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FAIR VALUE OF ASSETS AND LIABILITIES

6 Months Ended

Jun. 30, 2020

FAIR VALUE OF ASSETS AND LIABILITIES

FAIR VALUE OF ASSETS AND LIABILITIES

14.

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.

Interest Rate Swap designated as a cashflow hedge- The Company works directly with a third party vendor to provide periodic valuations for its interest rate risk management agreements to determine fair value of its interest rate swaps executed for interest rate risk management. The vendor utilizes standard valuation methodologies applicable to interest rate derivatives based on readily observable market data and are therefore considered Level 2 valuations.

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 76% and 85% at June 30, 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)

June 30, 2020
Assets

Securities available for sale		$	—		$	262,710		$	—		$	262,710
Loans held for sale			—			158,898			—			158,898
Mortgage servicing rights			—			16,127			—			16,127
Derivative loan commitments			—			—			10,822			10,822
Forward loan sale commitments			—			—			22			22
Interest rate swaps			—			46,855			—			46,855
		$	—		$	484,590		$	10,844		$	495,434
Liabilities

Derivative loan commitments		$	—		$	—		$	83		$	83
Forward loan sale commitments			—			—			1,984			1,984
Interest rate management agreements			—			1,762			—			1,762
Interest rate swaps			—			46,855			—			46,855
		$	—		$	48,617		$	2,067		$	50,684

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 and six months ended June 30, 2020 and 2019, the changes in Level 3 assets and liabilities that are measured at fair value on a recurring basis.


		Three Months Ended June 30,						Six Months Ended June 30,
		2020			2019			2020			2019

		(in thousands)

Assets: Derivative and Forward Loan Sale Commitments:

Balance at beginning of period		$	8,078		$	1,732		$	1,411		$	1,261

Total gains included in net income ⁽¹⁾			2,766			762			9,433			1,233
Balance at end of period		$	10,844		$	2,494		$	10,844		$	2,494

Changes in unrealized gains relating to instruments at period end		$	10,844		$	2,494		$	10,844		$	2,494


		Three Months Ended June 30,						Six Months Ended June 30,
		2020			2019			2020			2019

		(in thousands)

Liabilities: Derivative and Forward Loan Sale Commitments:

Balance at beginning of period		$	(5,480)		$	(539)		$	(332)		$	(630)

Total gains (losses) included in net income ⁽¹⁾			3,413			(643)			(1,735)			(552)
Balance at end of period		$	(2,067)		$	(1,182)		$	(2,067)		$	(1,182)

Changes in unrealized losses relating to instruments at period end		$	(2,067)		$	(1,182)		$	(2,067)		$	(1,182)

⁽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 June 30, 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.


		June 30, 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			—			—			13,244				—			—			2,272
Commercial			—			—			5,300				—			—			1,606
Other real estate owned and repossessed assets			—			—			537				—			—			719
		$	—		$	—		$	27,617			$	—		$	—		$	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 June 30, 2020 and December 31, 2019, respectively. Losses on fully charged off loans are not included in the table.


		Three Months Ended June 30,						Six Months Ended June 30,
		2020			2019			2020			2019

		(in thousands)

Impaired loans
Residential		$	584		$	—		$	581		$	—
Commercial			449			395			449			749
Other real estate owned and repossessed assets			—			67			55			67
		$	1,033		$	462		$	1,085		$	816

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.


		June 30, 2020
		Carrying			Fair Value
		Amount			Level 1			Level 2			Level 3			Total

		(in thousands)

Financial assets:
Cash and cash equivalents		$	248,972		$	248,972		$	—		$	—		$	248,972
Securities available for sale			262,710			—			262,710			—			262,710
Federal Home Loan Bank stock			15,786			N/A			N/A			N/A			N/A
Loans held for sale			158,898			—			158,898			—			158,898
Loans, net			3,437,915			—			—			3,479,805			3,479,805
Retirement plan annuities			13,537			—			—			13,537			13,537
Accrued interest receivable			11,979			—			11,979			—			11,979

Financial liabilities:
Deposits			3,308,674			—			—			3,316,033			3,316,033
Borrowed funds			341,114			—			344,825			—			344,825
Subordinated debt			33,970			—			—			35,481			35,481
Mortgagors' escrow accounts			8,299			—			—			8,299			8,299
Accrued interest payable			1,451			—			1,451			—			1,451

Derivative loan commitments:
Assets			10,822			—			—			10,822			10,822
Liabilities			83			—			—			83			83

Interest rate management agreements:
Liabilities			1,762			—			1,762			—			1,762

Interest rate swap agreements:
Assets			46,855			—			46,855			—			46,855
Liabilities			46,855			—			46,855			—			46,855

Forward loan sale commitments:
Assets			22			—			—			22			22
Liabilities			1,984			—			—			1,984			1,984


		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
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

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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