Note 16 - Assets and Liabilities Measured and Reported at Fair Value

9 Months Ended

Sep. 30, 2019

Notes to Financial Statements

Fair Value Measurement and Measurement Inputs, Recurring and Nonrecurring [Text Block]

(16) Assets and Liabilities Measured and Reported at Fair Value

Fair value represents 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: Valuation is based upon quoted (unadjusted) prices for identical instruments traded in active markets.

● Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

● Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions would reflect internal estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques could include pricing models, discounted cash flows and other similar techniques.

Authoritative guidance requires maximization of use of observable inputs and minimization of use of unobservable inputs in fair value measurements. Where there exists limited or no observable market data, Bancorp derives its own estimates by generally considering characteristics of the asset/liability, the current economic and competitive environment and other factors. For this reason, results cannot be determined with precision and may not be realized on an actual sale or immediate settlement of the asset or liability.

Bancorp’s AFS securities portfolio and interest rate swaps are recorded at fair value on a recurring basis.

All AFS securities are priced using standard industry models or matrices with various assumptions such as yield curves, volatility, prepayment speeds, default rates, time value, credit rating and market prices for similar instruments. These assumptions are observable in the market place and can be derived from or supported by observable data. These measurements are classified as Level 2.

Fair value measurements for interest rate swaps are based on benchmark forward yield curves and other relevant observable market data. For purposes of potential valuation adjustments to derivative positions, Bancorp evaluates the credit risk of its counterparties as well as its own credit risk. To date, Bancorp has not realized any losses due to counterparty’s inability to perform and the change in value of derivative assets and liabilities attributable to credit risk was not significant during the reporting period. Interest rate swaps are valued using primarily Level 2 inputs.

MSRs, impaired loans and OREO are recorded at fair value on a non-recurring basis, generally in the application of lower of cost or market adjustments or write-downs of specific assets.

Carrying values of assets measured at fair value on a recurring basis follows:

(In thousands)	Fair value at September 30, 2019
Assets	Total		Level 1		Level 2		Level 3
Securities available for sale:
Government sponsored enterprise obligations	$	214,365	$	—	$	214,365	$	—
Mortgage backed securities - government agencies		143,002		—		143,002		—
Obligations of states and political subdivisions		18,234		—		18,234		—
Total Securities available for sale		375,601		—		375,601		—
Interest rate swaps		3,708		—		3,708		—
Total assets	$	379,309	$	—	$	379,309	$	—
Liabilities
Interest rate swaps	$	3,802	$	—	$	3,802	$	—

(In thousands)	Fair value at December 31, 2018
Assets	Total		Level 1		Level 2		Level 3
Securities available for sale:
Government sponsored enterprise obligations	$	261,039	$	—	$	261,039	$	—
Mortgage backed securities - government agencies		146,277		—		146,277		—
Obligations of states and political subdivisions		29,679		—		29,679		—
Total Securities available for sale		436,995		—		436,995		—
Interest rate swaps		1,035		—		1,035		—
Total assets	$	438,030	$	—	$	438,030	$	—
Liabilities
Interest rate swaps	$	543	$	—	$	543	$	—

For the securities portfolio, Bancorp monitors the valuation technique used by pricing agencies to ascertain when transfers between levels have occurred. The nature of other assets and liabilities measured at fair value is such that transfers in and out of any level are expected to be rare. For the three and nine months ended September 30, 2019, there were no transfers between Levels 1, 2, or 3.

Bancorp had no financial instruments classified within Level 3 of the valuation hierarchy for assets and liabilities measured at fair value on a recurring basis at September 30, 2019 or December 31, 2018.

Discussion of assets measured at fair value on a non-recurring basis follows:

MSRs – On at least a quarterly basis, MSRs are evaluated for impairment based upon the fair value of the MSRs as compared to carrying amount. Fair value is based on a valuation model that calculates the present value of estimated net servicing income. The model incorporates assumptions that market participants would use in estimating future net servicing income. These measurements are classified as Level 3. At September 30, 2019 and December 31, 2018, there was no valuation allowance for MSRs, as the fair value exceeded the cost. Accordingly, the MSRs are not included in the following tabular disclosure for September 30, 2019 or December 31, 2018.

Impaired loans – Collateral-dependent impaired loans generally include loans that have received partial charge-downs or specific reserve allocations needed to record the loan at fair value. Fair value is commonly based on recent real estate appraisals or other sources of valuations based upon the underlying collateral. Fair value of impaired loans was primarily measured based on the value of collateral securing these loans. Impaired loans are classified within Level 3 of the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory, and/or accounts receivable. Bancorp typically determines the value of real estate collateral based on independent appraisals performed by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised values are discounted for costs to sell and may be discounted further based on management’s historical knowledge, changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts by management are subjective and are typically significant unobservable inputs for determining fair value. For other assets, Bancorp relies on both internal and third party assessments of asset value, based on information provided by the borrower, following methodologies similar to those described for real estate. As of September 30, 2019, total impaired collateral dependent loans charged down to their fair value and impaired loans with a valuation allowance were $383,000 and the specific allowance totaled $35,000, resulting in a fair value of $348,000, compared with total collateral dependent loans charged down to their fair value and impaired loans with a valuation allowance of $967,000, and the specific allowance allocation totaling $42,000, resulting in a fair value of $925,000 at December 31, 2018. Losses represent charge offs and changes in specific allowances for the periods indicated.

OREO – Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals or valuations performed by internal or external parties which use judgments and assumptions that are property-specific and sensitive to changes in the overall economic environment. Appraisals may be further discounted based on management’s historical knowledge and/or changes in market conditions from the date of the most recent appraisal. Many of these inputs are not observable and, accordingly, these measurements are classified as Level 3. For OREO in the following table, fair value is the carrying value of only parcels of OREO which have a carrying value equal to appraised value. Losses represent write-downs which occurred during the period indicated. At September 30, 2019 and December 31, 2018, carrying value of OREO was $563,000 and $1.0 million.

Below are the carrying values of assets measured at fair value on a non-recurring basis.

(In thousands)	Fair value at September 30, 2019								Losses recorded:
									Three months		Nine months
									ended		ended
	Total		Level 1		Level 2		Level 3		September 30, 2019		September 30, 2019
Impaired loans	$	348	$	—	$	—	$	348	$	—	$	—
Other real estate owned		239		—		—		239		—		—

(In thousands)	Fair value at December 31, 2018								Losses recorded:
									Three months		Nine months
									ended		ended
	Total		Level 1		Level 2		Level 3		September 30, 2018		September 30, 2018
Impaired loans	$	925	$	—	$	—	$	925	$	—	$	874
Other real estate owned		239		—		—		239		—		—

For Level 3 assets measured at fair value on a non-recurring basis, the significant unobservable inputs used in the fair value measurements are presented below.

September 30, 2019
	Fair		Valuation	Unobservable	(weighted
(Dollars in thousands)	value		technique	inputs	average)
Impaired loans - collateral dependent	$	348	Appraisal	Appraisal discounts		10.0	%
Other real estate owned		239	Appraisal	Appraisal discounts		22.0

December 31, 2018
	Fair		Valuation	Unobservable	(weighted
(Dollars in thousands)	value		technique	inputs	average)
Impaired loans - collateral dependent	$	925	Appraisal	Appraisal discounts		9.9	%
Other real estate owned		239	Appraisal	Appraisal discounts		22.0