Note Q—Fair Value of Financial Instruments

ASC 825, Financial Instruments, requires disclosure of the estimated fair value of an entity’s assets and liabilities considered to be financial instruments. For the Company, as for most financial institutions, the majority of its assets and liabilities are considered to be financial instruments. However, many of such instruments lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. Also, it is the Company’s general practice and intent to hold its financial instruments to maturity whether or not categorized as “available-for-sale” and not to engage in trading or sales activities, except for certain loans. For fair value disclosure purposes, the Company utilized the fair value measurement criteria of ASC 820, Fair Value Measurements and Disclosures.

ASC 820, Fair Value Measurements and Disclosures, establishes a common definition for fair value to be applied to assets and liabilities. It clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It also establishes a framework for measuring fair value and expands disclosures concerning fair value measurements. ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Level 1 valuation is based on quoted market prices for identical assets or liabilities to which the Company has access at the measurement date. Level 2 valuation is based on other observable inputs for the asset or liability, either directly or indirectly. This includes quoted prices for similar assets in active or inactive markets, inputs other than quoted prices that are observable for the asset or liability such as yield curves, volatilities, prepayment speeds, credit risks, default rates, or inputs that are derived principally from, or corroborated through, observable market data by market-corroborated reports. Level 3 valuation is based on “unobservable inputs” that are the best information available in the circumstances. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Transfers between levels in 2019, 2018 and 2017, consisted only of transfers resulting from the availability or non-availability of third party pricing for CRE securities from the Company’s securitizations, see Note E. For fair value disclosure purposes, the Company utilized certain value measurement criteria required under the ASC 820, “Fair Value Measurements and Disclosures”, as discussed below.

Estimated fair values have been determined by the Company using the best available data and an estimation methodology it believes to be suitable for each category of financial instruments. Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Also, there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values.

Cash and cash equivalents, which are comprised of cash and due from banks, the Company’s balance at the FRB and securities purchased under agreements to resell, had recorded values of $944.5 million and $554.3 million at December 31, 2019 and 2018, respectively, which approximated fair values.

Investment securities have estimated fair values based on quoted market prices or other observable inputs, if available, or by an estimation methodology based on management’s inputs. The fair values of the Company’s investment securities held-to-maturity and investments in certain available-for-sale securities are determined using unobservable (Level 3) inputs that are based on the best information available in the circumstances when market information is not available. For these investment securities, fair values are based on the present value of expected cash flows from principal and interest.

Commercial loans held-for-sale generally have estimated fair values based upon market indications of the sales price of such loans from recent sales transactions. If such information is not available, fair values reflect cash flow analysis based upon pricing for similar loans. The analysis is performed on an individual loan basis for commercial mortgage loans and a pooled basis for SBA loans.

Loans, net of deferred loan fees and costs, have an estimated fair value using the present value of future cash flow where market prices were not available. The discount rate used in these calculations is the estimated current market rate adjusted for borrower-specific credit risk. The carrying value of accrued interest approximates fair value.

FHLB and Atlantic Central Bankers Bank stock are held as required by those respective institutions and are carried at cost. Federal law requires a member institution of the FHLB to hold stock according to predetermined formulas. Atlantic Central Bankers Bank requires its correspondent banking institutions to hold stock as a condition of membership.

Investment in unconsolidated entity - On December 30, 2014, the Bank entered into an agreement for, and closed on, the sale of a portion of its discontinued commercial loan portfolio. The purchaser of the loan portfolio was a newly formed entity, WS 2014. For information regarding this transaction see Note H. The fair value of the notes issued to the Bank by WS 2014 was initially established by the sales price and subsequently marked to fair value which is determined using a discounted cash flow analysis. At December 31, 2019, the cash flows were modeled using a discount rate of 5.84%, based on market indications. A constant default rate on cash flowing loans of 1%, net of recoveries, was utilized. The change in value of investment in unconsolidated entity in the consolidated statements of operations reflects changes in estimated fair value.

Assets held-for-sale from discontinued operations as of December 31, 2019 are held at the lower of cost basis or market value. For loans, market value was determined using the income approach which converts expected cash flows from the loan portfolio by unit of measurement to a present value estimate. Unit of measurement was determined by loan type and for significant loans on an individual loan basis. The fair values of the Company’s loans classified as assets held-for-sale are based on “unobservable inputs” that are based upon available information. For commercial loans, a market adjusted rate to discount expected cash flows from outstanding principal and interest to expected maturity at the measurement date was utilized. For other real estate owned, market value was based upon appraisals of the underlying collateral by third party appraisers, reduced by 7% to 10% for estimated selling costs.

Demand deposits (comprising interest and non-interest bearing checking accounts, savings, and certain types of money market accounts) are equal to the amount payable on demand at the reporting date (generally, their carrying amounts). The fair values of securities sold under agreements to repurchase and short term borrowings are equal to their carrying amounts as they are overnight borrowings. There were no short term borrowings outstanding at December 31, 2019 or 2018.

Time deposits and subordinated debentures have a fair value estimated using a discounted cash flow calculation that applies current interest rates to discount expected cash flows. There were $475.0 million time deposits outstanding at December 31, 2019 and $0 at December 31, 2018.

Long term borrowings resulted from sold loans which did not qualify for true sale accounting. They are presented in the amount of principal of such loans.

Interest rate swaps are recorded in other assets and have a fair value which is estimated using models that use readily observable market inputs and a market standard methodology applied to the contractual terms of the derivatives, including the period to maturity and the applicable interest rate index.

The fair value of commitments to extend credit is estimated based on the amount of unamortized deferred loan commitment fees. The fair value of letters of credit is based on the amount of unearned fees plus the estimated cost to terminate the letters of credit. Fair values of unrecognized financial instruments, including commitments to extend credit, and the fair value of letters of credit are considered immaterial. Fair value information for specific balance sheet categories is as follows.


	December 31, 2019
			Quoted prices	Significant
			in active	other	Significant
			markets for	observable	unobservable
	Carrying	Estimated	identical assets	inputs	inputs
	amount	fair value	(Level 1)	(Level 2)	(Level 3)
	(in thousands)
Investment securities, available-for-sale	$ 1,320,692	$ 1,320,692	$ -	$ 1,203,359	$ 117,333
Investment securities, held-to-maturity	84,387	83,002	-	75,850	7,152
Federal Home Loan Bank and Atlantic Central Bankers Bank stock	5,342	5,342	-	-	5,342
Commercial loans held-for-sale	1,180,546	1,180,546	-	-	1,180,546
Loans, net of deferred loan fees and costs	1,824,245	1,826,154	-	-	1,826,154
Investment in unconsolidated entity	39,154	39,154	-	-	39,154
Assets held-for-sale from discontinued operations	140,657	140,657	-	-	140,657
Interest rate swaps, liability	232	232	-	232	-
Demand and interest checking	4,402,740	4,402,740	-	4,402,740	-
Savings and money market	174,290	174,290	-	174,290	-
Time deposits	475,000	475,000	-	-	475,000
Subordinated debentures	13,401	9,736	-	-	9,736
Securities sold under agreements to repurchase	82	82	82	-	-


	December 31, 2018
			Quoted prices	Significant
			in active	other	Significant
			markets for	observable	unobservable
	Carrying	Estimated	identical assets	inputs	inputs
	amount	fair value	(Level 1)	(Level 2)	(Level 3)
	(in thousands)
Investment securities, available-for-sale	$ 1,236,324	$ 1,236,324	$ -	$ 1,211,934	$ 24,390
Investment securities, held-to-maturity	84,432	83,391	-	76,113	7,278
Federal Home Loan Bank and Atlantic Central Bankers Bank stock	1,113	1,113	-	-	1,113
Commercial loans held-for-sale	688,471	688,471	-	-	688,471
Loans, net of deferred loan fees and costs	1,501,976	1,503,780	-	-	1,503,780
Investment in unconsolidated entity	59,273	59,273	-	-	59,273
Assets held-for-sale from discontinued operations	197,831	197,831	-	-	197,831
Interest rate swaps, asset	1,681	1,681	-	1,681	-
Demand and interest checking	3,904,638	3,904,638	-	3,904,638	-
Savings and money market	31,076	31,076	-	31,076	-
Subordinated debentures	13,401	9,975	-	-	9,975
Securities sold under agreements to repurchase	93	93	93	-	-

The assets and liabilities measured at fair value on a recurring basis, segregated by fair value hierarchy, are summarized below (in thousands):


		Fair Value Measurements at Reporting Date Using
		Quoted prices in active	Significant other	Significant
		markets for identical	observable	unobservable
	Fair value	assets	inputs	inputs
	December 31, 2019	(Level 1)	(Level 2)	(Level 3)

Investment securities, available-for-sale
U.S. Government agency securities	$ 52,910	$ -	$ 52,910	$ -
Asset-backed securities	244,349	-	244,349	-
Obligations of states and political subdivisions	65,568	-	65,568	-
Residential mortgage-backed securities	336,596	-	336,596	-
Collateralized mortgage obligation securities	222,727	-	222,727	-
Commercial mortgage-backed securities	398,542	-	281,209	117,333
Total investment securities, available-for-sale	1,320,692	-	1,203,359	117,333
Commercial loans held-for-sale	1,180,546	-	-	1,180,546
Investment in unconsolidated entity	39,154	-	-	39,154
Assets held-for-sale from discontinued operations	140,657	-	-	140,657
Interest rate swaps, liability	232	-	232	-
	$ 2,680,817	$ -	$ 1,203,127	$ 1,477,690


		Fair Value Measurements at Reporting Date Using
		Quoted prices in active	Significant other	Significant
		markets for identical	observable	unobservable
	Fair value	assets	inputs	inputs
	December 31, 2018	(Level 1)	(Level 2)	(Level 3)

Investment securities, available-for-sale
U.S. Government agency securities	$ 53,362	$ -	$ 53,362	$ -
Asset-backed securities	188,602	-	188,602	-
Obligations of states and political subdivisions	67,986	-	67,986	-
Residential mortgage-backed securities	369,741	-	369,741	-
Collateralized mortgage obligation securities	262,207	-	262,207	-
Commercial mortgage-backed securities	294,426	-	270,036	24,390
Total investment securities, available-for-sale	1,236,324	-	1,211,934	24,390
Commercial loans held-for-sale	688,471	-	-	688,471
Investment in unconsolidated entity	59,273	-	-	59,273
Assets held-for-sale from discontinued operations	197,831	-	-	197,831
Interest rate swaps, asset	1,681	-	1,681	-
	$ 2,183,580	$ -	$ 1,213,615	$ 969,965

The Company’s Level 3 asset activity for the categories shown for the years 2019 and 2018 is as follows (in thousands):


	Fair Value Measurements Using
	Significant Unobservable Inputs
	(Level 3)

	Available-for-sale		Commercial loans
	securities		held-for-sale
	December 31, 2019	December 31, 2018	December 31, 2019	December 31, 2018
Beginning balance	$ 24,390	$ 40,644	$ 688,471	$ 503,316
Transfers into level 3	100,664	-	-	-
Transfers out of level 3	-	(74,355)	-	-
Total gains or (losses) (realized/unrealized)
Included in earnings	-	-	25,986	19,850
Included in other comprehensive gain (loss)	688	(688)	-	-
Purchases, issuances, sales and settlements
Purchases	-	62,076	-	-
Issuances	-	-	1,795,376	866,303
Sales	-	-	(1,329,287)	(700,998)
Settlements	(8,409)	(3,287)	-	-
Ending balance	$ 117,333	$ 24,390	$ 1,180,546	$ 688,471

The amount of total gains or (losses) for the period
included in earnings attributable to the change in
unrealized gains or losses relating to assets still
held at the reporting date.	$ -	$ -	$ 963	$ (922)

Transfers between levels in 2019 and 2018, consisted of transfers resulting from the availability or non-availability of third party pricing for CRE securities from the Company’s securitizations, see Note E.

The Company’s Level 3 asset activity for the categories shown for the years 2019 and 2018 is as follows (in thousands):


	Fair Value Measurements Using
	Significant Unobservable Inputs
	(Level 3)

	Investment in		Assets held-for-sale
	unconsolidated entity		from discontinued operations
	December 31, 2019	December 31, 2018	December 31, 2019	December 31, 2018
Beginning balance	$ 59,273	$ 74,473	$ 197,831	$ 304,313
Transfers into level 3	-	-	-	-
Transfers out of level 3	-	-	-	-
Total gains or (losses) (realized/unrealized)
Included in earnings	-	(3,689)	(487)	352
Included in other comprehensive income	-	-	-	-
Purchases, issuances, sales, settlements and charge-offs
Purchases	-	-	-	-
Issuances	-	-	2,125	1,664
Sales	-	-	(7,136)	(35,000)
Settlements	(20,119)	(11,511)	(49,021)	(62,754)
Charge-offs	-	-	(2,655)	(10,744)
Ending balance	$ 39,154	$ 59,273	$ 140,657	$ 197,831

The amount of total gains or (losses) for the period
included in earnings attributable to the change in
unrealized gains or losses relating to assets still
held at the reporting date.	$ -	$ (3,689)	$ (487)	$ 352



	Fair value at	Fair value at			Range at	Range at
Level 3 instruments only	December 31, 2019	December 31, 2018	Valuation techniques	Unobservable inputs	December 31, 2019	December 31, 2018

Investment securities, available-for-sale	$ 117,333	$ 24,390	Discounted cash flow	Discount rate	4.05% - 8.18%	6.55%
Investment securities, held-to-maturity	7,152	7,278	Discounted cash flow	Discount rate	8.01%	8.80%
Federal Home Loan Bank and Atlantic	5,342	1,113	Cost	N/A	N/A	N/A
Central Bankers Bank stock
Loans, net of deferred loan fees and	1,826,154	1,503,780	Discounted cash flow	Discount rate	3.11% - 6.93%	4.22% - 6.93%
costs				Credit analysis
Commercial - SBL	220,358	199,977	Traders' pricing	Offered quotes	$101.6 - $107.9	$99.125 - $110
Commercial - fixed	88,986	95,307	Discounted cash flow	Discount rate	4.33% - 7.13%	5.23% - 6.92%
Commercial - floating	871,202	393,187	Discounted cash flow	Discount rate	4.51% - 6.81%	5.41% - 7.75%
Commercial loans held-for-sale	1,180,546	688,471
Investment in unconsolidated entity	39,154	59,273	Discounted cash flow	Discount rate	5.84%	6.30%
				Default rate	1.00%	1.00%
Assets held-for-sale from discontinued	140,657	197,831	Discounted cash flow	Discount rate,	3.49% -7.58%	4.26% - 8.36%
operations				Credit analysis
Subordinated debentures	9,736	9,975	Discounted cash flow	Discount rate	8.01%	8.81%

The following considerations are subject to judgments and uncertainties as of the balance sheet date. Fair values in the above table which are estimated by the discounted cash flow method, are subject to uncertainty resulting from the discount rate used as of the reporting date. The discount rates used are based on market comparables, which may vary significantly between periods based on credit spreads, interest rates movements or expected interest rate movements, or competitive factors. Changes in these factors could have a significant impact on estimated fair values. The discount rates utilized for loans, net of deferred loan fees and costs, and assets held-for-sale from discontinued operation reflect the results of credit analysis and collateral valuations, including that performed by the independent loan review department, to identify credit weaknesses which might require a higher discount rate. Credit analysis of borrowers’ repayment capabilities are based on historical financial information or performance, which may not reflect future performance. Collateral valuations such as appraisals, may not be realized upon ultimate sale.

Assets measured at fair value on a nonrecurring basis, segregated by fair value hierarchy, at December 31, 2019 and 2018 are summarized below (in thousands):


		Fair Value Measurements at Reporting Date Using
		Quoted prices in active	Significant other	Significant
		markets for identical	observable	unobservable
		assets	inputs	inputs (1)
Description	December 31, 2019	(Level 1)	(Level 2)	(Level 3)

Impaired loans - collateral dependent (1)	$ 3,651	$ -	$ -	$ 3,651
Intangible assets	2,315	-	-	2,315
	$ 5,966	$ -	$ -	$ 5,966


		Fair Value Measurements at Reporting Date Using
		Quoted prices in active	Significant other	Significant
		markets for identical	observable	unobservable
	Fair value	assets	inputs	inputs (1)
Description	December 31, 2018	(Level 1)	(Level 2)	(Level 3)


Impaired loans - collateral dependent (1)	$ 3,747	$ -	$ -	$ 3,747
Intangible assets	3,846	-	-	3,846
	$ 7,593	$ -	$ -	$ 7,593

(1)

The method of valuation approach for the impaired loans and other real estate owned was the market approach based upon appraisals of the underlying collateral by external appraisers, reduced by 7% to 10% for estimated selling costs. Intangible assets are valued based upon internal analyses.

At December 31, 2019, principal on impaired loans and troubled debt restructurings that is accounted for on the basis of the value of underlying collateral, is shown in the above table at an estimated fair value of $3.7 million. To arrive at that fair value, related loan principal of $6.8 million was reduced by specific reserves of $3.1 million within the allowance for loan losses, as of that date, representing the deficiency between principal and estimated collateral values, which were reduced by estimated costs to sell. When the deficiency is deemed uncollectible, it is charged off by reducing the specific reserve and decreasing principal. Included in the impaired balance at December 31, 2019, were troubled debt restructured loans with a balance of $2.1 million which had specific reserves of $1.0 million. At December 31, 2018, principal on impaired loans and troubled debt restructurings accounted for on the basis of the value of underlying collateral, is shown in the above table at estimated fair value of $3.7 million. To arrive at that fair value, related loan principal of $6.7 million was reduced by the specific reserves of $3.0 million within the allowance for loan losses, as of that date, representing the deficiency between principal and estimated collateral values, which were reduced by estimated costs to sell. Included in the impaired balance at December 31, 2018, were troubled debt restructured loans with a balance of $2.9 million, which had specific reserves of $1.5 million. Valuation techniques consistent with the market and/or cost approach were used to measure fair value and primarily included observable inputs for the individual impaired loans being evaluated such as recent sales of similar assets or observable market data for operational or carrying costs. In cases where such inputs were unobservable, the loan balance is reflected within the Level 3 hierarchy.