(9) Fair Value Measurements and Disclosures

The Corporation uses fair value measurements to record fair value adjustments to certain assets and liabilities. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Corporation’s various financial instruments. 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. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation techniques or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

In accordance with this guidance, the Corporation groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2 – Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on 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 for substantially the full term of the asset or liability.

Level 3 – Valuation is based on 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 determination of fair value requires significant management judgment or estimation.

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis.

Securities

The fair value of securities available‑for‑sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices.

Mortgage Loans Held-for-Sale

The fair value of loans held for sale is based on secondary market prices.

Mortgage Loans Held-for-Investment

The fair value of mortgage loans held for investment is based on the price secondary markets are currently offering for similar loans using observable market data.

Derivative Financial Instruments

The fair value of forward commitments and interest rate swaps is based on market pricing and therefore are considered Level 2. Derivatives classified as Level 3 consist of interest rate lock commitments related to mortgage loan commitments. The determination of fair value includes assumptions related to the likelihood that a commitment will ultimately result in a closed loan, which is a significant unobservable assumption. A significant increase or decrease in the external market price would result in a significantly higher or lower fair value measurement.

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2020 and December 31, 2019 are as follows:


	March 31, 2020
(dollars in thousands)	Total		Level 1	Level 2	Level 3
Assets
Securities available for sale:
U.S. asset backed securities	$	20,661	—	20,661	—
U.S. government agency mortgage-backed securities		8,132	—	8,132	—
U.S. government agency collateralized mortgage obligations		37,342	—	37,342	—
State and municipal securities		24,417	—	24,417	—
Investments in mutual funds		1,025	—	1,025	—
Mortgage loans held-for-sale		107,506	—	107,506	—
Mortgage loans held-for-investment		10,553	—	10,553	—
Interest rate lock commitments		4,021	—	—	4,021
Customer derivatives - Interest rate swaps		1,057	—	1,057	—
Total	$	214,714	—	210,693	4,021

Liabilities
Interest rate lock commitments		332	—	—	332
Forward commitments		2,424	—	2,424	—
Customer derivatives - Interest rate swaps		1,183	—	1,183	—
	$	3,939	—	3,607	332


	December 31, 2019
(dollars in thousands)	Total		Level 1	Level 2	Level 3
Assets
Securities available for sale:
U.S. asset backed securities	$	11,866	—	11,866	—
U.S. government agency mortgage-backed securities		5,497	—	5,497	—
U.S. government agency collateralized mortgage obligations		35,223	—	35,223	—
State and municipal securities		6,270	—	6,270	—
Investments in mutual funds		1,009	—	1,009	—
Mortgage loans held-for-sale		33,704	—	33,704	—
Mortgage loans held-for-investment		10,546	—	10,546	—
Interest rate lock commitments		504	—	—	504
Forward commitments		504	—	6	—
Customer derivatives - Interest rate swaps		382	—	382	—
Total	$	105,505	—	104,503	504

Liabilities
Interest rate lock commitments		157	—	—	157
Forward commitments		119	—	119	—
Customer derivatives - Interest rate swaps		431	—	431	—
	$	707	—	550	157

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2020 and December 31, 2019 are as follows:


	March 31, 2020
(dollars in thousands)	Total		Level 1	Level 2	Level 3
Mortgage servicing rights	$	423	—	—	423
SBA loan servicing rights		469	—	—	469
Impaired loans (1)		962	—	—	962
Other real estate owned (2)		—	—	—	—
Total	$	1,854	—	—	1,854


	December 31, 2019
(dollars in thousands)	Total		Level 1	Level 2	Level 3
Mortgage servicing rights	$	446	—	—	446
SBA loan servicing rights		337	—	—	337
Impaired loans (1)		804	—	—	804
Other real estate owned (2)		120	—	—	120
Total	$	1,707	—	—	1,707

(1)

Impaired loans are those in which the Corporation has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input is significant to the fair value measurements. The recorded investment in impaired loans noted above was $9.2 million and $7.3 million as of March 31, 2020 and December 21, 2019, respectively.

(2)

Real estate properties acquired through, or in lieu of, foreclosure are to be sold and are carried at fair value less estimated cost to sell. Fair value is based upon independent market prices or appraised value of the property. These assets are included in Level 3 fair value based upon the lowest level of input that is significant to the fair value measurement. Appraised values may be discounted based on management’s expertise, historical knowledge, changes in market conditions from the time of valuation and/or estimated costs to sell.

Below is management’s estimate of the fair value of all financial instruments, whether carried at cost or fair value on the Corporation’s balance sheet. The following information should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair value of the Corporation’s financial instruments:

Cash and Cash Equivalents

The carrying amounts reported in the balance sheet for cash and short‑term instruments approximate those assets’ fair values.

Loans Receivable

The fair value of loans receivable is estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate‑risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair value below is reflective of an exit price.

Loan Servicing Rights

The Corporation estimates the fair value of mortgage servicing rights and SBA loan servicing rights using discounted cash flow models that calculate the present value of estimated future net servicing income. The model uses readily available prepayment speed assumptions for the interest rates of the portfolios serviced. These servicing rights are classified within Level 3 in the fair value hierarchy based upon management’s assessment of the inputs. The Corporation reviews the servicing rights portfolios on a quarterly basis for impairment.

Impaired Loans

Impaired loans are those in which the Corporation has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third‑party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Restricted Investment in Bank Stock

The carrying amount of restricted investment in bank stock approximates fair value, and considers the limited marketability of such securities.

Accrued Interest Receivable and Payable

The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.

Deposit Liabilities

The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed‑rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Short‑Term Borrowings

The carrying amounts of short‑term borrowings approximate their fair values.

Long‑Term Debt

Fair values of FHLB advances are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.

Subordinated Debt

Fair values of junior subordinated debt are estimated using discounted cash flow analysis, based on market rates currently offered on such debt with similar credit risk characteristics, terms and remaining maturity.

Off‑Balance Sheet Financial Instruments

Off-balance sheet instruments are primarily comprised of loan commitments, which are generally priced at market at the time of funding. Fees on commitments to extend credit and stand-by letters of credit are deemed to be immaterial and these instruments are expected to be settled at face value or expire unused. It is impractical to assign any fair value to these instruments and as a result they are not included in the table below. Fair values assigned to the notional value of interest rate lock commitments and forward sale contracts are based on market quotes.

The estimated fair values of the Corporation’s financial instruments at March 31, 2020 and December 31, 2019 are as follows:


		March 31, 2020			December 31, 2019
	Fair Value	Carrying			Carrying
(dollars in thousands)	Hierarchy Level	amount		Fair value	amount	Fair value
Financial assets:
Cash and cash equivalents	Level 1	$	37,522	37,522	39,371	39,371
Securities available-for-sale	Level 2		90,552	90,552	58,856	58,856
Securities held-to-maturity	Level 2		7,747	7,946	8,780	9,003
Equity investments	Level 2		1,025	1,025	1,009	1,009
Mortgage loans held-for-sale	Level 2		107,506	107,506	33,704	33,704
Loans receivable, net of the allowance for loan and lease losses	Level 3		999,910	1,035,010	944,651	973,057
Mortgage loans held-for-investment	Level 2		10,553	10,553	10,546	10,546
Interest rate lock commitments	Level 3		4,021	4,021	504	504
Forward commitments	Level 2		—	—	6	6
Restricted investment in bank stock	NA		8,347	NA	8,072	NA
Accrued interest receivable	Level 3		3,283	3,283	3,148	3,148
Customer derivatives - Interest rate swaps	Level 2		1,057	1,057	382	382
Financial liabilities:
Deposits	Level 2		993,753	1,116,400	851,168	880,400
Short-term borrowings	Level 2		129,707	129,707	123,676	123,678
Long-term debt	Level 2		5,023	5,100	3,123	3,123
Subordinated debentures	Level 2		40,885	39,080	40,962	40,962
Accrued interest payable	Level 2		1,578	1,578	1,088	1,088
Interest rate lock commitments	Level 3		332	332	157	157
Forward commitments	Level 2		2,424	2,424	119	119
Customer derivatives - Interest rate swaps	Level 2		1,183	1,183	431	431

		Notional			Notional
Off-balance sheet financial instruments:		amount		Fair value	amount	Fair value
Commitments to extend credit	Level 2	$	323,829	4,021	327,788	504
Letters of credit	Level 2		7,866	—	9,750	—

The following table includes a rollforward of interest rate lock commitments for which the Corporation utilized Level 3 inputs to determine fair value on a recurring basis for the three month peiod ended March 31, 2020 and 2019.


	Three Months Ended March 31,
	2020		2019
Balance at beginning of the period	$	504	310
Increase in value		3,517	19
Balance at end of the period	$	4,021	329

The following table details the valuation techniques for Level 3 interest rate lock commitments.

Significant

Fair Value

Unobservable

Range of

Weighted

Level 3

Valuation Technique

Input

Inputs

Average

March 31, 2020

4,021

Market comparable pricing

Pull through

1 - 99

91.70

December 31, 2019

504

Market comparable pricing

Pull through

1 - 99

93.41

Net realized gains of $3.3 million and $19 thousand due to changes in the fair value of interest rate lock commitments which are classified as Level 3 assets and liabilities for the three months ended March 31, 2020 and 2019, respectively, are recorded in non-interest income as net change in the fair value of derivative instruments in the Corporation’s consolidated statements of income.