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Note 8 - Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2020

Notes to Financial Statements

Fair Value Disclosures [Text Block]

Note 8: Fair Value of Financial Instruments

Management uses its best judgment in estimating the fair value of the Company’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 their respective year-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 Company follows the guidance issued under ASC 820, Fair Value Measurement, which defines fair value, establishes a framework for measuring fair value under GAAP, and identifies required disclosures on 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 under ASC 820 are as follows:

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported with little or no market activity).

An asset 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.

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2020 and December 31, 2019 were as follows:

(dollars in thousands)		Total				(Level 1) Quoted Prices in Active Markets for Identical Assets				(Level 2) Significant Other Observable Inputs				(Level 3) Significant Unobservable Inputs

September 30, 2020
Assets:

U.S. Government agencies		$	33,372			$	-			$	33,372			$	-
Collateralized mortgage obligations			203,802				-				203,802				-
Agency mortgage-backed securities			131,203				-				131,203				-
Municipal securities			2,662				-				2,662				-
Corporate bonds			69,616				-				66,985				2,631
Securities Available for Sale		$	440,655			$	-			$	438,024			$	2,631

Mortgage Loans Held for Sale		$	41,683			$	-			$	41,683			$	-
SBA Servicing Assets			4,634				-				-				4,634
Interest Rate Lock Commitments			1,451				-				1,451				-
Best Efforts Forward Loan Sales Commitments			-				-				-				-
Mandatory Forward Loan Sales Commitments			-				-				-				-

Liabilities:

Interest Rate Lock Commitments			1				-				1				-
Best Efforts Forward Loan Sales Commitments			554				-				554				-
Mandatory Forward Loan Sales Commitments			525				-				525				-

December 31, 2019
Assets:

U.S. Government agencies		$	38,305			$	-			$	38,305			$	-
Collateralized mortgage obligations			331,438				-				331,438				-
Agency mortgage-backed securities			98,937				-				98,937				-
Municipal securities			4,082				-				4,082				-
Corporate bonds			66,280				-				63,460				2,820
Securities Available for Sale		$	539,042			$	-			$	536,222			$	2,820

Mortgage Loans Held for Sale		$	10,345			$	-			$	10,345			$	-
SBA Servicing Assets			4,447				-				-				4,447
Interest Rate Lock Commitments			362				-				362				-
Best Efforts Forward Loan Sales Commitments			4				-				4				-
Mandatory Forward Loan Sales Commitments			2				-				2				-

Liabilities:

Interest Rate Lock Commitments			-				-				-				-
Best Efforts Forward Loan Sales Commitments			133				-				133				-
Mandatory Forward Loan Sales Commitments			83				-				83				-

The following tables present an analysis of the activity in the SBA servicing assets for the three and nine months ended September 30, 2020 and 2019:

		Three Months Ended September 30,
(dollars in thousands)		2020				2019
Beginning balance, July 1^st		$	4,604			$	4,593
Additions			173				272
Fair value adjustments			(143	)			(361	)
Ending balance, September 30^th		$	4,634			$	4,504

		Nine Months Ended September 30,
(dollars in thousands)		2020				2019
Beginning balance, January 1^st		$	4,447			$	4,785
Additions			488				825
Fair value adjustments			(301	)			(1,106	)
Ending balance, September 30^th		$	4,634			$	4,504

Fair value adjustments are recorded as loan and servicing fees on the statement of income. Servicing fee income, not including fair value adjustments, totaled $510,000 and $498,000 for the three months ended September 30, 2020 and 2019, respectively. Servicing fee income, not including fair value adjustments, totaled $1.4 million and $1.4 million for the nine months ended September 30, 2020 and 2019, respectively. Total loans in the amount of $211.0 million at September 30, 2020 and $201.7 million at December 31, 2019 were serviced for others.

The following table presents a reconciliation of the securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2020 and 2019:

		Three Months Ended September 30, 2020				Three Months Ended September 30, 2019
Level 3 Investments Only (dollars in thousands)		Corporate Bonds				Corporate Bonds
Balance, July 1^st		$	2,665			$	2,999
Unrealized gains (losses)			(34	)			(108	)
Proceeds from sales			-				-
Realized losses			-				-
Balance, September 30^th		$	2,631			$	2,891

		Nine Months Ended September 30, 2020				Nine Months Ended September 30, 2019
Level 3 Investments Only (dollars in thousands)		Corporate Bonds				Corporate Bonds
Balance, January 1^st		$	2,819			$	3,069
Unrealized gains (losses)			(188	)			(178	)
Proceeds from sales			-				-
Realized losses			-				-
Balance, September 30^th		$	2,631			$	2,891

For assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2020 and December 31, 2019 were as follows:

(dollars in thousands)		Total				(Level 1) Quoted Prices in Active Markets for Identical Assets				(Level 2) Significant Other Observable Inputs				(Level 3) Significant Unobservable Inputs
September 30, 2020
Impaired loans		$	5,506			$	-			$	-			$	5,506
Other real estate owned			130				-				-				130

December 31, 2019
Impaired loans		$	5,730			$	-			$	-			$	5,730
Other real estate owned			899				-				-				899

The table below presents additional quantitative information about level 3 assets measured at fair value on a nonrecurring basis (dollars in thousands):

Quantitative Information about Level 3 Fair Value Measurements

Asset Description

Fair

Value

Valuation

Technique

Unobservable Input

Range (Weighted

Average)

September 30, 2020

Corporate bonds

$

2,631

Discounted Cash Flows

Discount Rate

(3.49%)

SBA servicing assets

$

4,634

Discounted Cash Flows

Conditional Prepayment Rate

(13.60%)

Discount Rate

(10.00%)

Impaired loans

$

5,506

Appraised Value of Collateral (1)

Liquidation expenses (2)

0%

-

23%

(15%)

(3)

Other real estate owned

$

130

Appraised Value of Collateral (1)

Liquidation expenses (2)

(7%)

(3)

December 31, 2019

Corporate bonds

$

2,820

Discounted Cash Flows

Discount Rate

(6.66%)

SBA servicing assets

$

4,447

Discounted Cash Flows

Conditional Prepayment Rate

(13.53%)

Discount Rate

(10.75%)

Impaired loans

$

5,730

Appraised Value of Collateral (1)

Liquidation expenses (2)

9%

-

20%

(12%)

(3)

Other real estate owned

$

899

Appraised Value of Collateral (1)

Liquidation expenses (2)

6%

-

16%

(8%)

(3)

(1)	Fair value is generally determined through independent appraisals of the underlying collateral, which include Level 3 inputs that are not identifiable.

(2)	Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.

(3)	The range and weighted average of qualitative factors such as economic conditions and estimated liquidation expenses are presented as a percent of the appraised value.

The significant unobservable inputs for impaired loans and other real estate owned are the appraised value or an agreed upon sales price. These values are adjusted for estimated costs to sell which are incremental direct costs to transact a sale such as broker commissions, legal fees, closing costs and title transfer fees. The costs must be considered essential to the sale and would not have been incurred if the decision to sell had not been made. The costs to sell are based on costs associated with the Company’s actual sales of other real estate owned which are assessed annually.

Fair Value Assumptions

The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at September 30, 2020 and December 31, 2019.

Investment Securities

The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) 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. 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. Internal 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.

The types of instruments valued based on matrix pricing in active markets include all of the Company’s U.S. government and agency securities, corporate bonds, asset backed securities, and municipal obligations held in the investment securities portfolio. Such instruments are generally classified within Level 2 of the fair value hierarchy. As required by ASC 820-10, the Company does not adjust the matrix pricing for such instruments.

Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, and may be adjusted to reflect illiquidity and/or non-transferability, with such adjustment generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. Subsequent to inception, management only changes Level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows. Republic has one Level 3 investment classified as available for sale which is a single corporate bond.

The corporate bond included in Level 3 was transferred from Level 2 in 2010 and is not actively traded. Impairment would depend on the repayment ability of the underlying issuer, which is assessed through a detailed quarterly review of the issuer’s financial statements. The issuer is a “well capitalized” financial institution as defined by federal banking regulations and has demonstrated the ability to raise additional capital, when necessary, through the public capital markets. The fair value of this corporate bond is estimated by obtaining a price of a comparable floating rate debt instrument through Bloomberg.

Mortgage Loans Held for Sale (Carried at Fair Value)

The fair value of mortgage loans held for sale is determined by obtaining prices at which they could be sold in the principal market at the measurement date and are classified within Level 2 of the fair value hierarchy. Republic elected to adopt the fair value option for its mortgage loans held for sale portfolio in order to more accurately reflect their economic value. Interest income on loans held for sale, which totaled $248,000 and $497,000 for three and nine months ended September 30, 2020, respectively, and $142,000 and $398,000 for the three and nine months ended September 30, 2019, respectively, are included in interest and fees in the statements of income.

The following table reflects the difference between the carrying amount of mortgage loans held for sale, measured at fair value and the aggregate unpaid principal amount that Republic is contractually entitled to receive at maturity as of September 30, 2020 and December 31, 2019.

		Carrying Amount				Aggregate Unpaid Principal Balance				Excess Carrying Amount Over Aggregate Unpaid Principal Balance
September 30, 2020		$	41,683			$	39,983			$	1,700

December 31, 2019		$	10,345			$	9,983			$	362

Changes in the excess carrying amount over aggregate unpaid principal balance are recorded in the statement of income in mortgage banking income. Republic did not have any mortgage loans held for sale recorded at fair value that were 90 or more days past due and on non-accrual at September 30, 2020 and December 31, 2019.

Interest Rate Lock Commitments (“IRLC”)

The Company determines the value of IRLCs by comparing the market price to the price locked in with the customer, adding fees or points to be collected at closing, subtracting commissions to be paid at closing, and subtracting estimated remaining loan origination costs to the bank based on the processing status of the loan. The Company also considers pull-through as it determines the fair value of IRLCs Factors that affect pull-through rates include the origination channel, current mortgage interest rates in the market versus the interest rate incorporated in the IRLC, the purpose of the mortgage (purchase versus financing), the stage of completion of the underlying application and underwriting process, and the time remaining until the IRLC expires. IRLCs are classified within Level 2 of the valuation hierarchy.

Best Efforts Forward Loan Sales Commitments

Best efforts forward loan sales commitments are classified within Level 2 of the valuation hierarchy. Best efforts forward loan sales commitments fix the forward sales price that will be realized upon the sale of mortgage loans into the secondary market. Best efforts forward loan sales commitments are entered into for loans at the time the borrower commitment is made. These best efforts forward loan sales commitments are valued using the committed price to the counterparty against the current market price of the interest rate lock commitment or mortgage loan held for sale.

Mandatory Forward Loan Sales Commitments

Fair values for mandatory forward loan sales commitments are based on fair values of the underlying mortgage loans and the probability of such commitments being exercised. Due to the observable inputs used by Republic, best efforts mandatory loan sales commitments are classified within Level 2 of the valuation hierarchy.

Impaired Loans (Carried at Lower of Cost or Fair Value)

Impaired loans are those that the Company has measured impairment 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. The fair value consists of the loan balances less any valuation allowance. The valuation allowance amount is calculated as the difference between the recorded investment in a loan and the present value of expected future cash flows or it is calculated based on discounted collateral values if the loans are collateral dependent.

Other Real Estate Owned (Carried at Lower of Cost or Fair Value)

These assets are carried at the lower of cost or fair value. Fair value is determined through valuations periodically performed by third-party appraisers, and the real estate is carried at the lower of its carrying amount or fair value less estimated costs to sell. Any declines in the fair value of the real estate properties below the initial cost basis are recorded through a valuation expense.

SBA Servicing Asset (Carried at Fair Value)

The SBA servicing asset is initially recorded when loans are sold and the servicing rights are retained and recorded on the balance sheet. An updated fair value is obtained from an independent third party on a quarterly basis and adjustments are presented as loan and servicing fees on the statement of income. The valuation begins with the projection of future cash flows for each asset based on their unique characteristics, the Company’s market-based assumptions for prepayment speeds and estimated losses and recoveries. The present value of the future cash flows are then calculated utilizing the Company’s market-based discount ratio assumptions. In all cases, the Company models expected payments for every loan for each quarterly period in order to create the most detailed cash flow stream possible.

The Company uses assumptions and estimates in determining the impairment of the SBA servicing asset. These assumptions include prepayment speeds and discount rates commensurate with the risks involved and comparable to assumptions used by participants to value and bid serving rights available for sale in the market. At September 30, 2020 and December 31, 2019, the sensitivity of the current fair value of the SBA loan servicing rights to immediate 10% and 20% adverse changes in key assumptions are included in the accompanying table.

(dollars in thousands)		September 30, 2020				December 31, 2019

SBA Servicing Asset

Fair Value of SBA Servicing Asset		$	4,634			$	4,447

Composition of SBA Loans Serviced for Others
Fixed-rate SBA loans			2	%			2	%
Adjustable-rate SBA loans			98	%			98	%
Total			100	%			100	%

Weighted Average Remaining Term (in years)		20.3				20.7

Prepayment Speed			13.60	%			13.53	%
Effect on fair value of a 10% increase		$	(167	)		$	(175	)
Effect on fair value of a 20% increase			(323	)			(338	)

Weighted Average Discount Rate			10.00	%			10.75	%
Effect on fair value of a 10% increase		$	(151	)		$	(154	)
Effect on fair value of a 20% increase			(293	)			(298	)

The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in value may not be linear. Also in this table, the effect of an adverse variation in a particular assumption on the value of the SBA servicing rights is calculated without changing any other assumption. While in reality, changes in one factor may magnify or counteract the effect of the change.

Off-Balance Sheet Financial Instruments (Disclosed at notional amounts)

Fair values for the Company’s off-balance sheet financial 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.

The estimated fair values of the Company’s financial instruments at September 30, 2020 were as follows.

		Fair Value Measurements at September 30, 2020
(dollars in thousands)		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)
Balance Sheet Data
Financial assets:
Cash and cash equivalents		$	918,161			$	918,161			$	918,161			$	-			$	-
Investment securities available for sale			440,655				440,655				-				438,024				2,631
Investment securities held to maturity			688,939				712,369				-				712,369				-
Restricted stock			3,789				3,789				-				3,789				-
Loans held for sale			42,549				42,588				-				41,683				905
Loans receivable, net			2,617,547				2,606,683				-				-				2,606,683
SBA servicing assets			4,634				4,634				-				-				4,634
Accrued interest receivable			15,021				15,021				-				15,021				-
Interest rate lock commitments			1,451				1,451				-				1,451				-
Best efforts forward loan sales commitments			-				-				-				-				-
Mandatory forward loan sales commitments			-				-				-				-				-

Financial liabilities:
Deposits
Demand, savings and money market		$	3,702,310			$	3,702,310			$	-			$	3,702,310			$	-
Time			203,296				204,384				-				204,384				-
Short-term borrowings			646,267				646,267				-				646,267				-
Subordinated debt			11,270				8,008				-				-				8,008
Accrued interest payable			1,277				1,277				-				1,277				-
Interest rate lock commitments			1				1				-				1				-
Best efforts forward loan sales commitments			554				554				-				554				-
Mandatory forward loan sales commitments			525				525				-				525				-

Off-Balance Sheet Data
Commitments to extend credit			-				-				-				-				-
Standby letters-of-credit			-				-				-				-				-

The estimated fair values of the Company’s financial instruments at December 31, 2019 were as follows:

		Fair Value Measurements at December 31, 2019
(dollars in thousands)		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)
Balance Sheet Data
Financial assets:
Cash and cash equivalents		$	168,319			$	168,319			$	168,319			$	-			$	-
Investment securities available for sale			539,042				539,042				-				536,222				2,820
Investment securities held to maturity			644,842				653,109				-				653,109				-
Restricted stock			2,746				2,746				-				2,746				-
Loans held for sale			13,349				13,349				-				10,345				3,004
Loans receivable, net			1,738,929				1,731,876				-				-				1,731,876
SBA servicing assets			4,447				4,447				-				-				4,447
Accrued interest receivable			9,934				9,934				-				9,934				-
Interest rate lock commitments			362				362				-				362				-
Best efforts forward loan sales commitments			4				4				-				4				-
Mandatory forward loan sales commitments			2				2				-				2				-

Financial liabilities:
Deposits
Demand, savings and money market		$	2,775,584			$	2,775,584			$	-			$	2,775,584			$	-
Time			223,579				224,095				-				224,095				-
Subordinated debt			11,265				8,540				-				-				8,540
Accrued interest payable			1,630				1,630				-				1,630				-
Interest rate lock commitments			-				-				-				-				-
Best efforts forward loan sales commitments			133				133				-				133				-
Mandatory forward loan sales commitments			83				83				-				83				-

Off-Balance Sheet Data
Commitments to extend credit			-				-				-				-				-
Standby letters-of-credit			-				-				-				-				-

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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