Fair Value Measurements and Disclosures about Fair Value of Financial Instruments

9 Months Ended

Jun. 30, 2017

Fair Value Measurements and Disclosures about Fair Value of Financial Instruments

8.	Fair Value Measurements and Disclosures about Fair Value of Financial Instruments

Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements, provides the framework for measuring fair value. That framework provides 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). The three levels of the fair value hierarchy under FASB ASC Topic 820 are described as follows:

Level 1:

Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets. A quoted market price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

Level 2:

Inputs to the valuation methodology include quoted market prices for similar assets or liabilities in active markets; quoted market prices for identical or similar assets or liabilities in markets that are not active; or inputs that are derived principally from or can be corroborated by observable market data by correlation or other means.

Level 3:

Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Level 3 assets and liabilities include financial instruments whose value is determined using discounted cash flow methodologies, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets carried at fair value or the lower of cost or fair value. The tables below present the balances of financial assets measured at fair value on a recurring and nonrecurring basis as of June 30, 2017 and September 30, 2016. The Company had no liabilities measured at fair value as of June 30, 2017 or September 30, 2016.

	Carrying Value
	Level 1		Level 2		Level 3		Total
	(In thousands)
June 30, 2017:
Assets Measured - Recurring Basis:
Trading account securities	$	-	$	5,819	$	-	$	5,819

Securities available for sale:
Agency mortgage-backed	$	-	$	39,340	$	-	$	39,340
Agency CMO		-		14,235		-		14,235
Privately issued CMO		-		2,059		-		2,059
Privately issued ABS		-		3,769		-		3,769
SBA certificates		-		1,050		-		1,050
Municipal		-		117,566		-		117,566
Total securities available for sale	$	-	$	178,019	$	-	$	178,019

Assets Measured - Nonrecurring Basis:
Impaired loans:
Residential real estate	$	-	$	-	$	4,400	$	4,400
Commercial real estate		-		-		5,464		5,464
Land and land development		-		-		314		314
Commercial business		-		-		198		198
Consumer		-		-		194		194
Total impaired loans	$	-	$	-	$	10,570	$	10,570

Loans held for sale:
Residential mortgage loans held for sale	$	-	$	755	$	-	$	755
SBA loans held for sale		-		24,215		-		24,215
Total loans held for sale	$	-	$	24,970	$	-	$	24,970

Loan servicing rights	$	-	$	-	$	1,026	$	1,026

Other real estate owned, held for sale:
Residential real estate	$	-	$	-	$	179	$	179
Commercial real estate		-		-		167		167
Total other real estate owned	$	-	$	-	$	346	$	346

	Carrying Value
	Level 1		Level 2		Level 3		Total
	(In thousands)
September 30, 2016:
Assets Measured - Recurring Basis:
Trading account securities	$	-	$	9,255	$	-	$	9,255

Securities available for sale:
Agency bonds and notes	$	-	$	1,032	$	-	$	1,032
Agency mortgage-backed		-		47,405		-		47,405
Agency CMO		-		16,095		-		16,095
Privately-issued CMO		-		2,652		-		2,652
Privately-issued ABS		-		4,532		-		4,532
SBA certificates		-		1,227		-		1,227
Municipal		-		101,550		-		101,550
Total securities available for sale	$	-	$	174,493	$	-	$	174,493

Assets Measured - Nonrecurring Basis:
Impaired loans:
Residential real estate	$	-	$	-	$	4,299	$	4,299
Commercial real estate		-		-		6,298		6,298
Land and land development		-		-		241		241
Commercial business		-		-		231		231
Consumer		-		-		244		244
Total impaired loans	$	-	$	-	$	11,313	$	11,313

Loans held for sale:
Residential mortgage loans held for sale	$	-	$	384	$	-	$	384
SBA loans held for sale		-		5,087		-		5,087
Total loans held for sale	$	-	$	5,471	$	-	$	5,471

Loan servicing rights	$	-	$	-	$	310	$	310

Other real estate owned, held for sale:
Residential real estate	$	-	$	-	$	397	$	397
Commercial real estate		-		-		122		122
Total other real estate owned	$	-	$	-	$	519	$	519

Fair value is based upon quoted market prices where available. If quoted market prices are not available, fair value is based on internally developed models or obtained from third parties that primarily use, as inputs, observable market-based parameters or a matrix pricing model that employs the Bond Market Association’s standard calculations for cash flow and price/yield analysis and observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value, or at the lower of cost or fair value. These adjustments may include unobservable parameters. Any such valuation adjustments have been applied consistently over time.

The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. There have been no changes in the valuation techniques and related inputs used for assets measured at fair value on a recurring and nonrecurring basis during the nine month period ended June 30, 2017.

Trading Account Securities and Securities Available for Sale.Securities classified as trading and available for sale are reported at fair value on a recurring basis. These securities are classified as Level 1 of the valuation hierarchy where quoted market prices from reputable third-party brokers are available in an active market. If quoted market prices are not available, the Company obtains fair value measurements from an independent pricing service. These securities are reported using Level 2 inputs and the fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, U.S. government and agency yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the security’s terms and conditions, among other factors. For securities where quoted market prices, market prices of similar securities or prices from an independent third party pricing service are not available, fair values are calculated using discounted cash flows or other market indicators and are classified within Level 3 of the fair value hierarchy. Changes in fair value of trading account securities are reported in noninterest income. Changes in fair value of securities available for sale are recorded in other comprehensive income, net of income tax effect.

Impaired Loans. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly. The fair value of impaired loans is classified as Level 3 in the fair value hierarchy.

Impaired loans are measured at the present value of estimated future cash flows using the loan's effective interest rate or the fair value of the collateral if the loan is a collateral-dependent loan. Collateral may be real estate and/or business assets, including equipment, inventory and/or accounts receivable, and its fair value is generally determined based on real estate appraisals or other independent evaluations by qualified professionals. The appraisals are generally then discounted by management in order to reflect management’s estimate of the fair value of the collateral given the current market conditions and the condition of the collateral. At June 30, 2017 and September 30, 2016, the significant unobservable inputs used in the fair value measurement of impaired loans included discounts from appraised value ranging from 0.0% to 15.0% and estimated costs to sell the collateral ranging from 0.0% to 6.0%. During the three month periods ended June 30, 2017 and 2016, the Company recognized provisions for loan losses of $139,000 and $3,000, respectively, for impaired loans. During the nine month periods ended June 30, 2017 and 2016, the Company recognized provisions for loan losses of $181,000 and $3,000, respectively, for impaired loans.

Loans Held for Sale. Loans held for sale are carried at the lower of cost or market value. The portfolio is comprised of residential mortgage loans and SBA loans. The fair value of loans held for sale is based on specific prices of the underlying contracts for sale to investors, and is classified as Level 2 in the fair value hierarchy.

Loan Servicing Rights. Loan servicing rights represent the value associated with servicing SBA loans that have been sold. The fair value of loan servicing rights is determined on a quarterly basis by an independent third party valuation model using market-based discount rate and prepayment assumptions, and is classified as Level 3 in the fair value hierarchy. At June 30, 2017, the significant unobservable inputs used in the fair value measurement of loan servicing rights included discount rates ranging from 8.41% to 12.93% with a weighted average of 11.41% and prepayment speed assumptions ranging from 3.34% to 8.78% with a weighted average rate of 6.81%. At September 30, 2016, the significant unobservable inputs used in the fair value measurement of loan servicing rights included discount rates ranging from 8.54% to 14.46% with a weighted average of 12.27% and prepayment speed assumptions ranging from 4.25% to 8.71% with a weighted average rate of 6.75%. Impairment of the loan servicing rights is recognized on a quarterly basis through a valuation allowance to the extent that fair value is less than the carrying amount. The Company did not recognize any impairment charges on loan servicing rights for the three and nine month periods ended June 30, 2017 and 2016.

Other Real Estate Owned. Other real estate owned held for sale is reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly. The fair value of other real estate owned is classified as Level 3 in the fair value hierarchy.

Other real estate owned is reported at fair value less estimated costs to dispose of the property. The fair values are determined by real estate appraisals, which are then generally discounted by management in order to reflect management’s estimate of the fair value of the property given current market conditions and the condition of the property. At June 30, 2017, the significant unobservable inputs used in the fair value measurement of other real estate owned included a discount from appraised value (including estimated costs to sell the property) ranging from 16.1% to 34.2% with a weighted average of 28.6%. At September 30, 2016, the significant unobservable inputs used in the fair value measurement of other real estate owned included a discount from appraised value (including estimated costs to sell the property) ranging from 15.0% to 34.2% with a weighted average of 24.6%. The Company recognized charges of $3,000 and $13,000 to write-down other real estate owned to fair value for the three and nine months ended June 30, 2017, respectively. The Company recognized charges of $21,000 and $100,000 to write-down other real estate owned to fair value for the three and nine months ended June 30, 2016, respectively.

Transfers Between Categories. There were no transfers into or out of Level 3 financial assets for the three and nine month periods ended June 30, 2017 and 2016.

GAAP requires disclosure of fair value information about financial instruments for interim reporting periods, whether or not recognized in the consolidated balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The carrying amounts and estimated fair values of the Company's financial instruments are as follows.

	Carrying		Fair Value Measurements Using:
June 30, 2017:	Amount		Level 1		Level 2		Level 3

	(In thousands)

Financial assets:
Cash and due from banks	$	10,926	$	10,926	$	-	$	-
Interest-bearing deposits with banks		30,164		30,164		-		-
Interest-bearing time deposits		2,555		-		2,556		-
Trading account securities		5,819		-		5,819		-
Securities available for sale		178,019		-		178,019		-
Securities held to maturity		2,955		-		3,343		-

Loans, net		564,771		-		-		557,854

Residential mortgage loans held for sale		755		-		755		-
SBA loans held for sale		24,215		-		24,215		-
FRB and FHLB stock		6,936		n/a		n/a		n/a
Accrued interest receivable		3,508		-		3,508		-
Loan servicing rights (included in other assets)		1,026		-		-		1,026

Financial liabilities:
Deposits		673,900		-		-		674,560
Repurchase agreements		1,347		-		1,347		-
Borrowings from FHLB		100,000		-		99,766		-
Accrued interest payable		265		-		265		-
Advance payments by borrowers for taxes and insurance		992		-		992		-

	Carrying		Fair Value Measurements Using:
September 30, 2016:	Amount		Level 1		Level 2		Level 3
	(In thousands)

Financial assets:
Cash and due from banks	$	11,449	$	11,449	$	-	$	-
Interest-bearing deposits with banks		17,893		17,893		-		-
Interest-bearing time deposits		3,100		-		3,114		-
Trading account securities		9,255		-		9,255		-
Securities available for sale		174,493		-		174,493		-
Securities held to maturity		3,166		-		3,654		-

Loans, net		518,611		-		-		522,560

Residential mortgage loans held for sale		384		-		384		-
SBA loans held for sale		5,087		-		5,087		-
FRB and FHLB stock		6,936		n/a		n/a		n/a
Accrued interest receivable		2,806		-		2,806		-
Loan servicing rights (included in other assets)		310		-		-		312

Financial liabilities:
Deposits		579,467		-		-		581,844
Short-term repurchase agreements		1,345		-		1,345		-
Borrowings from FHLB		121,633		-		123,794		-
Accrued interest payable		195		-		195		-
Advance payments by borrowers for taxes and insurance		1,014		-		1,014		-

The carrying amounts in the preceding tables are included in the consolidated balance sheets under the applicable captions. The fair value of financial instruments with off-balance-sheet risk is not material. The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value:

Cash and Cash Equivalents

For cash and short-term instruments, including cash and due from banks and interest-bearing deposits with banks, the carrying amount is a reasonable estimate of fair value.

Investment Securities and Interest-Bearing Time Deposits

For debt securities and interest-bearing time deposits, the Company obtains fair value measurements from an independent pricing service and the fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, U.S. government and agency yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the security’s terms and conditions, among other factors.

Loans

The fair value of loans, excluding loans held for sale, is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and terms. Impaired loans are valued at the lower of their carrying value or fair value, as previously described. The carrying amount of accrued interest receivable approximates its fair value.

The fair value of loans held for sale is estimated based on specific prices of underlying contracts for sales to investors, as previously described.

FRB and FHLB Stock

It is not practical to determine the fair value of FRB and FHLB stock due to restrictions placed on transferability.

Loan Servicing Rights

The fair value of loan serving rights is determined by a valuation model employed by an independent third party using market-based discount rate and prepayment assumptions, as previously described.

Deposits

The fair value of demand and savings deposits and other transaction accounts is the amount payable on demand at the balance sheet date. The fair value of fixed-maturity time deposits is estimated by discounting the future cash flows using the rates currently offered for deposits with similar remaining maturities. The carrying amount of accrued interest payable approximates its fair value.

Borrowed Funds

Borrowed funds include borrowings from the FHLB and repurchase agreements. Fair value for FHLB advances and long-term repurchase agreements is estimated by discounting the future cash flows at current interest rates for FHLB advances of similar maturities. For short-term repurchase agreements and FHLB line of credit borrowings, the carrying value is a reasonable estimate of fair value.

- 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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