Fair Value Measurements

Fair Value Hierarchy

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. GAAP established a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies. In accordance with GAAP, the Company groups its assets and liabilities measured at fair value into the following three levels:


•	Level 1: Valuation is based upon quoted prices for identical instruments traded in active markets. A quoted market price in an active market provides the most reliable evidence of fair value and is used to measure fair value whenever available. A contractually binding sales price also provides reliable evidence of fair value.


•	Level 2: Valuation is based upon quoted market prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.


•	Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market, or inputs that require significant management judgment or estimation, some of which may be internally developed.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Investment securities available for sale and marketable securities: Fair values are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

Loans held for sale: Due to the short term nature of these instruments, the carrying amounts reported in the consolidated balance sheets represent their fair values.

Servicing rights: MSR and CSR are measured at fair value on a recurring basis. These assets are classified as Level 3 as quoted prices are not available. In order to determine the fair value of MSR and CSR, the present value of net expected future cash flows is estimated. Assumptions used include market discount rates, anticipated prepayment speeds, escrow calculations, delinquency rates, and ancillary fee income net of servicing costs. The model assumptions are also compared to publicly filed information from several large MSR holders, as available.

Derivative instruments: The fair value of the interest rate lock commitments are estimated using quoted or published market prices for similar instruments, adjusted for factors such as pull-through rate assumptions based on historical information, where appropriate. The pull-through rate assumptions are considered Level 3 valuation inputs and are significant to the interest rate lock commitment valuation; as such, the interest rate lock commitment derivatives are classified as Level 3. Interest rate contracts are valued in a model, which uses as its basis a discounted cash flow technique incorporating credit valuation adjustments to reflect nonperformance risk in the measurement of fair value. Although the Company has determined that the majority of inputs used to value its interest rate derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of March 31, 2019, the Company has assessed the significance of the impact of these adjustments on the overall valuation of its interest rate positions and has determined that they are not significant to the overall valuation of its interest rate derivatives. As a result, the Company has classified its interest rate derivative valuations in Level 2 of the fair value hierarchy.

Commitments to extend credit and standby letters of credit: The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligation with the counterparties at the reporting date.

Assets Subject to Nonrecurring Adjustment to Fair Value:

The Company is also required to measure certain assets such as equity method investments, goodwill, intangible assets, impaired loans, and other real estate owned (“OREO”) at fair value on a nonrecurring basis in accordance with GAAP. Any nonrecurring adjustments to fair value usually result from the writedown of individual assets.

The Company uses either in-house evaluations or external appraisals to estimate the fair value of OREO and impaired loans as of each reporting date. In-house appraisals are considered Level 3 inputs and external appraisals are considered Level 2 inputs. The Company’s determination of which method to use is based upon several factors. The Company takes into account compliance with legal and regulatory guidelines, the amount of the loan, the size of the assets, the location and type of property to be valued and how critical the timing of completion of the analysis is to the assessment of value. Those factors are balanced with the level of internal expertise, internal experience and market information available, versus external expertise available such as qualified appraisers, brokers, auctioneers and equipment specialists.

The Company uses external sources to estimate fair value for projects that are not fully constructed as of the date of valuation. These projects are generally valued as if complete, with an appropriate allowance for cost of completion, including contingencies developed from external sources such as vendors, engineers and contractors. The Company believes that recording OREO that is not fully constructed based on as if complete values is more appropriate than recording OREO that is not fully constructed using as is values. We concluded that as-is-complete values are appropriate for these types of projects based on the accounting guidance for capitalization of project costs and subsequent measurement of the value of real estate. GAAP specifically states that estimates and cost allocations must be reviewed at the end of each reporting period and reallocated based on revised estimates. The Company adjusts the carrying value of OREO in accordance with this guidance for increases in estimated cost to complete that exceed the fair value of the real estate at the end of each reporting period.

Limitations

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

Estimated fair values as of the periods indicated are as follows:



	March 31, 2019				December 31, 2018
(In Thousands)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Level 1 inputs:
Cash, due from banks and deposits in other banks		$78,933		$78,933		$77,538		$77,538
Investment securities available for sale	88,331		88,331		74,549		74,549
Marketable equity securities	7,798		7,798		7,265		7,265

Level 2 inputs:
Investment securities available for sale	186,110		186,110		197,061		197,061
Investment in Federal Home Loan Bank stock	2,071		2,071		2,101		2,101
Accrued interest receivable	5,010		5,010		4,817		4,817
Interest rate swaps	514		514		853		853

Level 3 inputs:
Loans and loans held for sale	1,012,552			$994,382	1,019,056		995,115
Purchased receivables, net	21,286		21,286		14,406		14,406
Interest rate lock commitments	1,237		1,237		978		978
Mortgage servicing rights	11,254		11,254		10,821		10,821
Commercial servicing rights	1,047		1,047		1,030		1,030

Financial liabilities:
Level 2 inputs:
Deposits		$1,228,018		$1,227,692		$1,228,088		$1,227,086
Securities sold under repurchase agreements	34,621		34,621		34,278		34,278
Borrowings	7,200		7,098		7,241		6,965
Accrued interest payable	57		57		22		22
Interest rate swaps	300		300		246		246
Retail interest rate contracts	130		130		262		262

Level 3 inputs:
Junior subordinated debentures	10,310		11,191		10,310		10,809

The following table sets forth the balances as of the periods indicated of assets measured at fair value on a recurring basis:



(In Thousands)	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
March 31, 2019
Assets:
Available for sale securities
U.S. Treasury and government sponsored entities		$212,297		$55,037		$157,260		$—
Municipal securities	3,898		—		3,898		—
Corporate bonds	40,337		33,294		7,043		—
Collateralized loan obligations	17,909		—		17,909		—
Total available for sale securities		$274,441		$88,331		$186,110		$—
Marketable equity securities		$7,798		$7,798		$—		$—
Total marketable equity securities		$7,798		$7,798		$—		$—
Interest rate swaps		$514		$—		$514		$—
Interest rate lock commitments	1,237		—		—		1,237
Mortgage servicing rights	11,254		—		—		11,254
Commercial servicing rights	1,047		—		—		1,047
Total other assets		$14,052		$—		$514		$13,538
Liabilities:
Interest rate swaps		$300		$—		$300		$—
Retail interest rate contracts	130		—		130		—
Total other liabilities		$430		$—		$430		$—
December 31, 2018
Assets:
Available for sale securities
U.S. Treasury and government sponsored entities		$208,860		$54,863		$153,997		$—
Municipal securities	9,084		—		9,084		—
Corporate bonds	39,780		19,686		20,094		—
Collateralized loan obligations	13,886		—		13,886		—
Total available for sale securities		$271,610		$74,549		$197,061		$—
Marketable equity securities		$7,265		$7,265		$—		$—
Total marketable securities		$7,265		$7,265		$—		$—
Interest rate swaps		$853		$—		$853		$—
Interest rate lock commitments	978		—		—		978
Mortgage servicing rights	10,821		—		—		10,821
Commercial servicing rights	1,030		—		—		1,030
Total other assets		$13,682		$—		$853		$12,829
Liabilities:
Interest rate swaps		$246		$—		$246		$—
Retail interest rate contracts	262		—		262		—
Total other liabilities		$508		$—		$508		$—

The following table provides a reconciliation of the assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three-month periods ended March 31, 2019 and 2018:



(In Thousands)	Beginning balance		Change included in earnings			Purchases and issuances		Sales and settlements			Ending balance		Net change in unrealized gains (losses) relating to items held at end of period
Three Months Ended March 31, 2019
Interest rate lock commitments		$978		($329	)		$3,096		($2,508	)		$1,237		$1,237
Mortgage servicing rights	10,821		(674		)	1,107		—			11,254		—
Commercial servicing rights	1,030		(23		)	40		—			1,047		—
Total		$12,829		($1,026	)		$4,243		($2,508	)		$13,538		$1,237
Three Months Ended March 31, 2018
Interest rate lock commitments		$873		($400	)		$3,684		($2,834	)		$1,323		$1,323
Mortgage servicing rights	7,305		(26		)	760		—			8,039		—
Total		$8,178		($426	)		$4,444		($2,834	)		$9,362		$1,323

As of and for the periods ending March 31, 2019 and December 31, 2018, except for certain assets as shown in the following table, no impairment or valuation adjustment was recognized for assets recognized at fair value on a nonrecurring basis. For loans measured for impairment, the Company classifies fair value measurements using observable inputs, such as external appraisals, as Level 2 valuations in the fair value hierarchy, and unobservable inputs, such as in-house evaluations, as Level 3 valuations in the fair value hierarchy.



(In Thousands)	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
March 31, 2019
Loans measured for impairment		$1,706		$—		$—		$1,706
Total		$1,706		$—		$—		$1,706
December 31, 2018
Loans measured for impairment		$848		$—		$—		$848
Other assets - equity method investment	709		—		—		709
Total		$1,557		$—		$—		$1,557

The following table presents the gains and (losses) resulting from nonrecurring fair value adjustments for the three-month periods ended March 31, 2019 and 2018:



	Three Months Ended March 31,
(In Thousands)	2019		2018
Loans measured for impairment		$292		($594	)
Total loss from nonrecurring measurements		$292		($594	)

Assets and Liabilities Measured at Fair Value Using Significant Unobservable Inputs (Level 3)

The following table provides a description of the valuation technique, unobservable input, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a recurring and nonrecurring basis at March 31, 2019 and December 31, 2018:



Financial Instrument	Valuation Technique	Unobservable Input	Weighted Average Rate Range
March 31, 2019
Loans measured for impairment	In-house valuation of collateral	Discount rate	10% - 61.50%
Interest rate lock commitment	External pricing model	Pull through rate	92.12	%
Mortgage servicing rights	Discounted cash flow	Constant prepayment rate	8.31% - 9.25%
		Discount rate	9.60% - 10.00%
Commercial servicing rights	Discounted cash flow	Constant prepayment rate	7.64% - 15.67%
		Discount rate	11.49	%
December 31, 2018
Loans measured for impairment	In-house valuation of collateral	Discount rate	65	%
	Discounted cash flow	Discount rate	8.25% - 8.50%
Interest rate lock commitment	External pricing model	Pull through rate	91.66	%
Mortgage servicing rights	Discounted cash flow	Constant prepayment rate	7.62 % - 9.87%
		Discount rate	9.93% - 10.47%
Commercial servicing rights	Discounted cash flow	Constant prepayment rate	7.64% - 15.67%
		Discount rate	11.49	%