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FAIR VALUE MEASUREMENTS

6 Months Ended

Jun. 30, 2022

FAIR VALUE MEASUREMENTS

FAIR VALUE MEASUREMENTS

NOTE 10 - FAIR VALUE MEASUREMENTS

The Company determines fair value based on the requirements established in Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements, which provides a framework for measuring fair value in accordance with U.S. GAAP and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 defines fair value as the exit price, or the price that would be received for an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date under current market conditions. ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities, requires us to use the exit price notion when measuring the fair value of instruments for disclosure purposes.

The following definitions describe the levels of inputs that may be used to measure fair value:

Level 1 - Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 - Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 - Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

The following methods were used to estimate the fair value of certain assets and liabilities on a recurring and nonrecurring basis:

Securities - The fair value of securities available-for-sale and held-to-maturity are recorded on a recurring basis. The fair value of investments and mortgage-backed securities are provided by a third-party pricing service. These valuations are based on market data using pricing models that vary by asset class and incorporate available current trade, bid, and other market information, and for structured securities, cash flow, and loan performance data. The pricing processes utilize benchmark curves, benchmarking of similar securities, sector groupings, and matrix pricing. Option adjusted spread models are also used to assess the impact of changes in interest rates and to develop prepayment scenarios (Level 2).

Certain other corporate securities and municipal bonds are generally measured at fair value based on discounted cash flow models (Level 3). Transfers between the fair value hierarchy are determined through the third-party service provider which, from time to time will transfer between levels based on market conditions per the related security. All models and processes used take into account market convention.

Mortgage Loans Held for Sale - The fair value of loans held for sale reflects the value of commitments with investors and/or the relative price as delivered into a TBA mortgage-backed security (Level 2).

Loans receivable - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type, including commercial, real estate and consumer loans. Each loan category is further segregated by fixed and adjustable-rate loans. The fair value of loans is calculated by discounting expected cash flows at rates at which similar loans are currently being made. These amounts are discounted further by embedded probable losses expected to be realized in the portfolio. For loans originated as held for sale and transferred into loans held for investment, the fair value is determined based on quoted secondary market prices for similar loans. As of June 30, 2022 and December 31, 2021, there were $14.9 million and $16.1 million, respectively, in residential mortgage loans recorded at fair value as they were previously transferred from held for sale to loans held for investment (Level 2).

Derivative Instruments - Fair values for derivative assets and liabilities are measured on a recurring basis. The primary use of derivative instruments is related to the mortgage banking activities of the Company. The fair value of the interest rate lock commitments and forward sales commitments are estimated using quoted or published market prices for similar instruments, adjusted for factors such as pull-though rate assumptions based on historical information, where appropriate. TBA mortgage-backed securities are fair valued on similar contracts in active markets (Level 2), while locks and forwards with customers and investors are fair valued using similar contracts in the market and changes in the market interest rates (Level 2 and 3). Derivative instruments not related to mortgage banking activities include interest rate swap agreements. The fair values of interest rate swap agreements are based on valuation models using observable market data as of the measurement date (Level 2). The Company’s derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rates, and volatility factors to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including market transactions and third-party pricing services. The fair values of all interest rate swaps are determined from third-party pricing services without adjustment.

Other Real Estate Owned - Fair value adjustments to OREO are recorded at the lower of carrying amount of the loan or fair value of the collateral less selling costs. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for credit losses. After foreclosure, management periodically performs valuations such that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell (Level 3).

Loans individually evaluated - Expected credit losses for loans evaluated individually are measured based on the present value of expected future cash flows discounted at the loan’s original effective interest rate or when the Bank determines that foreclosure is probable, the expected credit loss is measured based on the fair value of the collateral as of the reporting date, less estimated selling costs, as applicable. As a practical expedient, the Bank measures the expected credit loss for a loan using the fair value of the collateral, if repayment is expected to be provided substantially through the operation or sale of the collateral when the borrower is experiencing financial difficulty based on the Bank’s assessment as of the reporting date. In both cases, if the fair value of the collateral is less than the amortized cost basis of the loan, the Bank will recognize an allowance as the difference between the fair value of the collateral, less costs to sell (if applicable), at the reporting date and the amortized cost basis of the loan. If the fair value of the collateral exceeds the amortized cost basis of the loan, any expected recovery added to the amortized cost basis will be limited to the amount previously charged-off by the subsequent changes in the expected credit losses for loans evaluated individually are included within the provision for credit losses in the same manner in which the expected credit loss initially was recognized or as a reduction in the provision that would otherwise be reported (Level 3).

Servicing Rights - The fair value of MSR is estimated using net present value of expected cash flows using a third-party model that incorporates assumptions used in the industry to value such rights, adjusted for factors such as weighted average prepayments speeds based on historical information where appropriate (Level 3).

The following tables present securities available-for-sale, mortgage loans held for sale, loans receivable, and derivative assets and liabilities measured at fair value on a recurring basis at the dates indicated:


Financial Assets		At June 30, 2022
Securities available-for-sale:		Level 1			Level 2			Level 3			Total
U.S. agency securities		$	—		$	18,550		$	—		$	18,550
Corporate securities			—			7,739			1,029			8,768
Municipal bonds			—			127,015			116			127,131
Mortgage-backed securities			—			77,175			—			77,175
U.S. Small Business Administration securities			—			16,208			—			16,208
Mortgage loans held for sale, at fair value			—			34,989			—			34,989
Loans receivable, at fair value			—			14,863			—			14,863
Derivatives:
Mandatory and best effort forward commitments with investors			—			—			518			518
Forward TBA mortgage-backed securities			—			203			—			203
Interest rate swaps			—			5,601			—			5,601
Interest rate lock commitments with customers			—			—			184			184
Total assets measured at fair value		$	—		$	302,343		$	1,847		$	304,190


Financial Assets		At December 31, 2021
Securities available-for-sale:		Level 1			Level 2			Level 3			Total
U.S. agency securities		$	—		$	20,970		$	—		$	20,970
Corporate securities			—			7,995			1,007			9,002
Municipal bonds			—			135,302			131			135,433
Mortgage-backed securities			—			89,402			—			89,402
U.S. Small Business Administration securities			—			16,552			—			16,552
Mortgage loans held for sale, at fair value			—			125,810			—			125,810
Loans receivable, at fair value			—			16,083			—			16,083
Derivatives:
Mandatory and best effort forward commitments with investors			—			—			808			808
Forward TBA mortgage-backed securities			—			53			—			53
Interest rate swaps			—			1,168			—			1,168
Interest rate lock commitments with customers			—			—			757			757
Total assets measured at fair value		$	—		$	413,335		$	2,703		$	416,038
Financial Liabilities
Derivatives:
Interest rate swaps			—			(155)			—			(155)
Total liabilities measured at fair value		$	—		$	(155)		$	—		$	(155)

The following tables present loans individually evaluated, OREO, and servicing rights measured at fair value on a nonrecurring basis for which a nonrecurring change in fair value has been recorded during the reporting periods indicated. The amounts disclosed below represent the fair values at the time the nonrecurring fair value measurements were evaluated.


		June 30, 2022
		Level 1			Level 2			Level 3			Total
Loans individually evaluated		$	—		$	—		$	6,658		$	6,658
OREO			—			—			145			145
Servicing rights			—			—			34,098			34,098


		December 31, 2021
		Level 1			Level 2			Level 3			Total
Loans individually evaluated		$	—		$	—		$	5,829		$	5,829
Servicing rights			—			—			26,070			26,070

Quantitative Information about Level 3 Fair Value Measurements - Shown in the table below is the fair value of financial instruments measured under a Level 3 unobservable input on a recurring and nonrecurring basis at June 30, 2022 and December 31, 2021:


Level 3				Significant				Weighted Average
Fair Value		Valuation		Unobservable				June 30,			December 31,
Instruments		Techniques		Inputs		Range		2022			2021
RECURRING
Interest rate lock commitments with customers		Quoted market prices		Pull-through expectations		80% - 99%		97.5	%		93.3	%
Individual forward sale commitments with investors		Quoted market prices		Pull-through expectations		80% - 99%		97.5	%		93.3	%
Corporate securities		Discounted cash flows		Discount rate		2.1% - 2.7%		2.1	%		2.2	%
Municipal bonds		Discounted cash flows		Discount rate		6.0%		6.0	%		6.0	%
NONRECURRING
Loans individually evaluated		Fair value of underlying collateral		Discount applied to the obtained appraisal		10.0%		10.0	%		10.0	%
OREO		Fair value of collateral		Discount applied to the obtained appraisal		10.0%		10.0	%		10.0	%
Servicing rights		Industry sources		Pre-payment speeds		0% - 50%		8.8	%		13.8	%

An increase in the pull-through rate utilized in the fair value measurement of the interest rate lock commitments with customers and forward sale commitments with investors will result in positive fair value adjustments (and an increase in the fair value measurement). Conversely, a decrease in the pull-through rate will result in a negative fair value adjustment (and a decrease in the fair value measurement).

The following tables provides a reconciliation of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three and six months ended June 30, 2022 and 2021:


					Purchases									Net change in			Net change in
Three Months Ended		Beginning			and			Sales and			Ending			fair value for			fair value for
June 30, 2022		Balance			Issuances			Settlements			Balance			gains/(losses) ⁽¹⁾			gains/(losses) ⁽²⁾
Interest rate lock commitments with customers		$	250		$	22		$	(88)		$	184		$	(66)		$	—
Individual forward sale commitments with investors			885			2,931			(3,298)			518			(367)			—
Securities available-for-sale, at fair value			1,121			27			(3)			1,145			—			24
June 30, 2021
Interest rate lock commitments with customers		$	1,985		$	7,169		$	(7,048)		$	2,106		$	121		$	—
Individual forward sale commitments with investors			506			(1,200)			141			(553)			(1,059)			—
Securities available-for-sale, at fair value			1,129			—			(12)			1,117			—			(9)


					Purchases									Net change in			Net change in
Six Months Ended		Beginning			and			Sales and			Ending			fair value for			fair value for
June 30, 2022		Balance			Issuances			Settlements			Balance			gains/(losses) ⁽¹⁾			gains/(losses) ⁽²⁾
Interest rate lock commitments with customers		$	757		$	2,117		$	(2,690)		$	184		$	(573)		$	—
Individual forward sale commitments with investors			808			5,073			(5,363)			518			(290)			—
Securities available-for-sale, at fair value			1,138			13			(6)			1,145			—			7
June 30, 2021
Interest rate lock commitments with customers		$	4,024		$	14,860		$	(16,778)		$	2,106		$	(1,918)		$	—
Individual forward sale commitments with investors			(67)			(546)			60			(553)			(486)			—
Securities available-for-sale, at fair value			1,111			12			(6)			1,117			—			12

___________________________

(1) Relating to items held at end of period included in income.

(2) Relating to items held at end of period included in other comprehensive income (loss).

Gains (losses) on interest rate lock commitments carried at fair value are recorded in other noninterest income. Gains (losses) on forward sale commitments with investors carried at fair value are recorded in noninterest income. Unrealized gains (losses) on securities available-for-sale, at fair value are recorded in accumulated OCI.

The following table provides estimated fair values of the Company’s financial instruments at June 30, 2022 and December 31, 2021, whether or not recognized at fair value on the Consolidated Balance Sheets:


		June 30,						December 31,
		2022						2021
Financial Assets		Carrying			Fair			Carrying			Fair
Level 1 inputs:		Amount			Value			Amount			Value
Cash and cash equivalents		$	28,659		$	28,659		$	26,491		$	26,491
Certificates of deposit at other financial institutions			4,960			4,960			10,542			10,542
Level 2 inputs:
Securities available-for-sale, at fair value			246,687			246,687			270,221			270,221
Securities held-to-maturity			8,500			8,342			7,500			8,128
Loans held for sale, at fair value			34,989			34,989			125,810			125,810
FHLB stock, at cost			6,295			6,295			4,778			4,778
Forward TBA mortgage-backed securities			203			203			53			53
Loans receivable, at fair value			14,863			14,863			16,083			16,083
Interest rate swaps			5,601			5,601			1,168			1,168
Accrued interest receivable			8,553			8,553			7,594			7,594
Level 3 inputs:
Securities available-for-sale, at fair value			1,145			1,145			1,138			1,138
Loans receivable, gross			1,931,209			1,895,089			1,738,092			1,725,651
Servicing rights, held at lower of cost or fair value			18,516			34,098			16,970			26,070
Fair value interest rate locks with customers			184			184			757			757
Mandatory and best effort forward commitments with investors			518			518			808			808
Financial Liabilities
Level 2 inputs:
Deposits			2,016,100			1,999,713			1,915,744			1,912,498
Borrowings			78,028			77,630			42,528			43,365
Subordinated notes, excluding unamortized debt issuance costs			50,000			47,188			50,000			51,688
Accrued interest payable			952			952			766			766
Interest rate swaps			—			—			155			155

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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