Note 4 - Fair Value Measurements

12 Months Ended

Dec. 31, 2022

Notes to Financial Statements

Fair Value Disclosures [Text Block]

NOTE 4.  FAIR VALUE MEASUREMENTS

In accordance with ASC 820 Fair Value Measurements, fair value is based upon the exchange price that would be received for an asset or paid to transfer a liability (an 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.  A fair value hierarchy is utilized to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The three levels of inputs used to measure fair value are as follows:

Level 1: Quoted prices (unadjusted) or 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 and 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.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and our creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes our valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein. A more detailed description of the valuation methodologies used for assets and liabilities measured at fair value is set forth below. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with our monthly and/or quarterly valuation process.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis include the following:

Debt Securities Available for Sale:  Debt securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available.  If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.  Level 1 debt securities include U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets.  Level 2 debt securities include U.S. agency securities, mortgage-backed securities, municipal bonds and corporate debt securities. Certain trust preferred securities classified as corporate debt securities are Level 3 due to limited market trades of these classes of securities.

Equity Investments: Equity investments are recorded at fair value on a recurring basis, with changes in fair value reported in net income. At December 31, 2022, we held an investment in an S&P 500 index mutual fund with a fair value of $5.2 million. The mutual fund is actively traded on an exchange, and we classify it as Level 1.

We purchased perpetual preferred stock of a bank holding company issued in October 2022 in a private offering. The perpetual preferred stock does not trade on an exchange or in an active over-the-counter market; therefore, we estimate its fair value using the present value of its future cash flows using observed discount rates of similar publicly-traded securities, adjusted for a liquidity premium. We classify the perpetual preferred stock as Level 2, and its fair value at December 31, 2022 was $2.9 million.

In addition, in December 2021, we invested as a limited partner in a hedge fund that primarily trades S&P 500 index options. The average duration of the option positions employed by the fund ranges 14 to 17 business days. Investors may withdraw funds at the end of any month with 30 calendar days prior written notice. As permitted by ASC 820, as a practical expedient, we estimate the fair value of this investment using the net asset value ("NAV") per share of the investment as of the reporting entity's measurement date. Accordingly, we classify this investment as Level 1, and its fair value was $20.5 million and $20.2 million at December 31, 2022 and 2021, respectively.

Equity securities without readily determinable fair values are carried at cost, minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for an identical or similar investment. Such equity securities totaled $800,000 and $407,000 at December 31, 2022 and 2021 respectively and are included in Equity Investments on the accompanying consolidated balance sheets.

Derivative Financial Instruments:  Derivative financial instruments are recorded at fair value on a recurring basis. Fair value measurement is based on pricing models run by a third-party, utilizing observable market-based inputs.  All future floating cash flows are projected and both floating and fixed cash flows are discounted to the valuation date.  As a result, we classify interest rate swaps and caps as Level 2.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis.

	Balance at		Fair Value Measurements Using:
Dollars in thousands	December 31, 2022		Level 1		Level 2		Level 3
Debt securities available for sale
U.S. Government sponsored agencies	$	20,219	$	—	$	20,219	$	—
Residential mortgage-backed securities:
Government sponsored agencies		51,456		—		51,456		—
Nongovernment sponsored entities		61,617		—		61,617		—
State and political subdivisions		93,067		—		93,067		—
Corporate debt securities		31,628		—		29,788		1,840
Asset-backed securities		19,476		—		19,476		—
Tax-exempt state and political subdivisions		127,738		—		127,738		—
Total debt securities available for sale	$	405,201	$	—	$	403,361	$	1,840
Equity investments	$	29,494	$	25,766	$	3,728	$	—
Derivative financial assets
Interest rate caps	$	30,601	$	—	$	30,601	$	—
Interest rate swaps		9,905		—		9,905		—

	Balance at		Fair Value Measurements Using:
Dollars in thousands	December 31, 2021		Level 1		Level 2		Level 3
Debt securities available for sale
U.S. Government sponsored agencies	$	36,629	$	—	$	36,629	$	—
Residential mortgage-backed securities:
Government sponsored agencies		62,211		—		62,211		—
Nongovernment sponsored entities		26,586		—		26,586		—
State and political subdivisions		137,786		—		137,786		—
Corporate debt securities		30,278		—		30,278		—
Asset-backed securities		24,883		—		24,883		—
Tax-exempt state and political subdivisions		82,730		—		82,730		—
Total debt securities available for sale	$	401,103	$	—	$	401,103	$	—
Equity investments	$	20,609	$	20,202	$	407	$	—
Derivative financial assets
Interest rate caps	$	11,187	$	—	$	11,187	$	—
Derivative financial liabilities
Interest rate swaps	$	1,124	$	—	$	1,124	$	—

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles.  These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period.  

Loans Held for Sale:  Loans held for sale are carried at the lower of cost or fair value.  The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics.  As such, we classify loans subject to nonrecurring fair value adjustments as Level 2.

Collateral Dependent Loans with an ACLL: In accordance with ASC 326, we may determine that an individual loan exhibits unique risk characteristics which differentiate it from other loans within our loan pools. In such cases, the loans are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Specific allocations of the allowance

for credit losses are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things. A loan is considered to be collateral dependent when, based upon management's assessment, the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. In such cases, expected credit losses are based on the fair value of the collateral at the measurement date, adjusted for estimated selling costs if satisfaction of the loan depends on the sale of the collateral. We reevaluate the fair value of collateral supporting collateral dependent loans on a quarterly basis. The fair value of real estate collateral supporting collateral dependent loans is evaluated by appraisal services using a methodology that is consistent with the Uniform Standards of Professional Appraisal Practice.

Property Held for Sale:  Property held for sale consists of real estate acquired in foreclosure or other settlement of loans. Foreclosed assets are initially recorded at fair value, less estimated selling costs, when acquired establishing a new cost basis. Such assets are carried on the balance sheet at the lower of the investment in the real estate or its fair value less estimated selling costs.  The fair value of foreclosed properties is determined on a nonrecurring basis generally utilizing current appraisals performed by an independent, licensed appraiser applying an income or market value approach using observable market data (Level 2).  Updated appraisals of foreclosed properties are generally obtained if the existing appraisal is more than 18 months old or more frequently if there is a known deterioration in value.  However, if a current appraisal is not available, the original appraised value is discounted, as appropriate, to compensate for the estimated depreciation in the value of the real estate since the date of its original appraisal.  Such discounts are generally estimated based upon management’s knowledge of sales of similar property within the applicable market area and its knowledge of other real estate market-related data as well as general economic trends (Level 3).  Upon foreclosure, any fair value adjustment is charged against the allowance for credit losses on loans.  Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense in the consolidated statements of income.

Assets measured at fair value on a nonrecurring basis are included in the tables below.

	Balance at		Fair Value Measurements Using:
Dollars in thousands	December 31, 2022		Level 1		Level 2		Level 3
Residential mortgage loans held for sale	$	—	$	—	$	—	$	—
Collateral-dependent loans with an ACLL
Commercial real estate	$	3,051	$	—	$	3,051	$	—
Construction and development		350		—		350		—
Residential real estate		182		—		182		—
Total collateral-dependent loans with an ACLL	$	3,583	$	—	$	3,583	$	—
Property held for sale
Commercial real estate	$	297	$	—	$	297	$	—
Construction and development		4,480		—		4,480		—
Residential real estate		—		—		—		—
Total property held for sale	$	4,777	$	—	$	4,777	$	—

	Balance at		Fair Value Measurements Using:
Dollars in thousands	December 31, 2021		Level 1		Level 2		Level 3
Residential mortgage loans held for sale	$	227	$	—	$	227	$	—
Collateral-dependent impaired loans
Commercial real estate	$	2,417	$	—	$	2,417	$	—
Construction and development		693		—		693		—
Residential real estate		528		—		528		—
Total collateral-dependent impaired loans	$	3,638	$	—	$	3,638	$	—
Property held for sale
Commercial real estate	$	1,170	$	—	$	1,170	$	—
Construction and development		7,893		—		7,893		—
Residential real estate		27		—		27		—
Total property held for sale	$	9,090	$	—	$	9,090	$	—

ASC Topic 825, Financial Instruments, requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The estimated fair value approximates carrying value for cash and cash equivalents, accrued interest and the cash surrender value of life insurance policies and annuities. The methodologies for other financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis are discussed below:

Loans: The estimated fair value approximates carrying value for variable-rate loans that reprice frequently and with no significant change in credit risk. The fair value of fixed-rate loans and variable-rate loans which reprice on an infrequent basis is estimated by discounting future cash flows using the current interest rates at which similar loans with similar terms would be made to borrowers of similar credit quality. An overall valuation adjustment is made for specific credit risks as well as general portfolio credit risk.

Other Investments: The carrying value of other investments, consisting principally of Federal Home Loan Bank stock, is a reasonable estimate of fair value of this stock. This stock is non-transferable and can only be redeemed at its par value by FHLB.

Deposits: The estimated fair value approximates carrying value for demand deposits. The fair value of fixed-rate deposit liabilities with defined maturities is estimated by discounting future cash flows using the interest rates currently offered for deposits of similar remaining maturities. The estimated fair value of deposits does not take into account the value of our long-term relationships with depositors, commonly known as core deposit intangibles, which are separate intangible assets, and not considered financial instruments. Nonetheless, we would likely realize a core deposit premium if our deposit portfolio were sold in the principal market for such deposits.

Borrowed Funds: The estimated fair value approximates carrying value for short-term borrowings. The fair value of long-term fixed-rate borrowings is estimated using quoted market prices, if available, or by discounting future cash flows using current interest rates for similar financial instruments.

The following tables present the carrying amount, fair value, and placement in the fair value hierarchy of our financial instruments as of December 31, 2022 and December 31, 2021.

	At December 31, 2022				Fair Value Measurements Using:
Dollars in thousands	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents	$	44,717	$	44,717	$	16,469	$	28,248	$	—
Debt securities available for sale		405,201		405,201		—		403,361		1,840
Debt securities held to maturity		96,163		86,627		—		86,627		—
Equity investments		29,494		29,494		25,766		3,728		—
Other investments		16,029		16,029		—		16,029		—
Loans held for sale, net		—		—		—		—		—
Loans, net		3,043,919		2,966,814		—		3,583		2,963,231
Accrued interest receivable		15,866		15,866		—		15,866		—
Cash surrender value of life insurance policies and annuities		71,640		71,640		—		71,640		—
Derivative financial assets		40,506		40,506		—		40,506		—
	$	3,763,535	$	3,676,894	$	42,235	$	669,588	$	2,965,071
Financial liabilities
Deposits	$	3,169,879	$	3,166,762	$	—	$	3,166,762	$	—
Short-term borrowings		225,999		225,999		—		225,999		—
Long-term borrowings		658		667		—		667		—
Subordinated debentures		103,296		91,801		—		91,801		—
Subordinated debentures owed to unconsolidated subsidiary trusts		19,589		19,589		—		19,589		—
Accrued interest payable		2,357		2,357		—		2,357		—
	$	3,521,778	$	3,507,175	$	—	$	3,507,175	$	—

	At December 31, 2021				Fair Value Measurements Using:
Dollars in thousands	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents	$	78,458	$	78,458	$	21,006	$	57,452	$	—
Debt securities available for sale		401,103		401,103		—		401,103		—
Debt securities held to maturity		98,060		101,242		—		101,242		—
Equity investments		20,609		20,609		20,202		407		—
Other investments		10,897		10,897		—		10,897		—
Loans held for sale, net		227		227		—		227		—
Loans, net		2,729,093		2,726,959		—		3,638		2,723,321
Accrued interest receivable		10,578		10,578		—		10,578		—
Cash surrender value of life insurance policies and annuities		60,613		60,613		—		60,613		—
Derivative financial assets		11,187		11,187		—		11,187		—
	$	3,420,825	$	3,421,873	$	41,208	$	657,344	$	2,723,321
Financial liabilities
Deposits	$	2,943,089	$	2,944,722	$	—	$	2,944,722	$	—
Short-term borrowings		140,146		140,146		—		140,146		—
Long-term borrowings		679		795		—		795		—
Subordinated debentures		102,891		103,623		—		103,623		—
Subordinated debentures owed to unconsolidated subsidiary trusts		19,589		19,589		—		19,589		—
Accrued interest payable		788		788		—		788		—
Derivative financial liabilities		1,124		1,124		—		1,124		—
	$	3,208,306	$	3,210,787	$	—	$	3,210,787	$	—