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FAIR VALUE OF ASSETS AND LIABILITIES

9 Months Ended

Sep. 30, 2022

FAIR VALUE OF ASSETS AND LIABILITIES

FAIR VALUE OF ASSETS AND LIABILITIES

14.

FAIR VALUE OF ASSETS AND LIABILITIES

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 – Significant other 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.

•Level 3 – Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

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

Debt Securities – Available-for-sale debt securities are recorded at fair value on a recurring basis. When available, the Company uses quoted market prices to determine the fair value of debt securities; such items are classified as Level 1. There were no Level 1 securities held at September 30, 2022 and December 31, 2021.

Level 2 debt securities are traded less frequently than exchange-traded instruments. The fair value of these securities is determined using matrix pricing with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category includes obligations of U.S. government-sponsored enterprises, including mortgage-backed securities, individual name issuer trust preferred debt securities and corporate bonds.

Debt securities not actively traded whose fair value is determined through the use of cash flows utilizing inputs that are unobservable are classified as Level 3. There were no Level 3 securities held at September 30, 2022 and December 31, 2021.

Loans held for sale - The fair value of mortgage loans held for sale is estimated based on current market prices for similar loans in the secondary market and therefore are classified as Level 2 assets. There were no mortgage loans held for sale 90 days or more past due as of September 30, 2022 and December 31, 2021.

Collateral-Dependent Impaired Loans - The fair value of collateral-dependent loans that are deemed to be impaired is determined based upon the fair value of the underlying collateral. Such collateral primarily consists of real estate and, to a lesser extent, other business assets. For collateral-dependent loans for which repayment is dependent on the sale of the collateral, management adjusts the fair value for estimated costs to sell. For collateral-dependent loans for which repayment is dependent on the operation of the collateral, such as accruing TDR loans, estimated costs to sell are not incorporated into the measurement. Management may also adjust appraised values to reflect estimated market value declines or apply other discounts to appraised values resulting from its knowledge of the property. Internal valuations are utilized to determine the fair value of other business assets. Collateral-dependent impaired loans are categorized as Level 3.

Appraisals for collateral-dependent impaired loans are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, the Company reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.

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 DCF 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 DCF 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 93% and 88% at September 30, 2022 and December 31, 2021, 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.

Although the Company has determined that the majority of the inputs used to value its interest rate swaps and risk participation agreements fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with interest rate contracts and risk participation agreements utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. As of September 30, 2022 and December 31, 2021, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and determined that the credit valuation adjustments were not significant to the overall valuation of its derivatives. As a result, the Company classified its derivative valuations in their entirety as Level 2.

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 is immaterial.

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)

September 30, 2022
Assets

Securities available for sale		$	—		$	304,852		$	—		$	304,852
Loans held for sale			—			18,805			—			18,805
Mortgage servicing rights			—			49,861			—			49,861
Derivative loan commitments			—			—			901			901
Forward loan sale commitments			—			—			1,334			1,334
Interest rate management agreements			—			8,669			—			8,669
Interest rate swaps			—			29,243			—			29,243
		$	—		$	411,430		$	2,235		$	413,665
Liabilities

Derivative loan commitments		$	—		$	—		$	343		$	343
Forward loan sale commitments			—			—			16			16
Interest rate swaps			—			29,243			—			29,243
		$	—		$	29,243		$	359		$	29,602

December 31, 2021
Assets

Securities available for sale		$	—		$	394,036		$	—		$	394,036
Loans held for sale			—			45,642			—			45,642
Mortgage servicing rights			—			38,268			—			38,268
Derivative loan commitments			—			—			1,527			1,527
Forward loan sale commitments			—			—			56			56
Interest rate management agreements			—			1,663			—			1,663
Interest rate swaps			—			18,874			—			18,874
		$	—		$	498,483		$	1,583		$	500,066
Liabilities

Derivative loan commitments		$	—		$	—		$	95		$	95
Forward loan sale commitments			—			—			94			94
Interest rate swaps			—			19,214			—			19,214
		$	—		$	19,214		$	189		$	19,403

The table below presents, for the three and nine months ended September 30, 2022 and 2021, the changes in Level 3 assets and liabilities that are measured at fair value on a recurring basis.


		Three Months Ended September 30,						Nine Months Ended September 30,
		2022			2021			2022			2021

		(in thousands)

Assets: Derivative and Forward Loan Sale Commitments:

Balance at beginning of period		$	1,344		$	5,134		$	1,583		$	12,623

Total gains (losses) included in net income ⁽¹⁾			891			(1,103)			652			(8,592)
Balance at end of period		$	2,235		$	4,031		$	2,235		$	4,031

Changes in unrealized gains relating to instruments at period end		$	2,235		$	4,031		$	2,235		$	4,031


		Three Months Ended September 30,						Nine Months Ended September 30,
		2022			2021			2022			2021

		(in thousands)

Liabilities: Derivative and Forward Loan Sale Commitments:

Balance at beginning of period		$	(239)		$	(342)		$	(189)		$	(2,545)

Total gains (losses) included in net income ⁽¹⁾			(120)			270			(170)			2,473
Balance at end of period		$	(359)		$	(72)		$	(359)		$	(72)

Changes in unrealized losses relating to instruments at period end		$	(359)		$	(72)		$	(359)		$	(72)

⁽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 is required, on a non-recurring basis, to adjust the carrying value or provide valuation allowances for certain assets using fair value measurements in accordance with GAAP. The following is a summary of applicable non-recurring fair value measurements. There are no liabilities measured at fair value on a non-recurring basis.


		September 30, 2022										December 31, 2021
		Level 1			Level 2			Level 3				Level 1			Level 2			Level 3

		(in thousands)


Collateral-dependent impaired loans		$	—		$	—		$	8,996			$	—		$	—		$	21,615
Other real estate owned and repossessed assets			—			—			74				—			—			53
		$	—		$	—		$	9,070			$	—		$	—		$	21,668

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 September 30, 2022 and December 31, 2021, respectively. Losses on fully charged off loans are not included in the table.


		Three Months Ended September 30,						Nine Months Ended September 30,
		2022			2021			2022			2021

		(in thousands)


Collateral-dependent impaired loans		$	92		$	5,132		$	840		$	7,948
Other real estate owned and repossessed assets			—			—			—			24
		$	92		$	5,132		$	840		$	7,972

The table below presents quantitative information about significant unobservable inputs (Level 3) for assets measured at fair value on a nonrecurring basis at the dates indicated.


		Fair Value
		September 30,			December 31,			Valuation Technique
		2022			2021

		(in thousands)


Collateral-dependent impaired loans		$	5,862		$	21,615		Sales Comparison Approach ⁽¹⁾
Real estate owned and repossessed assets		$	—		$	—


⁽¹⁾ Fair value is generally determined through independent appraisals of the underlying collateral. The Company may also use another source of collateral assessment to determine a reasonable estimate of the fair value of the collateral. Appraisals may be adjusted by management for qualitative factors and estimated liquidation expenses. Unobservable inputs are adjustments for differences between the comparable sales. Residential real estate appraisals are generally discounted 0% - 20%. Commercial real estate loan appraisals are discounted 0% - 50%. Commercial and industrial appraisals are discounted 0-90%.

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.


		September 30, 2022
		Carrying			Fair Value
		Amount			Level 1			Level 2			Level 3			Total

		(in thousands)

Financial assets:
Cash and cash equivalents		$	85,954		$	85,954		$	—		$	—		$	85,954
Securities available for sale			304,852			—			304,852			—			304,852
Securities held to maturity			15,000			—			14,451			—			14,451
Federal Home Loan Bank stock			15,973			N/A			N/A			N/A			N/A
Loans held for sale			18,805			—			18,805			—			18,805
Loans, net			4,152,733			—			—			4,067,780			4,067,780
Retirement plan annuities			14,511			—			—			14,511			14,511
Accrued interest receivable			12,746			—			12,746			—			12,746

Financial liabilities:
Deposits			3,883,110			—			—			3,861,090			3,861,090
Borrowed funds			345,684			—			344,611			—			344,611
Subordinated debt			34,254			—			—			31,054			31,054
Mortgagors' escrow accounts			9,842			—			—			9,842			9,842
Accrued interest payable			950			—			950			—			950

Derivative loan commitments:
Assets			901			—			—			901			901
Liabilities			343			—			—			343			343

Interest rate management agreements:
Assets			8,669			—			8,669			—			8,669
Liabilities			—			—			—			—			—

Interest rate swap agreements:
Assets			29,243			—			29,243			—			29,243
Liabilities			29,243			—			29,243			—			29,243

Forward loan sale commitments:
Assets			1,334			—			—			1,334			1,334
Liabilities			16			—			—			16			16


		December 31, 2021
		Carrying			Fair Value
		Amount			Level 1			Level 2			Level 3			Total

		(in thousands)

Financial assets:
Cash and cash equivalents		$	194,719		$	194,719		$	—		$	—		$	194,719
Securities available for sale			394,036			—			394,036			—			394,036
Federal Home Loan Bank stock			5,931			N/A			N/A			N/A			N/A
Loans held for sale			45,642			—			45,642			—			45,642
Loans, net			3,562,356			—			—			3,558,934			3,558,934
Retirement plan annuities			14,174			—			—			14,174			14,174
Accrued interest receivable			10,624			—			10,624			—			10,624

Financial liabilities:
Deposits			3,682,649			—			—			3,683,465			3,683,465
Borrowed funds			55,711			—			55,765			—			55,765
Subordinated debt			34,159			—			—			35,790			35,790
Mortgagors' escrow accounts			8,459			—			—			8,459			8,459
Accrued interest payable			1,083			—			1,083			—			1,083

Derivative loan commitments:
Assets			1,527			—			—			1,527			1,527
Liabilities			95			—			—			95			95

Interest rate management agreements:
Assets			1,663			—			1,663			—			1,663
Liabilities			—			—			—			—			—

Interest rate swap agreements:
Assets			18,874			—			18,874			—			18,874
Liabilities			19,214			—			19,214			—			19,214

Forward loan sale commitments:
Assets			56			—			—			56			56
Liabilities			94			—			—			94			94

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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