FAIR VALUE DISCLOSURES

3 Months Ended

Mar. 31, 2023

13. FAIR VALUE DISCLOSURES

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

Valuation techniques that are consistent with the market approach, the income approach and/or the cost approach are required by GAAP. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset. Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The fair value hierarchy for valuation inputs gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

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Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

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Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

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Level 3 Inputs - Significant unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

The following table summarizes fair value measurements at the dates indicated (dollars in thousands):

	Level 1		Level 2			Level 3		Total
March 31, 2023
Assets (liabilities) measured at fair value on a recurring basis:
Securities available for sale:
State and municipal	$	—	$	231,177		$	—	$	231,177
Residential mortgage-backed securities		—		327,523			—		327,523
Commercial mortgage-backed securities		—		42,667			—		42,667
Collateralized mortgage obligations		—		67,551			—		67,551
Asset-backed and other amortizing securities		—		18,669			—		18,669
Other securities		—		10,992			—		10,992
Loans held for sale (mandatory)		—		11,576			—		11,576
Mortgage servicing rights		—		—			25,795		25,795
Asset derivatives		—		18,931			—		18,931
Liability derivatives		—		(409	)		—		(409	)

Assets measured at fair value on a non-recurring basis:
Loans held for investment		—		—			4,161		4,161

December 31, 2022
Assets (liabilities) measured at fair value on a recurring basis:
Securities available for sale:
State and municipal	$	—	$	225,055		$	—	$	225,055
Residential mortgage-backed securities		—		328,845			—		328,845
Commercial mortgage-backed securities		—		41,967			—		41,967
Collateralized mortgage obligations		—		75,638			—		75,638
Asset-backed and other amortizing securities		—		19,094			—		19,094
Other securities		—		11,112			—		11,112
Loans held for sale (mandatory)		—		10,038			—		10,038
Mortgage servicing rights		—		—			27,474		27,474
Asset derivatives		—		21,162			—		21,162
Liability derivatives		—		(128	)		—		(128	)

Assets measured at fair value on a non-recurring basis:
Loans held for investment		—		—			4,821		4,821

Securities – Fair value is calculated based on market prices of similar securities using matrix pricing. Matrix pricing is a mathematical technique commonly used to price debt securities that are not actively traded.

Mortgage servicing rights – Mortgage servicing rights are reported at fair value using Level 3 inputs. The mortgage servicing rights asset is valued by projecting net servicing cash flows, which are then discounted to estimate the fair value. The fair value of the mortgage servicing rights asset is impacted by a variety of factors, including prepayment speeds, default rates, and discount rates, which are significant unobservable inputs. Mortgage servicing rights are the only Level 3 asset measured at fair value on a recurring basis, see Note 5 for the Level 3 change activity for the three months ended March 31, 2023 and 2022.

Derivatives – Fair value of derivatives is based on valuation models using observable market data as of the measurement date.

Loans held for investment – Includes certain collateral-dependent loans which are reported at the fair value, for which a specific allocation of the allowance for credit losses is based off of the underlying collateral, less estimated disposal costs, if repayment is expected solely from the sale of the collateral. Collateral values are estimated using Level 2 inputs based on observable market data or Level 3 inputs based on customized discounting criteria.

Fair Values of Assets Recorded on a Recurring Basis for which the Fair Value Option has been Elected

Loans held for sale (mandatory) – Loans held for sale originated for mandatory delivery are reported at fair value on a recurring basis due to the Company’s election to adopt fair value accounting treatment for these assets. This election allows for a more effective offset of the changes in fair values of the assets and the derivative instruments used to economically hedge them without the burden of complying with the requirements for hedge accounting under ASC Topic 815, Derivatives and Hedging. For assets for which the fair value option has been elected, the earned current contractual interest payment is recognized in interest income, loan origination costs and fees on fair value option loans are recognized in earnings as incurred and not deferred. At March 31, 2023, and December 31, 2022, there were no gains or losses recorded attributable to changes in instrument-specific credit risk. Fair value is determined using quoted prices for similar assets, adjusted for specific attributes of that loan. At March 31, 2023 and December 31, 2022 the aggregate fair value of loans held for sale for mandatory delivery was $11.6 million and $10.0 million, respectively. The aggregate unpaid principal balance as of the same dates was $12.0 million and $9.9 million, respectively, representing differences between fair value and unpaid principal balance of $(469) thousand and $163 thousand, respectively. There were no loans held for sale for mandatory delivery designated as nonaccrual or 90 days or more past due at March 31, 2023 and December 31, 2022.

The total fair value option impact on noninterest income for loans held for sale for mandatory delivery is included in Net gain on sales of loans in the Company’s Consolidated Statements of Comprehensive Income (Loss). For the three months ended March 31, 2023 and 2022 the net (gain) loss amount totaled $(261) thousand and $2.1 million, respectively.

The following table presents quantitative information about recurring and non-recurring Level 3 fair value measurements at the dates indicated (dollars in thousands):

	Fair Value		Valuation Techniques	Unobservable Inputs	Range of Discounts
March 31, 2023
Non-recurring:
Loans held for investment	$	4,161	Third party appraisals or inspections	Collateral discounts and selling costs		20%-100	%
Recurring:
Mortgage servicing rights		25,795	Discounted cash flows	Conditional prepayment rate		7.44	%
				Discount rate		9.65	%

December 31, 2022
Non-recurring:
Loans held for investment	$	4,821	Third party appraisals or inspections	Collateral discounts and selling costs		20%-100	%
Recurring:
Mortgage servicing rights		27,474	Discounted cash flows	Conditional prepayment rate		7.47	%
				Discount rate		9.15	%

The estimated fair values, and related carrying amounts, of the Company’s financial instruments that are not previously disclosed in the recurring fair value section are as follows (dollars in thousands):

	Carrying Amount		Level 1		Level 2		Level 3		Total Fair Value

March 31, 2023
Financial assets:
Cash and cash equivalents	$	328,002	$	328,002	$	—	$	—	$	328,002
Loans held for investment, net		2,749,080		—		—		2,697,002		2,697,002
Loans held for sale (best efforts)		8,872		—		9,070		—		9,070
Accrued interest receivable		14,421		—		14,421		—		14,421

Financial liabilities:
Deposits	$	3,508,054	$	—	$	3,507,917	$	—	$	3,507,917
Accrued interest payable		2,754		—		2,754		—		2,754
Junior subordinated deferrable interest debentures		46,393		—		32,395		—		32,395
Subordinated debt securities		76,007		—		64,498		—		64,498

	Carrying Amount		Level 1		Level 2		Level 3		Total Fair Value

December 31, 2022
Financial assets:
Cash and cash equivalents	$	234,883	$	234,883	$	—	$	—	$	234,883
Loans held for investment, net		2,708,793		—		—		2,662,609		2,662,609
Loans held for sale (best efforts)		20,365		—		20,745		—		20,745
Accrued interest receivable		16,432		—		16,432		—		16,432

Financial liabilities:
Deposits	$	3,406,430	$	—	$	3,405,222	$	—	$	3,405,222
Accrued interest payable		2,836		—		2,836		—		2,836
Junior subordinated deferrable interest debentures		46,393		—		34,606		—		34,606
Subordinated debt securities		75,961		—		70,835		—		70,835

- 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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