Fair Value Measurements

9 Months Ended

Sep. 30, 2020

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Investment securities available for sale and marketable equity 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.

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 September 30, 2020, 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 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:


	September 30, 2020		December 31, 2019
(In Thousands)	Carrying Amount	Fair Value	Carrying Amount	Fair Value
Financial assets:
Level 1 inputs:
Cash, due from banks and deposits in other banks	$101,129	$101,129	$95,424	$95,424
Investment securities available for sale	59,865	59,865	75,456	75,456
Marketable equity securities	8,534	8,534	7,945	7,945

Level 2 inputs:
Investment securities available for sale	155,504	155,504	200,682	200,682
Investment in Federal Home Loan Bank stock	2,508	2,508	2,138	2,138
Accrued interest receivable	8,024	8,024	4,512	4,512
Interest rate swaps	8,846	8,846	2,950	2,950

Level 3 inputs:
Loans and loans held for sale	1,620,826	1,602,727	1,111,205	1,095,031
Purchased receivables, net	13,520	13,520	24,373	24,373
Interest rate lock commitments	6,519	6,519	810	810
Mortgage servicing rights	10,589	10,589	11,920	11,920
Commercial servicing rights	1,286	1,286	1,214	1,214

Financial liabilities:
Level 2 inputs:
Deposits	$1,806,133	$1,808,534	$1,372,351	$1,373,647

Borrowings	13,737	15,119	8,891	9,216
Accrued interest payable	139	139	23	23
Interest rate swaps	11,002	11,002	3,484	3,484
Retail interest rate contracts	466	466	71	71

Level 3 inputs:

Junior subordinated debentures	10,310	10,610	10,310	11,000

The following table sets forth the balances as of the periods indicated of assets and liabilities 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)
September 30, 2020
Assets:
Available for sale securities
U.S. Treasury and government sponsored entities	$157,552	$37,691	$119,861	$—
Municipal securities	2,336	—	2,336	—

Corporate bonds	27,215	22,174	5,041	—
Collateralized loan obligations	28,266	—	28,266	—
Total available for sale securities	$215,369	$59,865	$155,504	$—
Marketable equity securities	$8,534	$8,534	$—	$—
Total marketable equity securities	$8,534	$8,534	$—	$—
Interest rate swaps	8,846	—	8,846	—
Interest rate lock commitments	6,519	—	—	6,519
Mortgage servicing rights	10,589	—	—	10,589
Commercial servicing rights	1,286	—	—	1,286
Total other assets	$27,240	$—	$8,846	$18,394
Liabilities:
Interest rate swaps	$11,002	$—	$11,002	$—
Retail interest rate contracts	466	—	466	—
Total other liabilities	$11,468	$—	$11,468	$—
December 31, 2019
Assets:
Available for sale securities
U.S. Treasury and government sponsored entities	$211,852	$57,480	$154,372	$—
Municipal securities	3,297	—	3,297	—

Corporate bonds	35,066	17,976	17,090	—
Collateralized loan obligations	25,923	—	25,923	—
Total available for sale securities	$276,138	$75,456	$200,682	$—
Marketable equity securities	$7,945	$7,945	$—	$—
Total marketable securities	$7,945	$7,945	$—	$—
Interest rate swaps	2,950	—	2,950	—
Interest rate lock commitments	810	—	—	810
Mortgage servicing rights	11,920	—	—	11,920
Commercial servicing rights	1,214	—	—	1,214
Total other assets	$16,894	$—	$2,950	$13,944
Liabilities:
Interest rate swaps	$3,484	$—	$3,484	$—
Retail interest rate contracts	71	—	71	—
Total other liabilities	$3,555	$—	$3,555	$—

The following tables provide a reconciliation of the assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three and nine-month periods ended September 30, 2020 and 2019:


(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 September 30, 2020
Interest rate lock commitments	$4,653	($1,784)	$15,329	($11,679)	$6,519	$6,519
Mortgage servicing rights	10,721	(1,505)	1,373	—	10,589	—
Commercial servicing rights	1,162	(101)	225	—	1,286	—
Total	$16,536	($3,390)	$16,927	($11,679)	$18,394	$6,519
Three Months Ended September 30, 2019
Interest rate lock commitments	$2,072	($553)	$4,569	($4,725)	$1,363	$1,363
Mortgage servicing rights	10,836	(663)	1,033	—	11,206	—
Commercial servicing rights	999	(20)	39	—	1,018	—
Total	$13,907	($1,236)	$5,641	($4,725)	$13,587	$1,363


(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
Nine Months Ended September 30, 2020
Interest rate lock commitments	$810	($4,923)	$40,441	($29,809)	$6,519	$6,519
Mortgage servicing rights	11,920	(4,363)	3,032	—	10,589	—
Commercial servicing rights	1,214	(180)	252	—	1,286	—
Total	$13,944	($9,466)	$43,725	($29,809)	$18,394	$6,519
Nine Months Ended September 30, 2019
Interest rate lock commitments	$978	($1,431)	$12,759	($10,943)	$1,363	$1,363
Mortgage servicing rights	10,821	(2,287)	2,672	—	11,206	—
Commercial servicing rights	1,030	(118)	106	—	1,018	—
Total	$12,829	($3,836)	$15,537	($10,943)	$13,587	$1,363

There were no changes in unrealized gains and losses for the three and nine-month periods ending September 30, 2020 and 2019 included in other comprehensive income for recurring Level 3 fair value measurements.

As of and for the periods ending September 30, 2020 and December 31, 2019, 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)
September 30, 2020
Loans measured for impairment	$202	$—	$—	$202


Total	$202	$—	$—	$202
December 31, 2019
Loans measured for impairment	$561	$—	$—	$561


Total	$561	$—	$—	$561

The following table presents the gains resulting from nonrecurring fair value adjustments for the three and nine-month periods ended September 30, 2020 and 2019:


	Three Months Ended September 30,		Nine Months Ended September 30,
(In Thousands)	2020	2019	2020	2019
Loans measured for impairment	$10	$96	$24	$89


Total loss from nonrecurring measurements	$10	$96	$24	$89

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 September 30, 2020 and December 31, 2019:


Financial Instrument	Valuation Technique	Unobservable Input	Weighted Average Rate Range
September 30, 2020
Loans measured for impairment	In-house valuation of collateral	Discount rate	40	%


Interest rate lock commitment	External pricing model	Pull through rate	90.24	%
Mortgage servicing rights	Discounted cash flow	Constant prepayment rate	9.54% - 14.50%
		Discount rate	7.75	%
Commercial servicing rights	Discounted cash flow	Constant prepayment rate	7.64% - 15.67%
		Discount rate	11.70	%
December 31, 2019
Loans measured for impairment	In-house valuation of collateral	Discount rate	25	%


Interest rate lock commitment	External pricing model	Pull through rate	92.65	%
Mortgage servicing rights	Discounted cash flow	Constant prepayment rate	9.11% - 10.67%
		Discount rate	8.51% - 8.66%
Commercial servicing rights	Discounted cash flow	Constant prepayment rate	7.64% - 15.67%
		Discount rate	11.70	%

- 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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