Fair Value of Financial Instruments

6 Months Ended

Dec. 31, 2018

17. FAIR VALUE OF FINANCIAL INSTRUMENTS

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments”. This guidance amends existing guidance to improve accounting standards for financial instruments including clarification and simplification of accounting and disclosure requirements and the requirement for public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. The Company adopted the guidance effective July 1, 2018. Upon adoption, the fair value of the Company’s loan portfolio is now presented using an exit price method.

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:

Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability or inputs that are derived principally from, or corroborated by, market data by correlation or other means.

Level 3:

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

Assets Measured on a Recurring Basis:

The following methods and significant assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a recurring basis at December 31, 2018 and June 30, 2018:

Investment Securities Available for Sale

The majority of the Company’s available for sale investment securities are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the securities’ terms and conditions, among other things. From time to time, the Company validates prices supplied by the independent pricing service by comparison to prices obtained from third-party sources or derived using internal models.

The Company held one trust preferred security whose fair value of $1.0 million at December 31, 2018 was determined using Level 3 inputs. For the periods ended December 31, 2018 and June 30, 2018, management has been unable to obtain a market quote for this security. Consequently, the security’s fair value as reported at December 31, 2018 and June 30, 2018, is based upon the present value of expected future cash flows assuming the security continues to meet all of its payment obligations and utilizing a discount rate based upon the security’s contractual interest rate.

Derivatives

The Company has contracted with a third party vendor to provide periodic valuations for its interest rate derivatives to determine the fair value of its interest rate caps and swaps. The vendor utilizes standard valuation methodologies applicable to interest rate derivatives such as discounted cash flow analysis and extensions of the Black-Scholes model. Such valuations are based upon readily observable market data and are therefore considered Level 2 valuations by the Company.

Those assets measured at fair value on a recurring basis are summarized below:

	December 31, 2018
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
	(In Thousands)
Assets:
Debt securities available for sale:
U.S. agency securities	$	-	$	3,942	$	-	$	3,942
Obligations of state and political subdivisions		-		26,205		-		26,205
Asset-backed securities		-		180,828		-		180,828
Collateralized loan obligations		-		184,439		-		184,439
Corporate bonds		-		144,692		-		144,692
Trust preferred securities		-		2,726		1,000		3,726
Total debt securities		-		542,832		1,000		543,832

Mortgage-backed securities available for sale:
Collateralized mortgage obligations		-		23,019		-		23,019
Residential pass-through securities		-		91,918		-		91,918
Commercial pass-through securities		-		7,833		-		7,833
Total mortgage-backed securities		-		122,770		-		122,770
Total securities available for sale	$	-	$	665,602	$	1,000	$	666,602
Interest rate swaps		-		22,109		-		22,109

Total assets	$	-	$	687,711	$	1,000	$	688,711

	June 30, 2018
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
	(In Thousands)
Assets:
Debt securities available for sale:
U.S. agency securities	$	-	$	4,411	$	-	$	4,411
Obligations of state and political subdivisions		-		26,088		-		26,088
Asset-backed securities		-		182,620		-		182,620
Collateralized loan obligations		-		226,066		-		226,066
Corporate bonds		-		147,594		-		147,594
Trust preferred securities		-		2,783		1,000		3,783
Total debt securities		-		589,562		1,000		590,562

Mortgage-backed securities available for sale:
Collateralized mortgage obligations		-		24,292		-		24,292
Residential pass-through securities		-		102,359		-		102,359
Commercial pass-through securities		-		7,872		-		7,872
Total mortgage-backed securities		-		134,523		-		134,523
Total securities available for sale		-		724,085		1,000		725,085
Interest rate swaps and caps		-		31,881		-		31,881

Total assets	$	-	$	755,966	$	1,000	$	756,966

In addition to the financial instruments noted above, at December 31, 2018 and June 30, 2018, the Company’s pipeline of loans held for sale included $4.6 million and $10.8 million, respectively, of in process loans whose terms included interest rate locks to borrowers which are considered free-standing derivative instruments whose fair values are not material to our financial condition or results of operations. Given the short-term nature of the commitments and their immateriality to the statements of condition and operations, the Company assumes no change in the fair value of these derivative instruments during their outstanding period.

Assets Measured on a Non-Recurring Basis:

The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a non-recurring basis at December 31, 2018 and June 30, 2018:

Impaired Loans

An impaired loan is evaluated and valued at the time the loan is identified as impaired at the lower of cost or fair value. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Fair value is measured based on the value of the collateral securing the loan and is classified at a Level 3 in the fair value hierarchy. Once a loan is identified as individually impaired, management measures impairment in accordance with the FASB’s guidance on accounting by creditors for impairment of a loan with the fair value estimated using the fair value of the collateral reduced by estimated disposal costs. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceeds the recorded investments in such loans. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned

Other real estate owned (“OREO”) is recorded at estimated fair value, less estimated selling costs when acquired, thus establishing a new cost basis. Fair value is generally based on independent appraisals. These appraisals include adjustments to comparable assets based on the appraisers’ market knowledge and experience. When an asset is acquired, the excess of the loan balance over fair value, less estimated selling costs, is charged to the allowance for loan losses. If further declines in the estimated fair value of the asset occur, a write-down is recorded through expense. The valuation of foreclosed assets is subjective in nature and may be adjusted in the future because of changes in economic conditions.

Loans-Held-for-Sale

The fair value of loans held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan or other observable market data, such as outstanding commitments from third party investors (Level 2).

Those assets measured at fair value on a non-recurring basis are summarized below:

	December 31, 2018
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
	(In Thousands)
Impaired loans:
Residential mortgage	$	-	$	-	$	3,446	$	3,446
Non-residential mortgage		-		-		791		791
Commercial business		-		-		62		62
Total	$	-	$	-	$	4,299	$	4,299

Other real estate owned, net:
Residential mortgage	$	-	$	-	$	288	$	288
Total	$	-	$	-	$	288	$	288

	June 30, 2018
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
	(In Thousands)
Impaired loans:
Residential mortgage	$	-	$	-	$	3,562	$	3,562
Non-residential mortgage		-		-		794		794
Commercial business		-		-		113		113
Total	$	-	$	-	$	4,469	$	4,469

The following table presents additional quantitative information about assets measured at fair value on a non-recurring basis and for which the Company has utilized adjusted Level 3 inputs to determine fair value:

	December 31, 2018
	Fair Value		Valuation Techniques		Unobservable Input		Range	Weighted Average
	(In Thousands)
Impaired loans:
Residential mortgage	$	3,446	Market valuation of underlying collateral	⁽¹⁾	Adjustments to reflect current conditions/selling costs	⁽²⁾	6% - 21%		9.35	%
Non-residential mortgage		791	Market valuation of underlying collateral	⁽¹⁾	Adjustments to reflect current conditions/selling costs	⁽²⁾	11% - 12%		11.74	%
Commercial business		62	Market valuation of underlying collateral	⁽¹⁾	Adjustments to reflect current conditions/selling costs	⁽²⁾	0% - 10%		6.46	%
Total	$	4,299

Other real estate owned, net:
Residential mortgage	$	288	Market valuation of underlying collateral	⁽³⁾	Adjustments to reflect current conditions/selling costs	⁽²⁾	5.00%		5.00	%
Total	$	288

June 30, 2018

Fair

Value

Valuation

Techniques

Unobservable

Input

Range

Weighted

Average

(In Thousands)

Impaired loans:

Residential mortgage

3,562

Market valuation of

underlying collateral

⁽¹⁾

Adjustments to reflect current

conditions/selling costs

⁽²⁾

6% - 26%

12.34

Non-residential mortgage

794

Market valuation of

underlying collateral

⁽¹⁾

Adjustments to reflect current

conditions/selling costs

⁽²⁾

14% - 15%

14.07

Commercial business

113

Market valuation of

underlying collateral

⁽¹⁾

Adjustments to reflect current

conditions/selling costs

⁽²⁾

10% - 24%

14.54

Total

4,469

(1)	The fair value of impaired loans is generally determined based on an independent appraisal of the fair value of a loan’s underlying collateral.

(2)	The fair value basis of impaired loans and other real estate owned is adjusted to reflect management estimates of selling costs including, but not necessarily limited to, real estate brokerage commissions and title transfer fees.

(3)	The fair value basis of other real estate owned is generally determined based upon the lower of an independent appraisal of the property’s fair value or the applicable listing price or contracted sales price.

At December 31, 2018, impaired loans valued using Level 3 inputs comprised loans with principal balances totaling $4.7 million and valuation allowances of $352,000 reflecting fair values of $4.3 million. By comparison, at June 30, 2018, impaired loans valued using Level 3 inputs comprised loans with principal balances totaling $4.8 million and valuation allowances of $306,000 reflecting fair values of $4.5 million.

Once a loan is foreclosed, the fair value of the other real estate owned continues to be evaluated based upon the fair value of the repossessed real estate originally securing the loan. At December 31, 2018, the Company held other real estate owned totaling $288,000 whose carrying value was written down utilizing Level 3 inputs. At June 30, 2018, the Company held no other real estate owned whose carrying value was written down utilizing Level 3 inputs.

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of December 31, 2018 and June 30, 2018:

	December 31, 2018
	Carrying Amount		Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(In Thousands)
Financial assets:
Cash and cash equivalents	$	51,483	$	51,483	$	51,483	$	-	$	-
Investment securities available for sale		666,602		666,602		-		665,602		1,000
Investment securities held to maturity		598,318		592,151		-		592,151		-
Loans held-for-sale		1,001		1,001		-		1,001		-
Net loans receivable		4,719,866		4,588,099		-		-		4,588,099
FHLB Stock		64,514		-		-		-		-
Interest receivable		19,435		19,435		6		5,060		14,369
Interest rate swaps		22,109		22,109		-		22,109		-

Financial liabilities:
Deposits		4,173,434		4,160,515		2,287,548		-		1,872,967
Borrowings		1,310,547		1,314,802		-		-		1,314,802
Interest payable on deposits		1,446		1,446		-		1,446		-
Interest payable on borrowings		3,866		3,866		-		-		3,866

	June 30, 2018
	Carrying Amount		Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(In Thousands)
Financial assets:
Cash and cash equivalents	$	128,864	$	128,864	$	128,864	$	-	$	-
Investment securities available for sale		725,085		725,085		-		724,085		1,000
Investment securities held to maturity		589,730		579,499		-		579,499		-
Loans held-for-sale		863		863		-		863		-
Net loans receivable		4,470,483		4,367,150		-		-		4,367,150
FHLB Stock		59,004		-		-		-		-
Interest receivable		18,510		18,510		32		5,252		13,226
Interest rate swaps and caps		31,881		31,881				31,881

Financial liabilities:
Deposits		4,073,604		4,055,543		2,056,966		-		1,998,577
Borrowings		1,198,646		1,199,601		-		-		1,199,601
Interest payable on deposits		675		675		-		675		-
Interest payable on borrowings		2,427		2,427		-		-		2,427

Commitments. The fair value of commitments to fund credit lines and originate or participate in loans held in portfolio or loans held for sale is estimated using fees currently charged to enter into similar agreements taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, including those relating to loans held for sale that are considered derivative instruments for financial statement reporting purposes, the fair value also considers the difference between current levels of interest and the committed rates. The carrying value, represented by the net deferred fee arising from the unrecognized commitment, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment using fees currently charged to enter into similar agreements with similar credit risk, is not considered material for disclosure.

Limitations. Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire holdings of a particular financial instrument. Because no fair value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature, involve uncertainties and matters of judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

The fair value estimates are based on existing on-and-off balance sheet financial instruments without attempting to value anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial assets and liabilities include premises and equipment, and advances from borrowers for taxes and insurance. In addition, the ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.

Finally, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates which must be made given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies introduces a greater degree of subjectivity to these estimated fair values.

- 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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