13.FAIR VALUE OF ASSETS AND LIABILITIES

Determination of Fair Value

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of an asset or liability 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 Company’s various assets or liabilities. 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 asset or liability.

The following methods and assumptions were used by the Company in estimating fair value disclosures:

Cash and cash equivalents - The carrying amounts of cash and short-term instruments approximate fair values based on the short-term nature of the assets.

Securities - All fair value measurements are obtained from a third-party pricing service and are not adjusted by management. Securities measured at fair value in Level 1 are based on quoted market prices in an active exchange market. Securities measured at fair value in Level 2 are based on pricing models that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes, credit spreads and new issue data.

FHLB stock - FHLB stock has restrictions placed on its transferability. As a result, the fair value of FHLB stock was not practicable to determine.

Loans held for sale - Fair values are based on prevailing market prices for similar commitments.

Loans - Fair values for mortgage loans and other loans are estimated using discounted cash flow analyses, using market interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using comparable sales or recent appraisals, adjusted for selling costs and other expenses.

Retirement plan annuities - The carrying value of the annuities are based on their contract values which approximate fair value.

MSRs - Fair value is based on a third-party valuation model that calculates the present value of estimated future net servicing income and includes observable market data such as prepayment speeds and default and loss rates.

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

Borrowed funds - The fair values of borrowed funds are estimated using discounted cash flow analyses based on the current incremental borrowing rates in the market for similar types of borrowing arrangements.

Accrued interest - The carrying amounts of accrued interest approximate fair value.

Forward loan sale commitments and derivative loan commitments - Forward loan sale commitments and derivative loan commitments are based on fair values of the underlying mortgage loans and the probability of such commitments being exercised. The assumptions for pull-through rates are derived from internal data and adjusted using management judgment. Derivative loan commitments include the value of servicing rights and non-refundable costs of originating the loan based on the Company’s internal cost analysis that is not observable. The weighted average pull-through rate for derivative loan commitments was approximately 82% and 85% at March 31, 2020 and December 31, 2019, respectively.

Interest rate swaps and risk participation agreements - The Company’s interest rate swaps are traded in over-the-counter markets where quoted market prices are not readily available. For these interest rate derivatives, fair value is determined by a third party utilizing models that use primarily market observable inputs, such as swap rates and yield curves. The pricing models used to value interest rate swaps calculate the sum of each instrument’s fixed and variable cash flows, which are then discounted using an appropriate yield curve to arrive at the fair value of each swap. The pricing models do not contain a high level of subjectivity as the methodologies used do not require significant judgment. The Company incorporates credit valuation analysis for counterparty nonperformance risk in the fair value measurement, including the impact of netting applicable credit enhancements such as available collateral.

Off-balance sheet credit-related instruments - Fair values for off-balance sheet, credit related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of off-balance sheet instruments are immaterial.

Fair Value Hierarchy

The Company groups its assets and 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. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 – Valuation is based on observable inputs other than Level 1 prices, such as 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 assets or liabilities.

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 assets and liabilities whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as assets and liabilities for which the determination of fair value requires significant management judgment or estimation.

Transfers between levels are recognized at the end of the reporting period, if applicable. There were no transfers during the periods presented.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below:


							Total
	Level 1		Level 2		Level 3		Fair Value
	(in thousands)

March 31, 2020
Assets

Securities available for sale	$	—	$	249,789	$	—	$	249,789
Loans held for sale		—		118,316		—		118,316
Mortgage servicing rights		—		13,207		—		13,207
Derivative loan commitments		—		—		8,065		8,065
Forward loan sale commitments		—		—		13		13
Interest rate swaps		—		43,278		—		43,278
	$	—	$	424,590	$	8,078	$	432,668
Liabilities

Derivative loan commitments	$	—	$	—	$	1,663	$	1,663
Forward loan sale commitments		—		—		3,817		3,817
Interest rate swaps		—		43,278		—		43,278
	$	—	$	43,278	$	5,480	$	48,758

December 31, 2019
Assets

Securities available for sale	$	—	$	239,473	$	—	$	239,473
Loans held for sale		—		110,552		—		110,552
Mortgage servicing rights		—		17,150		—		17,150
Derivative loan commitments		—		—		1,385		1,385
Forward loan sale commitments		—		—		26		26
Interest rate swaps		—		15,092		—		15,092
	$	—	$	382,267	$	1,411	$	383,678
Liabilities

Derivative loan commitments	$	—	$	—	$	174	$	174
Forward loan sale commitments		—		—		158		158
Interest rate swaps		—		15,092		—		15,092
	$	—	$	15,092	$	332	$	15,424

The table below presents, for the three months ended March 31, 2020 and 2019, the changes in Level 3 assets and liabilities that are measured at fair value on a recurring basis.


	Three Months Ended March 31,
	2020		2019
	(in thousands)

Assets: Derivative and Forward Loan Sale Commitments:

Balance at beginning of period	$	1,411	$	1,261

Total gains included in net income (1)		6,667		471
Balance at end of period	$	8,078	$	1,732

Changes in unrealized gains relating to instruments at period end	$	8,078	$	1,732


Liabilities: Derivative and Forward Loan Sale Commitments:

Balance at beginning of period	$	(332)	$	(630)

Total gains (losses) included in net income (1)		(5,148)		91
Balance at end of period	$	(5,480)	$	(539)

Changes in unrealized losses relating to instruments at period end	$	(5,480)	$	(539)

(1) Included in mortgage banking income on the Consolidated Statements of Net Income.

Assets Measured at Fair Value on a Non-recurring Basis

The Company may also be required, from time to time, to measure certain other financial assets on a nonrecurring basis in accordance with generally accepted accounting principles. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. There were no liabilities measured at fair value on a non-recurring basis at March 31, 2020 and December 31, 2019. The following table summarizes the fair value hierarchy used to determine each adjustment and the carrying value of the related individual assets.


	March 31, 2020						December 31, 2019
	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3
	(in thousands)

Asset held for sale	$	—	$	—	$	8,536	$	—	$	—	$	8,536
Impaired loans:
Residential		—		—		1,975		—		—		2,272
Commercial real estate		—		—		3,096		—		—		—
Commercial		—		—		419		—		—		1,606
Other real estate owned and repossessed assets		—		—		538		—		—		719
	$	—	$	—	$	14,564	$	—	$	—	$	13,133

Losses in the following table represent the amount of the fair value adjustments recorded during the period on the carrying value of the assets held at March 31, 2020 and December 31, 2019, respectively. Losses on fully charged off loans are not included in the table.


	Three Months Ended March 31,
	2020		2019
	(in thousands)

Asset held for sale	$	—	$	—
Impaired loans
Residential		2		325
Commercial real estate		1,174		—
Commercial		194		—
Other real estate owned and repossessed assets		55		42
	$	1,425	$	367

Losses applicable to write-downs of impaired loans and other real estate owned and repossessed assets are based on the appraised value of the underlying collateral less estimated costs to sell. The losses on impaired loans are not recorded directly as an adjustment to current earnings, but rather as a component in determining the allowance for loan losses. The losses on other real estate owned and repossessed assets represent adjustments in valuation recorded during the time period indicated and not for losses incurred on sales. Appraised values are typically based on a blend of (a) an income approach using observable cash flows to measure fair value, and (b) a market approach using observable market comparables. These appraised values may be discounted based on management’s historical knowledge, expertise or changes in market conditions from time of valuation.

Summary of Fair Values of Financial Instruments

The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments are as follows. Certain financial instruments and all nonfinancial instruments are exempt from disclosure requirements. Accordingly, the aggregate fair value amounts presented herein may not necessarily represent the underlying fair value of the Company.


	March 31, 2020
	Carrying		Fair Value
	Amount		Level 1		Level 2		Level 3		Total
	(in thousands)

Financial assets:
Cash and cash equivalents	$	235,420	$	235,420	$	—	$	—	$	235,420
Securities available for sale		249,789		—		249,789		—		249,789
Federal Home Loan Bank stock		13,530		N/A		N/A		N/A		N/A
Loans held for sale		118,316		—		118,316		—		118,316
Loans, net		3,157,481		—		—		3,212,565		3,212,565
Retirement plan annuities		13,434		—		—		13,434		13,434
Mortgage servicing rights		13,207		—		13,207		—		13,207
Accrued interest receivable		9,710		—		9,710		—		9,710

Financial liabilities:
Deposits		3,021,224		—		—		3,029,586		3,029,586
Borrowed funds		285,123		—		287,917		—		287,917
Subordinated debt		33,938		—		—		37,026		37,026
Mortgagors' escrow accounts		8,279		—		—		8,279		8,279
Accrued interest payable		1,337		—		1,337		—		1,337

Derivative loan commitments:
Assets		8,065		—		—		8,065		8,065
Liabilities		1,663		—		—		1,663		1,663

Interest rate swap agreements:
Assets		43,278		—		43,278		—		43,278
Liabilities		43,278		—		43,278		—		43,278

Forward loan sale commitments:
Assets		13		—		—		13		13
Liabilities		3,817		—		—		3,817		3,817


	December 31, 2019
	Carrying		Fair Value
	Amount		Level 1		Level 2		Level 3		Total
	(in thousands)

Financial assets:
Cash and cash equivalents	$	211,616	$	211,616	$	—	$	—	$	211,616
Securities available for sale		239,473		—		239,473		—		239,473
Securities held to maturity		26,372		—		26,927		—		26,927
Federal Home Loan Bank stock		17,121		N/A		N/A		N/A		N/A
Loans held for sale		110,552		—		110,552		—		110,552
Loans, net		3,147,498		—		—		3,176,442		3,176,442
Retirement plan annuities		13,333		—		—		13,333		13,333
Mortgage servicing rights		17,150		—		17,150		—		17,150
Accrued interest receivable		9,807		—		9,807		—		9,807

Financial liabilities:
Deposits		2,942,873		—		—		2,943,899		2,943,899
Borrowed funds		354,132		—		354,881		—		354,881
Subordinated debt		33,907		—		—		34,619		34,619
Mortgagors' escrow accounts		6,053		—		—		6,053		6,053
Accrued interest payable		1,669		—		1,669		—		1,669

Derivative loan commitments:
Assets		1,385		—		—		1,385		1,385
Liabilities		174		—		—		174		174

Interest rate swap agreements:
Assets		15,092		—		15,092		—		15,092
Liabilities		15,092		—		15,092		—		15,092

Forward loan sale commitments:
Assets		26		—		—		26		26
Liabilities		158		—		—		158		158