NOTE 6 – FAIR VALUE

ASC Topic 820 provides a framework for measuring and disclosing fair value under GAAP. ASC 820 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available-for-sale investment securities) or a nonrecurring basis (for example, impaired loans).

ASC 820 defines fair value as 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. ASC 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The Fair Value Hierarchy

ASC 820‑10 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. In accordance with ASC 820‑10, these inputs are summarized in the three broad levels listed below:

Level 1 – Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.

Level 2 – Other significant observable inputs (including quoted prices in active markets for similar securities).

Level 3 – Significant unobservable inputs (including the Company’s own assumptions in determining the fair value of investments).

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value:

Investment Securities Available-for-Sale and Interest Rate Swaps. Investment securities available-for-sale and interest rate swap contracts 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 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 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage backed securities issued by government sponsored entities, municipal bonds and corporate debt securities, and interest rate swap contracts. Securities classified as Level 3 include asset-backed securities in illiquid markets.

The Bank may be required, from time to time, to measure certain other financial and non-financial assets and liabilities at fair value on a non-recurring basis in accordance with GAAP.

Loans. At March 31, 2021, these assets included 5 loans, excluding $1,806,384 of single-family residential, commercial real estate and automobile loans. They have been classified as impaired and include nonaccrual, past due 90 days or more and still accruing, and a homogeneous pool of indirect loans all considered to be impaired loans, which are valued under Level 3 inputs. Impaired loans totaled $2,635,565 with $10,589 of specific reserves as of March 31, 2021. Foreclosed real estate assets are primarily valued on a nonrecurring basis at the fair values of the underlying real estate collateral. The Company is predominantly a cash flow lender with real estate serving as collateral on a majority of loans. Impaired loans totaled $4,204,863 as of March 31, 2021. On a quarterly basis, the Company determines such fair values through a variety of data points and mostly rely on appraisals from independent appraisers. We obtain an appraisal on properties when they become impaired and conduct new appraisals at least every year. Typically, these appraisals do not include an inside inspection of the property as our loan documents do not require the borrower to allow access to the property. Therefore, the most significant unobservable inputs are the details of the amenities included within the property and the condition of the property. Further, we cannot always accurately assess the amount of time it takes to gain ownership of our collateral through the foreclosure process and the damage, as well as potential looting, of the property further decreasing our value. Thus, in determining the fair values we discount the current independent appraisals, with a range from 0% to 16%, based on individual circumstances. The remaining impaired loans ($237,000 with $10,589 of specific reserves as of March 31, 2021) include single-family residential, automobile loans, which are valued based on the value of the underlying collateral.

The changes in the assets subject to fair value measurements are summarized below by level:


							Fair
(dollars in thousands)	Level 1		Level 2		Level 3		Value
March 31, 2021
Recurring:
Securities available for sale
Collateralized mortgage obligations	$	—	$	27,020	$	—	$	27,020
Agency mortgage-backed securities		—		35,270		—		35,270
Municipal securities		—		30,997		—		30,997
U.S. Government agency securities		—		41,610		—		41,610
Interest rate swap		—		(810)		—		(810)

Non-recurring:
Maryland Financial Bank stock		—		—		3		3
Impaired loans		—		—		4,431		4,431
OREO		—		575		—		575
	$	—	$	134,662	$	4,434	$	139,096
December 31, 2020
Recurring:
Securities available for sale
Collateralized mortgage obligations	$	—	$	24,643	$	—	$	24,643
Agency mortgage-backed securities		—		26,948		—		26,948
Municipal securities		—		29,413		—		29,413
U.S. Government agency securities		—		33,045		—		33,045
Interest rate swap		—		(949)		—		(949)

Non-recurring:
Maryland Financial Bank stock		—		—		3		3
Impaired loans		—		—		4,893		4,893
OREO				575				575
	$	—	$	113,675	$	4,896	$	118,571

The estimated fair values of the Company’s financial instruments at March 31, 2021 and December 31, 2020 are summarized below. The fair values of a significant portion of these financial instruments are estimates derived using present value techniques and may not be indicative of the net realizable or liquidation values. Also, the calculation of estimated fair values is based on market conditions at a specific point in time and may not reflect current or future fair values.


	March 31, 2021				December 31, 2020
(dollars in thousands)	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
Financial assets:
Cash and due from banks	$	2,130	$	2,130	$	2,117	$	2,117
Interest-bearing deposits in other financial institutions		33,277		33,277		29,730		29,730
Federal funds sold		5,067		5,067		5,246		5,246
Investment securities available for sale		134,897		134,897		114,049		114,049
Investments in restricted stock		1,062		1,062		1,199		1,199
Ground rents		140		140		140		140
Loans, less allowance for credit losses		243,932		249,391		252,296		253,946
Accrued interest receivable		1,277		1,277		1,302		1,302
Cash value of life insurance		8,219		8,219		8,181		8,181

Financial liabilities:
Deposits		368,923		369,234		349,620		350,666
Short-term borrowings		31,244		31,236		29,912		29,935
Accrued interest payable		17		17		16		16
Unrecognized financial instruments:
Commitments to extend credit		30,729		30,729		31,561		31,561
Standby letters of credit		1,044		1,044		1,044		1,044

The following table presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments that were estimated using an exit pricing notion.


(dollars in thousands)
	Carrying		Fair
March 31, 2021	Amount		Value		Level 1		Level 2		Level 3

Financial instruments - Assets
Cash and cash equivalents	$	40,474	$	40,474	$	40,474	$	—	$	—
Loans receivable, net		243,932		249,391		—		—		249,391
Cash value of life insurance		8,219		8,219		—		8,219		—
Financial instruments - Liabilities
Deposits		368,923		369,234		147,911		221,323		—
Short-term debt		31,244		31,236		11,244		19,992		—

Fair values are based on quoted market prices for similar instruments or estimated using discounted cash flows. The discounts used are estimated using comparable market rates for similar types of instruments adjusted to be commensurate with the credit risk, overhead costs, and optionality of such instruments.

The fair value of cash and due from banks, federal funds sold, investments in restricted stocks and accrued interest receivable are equal to the carrying amounts. The fair values of investment securities are determined using market quotations, if available, or measured using pricing models or other model-based valuation techniques such as present value and future value cash flows. The fair value of loans receivable is estimated using discounted cash flow analysis. For cash surrender value of life insurance, the carrying value is a reasonable estimate of fair value. Cash surrender value of life insurance is reported in the Level 2 fair value category. The fair value of the Commercial SBA PPP loans is equal to the carrying amounts. The fair value of FHLB borrowings is estimated based upon discounted future cash flows using a discounted rate comparable to the current market rate for such borrowings. FHLB borrowings are reported in the Level 2 fair value category.

The fair value of non-interest bearing deposits, interest-bearing checking, savings, and money market deposit accounts, securities sold under agreements to repurchase, and accrued interest payable are equal to the carrying amounts. The fair value of fixed-maturity time deposits is estimated using discounted cash flow analysis.