Fair Value of Financial Instruments

6 Months Ended

Jun. 30, 2020

Fair Value Disclosures [Abstract]

Fair Value of Financial Instruments

Note 8 – Fair Value of Financial Instruments

Accounting standards require that the Company adopt fair value measurement for financial assets and financial liabilities. This enhanced guidance for using fair value to measure assets and liabilities applies whenever other standards require or permit assets or liabilities to be measured at fair value. This guidance does not expand the use of fair value in any new circumstances.

Accounting standards establish a hierarchical disclosure framework associated with the level of pricing observability utilized in measuring assets and liabilities at fair value. The three broad levels defined by these standards are as follows:

Level I:	Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
Level II:	Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.
Level III:	Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

The methods of determining the fair value of assets and liabilities presented in this footnote are consistent with our methodologies disclosed in Note 17, “Fair Value of Financial Instruments” and Note 18, “Fair Value Measurement” of the Notes to the Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of the Company’s 2019 Annual Report on Form 10-K.

Assets Measured on a Recurring Basis

As required by accounting standards, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following measurements are made on a recurring basis.

•Available-for-sale investment securities – Available-for-sale investment securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level I securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level II securities include mortgage-backed securities issued by government sponsored entities and private label entities, municipal bonds, and corporate debt securities. There have been no changes in valuation techniques for the three and six months ended June 30, 2020. Valuation techniques are consistent with techniques used in prior periods. Certain local municipal securities related to tax increment financing (“TIF”) are independently valued and classified as Level III instruments. The Company classified investments in government securities as Level II instruments and valued them using the market approach.

•Equity securities – Certain equity securities are recorded at fair value on both a recurring and nonrecurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security's credit rating, prepayment assumptions, and other factors such as credit loss assumptions. The valuation methodologies utilized may include significant unobservable inputs. There have been no changes in valuation techniques for the three and six months ended June 30, 2020. Valuation techniques are consistent with techniques used in prior periods.

•Loans held for sale – The fair value of mortgage loans held for sale is determined, when possible, using quoted secondary-market prices or investor commitments. If no such quoted price exists, the fair value of a loan is determined using quoted prices for a similar asset or assets, adjusted for the specific attributes of that loan, which would be used by other market participants.

•Interest rate lock commitments – The Company estimates the fair value of interest rate lock commitments based on the value of the underlying mortgage loan, quoted mortgage-backed security prices, and estimates of the fair value of the mortgage servicing rights and the probability that the mortgage loan will fund within the terms of the interest rate lock commitments.

•Mortgage-backed security hedges – MBS hedges are considered derivatives and are recorded at fair value based on observable market data of the individual mortgage-backed security.

•Interest rate swap – Interest rate swaps are recorded at fair value based on third party vendors who compile prices from various sources and may determine fair value of identical or similar instruments by using pricing models that consider observable market data.

•Fair value hedge – Treated like an interest rate swap, fair value hedges are recorded at fair value based on third party vendors who compile prices from various sources and may determine fair value of identical or similar instruments by using pricing models that consider observable market data.

The following tables present the assets reported on the consolidated statements of financial condition at their fair value on a recurring basis as of June 30, 2020 and December 31, 2019 by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

	June 30, 2020
(Dollars in thousands)	Level I		Level II		Level III		Total
Assets:
U.S. Government Agency securities	$	—	$	41,980	$	—	$	41,980
U.S. Sponsored Mortgage backed securities	—		34,274		—		34,274
Municipal securities	—		89,748		40,457		130,205
Other securities	—		14,240		—		14,240
Equity securities	383		—		—		383
Loans held for sale	—		242,089		—		242,089
Interest rate lock commitment	—		—		7,338		7,338
Interest rate swap	—		16,514		—		16,514
Fair value hedge	—		2,430		—		2,430
Bank-owned life insurance	—		35,818		—		35,818
Liabilities:
Interest rate swap	—		16,514		—		16,514
Fair value hedge	—		2,659		—		2,659
Mortgage-backed security hedges	—		858		—		858

	December 31, 2019
(Dollars in thousands)	Level I		Level II		Level III		Total
Assets:
U.S. Government Agency securities	$	—	$	51,996	$	—	$	51,996
U.S. Sponsored Mortgage backed securities	—		58,312		—		58,312
Municipal securities	—		75,833		37,259		113,092
Other securities	—		12,421		—		12,421
Loans held for sale	—		109,788		—		109,788
Interest rate lock commitment	—		—		1,660		1,660
Interest rate swap	—		5,722		—		5,722
Fair value hedge	—		1,770		—		1,770
Bank-owned life insurance	—		35,374		—		35,374
Liabilities:
Interest rate swap	—		5,722		—		5,722
Fair value hedge	—		1,418		—		1,418
Mortgage-backed security hedges	—		186		—		186

The following table represents recurring level III assets:

(Dollars in thousands)	Interest Rate Lock Commitments		Municipal Securities		Equity Securities		Total
Balance at December 31, 2019	$	1,660	$	37,259	$	—	$	38,919
Realized and unrealized gains included in earnings	5,678		—		—		5,678
Purchase of securities	—		20,780		—		20,780
Unrealized gain included in other comprehensive income (loss)	—		1,645		—		1,645
Unrealized loss included in other comprehensive income (loss)	—		(19,227)		—		(19,227)
Balance at June 30, 2020	$	7,338	$	40,457	$	—	$	47,795
Balance at March 31, 2020	$	5,791	$	36,626	$	—	$	42,417
Realized and unrealized gains included in earnings	1,547		—		—		1,547
Purchase of securities	—		20,258		—		20,258
Unrealized gain included in other comprehensive income (loss)	—		1,366		—		1,366
Unrealized loss included in other comprehensive income (loss)	—		(17,793)		—		(17,793)
Balance at June 30, 2020	$	7,338	$	40,457	$	—	$	47,795
Balance at December 31, 2018	$	1,750	$	33,122	$	300	$	35,172
Realized and unrealized gains included in earnings	791		—		—		791
Purchase of securities	—		109		1,250		1,359
Unrealized gain included in other comprehensive income (loss)	—		6,915		—		6,915
Unrealized loss included in other comprehensive income (loss)	—		(9,609)		—		(9,609)
Balance at June 30, 2019	$	2,541	$	30,537	$	1,550	$	34,628
Balance at March 31, 2019	$	2,256	$	36,801	$	750	$	39,807
Realized and unrealized losses included in earnings	285		—		—		285
Purchase of securities	—		109		800		909
Unrealized gain included in other comprehensive income (loss)	—		2,160		—		2,160
Unrealized loss included in other comprehensive income (loss)	—		(8,424)		—		(8,424)
Balance at June 30, 2019	$	2,541	$	30,537	$	1,550	$	34,628

Assets Measured on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain financial assets, financial liabilities, non-financial assets, and non-financial liabilities at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market value that were recognized at fair value below cost at the end of the period. Certain non-financial assets measured at fair value on a nonrecurring basis include foreclosed assets (upon initial recognition or subsequent impairment), non-financial assets and non-financial liabilities measured at fair value in the second step of a goodwill impairment test, and intangible assets and other non-financial long-lived assets measured at fair value for impairment assessment. Non-financial assets measured at fair value on a nonrecurring basis during 2020 and 2019 include certain foreclosed assets which, upon initial recognition, were remeasured and reported at fair value through a charge-off to the allowance for possible loan losses and certain foreclosed assets which, subsequent to their initial recognition, were remeasured at fair value through a write-down included in other noninterest expense.

•Impaired loans – Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually

impaired, management measures impairment using one of several methods, including collateral value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. Collateral values are estimated using Level II inputs based on observable market data or Level III inputs based on customized discounting criteria. For a majority of impaired real estate related loans, the Company obtains a current external appraisal. Other valuation techniques are used as well, including internal valuations, comparable property analysis and contractual sales information.

•Other real estate owned – Other real estate owned, which is obtained through the Bank’s foreclosure process is valued utilizing the appraised collateral value. Collateral values are estimated using Level II inputs based on observable market data or Level III inputs based on customized discounting criteria. At the time, the foreclosure is completed, the Company obtains a current external appraisal.

•Equity securities – Certain equity securities are recorded at fair value on a nonrecurring basis. Equity securities without a readily determinable fair value are measured at cost minus impairment, if any, plus or minus any changes resulting from observable price changes in orderly transactions, as defined, for identical or similar investments of the same issuer.

Assets measured at fair value on a nonrecurring basis as of June 30, 2020 and December 31, 2019 are included in the table below:

	June 30, 2020
(Dollars in thousands)	Level I		Level II		Level III		Total
Impaired loans	$	—	$	—	$	16,201	$	16,201
Other real estate owned	—		—		8,907		8,907
Equity securities	—		—		19,081		19,081

	December 31, 2019
(Dollars in thousands)	Level I		Level II		Level III		Total
Impaired loans	$	—	$	—	$	8,909	$	8,909
Other real estate owned	—		—		1,397		1,397
Equity securities	—		—		18,514		18,514

The following tables presents quantitative information about the Level III significant unobservable inputs for assets and liabilities measured at fair value at June 30, 2020 and December 31, 2019.

	Quantitative Information about Level III Fair Value Measurements
(Dollars in thousands)	Fair Value		Valuation Technique	Unobservable Input	Range
June 30, 2020
Nonrecurring measurements:
Impaired loans	$	16,201	Appraisal of collateral 1	Appraisal adjustments 2	20% - 62%
				Liquidation expense 2	5% - 10%
Other real estate owned	$	8,907	Appraisal of collateral 1	Appraisal adjustments 2	20% - 30%
				Liquidation expense 2	5% - 10%
Equity securities	$	19,081	Net asset value	Cost minus impairment	0%
Recurring measurements:
Municipal securities (Local TIF bonds)	$	40,457	Appraisal of bond 3	Bond appraisal adjustment 4	5% - 15%
Interest rate lock commitments	$	7,338	Pricing model	Pull through rates	76% - 84%

	Quantitative Information about Level III Fair Value Measurements
(Dollars in thousands)	Fair Value		Valuation Technique	Unobservable Input	Range
December 31, 2019
Nonrecurring measurements:
Impaired loans	$	8,909	Appraisal of collateral 1	Appraisal adjustments 2	20% - 62%
				Liquidation expense 2	5% - 10%
Other real estate owned	$	1,397	Appraisal of collateral 1	Appraisal adjustments 2	20% - 30%
				Liquidation expense 2	5% - 10%
Equity securities	$	18,514	Net asset value	Cost minus impairment	0%
Recurring measurements:
Municipal securities (Local TIF bonds)	$	37,259	Appraisal of bond 3	Bond appraisal adjustment 4	5% - 15%
Interest rate lock commitments	$	1,660	Pricing model	Pull through rates	77% - 82%

¹ Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level III inputs which are not identifiable.

² Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

³ Fair value determined through independent analysis of liquidity, rating, yield and duration.

⁴ Appraisals may be adjusted for qualitative factors such as local economic conditions.

Estimated fair value of financial instruments have been determined by the Company using historical data, as generally provided in the Company’s regulatory reports, and an estimation methodology suitable for each category of financial instruments.

The carrying values and estimated fair values of the Company’s financial instruments are summarized as follows:

Fair Value Measurements at:

(Dollars in thousands)	Carrying Value		Estimated Fair Value		Quoted Prices in Active Markets for Identical Assets (Level I)		Significant Other Observable Inputs (Level II)		Significant Unobservable Inputs (Level III)
June 30, 2020
Financial assets:
Cash and cash equivalents	$	78,854	$	78,854	$	78,854	$	—	$	—
Certificates of deposits with other banks	13,046		13,387		—		13,387		—
Securities available-for-sale	220,699		220,699		—		180,242		40,457
Equity securities	19,464		19,464		383		—		19,081
Loans held for sale	242,089		242,089		—		242,089		—
Loans, net	1,476,930		1,502,388		—		—		1,502,388
Mortgage servicing rights	3,331		3,331		—		—		3,331
Interest rate lock commitment	7,338		7,338		—		—		7,338
Interest rate swap	16,514		16,514		—		16,514		—
Accrued interest receivable	8,900		8,900		—		1,515		7,385
Bank-owned life insurance	35,818		35,818		—		35,818		—
Financial liabilities:
Deposits	$	1,863,963	$	1,892,397	$	—	$	1,892,397	$	—
Repurchase agreements	9,815		9,815		—		9,815		—
FHLB and other borrowings	36,610		37,336		—		37,336		—
Mortgage-backed security hedges	858		858		—		858		—
Interest rate swap	16,514		16,514		—		16,514		—
Fair value hedge	2,659		2,659		—		2,659		—
Accrued interest payable	622		622		—		622		—
Subordinated debt	4,124		4,124		—		4,124		—
December 31, 2019
Financial assets:
Cash and cash equivalents	$	28,002	$	28,002	$	28,002	$	—	$	—
Certificates of deposits with other banks	12,549		12,586		—		12,586		—
Securities available-for-sale	235,821		235,821		—		198,562		37,259
Equity securities	18,514		18,514		—		—		18,514
Loans held for sale	109,788		109,788		—		109,788		—
Loans, net	1,362,766		1,364,706		—		—		1,364,706
Mortgage servicing rights	348		348		—		—		348
Interest rate lock commitment	1,660		1,660		—		—		1,660
Interest rate swap	5,722		5,722		—		5,722		—
Fair value hedge	1,770		1,770		—		1,770
Accrued interest receivable	7,909		7,909		—		1,591		6,317
Bank-owned life insurance	35,374		35,374		—		35,374		—
Financial liabilities:
Deposits	$	1,265,042	$	1,249,135	$	—	$	1,249,135	$	—
Repurchase agreements	10,172		10,172		—		10,172		—
FHLB and other borrowings	222,885		222,891		—		222,891		—
Mortgage-backed security hedges	186		186		—		186		—
Interest rate swap	5,722		5,722		—		5,722		—
Fair value hedge	1,418		1,418		—		1,418		—
Accrued interest payable	1,060		1,060		—		1,060		—
Subordinated debt	4,124		4,124		—		4,124		—

Fair value estimates are made at a specific point in time, based on relevant market 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. Fair value estimates are based on existing on-and-off balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments.