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FAIR VALUE

3 Months Ended

Mar. 31, 2021

NOTE 13 - FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:


Level 1:	Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2:	Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3:	Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate fair value:

Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

Guarantee Asset and Liability: The guarantee asset represents the fair value of the consideration received in exchange for the credit enhancement fee. The guarantee liability represents a financial guarantee to cover the second layer of any losses on loan sold to FHLB under the MPF 125 loan sales agreement. The guarantee liability value on day one is equivalent to the guarantee asset fair value which is the consideration for the credit enhancement. The liability is then carried at amortized cost. Significant inputs in the valuation analysis for the asset are Level 3, due to the nature of this asset and the lack of market quotes. The fair value of the guarantee asset is determined using a discounted cash flow model, for which significant unobservable inputs include assumed future prepayment rates ("CPR") and market discount rate (Level 3). An increase in prepayment rates or discount rate would generally reduce the estimated fair value of the guarantee asset.

Mortgage Related Derivatives: Mortgage related derivatives include our Interest Rate Lock Commitments ("IRLC"), Forward Sale Commitments ("FSC") and the forward commitments on our Loans Held for Sale ("LHFS") pipeline. The fair value estimate is based on valuation models using market data from secondary market loan sales and direct contacts with third party investors as of the measurement date and pull through assumptions (Level 3). The FSC fair value estimate reflects the potential pair off fee associated with mandatory trades by using a market differential and pair off penalty assessed by the investor (Level 3). The fair value estimate of the forward commitments is based on market prices of similar securities to the underlying MBS (Level 2).

Our mortgage derivatives are carried at fair value in the Company’s financial statements with changes in the fair value accounted for within the Condensed Consolidated Statements of Income.

Mortgage Loans Held for Sale: The fair value of mortgage loans held for sale is estimated based upon quotes from third party investors for similar assets resulting in a Level 2 classification.

Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. They are subsequently accounted for at lower of cost

or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than on an annual basis. Appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between comparable sales and income data available. Such adjustments can be significant and typically result in Level 3 classifications of the inputs for determining fair value. Other real estate owned is evaluated annually for additional impairment and adjusted accordingly.

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments can be significant and typically result in Level 3 classifications of the inputs for determining fair value. Impaired loans are evaluated monthly for additional impairment and adjusted accordingly.

Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, the Company reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.

The following presents assets and liabilities measured on a recurring basis as of March 31, 2021 and December 31, 2020 (in thousands):


		Quoted
		Prices in			Significant
		Active Markets			Other			Significant
		for Identical			Observable			Unobservable
		Assets			Inputs			Inputs			Reported
March 31, 2021		(Level 1)			(Level 2)			(Level 3)			Balance
Investment securities available-for-sale:
U.S. Treasury debt		$	253		$	—		$	—		$	253
Corporate bonds			—			6,088			—			6,088
GNMA mortgage-backed securities - residential			—			19,980			—			19,980
FNMA mortgage-backed securities - residential			—			1,670			—			1,670
Corporate CMO and MBS			—			2,852			—			2,852
Total securities available-for-sale		$	253		$	30,590		$	—		$	30,843
Equity securities		$	717		$	—		$	—		$	717
Guarantee asset		$	—		$	—		$	188		$	188
IRLC, net		$	—		$	—		$	2,105		$	2,105
Forward commitments		$	—		$	5,482		$	(173)		$	5,309
Mortgage loans held for sale		$	—		$	176,644		$	—		$	176,644


		Quoted
		Prices in			Significant
		Active Markets			Other			Significant
		for Identical			Observable			Unobservable
		Assets			Inputs			Inputs			Reported
December 31, 2020		(Level 1)			(Level 2)			(Level 3)			Balance
Investment securities available-for-sale:
U.S. Treasury debt		$	254		$	—		$	—		$	254
Corporate bonds			—			6,044			—			6,044
GNMA mortgage-backed securities - residential			—			24,604			—			24,604
FNMA mortgage-backed securities - residential			—			1,677			—			1,677
Corporate CMO and MBS			—			4,087			—			4,087
Total securities available-for-sale		$	254		$	36,412		$	—		$	36,666
Equity securities		$	730		$	—		$	—		$	730
Guarantee asset		$	—		$	—		$	232		$	232
IRLC, net		$	—		$	—		$	9,841		$	9,841
Forward commitments		$	—		$	(2,534)		$	(89)		$	(2,623)
Mortgage loans held for sale		$	—		$	161,843		$	—		$	161,843

The following presents a reconciliation for level 3 instruments measured at fair value on a recurring basis (in thousands):


Three Months Ended March 31, 2021		Guarantee Asset			IRLC			Forward Commitments
Beginning balance		$	232		$	9,841		$	(89)
Acquisitions			—			2,684			—
Originations			—			(7,016)			—
Sales			—			—			—
Gains (losses) in net income, net			(44)			(3,404)			(84)
Other settlements			—			—			—
Ending balance		$	188		$	2,105		$	(173)


Three Months Ended March 31, 2020		Guarantee Asset			IRLC			Forward Commitments
Beginning balance		$	—		$	1,184		$	—
Acquisitions			—			7,722			—
Originations			—			(5,644)			—
Sales			229			—			—
Gains (losses) in net income, net			(33)			763			(16)
Other settlements			—			—			—
Ending balance		$	196		$	4,025		$	(16)

Mutual funds and U.S. Treasury debt are reported at fair value utilizing Level 1 inputs. The remaining portfolio of securities are reported at fair value with Level 2 inputs provided by a pricing service. As of March 31, 2021 and December 31, 2020, the majority of the securities had credit support provided by the Federal Home Loan Mortgage Corporation, GNMA, and FNMA. Factors used to value the securities by the pricing service include: benchmark yields, reported trades, interest spreads, prepayments, and other market research. In addition, ratings and collateral quality are considered.

As of March 31, 2021, equity securities, IRLC, and guarantee assets have been recorded at fair value within the Other assets line item and the FSC and guarantee liabilities have been recorded at fair value with the Other liabilities line item in the Condensed Consolidated Balance Sheets. All changes are recorded in the Other line item in the Condensed Consolidated Statements of Income.

The following presents quantitative information about Level 3 assets measured on a recurring basis as of March 31, 2021 and December 31, 2020 (dollars in thousands):

Quantitative Information about Level 3 Fair Value Measurements as of March 31, 2021

Valuation

Significant

Range

Fair Value

Technique

Unobservable Input

(Weighted Average)

Guarantee asset

$

188

Discounted cash flow

Discount rate
Prepayment rate

3% (3%)
26% (26%)

IRLC, net

2,105

Best execution model

Pull through

74% to 100% (91%)

Forward commitments

(173)

Internal pricing model

Market Differential

-164bps to -18bps
(-49bps)

Quantitative Information about Level 3 Fair Value Measurements as of December 31, 2020

Valuation

Significant

Range

Fair Value

Technique

Unobservable Input

(Weighted Average)

Guarantee asset

$

232

Discounted cash flow

Discount rate
Prepayment rate

3% (3%)
25% (25%)

IRLC, net

9,841

Best execution model

Pull through

55% to 100% (86%)

Forward commitments

(89)

Internal pricing model

Market Differential

-59bps to -17bps
(-31bps)

The following presents assets measured on a nonrecurring basis as of March 31, 2021 and December 31, 2020 (in thousands):

Quoted

Prices in

Significant

Active Markets

Other

Significant

for Identical

Observable

Unobservable

Assets

Inputs

Inputs

Reported

March 31, 2021

(Level 1)

(Level 2)

(Level 3)

Balance

Total impaired loans⁽¹⁾:

Commercial and Industrial

$

—

$

—

$

1,668

$

1,668


		Quoted
		Prices in			Significant
		Active Markets			Other			Significant
		for Identical			Observable			Unobservable
		Assets			Inputs			Inputs			Reported
December 31, 2020		(Level 1)			(Level 2)			(Level 3)			Balance
Other real estate owned:
Commercial properties		$	—		$	—		$	194		$	194

Total impaired loans⁽¹⁾:
Commercial and Industrial		$	—		$	—		$	1,800		$	1,800

______________________________________

⁽¹⁾ An immaterial Cash, Securities, and Other loan was fully reserved for using a specific allowance as of March 31, 2021 and December 31, 2020.

The sales comparison approach was utilized for estimating the fair value of non-recurring assets.

As of March 31, 2021, the Company did not own any OREO properties. As of December 31, 2020, OREO had a carrying amount of $0.2 million, which is the cost basis of $2.1 million net of a valuation allowance of $1.9 million.

As of March 31, 2021, total impaired loans measured for impairment using the fair value of the collateral for collateral dependent loans had carrying values of $3.4 million with valuation allowances of $1.8 million and were classified as Level 3. As of December 31, 2020, impaired loans measured for impairment using the fair value of the collateral for collateral dependent loans had carrying values of $3.4 million with valuation allowances of $1.6 million and were classified as Level 3.

Impaired loans accounted for specific reserves of $1.8 million and $1.6 million as of March 31, 2021 and December 31, 2020. The Bank did not have any charge offs during the three months ended March 31, 2021 from the specific reserve. The Bank charged off an immaterial amount during the year ended December 31, 2020 from the specific reserve.

The following presents quantitative information about the significant unobservable inputs used in the fair value measurement of recurring and nonrecurring non-financial instruments categorized within Level 3 of the fair value hierarchy as of March 31, 2021 and December 31, 2020 (dollars in thousands):

Quantitative Information about Level 3 Fair Value Measurements as of March 31, 2021

Valuation

Significant

Range

Fair Value

Technique

Unobservable Input

(Weighted Average)

Total impaired loans⁽¹⁾:

Commercial and Industrial

$

1,668

Sales comparison, Market approach - guideline transaction method

Management discount for asset/property type

17% - 45% (31%)

Quantitative Information about Level 3 Fair Value Measurements as of December 31, 2020

Valuation

Significant

Range

Fair Value

Technique

Unobservable Input

(Weighted Average)

Other real estate owned:

Commercial properties

$

194

Sales contract

Commission, cost to sell, closing costs

5% (5%)

Total impaired loans⁽¹⁾:

Commercial and Industrial

$

1,800

Sales comparison, Market approach - guideline transaction method

Management discount for asset/property type

17% - 35% (26%)

______________________________________

⁽¹⁾ Two immaterial Cash, Securities and Other loans were fully reserved for using a specific allowance as of March 31, 2021 and one immaterial Cash, Securities and Other loan was fully reserved for using a specific allowance as of December 31, 2020.

The following presents carrying amounts and estimated fair values for financial instruments not carried at fair value as of March 31, 2021 and December 31, 2020 (in thousands):


		Carrying			Fair Value Measurements Using:
March 31, 2021		Amount			Level 1			Level 2			Level 3
Assets:
Cash and cash equivalents		$	375,936		$	375,936		$	—		$	—
Loans, net			1,531,387			—			—			1,526,059
Accrued interest receivable			6,852			—			6,852			—
Liabilities:
Deposits			1,807,825			—			1,809,274			—
Borrowings:
FHLB borrowings – fixed rate			15,000			—			15,083			—
Federal Reserve borrowings – fixed rate			183,041			—			183,041			—
Subordinated notes – fixed-to-floating rate			24,248			—			—			25,658
Accrued interest payable		$	612		$	—		$	612		$	—


		Carrying			Fair Value Measurements Using:
December 31, 2020		Amount			Level 1			Level 2			Level 3
Assets:
Cash and cash equivalents		$	155,989		$	155,989		$	—		$	—
Loans, net			1,520,294			—			—			1,512,699
Accrued interest receivable			6,618			—			6,618			—
Liabilities:
Deposits			1,619,910			—			1,621,648			—
Borrowings:
FHLB borrowings – fixed rate			15,000			—			15,099			—
Federal Reserve borrowings – fixed rate			134,563			—			134,563			—
Subordinated notes – fixed-to-floating rate			24,291			—			—			25,750
Accrued interest payable		$	453		$	—		$	453		$	—

The fair value estimates presented and discussed above are based on pertinent information available to management as of the dates specified. The estimated fair value amounts are based on the exit price notion set forth by ASU 2016-01. Although management is not aware of any factors that would significantly affect the estimated fair values, such amounts have not been comprehensively revalued for purposes of these consolidated financial statements since the balance sheet dates. Therefore, current estimates of fair value may differ significantly from the amounts presented herein.

The methods and assumptions, not previously presented, used to estimate fair values are described as follows.

Cash and Cash Equivalents and Restricted Cash: The carrying amounts of cash and cash equivalents and restricted cash approximate fair values as maturities are less than 90 days and balances are generally in accounts bearing current market interest rates.

Loans, net: The fair values for all fixed-rate and variable-rate performing loans were estimated using the income approach and by discounting the projected cash flows of such loans. Principal and interest cash flows were projected based on the contractual terms of the loans, including maturity, contractual amortization and adjustments for prepayments and expected losses, where appropriate. A discount rate was developed based on the relative risk of the cash flows, taking into account the loan type, maturity and a required return on capital.

Accrued Interest Receivable and Payable: The carrying amounts of accrued interest approximate fair value due to their short-term nature.

Deposits: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amounts payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting dates. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Fixed Rate Borrowings: Borrowings with fixed rates are valued using inputs such as discounted cash flows and current interest rates for similar instruments and borrowers with similar credit ratings.

Fixed-to-Floating Rate Borrowings: Borrowings with fixed-to-floating rates are valued using inputs such as discounted cash flows and current interest rates for similar instruments and assume the Company will redeem the instrument prior to the first interest rate reset date.

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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