	12,345
Financial liabilities:
Derivative liabilities	$	99	$	-	$	99	$	-
Total financial liabilities	$	99	$	-	$	99	$	-

There was one corporate debt security transferred from Level 3 hierarchy to Level 2 during the year ended, December 31, 2022.

For the year ended December 31, 2021, eight corporate debt securities were transferred from Level 3 hierarchy to Level 2. The market for these securities was previously not active and management obtained fair values from an independent third party. During 2021, the market of these securities became active.  Accordingly, management was able to obtain fair values for these eight securities from the independent pricing service used to price the remainder of the portfolio.

The following table presents a reconciliation and statement of operations classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3), which consisted entirely of corporate debt securities, for the years ended  December 31, 2022 and 2021:

Fair Value Measurements
Using Significant Unobservable Inputs (Level 3)
	Corporate Debt Securities
	For the Year Ended December 31,
(in thousands)	2022			2021
Balance at January 1,	$	12,345		$	16,424
Additions		-			4,500
Redemptions		(2,066	)		(1,000	)
Transfer to Level 2		(756	)		(7,550	)
Total gains or losses (realized/unrealized):
Included in earnings		-			-
Included in other comprehensive income		(1,587	)		(29	)
Balance at December 31,	$	7,936		$	12,345

Assets Measured at Fair Value on a Non-Recurring Basis

The following tables present assets and liabilities measured at fair value on a non-recurring basis at  December 31, 2022 and 2021, and additional quantitative information about the valuation techniques and inputs utilized by FNCB to determine fair value. All such assets and liabilities were measured using Level 3 inputs:

	December 31, 2022
	Fair Value Measurement						Quantitative Information
	Recorded		Valuation		Fair		Valuation	Unobservable	Value/
(in thousands)	Investment		Allowance		Value		Technique	Inputs	Range
Impaired loans - collateral dependent	$	1,902	$	8	$	1,894	Appraisal of collateral	Selling costs		10.0%
Impaired loans - other		5,698		26		5,672	Discounted cash flows	Discount rate	3.00%	-	10.25%

	December 31, 2021
	Fair Value Measurement						Quantitative Information
	Recorded		Valuation		Fair		Valuation	Unobservable	Value/
(in thousands)	Investment		Allowance		Value		Technique	Inputs	Range
Impaired loans - collateral dependent	$	3,208	$	-	$	3,208	Appraisal of collateral	Selling costs		10.0%
Impaired loans - other		6,765		26		6,739	Discounted cash flows	Discount rate	3.00%	-	8.75%
Other real estate owned		920		-		920	Appraisal of collateral	Selling costs		1.0%

The fair value of collateral-dependent impaired loans is determined through independent appraisals or other reasonable offers, which generally include various Level 3 inputs which are not identifiable. Management reduces the appraised value by the estimated costs to sell the property and may make adjustments to the appraised values as necessary to consider any declines in real estate values since the time of the appraisal. For impaired loans that are not collateral-dependent, fair value is determined using the discounted cash flow method. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance or is charged off. The amount shown is the balance of impaired loans, net of any charge-offs and the related allowance for loan losses.

OREO properties are recorded at fair value less the estimated cost to sell at the date of FNCB’s acquisition of the property. Subsequent to acquisition of the property, the balance may be written down further. It is FNCB’s policy to obtain certified external appraisals of real estate collateral underlying impaired loans and OREO, and estimate fair value using those appraisals. Other valuation sources may be used, including broker price opinions, letters of intent and executed sale agreements.

The following table summarizes the estimated fair values of FNCB’s financial instruments at  December 31, 2022 and 2021. FNCB discloses fair value information about financial instruments, whether or not recognized in the statements of financial condition, for which it is practicable to estimate that value. The fair value of financial instruments that are not measured at fair value in the financial statements were based on exit price notion. The following estimated fair value amounts have been determined using available market information and appropriate valuation methodologies. However, management judgment is required to interpret data and develop fair value estimates. Accordingly, the estimates below are not necessarily indicative of the amounts FNCB could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

	Fair Value	December 31, 2022				December 31, 2021
(in thousands)	Measurement	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial assets:
Cash and short term investments	Level 1	$	41,916	$	41,916	$	99,020	$	99,020
Available-for-sale debt securities	See previous table		476,091		476,091		522,566		522,566
Equity securities	Level 1		7,717		7,717		4,922		4,922
Restricted stock	Level 2		8,545		8,545		1,911		1,911
Loans held for sale	Level 2		60		60		-		-
Loans, net	Level 3		1,110,124		1,079,266		967,023		967,087
Accrued interest receivable	Level 2		5,957		5,957		4,643		4,643
Servicing rights	Level 3		254		621		268		526
Derivative assets	Level 2		1,946		2,104		371		363
Financial liabilities:
Deposits	Level 2		1,420,647		1,416,272		1,455,028		1,454,812
Borrowed funds	Level 2		182,360		182,108		30,310		30,310
Accrued interest payable	Level 2		171		171		49		49
Derivative liabilities	Level 2		921		931		96		99