NOTE 15 – FAIR VALUE

Financial Instruments Measured at 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 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.

Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety.

The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

The following presents the assets and liabilities as of December 31, 2019 and 2018 which are measured at fair value on a recurring basis, aggregated by the level in the fair value hierarchy within which those measurements fall, and the financial instruments carried on the consolidated balance sheet by caption and by level in the fair value hierarchy, for which a nonrecurring change in fair value has been recorded:


	December 31, 2019
									Total Gains
(Dollars in thousands)	Total		Level 1		Level 2		Level 3		(Losses)
Assets
Recurring fair value measurements:
Securities available for sale:
Obligations of U.S. Government entities and agencies	$	12,436	$	—	$	—	$	12,436
States and political subdivisions		1,279		—		1,279		—
Mortgage-backed GSE residential		1,980		—		1,980		—
Total securities available for sale		15,695		—		3,259		12,436

SBA servicing asset		8,162		—		—		8,162
Interest only strip		26		—		—		26
	$	23,883	$	—	$	3,259	$	20,624
Non-recurring fair value measurements:
Impaired loans	$	4,523	$	—	$	—	$	4,523	$	338


	December 31, 2018
									Total Gains
(Dollars in thousands)	Total		Level 1		Level 2		Level 3		(Losses)
Assets
Recurring fair value measurements:
Securities available for sale:
Obligations of U.S. Government entities and agencies	$	15,183	$	—	$	—	$	15,183
States and political subdivisions		1,213		—		1,213		—
Mortgage-backed GSE residential		2,492		—		2,492		—
Total securities available for sale		18,888		—		3,705		15,183

SBA servicing asset		8,419		—		—		8,419
Interest only strip		27		—		—		27
	$	27,334	$	—	$	3,705	$	23,629
Non-recurring fair value measurements:
Impaired loans	$	3,472	$	—	$	—	$	3,472	$	169

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

Securities, Available for Sales: The Company carries securities available for sale at fair value. For securities where quoted prices are not available (Level 2), 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 bond’s terms and conditions, among other things. The investments in the Company’s portfolio are generally not quoted on an exchange but are actively traded in the secondary institutional markets.

The Company owns certain SBA investments that for which the fair value is determined using Level 3 hierarchy inputs and assumptions as the trading market for such securities was determined to be “not active.” This determination was based on the limited number of trades or, in certain cases, the existence of no reported trades. Discounted cash flows are calculated by a third party using interest rate curves that are updated to incorporate current market conditions, including prepayment vectors and credit risk. During time when trading is more liquid, broker quotes are used to validate the model.

SBA Servicing Assets and Interest Only Strip: The fair values of the Company’s servicing assets are determined using Level 3 inputs. All separately recognized servicing assets and servicing liabilities are initially measured at fair value initially and at each reporting date and changes in fair value are reported in earnings in the period in which they occur.

The fair values of the Company’s interest-only strips are determined using Level 3 inputs. When the Company sells loans to others, it may hold interest-only strips, which is an interest that continues to be held by the transferor in the securitized receivable. It may also obtain servicing assets or assume servicing liabilities that are initially measured at fair value. Gain or loss on sale of the receivables depends in part on both (a) the previous carrying amount of the financial assets involved in the transfer, allocated between the assets sold and the interests that continue to be held by the transferor based on their relative fair value at the date of transfer, and (b) the proceeds received. To obtain fair values, quoted market prices are used if available. However, quotes are generally not available for interests that continue to be held by the transferor, so the Company generally estimates fair value based on the future expected cash flows estimated using management’s best estimates of the key assumptions — credit losses and discount rates commensurate with the risks involved.

Under certain circumstances we make adjustments to fair value for our assets and liabilities although they are not measured at fair value on an ongoing basis.

Impaired loans: Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or fair value. Fair value is measured based on the value of the collateral securing these loans and is classified at a Level 3 in the fair value hierarchy. Collateral may include real estate, or business assets including equipment, inventory and accounts receivable. The value of real estate collateral is determined based on an appraisal by qualified licensed appraisers hired by the Company. The value of business equipment is based on an appraisal by qualified licensed appraisers hired by the Company if significant, or the equipment’s net book value on the business’ financial statements. Inventory and accounts receivable collateral are valued based on independent field examiner review or aging reports. Appraisals may utilize a single valuation approach or a combination or 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 for similar loans and collateral underlying such loans. Appraised values are reviewed by management using historical knowledge, market considerations, and knowledge of the client and client’s business.

Foreclosed real estate: Foreclosed real estate is adjusted to fair value upon transfer of the loans to foreclosed real estate. Subsequently, foreclosed real estate is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices or appraised values of the collateral and is classified as nonrecurring Level 3. Adjustments are routinely made in the appraisal process by the independent appraisers engaged by the Company to adjust for differences between the comparable sales. Appraised values are reviewed by management using our market knowledge and historical experience.

Changes in level 3 fair value measurements

The table below presents a reconciliation of assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2019, 2018 and 2017:


	Obligations of		SBA
	U.S. Government		Servicing		Interest Only
(Dollars in thousands)	Entities and Agencies		Asset		Strip		Liabilities

Fair value, January 1, 2019	$	15,183	$	8,419	$	27	$	—
Total loss included in income		—		(257)		(1)		—
Settlements		—		—		—		—
Prepayments/paydowns		(2,747)		—		—		—
Transfers in and/or out of level 3		—		—		—		—
Fair value, December 31, 2019	$	12,436	$	8,162	$	26	$	—

Fair value, January 1, 2018	$	16,661	$	9,329	$	36	$	—
Total loss included in income		—		(910)		(9)		—
Settlements		—		—		—		—
Prepayments/paydowns		(1,478)		—		—		—
Transfers in and/or out of level 3		—		—		—		—
Fair value, December 31, 2018	$	15,183	$	8,419	$	27	$	—

Fair value, January 1, 2017	$	23,916	$	8,823	$	30	$	—
Total gain included in income		—		506		6		—
Settlements		—		—		—		—
Prepayments/paydowns		(7,255)		—		—		—
Transfers in and/or out of level 3		—		—		—		—
Fair value, December 31, 2017	$	16,661	$	9,329	$	36	$	—

There were no gains or losses included in earnings for securities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the periods presented above. The only activity for these securities were prepayments. There were no purchases, sales, or transfers into and out of Level 3. The following table presents quantitative information about recurring Level 3 fair value measures at December 31, 2019 and 2018:


	Valuation	Unobservable	General
	Technique	Input	Range
December 31, 2019
Obligations of U.S. Government entities and agencies	Discounted Cash Flows	Discount Rate	0%-3%
SBA servicing asset and interest only strip	Discounted Cash Flows	Prepayment speed	10.82%-16.54%
		Discount rate	5.80%-12.06%

December 31, 2018
Obligations of U.S. Government entities and agencies	Discounted Cash Flows	Discount Rate	0%-3%
SBA servicing asset and interest only strip	Discounted Cash Flows	Prepayment speed	6.82%-12.87%
		Discount rate	8.78%-14.56%

The carrying amounts and estimated fair values of the Company’s financial instruments at December 31, 2019 and 2018 are as follows:


	Carrying			Estimated Fair Value at December 31, 2019
(Dollars in thousands)	Amount		Level 1		Level 2		Level 3		Total
Financial Assets:
Cash, due from banks, and federal funds sold	$	276,413	$	—	$	276,413	$	—	$	276,413
Securities purchased under agreements to resell		15,000		—		15,000		—		15,000
Investment securities		15,695		—		3,259		12,436		15,695
FHLB stock		3,842		—		—		—		N/A
Loans, net		1,154,323		—		—		1,169,214		1,169,214
Loans held for sale		85,793		—		88,178		—		88,178
Accrued interest receivable		5,101		—		—		5,101		5,101
SBA servicing assets		8,162		—		—		8,162		8,162
Mortgage servicing assets		18,068		—		—		19,035		19,035
Interest only strips		26		—		—		26		26
Financial Liabilities:
Deposits		1,307,377		—		1,308,946		—		1,308,946
Federal Home Loan Bank advances		60,000		—		60,000		—		60,000
Other borrowings		3,129		—		3,129		—		3,129
Accrued interest payable		890		—		890		—		890


	Carrying		Estimated Fair Value at December 31, 2018
(Dollars in thousands)	Amount		Level 1		Level 2		Level 3		Total
Financial Assets:
Cash, due from banks, and federal funds sold	$	138,427	$	—	$	138,427	$	—	$	138,427
Securities purchased under agreements to resell		15,000		—		15,000		—		15,000
Investment securities		18,888		—		3,705		15,183		18,888
FHLB stock		1,163		—		—		—		N/A
Loans, net		1,136,930		—		—		1,166,945		1,166,945
Loans held for sale		56,865		—		56,865		—		56,865
Accrued interest receivable		4,957		—		—		4,957		4,957
SBA servicing asset		8,419		—		—		8,419		8,419
Mortgage servicing assets		14,934		—		—		16,460		16,460
Interest only strips		27		—		—		27		27
Financial Liabilities:
Deposits		1,244,232		—		1,242,863		—		1,242,863
Other borrowings		4,257		—		4,257		—		4,257
Accrued interest payable		1,251		—		1,251		—		1,251