FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (fair values are not adjusted for transaction costs). ASC 820 also establishes a framework (fair value hierarchy) for measuring fair value under US GAAP and expands disclosures about fair value measurements.

ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The measurement of fair value should be consistent with one of the following valuation techniques: market approach, income approach, and/or cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). For example, valuation techniques consistent with the market approach often use market multiples derived from a set of comparables. Multiples might lie in ranges with a different multiple for each comparable. The selection of where within the range the appropriate multiple falls requires judgment, considering factors specific to the measurement (qualitative and quantitative). Valuation techniques consistent with the market approach include matrix pricing. Matrix pricing is a mathematical technique used principally to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the security’s relationship to other benchmark quoted securities.

For financial assets measured at fair value on a recurring and nonrecurring basis, the fair value measurements by level within the fair value hierarchy used were as follows:

December 31, 2021	Quoted prices in active markets for identical assets (Level 1)		Significant other observable input (Level 2)		Significant unobservable inputs (Level 3)		Balance at end of period
Recurring fair value measurements
Securities available-for-sale
U.S. Government agency securities	$	—	$	97,499	$	—	$	97,499
State and municipal securities		—		131,035		—		131,035
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed securities		—		329,938		—		329,938
Collateralized mortgage obligations (CMOs)		—		127,012		—		127,012
Pooled trust preferred securities		—		—		75		75
Corporate debt securities		—		6,801		—		6,801
Total securities available-for-sale		—		692,285		75		692,360
Equity securities		12,410		—		—		12,410
Total recurring fair value measurements	$	12,410	$	692,285	$	75	$	704,770

Nonrecurring fair value measurements *
Impaired loans	$	—	$	—	$	4,686	$	4,686
Mortgage servicing rights		—		—		117		117
Total nonrecurring fair value measurements	$	—	$	—	$	4,803	$	4,803

December 31, 2020	Quoted prices in active markets for identical assets (Level 1)		Significant other observable input (Level 2)		Significant unobservable inputs (Level 3)		Balance at end of period
Recurring fair value measurements
Securities available-for-sale
U.S. Government agency securities	$	—	$	69,776	$	—	$	69,776
State and municipal securities		—		87,812		—		87,812
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed securities		—		175,847		—		175,847
Collateralized mortgage obligations (CMOs)		—		94,948		—		94,948
Pooled trust preferred securities		—		—		70		70
Corporate debt securities		—		7,193		—		7,193
Total securities available-for-sale		—		435,576		70		435,646
Equity securities		12,849		—		—		12,849
Total recurring fair value measurements	$	12,849	$	435,576	$	70	$	448,495

Nonrecurring fair value measurements *
Impaired loans	$	—	$	—	$	5,034	$	5,034
Mortgage servicing rights		—		—		291		291
Total nonrecurring fair value measurements	$	—	$	—	$	5,325	$	5,325

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which QNB has utilized Level 3 inputs to determine fair value:

Quantitative information about Level 3 fair value measurements

December 31, 2021

Fair value

Valuation

techniques

Unobservable

input

Value or range

of values

Impaired loans

4,369

Appraisal of collateral

(1)

Appraisal adjustments

(2)

-15% to -20%

Liquidation expenses

(3)

-10%

Impaired loans

317

Financial statement values for UCC collateral

Financial statement value discounts

(4)

-30 to -100%

Mortgage servicing rights

117

Discounted cash flow

Remaining term

3 to 29 yrs

Prepayment Speeds

187% to 312%

Discount rate

12.0% to 12.5%

Quantitative information about Level 3 fair value measurements

December 31, 2020

Fair value

Valuation

techniques

Unobservable

input

Value or range

of values

Impaired loans

4,754

Appraisal of collateral

(1)

Appraisal adjustments

(2)

-10% to -30%

Liquidation expenses

(3)

-10%

Impaired loans

280

Financial statement values for UCC collateral

Financial statement value discounts

(4)

-87.5 to -100%

Mortgage servicing rights

291

Discounted cash flow

Remaining term

2 to 30 yrs

Prepayment Speeds

243% to 320%

Discount rate

12.0% to 12.5%

The following table presents additional information about the securities available-for-sale measured at fair value on a recurring basis and for which QNB utilized significant unobservable inputs (Level 3 inputs) to determine fair value for the year ended December 31:

There were also no transfers in or out of level 3 for the same periods. There were no losses included in earnings attributable to the change in unrealized gains or losses relating to the available-for-sale securities above with fair value measurements utilizing significant unobservable inputs for the years ended December 31, 2021 and 2020.

The Level 3 securities consist of one collateralized debt obligation security (“PreTSL”), which is backed by trust preferred securities issued by banks. The market for this security at December 31, 2021 was not active and markets for similar securities also are not active. The new issue market is also inactive and there are currently very few market participants who are willing and or able to transact for these securities.

Given conditions in the debt markets today and the absence of observable transactions in the secondary and new issue markets, we determined:

The Bank used an independent third party to value this security using a discounted cash flow analysis. Based on management’s review of the bond’s single underlying issuer, there are no expected credit losses or prepayments; cashflows used were contractual based on the Bloomberg YA screen. The assumed cashflows have been discounted using and estimated market discount rate based on the 30-year swap rate. The 30-year is used as the reference rate since it is indicative of market expectation for short-term rates in the future. This is consistent with the 30-year nature of PreTSL securities, which are priced using the 3-month LIBOR as a reference rate. The discount rate of 5.53% includes the risk-free rate, a credit component and a spread for illiquidity.

The following information should not be interpreted as an estimate of the fair value of QNB since a fair value calculation is only provided for a limited portion of QNB’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between QNB’s disclosures and those of other companies may not be meaningful.

The following methods and assumptions were used to estimate the fair values of each major classification of financial instrument and non-financial asset at December 31, 2021 and 2020:

Cash and cash equivalents, accrued interest receivable and accrued interest payable (carried at cost): The carrying amounts reported in the balance sheet approximate those assets’ fair value.

Investment securities: available-for-sale (carried at fair value) and equity investments with readily determinable fair values (carried at fair value): The fair value of securities are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or 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. Level 2 debt securities are valued by a third-party pricing service commonly used in the banking industry. Level 2 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 date, market consensus prepayment speeds, credit information and the security’s terms and conditions, among other things. For certain securities which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level 3). In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) were used to support fair values of certain Level 3 investments.

Restricted investment in stocks (carried at cost): The fair value of stock in Atlantic Community Bankers Bank and the Federal Home Loan Bank and VISA Class B is the carrying amount, based on redemption provisions, and considers the limited marketability of such securities.

Loans Held for Sale (carried at lower of cost or fair value): The fair value of loans held for sale is determined, when possible, using quoted secondary market prices. If no such quoted prices exist, the fair value of a loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of that loan.

Loans Receivable (carried at cost): The fair values of loans are 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.

Impaired Loans (generally carried at fair value): Impaired loans are loans in which QNB 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.

Mortgage Servicing Rights (carried at lower of cost or fair value): The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The mortgage servicing rights are stratified into tranches based on predominant characteristics, such as interest rate, loan type and investor type. The valuation incorporates assumptions that market participants would use in estimating future net servicing income.

Deposit liabilities (carried at cost): The fair value of deposits with no stated maturity (e.g. demand deposits, interest-bearing demand accounts, money market accounts and savings accounts) are by definition, equal to the amount payable on demand at the reporting date (i.e. their carrying amounts). This approach to estimating fair value excludes the significant benefit that results from the low-cost funding provided by such deposit liabilities, as compared to alternative sources of funding. Deposits with a stated maturity (time deposits) have been valued using the present value of cash flows discounted at rates approximating the current market for similar deposits.

Short-term borrowings (carried at cost): The carrying amount of short-term borrowings approximates their fair values.

Long-term debt (carried at cost): Long-term debt has stated maturities and have been valued using the present value of cash flows discounted at rates approximating the current market for similar debt instruments.

Off-balance-sheet instruments (disclosed at cost): The fair value for the Bank’s off-balance sheet instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing.

Management uses its best judgment in estimating the fair value of QNB’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of the respective period ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each year end.

The estimated fair values and carrying amounts of QNB’s financial and off-balance sheet instruments are summarized as follows:

					Fair value measurements
December 31, 2021	Carrying amount		Fair value		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Financial assets
Cash and cash equivalents	$	13,390	$	13,390	$	13,390	$	—	$	—
Investment securities:
Available-for-sale		692,360		692,360		—		692,285		75
Equity		12,410		12,410		12,410		—		—
Restricted investment in bank stocks		1,329		1,329		—		1,329		—
Loans held for sale		—		—		—		—		—
Net loans		915,286		916,271		—		—		916,271
Mortgage servicing rights		538		615		—		—		615
Accrued interest receivable		4,104		4,104		—		4,104		—

Financial liabilities
Deposits with no stated maturities	$	1,281,372	$	1,281,372	$	1,281,372	$	—	$	—
Deposits with stated maturities		168,373		168,039		—		168,039		—
Short-term borrowings		68,476		68,476		68,476		—		—
Long-term debt		10,000		10,114		10,114		—		—
Accrued interest payable		211		211		—		211		—

Off-balance sheet instruments
Commitments to extend credit	$	—	$	—	$	—	$	—	$	—
Standby letters of credit		—		70		—		70		—

					Fair value measurements
December 31, 2020	Carrying amount		Fair value		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Financial assets
Cash and cash equivalents	$	39,331	$	39,331	$	39,331	$	—	$	—
Investment securities:
Available-for-sale		435,646		435,646		—		435,576		70
Equity		12,849		12,849		12,849		—		—
Restricted investment in bank stocks		1,041		1,041		—		1,041		—
Loans held for sale		6,570		6,886		—		6,886		—
Net loans		909,216		915,726		—		—		915,726
Mortgage servicing rights		533		568		—		—		568
Accrued interest receivable		4,825		4,825		—		4,825		—

Financial liabilities
Deposits with no stated maturities	$	1,030,982	$	1,030,982	$	1,030,982	$	—	$	—
Deposits with stated maturities		197,085		199,127		—		199,127		—
Short-term borrowings		58,838		58,838		58,838		—		—
Long-term debt		10,000		10,269		10,269		—		—
Accrued interest payable		350		350		—		350		—

Off-balance sheet instruments
Commitments to extend credit	$	—	$	—	$	—	$	—	$	—
Standby letters of credit		—		88		—		88		—