FAIR VALUE

9 Months Ended

Sep. 30, 2022

FAIR VALUE

FAIR VALUE

NOTE 14 - 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.

Recurring Fair Value

Available-for-sale securities:  The fair values for available-for-sale 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).

Equity Securities:  Fair value of equity securities represents the market value of mutual funds based on quoted market prices (Level 1) and the value of stock held in other companies, which is based on recent market transactions or quoted rates that are not actively traded (Level 2).

Equity Warrants:  Fair value of equity warrants of private companies are priced using a Black-Scholes option pricing model to estimate the asset fair value by using strike prices, option expiration dates, risk-free interest rates, and option volatility assumptions (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 loans 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 fee paid over the life of the loans. 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 IRLC, FSC, and the forward commitments on our loans held for sale pipeline. The fair value estimate of our IRLC 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 and is estimated 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).

Loans Held for Investment:  The fair value of loans held for investment are typically determined based on discounted cash flow analysis using market-based interest rate spreads. Discounted cash flow analysis are adjusted, as appropriate, to reflect current market conditions and borrower specific credit risk. Due to the nature of the valuation inputs, loans held for investment are classified within Level 3 of the valuation hierarchy.

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.

The following presents assets and liabilities measured on a recurring basis as of the dates noted (dollars in thousands):

	Quoted
	Prices in		Significant
	Active Markets		Other		Significant
	for Identical		Observable		Unobservable
	Assets		Inputs		Inputs		Reported
September 30, 2022	(Level 1)		(Level 2)		(Level 3)		Balance
Mortgage loans held for sale	$	—	$	12,743	$	—	$	12,743
Loans held at fair value	$	—	$	—	$	22,871	$	22,871
Forward commitments and FSC	$	—	$	1,139	$	(11)	$	1,128
Equity securities	$	626	$	122	$	—	$	748
Guarantee asset	$	—	$	—	$	159	$	159
IRLC, net	$	—	$	—	$	138	$	138
Equity warrants	$	—	$	—	$	827	$	827

	Quoted
	Prices in		Significant
	Active Markets		Other		Significant
	for Identical		Observable		Unobservable
	Assets		Inputs		Inputs		Reported
December 31, 2021	(Level 1)		(Level 2)		(Level 3)		Balance
Investment securities available-for-sale:
U.S. Treasury debt	$	247	$	—	$	—	$	247
U.S. Government Agency		—		3,522		—		3,522
Corporate bonds		—		6,212		2,113		8,325
GNMA mortgage-backed securities - residential		—		26,650		—		26,650
FNMA mortgage-backed securities - residential		—		14,443		—		14,443
Government CMO and MBS		—		878		—		878
Corporate CMO and MBS		—		1,497		—		1,497
Total securities available-for-sale	$	247	$	53,202	$	2,113	$	55,562
Mortgage loans held for sale	$	—	$	30,620	$	—	$	30,620
Forward commitments and FSC	$	—	$	(65)	$	(9)	$	(74)
Equity securities	$	709	$	489	$	—	$	1,198
Guarantee asset	$	—	$	—	$	237	$	237
IRLC, net	$	—	$	—	$	1,473	$	1,473
Equity warrants	$	—	$	—	$	160	$	160

There were no transfers between levels during the nine months ended September 30, 2022 or year ended December 31, 2021. On April 1, 2022, the Company elected to transfer all securities classified as available-for-sale to held-to-maturity and are now carried at amortized cost.  See Note 3 – Investment Securities for more information.

As of December 31, 2021, U.S. Treasury debt was reported at fair value utilizing Level 1 inputs. Three Corporate bonds were reported at fair value utilizing Level 3 inputs.  The remaining portfolio of securities were reported at fair value with Level 2 inputs provided by a pricing service. 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 were considered.

As of September 30, 2022, equity securities, equity warrants, IRLC, and guarantee assets have been recorded at fair value within the Other assets line item in the Condensed Consolidated Balance Sheets. All changes are recorded in the Other line item in the Condensed Consolidated Statements of Income.

Fair Value Option

The Company has elected to account for certain purchased whole loans held for investment under the fair value option in order to align the accounting presentation with the Company’s viewpoint of the economics of the loans. Interest income on loans held for investment accounted for under the fair value option is recognized within Interest and dividend income in the accompanying Condensed Consolidated Statements of Income. Not electing fair value generally results in a larger discount being recorded on the date of the loan purchase. The discount is subsequently accreted into interest income over the underlying loan’s remaining term using the effective interest method. Additionally, management has elected the fair value option for mortgage loans originated and held for sale.

There were no loans accounted for under the fair value option that were 90 days or more past due and still accruing interest as of September 30, 2022 or December 31, 2021. As of September 30, 2022, there were 68 loans, totaling $0.1 million, accounted for under the fair value option that were on nonaccrual.  As of December 31, 2021, there were no loans accounted for under the fair value option that were on nonaccrual.

The following provides more information about the fair value carrying amount and unpaid principal outstanding of loans accounted for under the fair value option as of the dates noted (dollars in thousands):

	September 30, 2022
	Total Loans						Non Accruals						90 Days or More Past Due
	Fair Value Carrying Amount		Unpaid Principal Balance		Difference		Fair Value Carrying Amount		Unpaid Principal Balance		Difference		Fair Value Carrying Amount		Unpaid Principal Balance		Difference
Loans held for sale	$	12,743	$	12,955	$	(212)	$	—	$	—	$	—	$	—	$	—	$	—
Loans held for investment		22,871		22,648		223		59		56		3		59		56		3
	$	35,614	$	35,603	$	11	$	59	$	56	$	3	$	59	$	56	$	3

	December 31, 2021
	Total Loans						Non Accruals						90 Days or More Past Due
	Fair Value Carrying Amount		Unpaid Principal Balance		Difference		Fair Value Carrying Amount		Unpaid Principal Balance		Difference		Fair Value Carrying Amount		Unpaid Principal Balance		Difference
Loans held for sale	$	30,620	$	29,857	$	763	$	—	$	—	$	—	$	—	$	—	$	—
Loans held for investment		—		—		—		—		—		—		—		—		—
	$	30,620	$	29,857	$	763	$	—	$	—	$	—	$	—	$	—	$	—

The following presents the changes in fair value of loans accounted for under the fair value option as of the dates noted (dollars in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
		2022		2021		2022		2021
Loans held for sale	$	(556)	$	(213)	$	(975)	$	(4,378)
Loans held for investment		(105)		—		223		—
	$	(661)	$	(213)	$	(752)	$	(4,378)

The following summarizes the activity pertaining to loans accounted for under the fair value option as of the dates noted (dollars in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
Loans held for sale		2022		2021		2022		2021
Balance at beginning of period	$	26,202	$	48,563	$	30,620	$	161,843
Loans originated		82,372		256,284		377,631		1,082,120
Fair value changes		(556)		(213)		(975)		(4,378)
Sales		(95,053)		(252,242)		(394,261)		(1,183,876)
Settlements		(222)		(1,083)		(272)		(4,400)
Balance at end of period	$	12,743	$	51,309	$	12,743	$	51,309

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
Loans held for investment		2022		2021		2022		2021
Balance at beginning of period	$	21,477	$	—	$	—	$	—
Loans acquired		7,860		—		32,109		—
Fair value changes		(105)		—		223		—
Settlements		(6,361)		—		(9,461)		—
Balance at end of period	$	22,871	$	—	$	22,871	$	—

Nonrecurring Fair Value

Other Real Estate Owned (“OREO”):  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. OREO 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 OREO 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 measured on a nonrecurring basis as of the dates noted (dollars in thousands):

	Quoted
	Prices in		Significant
	Active Markets		Other		Significant
	for Identical		Observable		Unobservable
	Assets		Inputs		Inputs		Reported
September 30, 2022	(Level 1)		(Level 2)		(Level 3)		Balance
OREO:
Commercial properties	$	—	$	—	$	187	$	187

	Quoted
	Prices in		Significant
	Active Markets		Other		Significant
	for Identical		Observable		Unobservable
	Assets		Inputs		Inputs		Reported
December 31, 2021	(Level 1)		(Level 2)		(Level 3)		Balance
Impaired loans(1):
Commercial and Industrial	$	—	$	—	$	439	$	439

______________________________________

⁽¹⁾ One immaterial Consumer and Other loan was fully reserved for using a specific allowance as of December 31, 2021.

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

In the second quarter of 2022, the Company recorded $0.4 million of OREO as a result of obtaining physical possession of a foreclosed property as partial consideration for amounts owed on an impaired loan. In the third quarter of 2022, one of the units associated with the property was sold for $0.2 million. As of September 30, 2022, the remaining unit of the OREO property had a carrying amount of $0.2 million. As of December 31, 2021, the Company did not own any OREO properties.  

As of December 31, 2021, total impaired loans measured for impairment using the fair value of the collateral dependent loans had carrying values of $2.2 million with valuation allowances of $1.8 million and were classified as Level 3.

Impaired loans accounted for no specific reserves as of September 30, 2022 and $1.8 million as of December 31, 2021. The Company did not have any charge offs during the nine months ended September 30, 2022 from the specific reserve. The Company charged off an immaterial amount during the year ended December 31, 2021 from the specific reserve.

Level 3 Analysis

The following presents a reconciliation for Level 3 instruments measured at fair value on a recurring basis as of the dates noted (dollars in thousands):

Three Months Ended September 30, 2022	Corporate Bonds		Loans Held at Fair Value		FSC		Guarantee Asset		IRLC		Equity Warrants
Beginning balance	$	—	$	21,477	$	—	$	174	$	990	$	725
Acquisitions		—		7,867		(11)		—		170		102
Originations		—		—		—		—		(720)		—
Gains/(losses) in net income, net		—		(134)		—		(15)		(302)		—
Settlements		—		(6,339)		—		—		—		—
Ending balance	$	—	$	22,871	$	(11)	$	159	$	138	$	827

Three Months Ended September 30, 2021	Corporate Bonds		Loans Held at Fair Value		FSC		Guarantee Asset		IRLC		Equity Warrants
Beginning balance	$	—	$	—	$	—	$	196	$	2,809	$	—
Acquisitions		—		—		(17)		—		6,617		—
Originations		—		—		—		—		(7,705)		—
Gains/(losses) in net income, net		—		—		—		35		464		—
Ending balance	$	—	$	—	$	(17)	$	231	$	2,185	$	—

Nine Months Ended September 30, 2022	Corporate Bonds		Loans Held at Fair Value		FSC		Guarantee Asset		IRLC		Equity Warrants
Beginning balance	$	2,113	$	—	$	(9)	$	237	$	1,473	$	160
Acquisitions		4,000		32,599		(2)		—		1,253		344
Originations		—		—		—		—		(2,783)		—
Gains/(losses) in net income, net		—		(289)		—		(78)		195		323
Unrealized gains, net		102		—		—		—		—		—
Transfer to held-to-maturity		(6,215)		—		—		—		—		—
Settlements		—		(9,439)		—		—		—		—
Ending balance	$	—	$	22,871	$	(11)	$	159	$	138	$	827

Nine Months Ended September 30, 2021	Corporate Bonds		Loans Held at Fair Value		FSC		Guarantee Asset		IRLC		Equity Warrants
Beginning balance	$	—	$	—	$	(89)	$	232	$	9,841	$	—
Acquisitions		—		—		(190)		—		15,123		—
Originations		—		—		—		2		(20,702)		—
Gains/(losses) in net income, net		—		—		262		(3)		(2,077)		—
Ending balance	$	—	$	—	$	(17)	$	231	$	2,185	$	—

The following presents quantitative information about Level 3 assets measured on a recurring and nonrecurring basis as of the dates noted (dollars in thousands):

	Quantitative Information about Level 3 Fair Value Measurements as of September 30, 2022
			Valuation		Significant		Range
	Fair Value		Technique		Unobservable Input		(Weighted Average)
Recurring fair value
Loans held for investment at fair value	$	22,871		Discounted cash flow		Discount rate		4% to 18% (9%)
FSC		(11)		Internal pricing model		Market Differential		56 bps to 67 bps (62 bps)
Guarantee asset		159		Discounted cash flow		Discount rate Prepayment rate		5% (5%) 6% (6%)
IRLC, net		138		Best execution model		Pull through		73% to 100% (94%)
Equity warrants		827		Black-Scholes option pricing model		Volatility Risk-free interest rate Remaining life		31.2% to 32.4% (31.4%) 1.78% to 4.14% (3.68%) 0 to 4 years
Nonrecurring fair value
OREO:
Commercial properties		187		Appraisal value		Commission, cost to sell, closing costs		9% (9%)

	Quantitative Information about Level 3 Fair Value Measurements as of December 31, 2021
			Valuation		Significant		Range
	Fair Value		Technique		Unobservable Input		(Weighted Average)
Recurring fair value
Corporate Bonds	$	2,113		Discounted cash flow		Discount rate		7% (7%)
FSC		(9)		Internal pricing model		Market Differential		-14bps to -2 bps (-6bps)
Guarantee asset		237		Discounted cash flow		Discount rate Prepayment rate		3% (3%) 18% (18%)
IRLC, net		1,473		Best execution model		Pull through		71% to 100% (88%)
Equity warrants		160		Black-Scholes option pricing model		Volatility Risk-free interest rate Remaining life		24% to 37% (32%) 0.30% to 1.10% (0.97%) 0 to 4 years
Nonrecurring fair value
Impaired loans(1):
Commercial and Industrial		439		Sales comparison, Market approach - guideline transaction method		Management discount for asset/property type		17% - 45% (39%)

______________________________________

⁽¹⁾ One immaterial Consumer and Other loan was fully reserved for using a specific allowance as of December 31, 2021.

Estimated Fair Value of Other Financial Instruments

The following presents carrying amounts and estimated fair values for financial instruments not carried at fair value as of the dates noted (dollars in thousands):

	Carrying		Fair Value Measurements Using:
September 30, 2022	Amount		Level 1		Level 2		Level 3
Assets:
Cash and cash equivalents	$	165,248	$	165,248	$	—	$	—
Held-to-maturity securities		84,257		232		69,927		8,465
Loans, net		2,335,241		—		—		2,315,505
Accrued interest receivable		8,451		3		440		8,008
Liabilities:
Deposits		2,167,447		1,980,757		—		189,552
Borrowings:
FHLB borrowings – fixed rate		267,432		—		267,211		—
Federal Reserve borrowings – fixed rate		5,793		—		5,793		—
Subordinated notes – fixed-to-floating rate		32,584		—		—		35,030
Accrued interest payable		664		—		404		260

	Carrying		Fair Value Measurements Using:
December 31, 2021	Amount		Level 1		Level 2		Level 3
Assets:
Cash and cash equivalents	$	386,983	$	386,983	$	—	$	—
Loans, net		1,935,405		—		—		1,919,625
Accrued interest receivable		7,151		2		203		6,946
Liabilities:
Deposits		2,205,703		2,035,212		—		172,240
Borrowings:
FHLB borrowings – fixed rate		15,000		—		14,990		—
Federal Reserve borrowings – fixed rate		23,629		—		23,629		—
Subordinated notes – fixed-to-floating rate		39,031		—		—		40,325
Accrued interest payable		355		9		77		269

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 condensed 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.

Held-to-maturity securities: The fair values for held-to-maturity 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 is not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

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, considering 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.

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.