Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2022

NOTE 6 FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair values of financial instruments are management's estimate of the values at which the instruments could be exchanged in a transaction between willing parties. These estimates are subjective and may vary significantly from amounts that would be realized in actual transactions. In addition, other significant assets are not considered financial assets including deferred tax assets, premises, equipment and intangibles. Further, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on the fair value estimates and have not been considered in any of the estimates.

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The estimated fair values, and related carrying or notional amounts, for on and off-balance sheet financial instruments as of September 30, 2022 and December 31, 2021 are reflected below.


	(In Thousands)
	September 30, 2022
	Carrying		Fair
	Amount		Value		Level 1		Level 2		Level 3
Financial Assets:
Cash and cash equivalents	$	70,670	$	70,670	$	70,670	$	-	$	-
Interest-bearing time deposits		5,187		5,187		-		5,187		-
Securities - available-for-sale		395,485		395,485		95,162		296,957		3,366
Other securities		8,227		8,227		-		-		8,227
Loans held for sale		2,182		2,219		-		-		2,219
Loans, net		2,122,626		2,080,950		-		-		2,080,950
Interest receivable		9,856		9,856		-		-		9,856

Financial Liabilities:
Interest bearing deposits	$	1,313,263	$	1,313,263	$	-	$	-	$	1,313,263
Non-interest bearing deposits		506,928		506,928		-		506,928		-
Time deposits		462,845		449,985		-		-		449,985
Total Deposits		2,283,036		2,270,176		-		506,928		1,763,248

Federal funds purchased and securities sold under agreement to repurchase		55,802		55,802		-		-		55,802
Federal Home Loan Bank advances		102,147		103,588		-		-		103,588
Other borrowings		10,000		10,000		-		10,000		-
Subordinated notes, net of unamortized issuance costs		34,557		35,003		-		35,003		-
Interest payable		787		787		-		-		787


	(In Thousands)
	December 31, 2021
	Carrying		Fair
	Amount		Value		Level 1		Level 2		Level 3
Financial Assets:
Cash and cash equivalents	$	180,823	$	180,823	$	180,823	$	-	$	-
Interest-bearing time deposits		10,913		10,933		-		10,933		-
Securities - available-for-sale		429,931		429,931		89,177		335,981		4,773
Other securities		8,162		8,162		-		-		8,162
Loans held for sale		7,714		7,844		-		-		7,844
Loans, net		1,841,177		1,864,386		-		-		1,864,386
Interest receivable		7,209		7,209		-		-		7,209

Financial Liabilities:
Interest bearing deposits	$	1,248,294	$	1,248,044	$	-	$	-	$	1,248,044
Non-interest bearing deposits		473,689		473,689		-		473,689		-
Time deposits		471,479		475,810		-		-		475,810
Total Deposits		2,193,462		2,197,543		-		473,689		1,723,854

Federal funds purchased and securities sold under agreement to repurchase		29,268		29,268		-		-		29,268
Federal Home Loan Bank advances		24,065		24,305		-		-		24,305
Other borrowings		40,000		40,000		-		40,000		-
Subordinated notes, net of unamortized issuance costs		34,471		35,000		-		35,000		-
Interest payable		1,125		1,125		-		-		1,125

Fair Value Measurements:

In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities in active markets that the Company has the ability to access.

Available-for-sale securities, when quoted prices are available in an active market, securities are valued using the quoted price and are classified as Level 1.

Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

Available-for-sale securities classified as Level 2 are valued using the prices obtained from an independent pricing service. The prices are not adjusted. Securities of obligations of state and political subdivisions are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate based on credit rating. Substantially all assumptions used by the independent pricing service are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace.

Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability. The Bank holds some local municipals that the Bank evaluates based on the credit strength of the underlying project. The fair value is determined by valuing similar credit payment streams at similar rates.

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Company's assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset.

The following summarizes financial assets measured at fair value on a recurring basis as of September 30, 2022 and December 31, 2021, segregated by level or the valuation inputs within the fair value hierarchy utilized to measure fair value:


Assets and Liabilities Measured at Fair Value on a Recurring Basis (In Thousands)
September 30, 2022	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets - (Securities Available-for-Sale)
U.S. Treasury	$	95,162	$	-	$	-
U.S. Government agencies		-		138,020		-
Mortgage-backed securities		-		90,264		-
State and local governments		-		68,673		3,366
Total Securities Available-for-Sale	$	95,162	$	296,957	$	3,366


December 31, 2021	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets - (Securities Available-for-Sale)
U.S. Treasury	$	89,177	$	-	$	-
U.S. Government agencies		-		156,886		-
Mortgage-backed securities		-		117,927		-
State and local governments		-		61,168		4,773
Total Securities Available-for-Sale	$	89,177	$	335,981	$	4,773

The following tables represent the changes in the Level 3 fair-value category of which unobservable inputs are relied upon as of the three and nine month periods ended September 30, 2022 and September 30, 2021. During the three month period ended March 31, 2022, there was one security transferred from Level 3 to Level 2.


	(In Thousands)
	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
	State and Local Governments Tax-Exempt			State and Local Governments Taxable			State and Local Governments Total
Balance at July 1, 2022	$	2,089		$	1,325		$	3,414

Change in Market Value		(19	)		(29	)		(48	)

Purchases		-			-			-

Payments & Maturities		-			-			-

Reclassification & Adjustments		-			-			-

Balance at September 30, 2022	$	2,070		$	1,296		$	3,366


	(In Thousands)
	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
	State and Local Governments Tax-Exempt			State and Local Governments Taxable			State and Local Governments Total
Balance at July 1, 2021	$	2,410		$	1,538		$	3,948

Change in Market Value		(9	)		(17	)		(26	)

Purchases		-			-			-

Payments & Maturities		(155	)		-			(155	)

Reclassification & Adjustments		-			-			-

Balance at September 30, 2021	$	2,246		$	1,521		$	3,767


	(In Thousands)
	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
	State and Local Governments Tax-Exempt			State and Local Governments Taxable			State and Local Governments Total
Balance at January 1, 2022	$	2,307		$	2,466		$	4,773

Change in Market Value		(77	)		(181	)		(258	)

Purchases		-			-			-

Payments & Maturities		(160	)		-			(160	)

Reclassification & Adjustments		-			(989	)		(989	)

Balance at September 30, 2022	$	2,070		$	1,296		$	3,366


	(In Thousands)
	Fair Value Measurements Using Significant
	Unobservable Inputs (Level 3)
	State and Local Governments Tax-Exempt			State and Local Governments Taxable			State and Local Governments Total
Balance at January 1, 2021	$	-		$	1,562		$	1,562

Change in Market Value		(17	)		(41	)		(58	)

Purchases		2,418			-			2,418

Payments & Maturities		(155	)		-			(155	)

Reclassification & Adjustments		-			-			-

Balance at September 30, 2021	$	2,246		$	1,521		$	3,767

Most of the Company's available-for-sale securities, including any bonds issued by local municipalities, have CUSIP numbers or have similar characteristics of those in the municipal markets, making them marketable and comparable as Level 2.

The Company also has assets that, under certain conditions, are subject to measurement at fair value on a non-recurring basis. At September 30, 2022 and December 31, 2021, such assets consist primarily of collateral dependent impaired loans. Collateral dependent impaired loans categorized as Level 3 assets consist of non-homogeneous loans that are considered impaired. The Company estimates the fair value of the loans based on the present value of expected future cash flows using management's best estimate of key assumptions. These assumptions include future payment ability, timing of payment streams, and estimated realizable values of available collateral (typically based on outside appraisals.)

At September 30, 2022 and December 31, 2021, fair value of collateral dependent impaired loans categorized as Level 3 was $2.5 million and $8.5 million, respectively. The specific allocation for impaired loans was $2.4 million and $2.2 million as of September 30, 2022 and December 31, 2021, respectively, which are accounted for in the allowance for loan losses (see Note 4).

During 2021, impairment was recognized on mortgage servicing rights based upon the independent third party’s quarterly valuations. A valuation allowance was established by strata to quantify the likely impairment of the value of the mortgage servicing rights to the Company. If the carrying amount of an individual strata exceeds the fair value, impairment was recorded on that strata so the servicing asset was carried at fair value. Impairment was $1 thousand at September 30, 2022 and $414 thousand at December 31, 2021.

Other real estate is reported at either the lower of the fair value of the real estate minus the estimated costs to sell the asset or the cost of the asset. The determination of fair value of the real estate relies primarily on appraisals from third parties. If the fair value of the real estate, minus the estimated costs to sell the asset, is less than the asset's cost, the deficiency is recognized as a valuation allowance against the asset through a charge to expense. The valuation allowance is therefore increased or decreased, through charges or credits to expense, for changes in the asset's fair value or estimated selling costs.

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements:


	(In Thousands)				Range
	Fair Value at				(Weighted
	September 30, 2022		Valuation Technique	Unobservable Inputs	Average)
State and local government	$	3,366	Discounted Cash Flow	Credit strength of underlying project or entity / Discount rate	2.13-4.59% (3.96%)

Collateral dependent impaired loans		2,482	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability	20.00-23.87% (23.80%)

Mortgage servicing rights		52	Discounted Cash Flow	Constant prepayment rate and probability of default / Discount rate	0.09-1.85% (1.81%)

Other real estate owned - residential		-	Appraisals	Discount to reflect current market	— % ( — %)


	(In Thousands)				Range
	Fair Value at				(Weighted
	December 31, 2021		Valuation Technique	Unobservable Inputs	Average)
State and local government	$	4,773	Discounted Cash Flow	Credit strength of underlying project or entity / Discount rate	0.21-1.77% (1.33%)

Collateral dependent impaired loans		8,527	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability	20.00-53.95% (34.78%)

Mortgage servicing rights		3,157	Discounted Cash Flow	Constant prepayment rate and probability of default / Discount rate	1.94-27.70% (18.44%)

Other real estate owned - residential		99	Appraisals	Discount to reflect current market	32.72% (32.72%)

The following table presents assets measured at fair value on a nonrecurring basis at September 30, 2022 and December 31, 2021:


	Assets Measured at Fair Value on a Nonrecurring Basis at September 30, 2022
	(In Thousands)
	Balance at September 30, 2022		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Collateral dependent impaired loans	$	2,482	$	-	$	-	$	2,482
Mortgage servicing rights		52		-		-		52
Other real estate owned - residential		-		-		-		-


	Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2021
	(In Thousands)
	Balance at December 31, 2021		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Collateral dependent impaired loans	$	8,527	$	-	$	-	$	8,527
Mortgage servicing rights		3,157		-		-		3,157
Other real estate owned - residential		99		-		-		99

- Definition

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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