FAIR VALUE DISCLOSURES AND REPORTING, THE FAIR VALUE OPTION AND FAIR VALUE MEASUREMENTS

6 Months Ended

Jun. 30, 2020

FAIR VALUE DISCLOSURES AND REPORTING, THE FAIR VALUE OPTION AND FAIR VALUE MEASUREMENTS

FAIR VALUE DISCLOSURES AND REPORTING, THE FAIR VALUE OPTION AND FAIR VALUE MEASUREMENTS

NOTE 8 – FAIR VALUE DISCLOSURES AND REPORTING, THE FAIR VALUE OPTION AND FAIR VALUE MEASUREMENTS

Fair value is 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 assets 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: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant 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 factors that market participants would likely consider in pricing an asset or liability.

The following methods and assumptions were used by the Company to estimate its financial instrument fair values disclosed at June 30, 2020 and December 31, 2019:

● Investment Securities:  The fair value for investment securities are determined by quoted market prices, if available (Level 1).  For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2), using matrix pricing.  Matrix pricing is a mathematical technique commonly used to price debt securities that are not actively traded, valuing debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).  For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).  

● Loans held for sale:  Since loans designated by the Company as available-for-sale are typically sold shortly after making the decision to sell them, realized gains or losses are usually recognized within the same period and

fluctuations in fair values are not relevant for reporting purposes.  If available-for-sale loans are held on our books for an extended period of time, the fair value of those loans is determined using quoted secondary-market prices.

● Impaired Loans: Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment.  If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral.  These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.  Adjustments are routinely made in the appraisal process by independent appraisers to adjust for differences between the comparable sales and income data available for similar loans and collateral underlying such loans.  Such adjustments, if any, result in a Level 3 classification of the inputs for determining fair value.   The Company generally adjusts the appraisal down by approximately 10 percent to account for selling costs.  Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification.  Impaired loans are evaluated on a quarterly basis for additional impairment.

● Other Real Estate Owned: Other real estate owned consists of properties obtained through foreclosure.  The adjustment at the time of foreclosure is recorded through the allowance for loan losses.  Fair value of other real estate owned is based on current independent appraisals of the collateral 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, which are updated no less frequently than annually.  These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach with data from comparable properties.  Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available.  Such adjustments, if any, result in a Level 3 classification of the inputs for determining fair value.  In the determination of fair value subsequent to foreclosure, Management also considers other factors or recent developments, such as changes in market conditions from the time of valuation and anticipated sales values considering plans for disposition, which could result in an adjustment to lower the collateral value estimates indicated in the appraisals.  The Company generally adjusts the appraisal down by approximately 10 percent to account for selling costs.  Periodic revaluations are classified as Level 3 in the fair value hierarchy since assumptions are used that may not be observable in the market. Due to the subjective nature of establishing the fair value when the asset is acquired, the actual fair value of the other real estate owned or foreclosed asset could differ from the original estimate. If it is determined the fair value declines subsequent to foreclosure, a valuation allowance is recorded through other non-interest income. Operating costs associated with the assets after acquisition are also recorded as non-interest expense. Gains and

losses on the disposition of other real estate owned and foreclosed assets are netted and recorded in other non-interest income. Other real estate owned is classified within Level 3 of the fair value hierarchy.

Estimated fair values for the Company’s financial instruments are as follows, as of the dates noted:

As of June 30, 2020

					Fair Value Measurements
							Significant
							Other		Significant
							Observable		Unobservable
	Carrying		Estimated		Quoted Prices		Inputs		Inputs
($ in thousands)	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
Financial Instruments:
Assets:
Cash and cash equivalents	$	539,125	$	539,125	$	539,125	$	—	$	—
Securities available-for- sale:
U.S. Treasury		9,443		9,443		9,443		—		—
Obligations of U.S. government agencies and sponsored entities		100,213		100,213		—		100,213		—
Municipal securities		389,849		389,849		—		378,965		10,884
Mortgage- backed securities		398,818		398,818		—		398,818		—
Corporate obligations		28,882		28,882		—		28,642		240
Loans, net		3,162,103		3,135,815		—		—		3,135,815
Accrued interest receivable		24,782		24,782		—		5,629		19,153
Liabilities:
Noninterest-bearing deposits	$	486,039	$	486,039	$	—	$	486,039	$	—
Interest-bearing deposits		3,730,851		3,733,230		—		3,733,230		—
Subordinated debentures		80,756		73,784		—		—		73,784
FHLB and other borrowings		116,005		116,005		—		116,005		—
Accrued interest payable		2,195		2,195		—		2,195		—

As of December 31, 2019

			Fair Value Measurements
							Significant
							Other		Significant
					Quoted		Observable		Unobservable
	Carrying		Estimated		Prices		Inputs		Inputs
($ in thousands)	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
Financial Instruments:
Assets:
Cash and cash equivalents	$	168,864	$	168,864	$	168,864	$	—	$	—
Securities available-for-sale:
U.S. Treasury		4,894		4,894		4,894		—		—
Obligations of U.S. government agencies and sponsored entities		77,950		77,950		—		77,950		—
Municipal securities		258,982		258,982		—		248,637		10,345
Mortgage-backed securities		395,315		395,315		—		395,315		—
Corporate obligations		27,946		27,946		—		27,538		408
Loans, net		2,597,260		2,560,668		—		—		2,560,668
Accrued interest receivable		14,802		14,802		—		4,246		10,556
Liabilities:
Non-interest-bearing deposits	$	723,208	$	723,208	$	—	$	723,208	$	—
Interest-bearing deposits		2,353,325		2,339,537		—		2,339,537		—
Subordinated debentures		80,678		80,330		—		—		80,330
FHLB and other borrowings		214,319		214,319		—		214,319		—
Accrued interest payable		2,508		2,508		—		2,508		—

Assets measured at fair value on a recurring basis are summarized below:

June 30, 2020

			Fair Value Measurements Using
			Quoted Prices
			in
			Active
			Markets		Significant
			For		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
($ in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
Available-for-sale
U.S. Treasury	$	9,443	$	9,443	$	—	$	—
Obligations of U.S. Government agencies and sponsored entities		100,213		—		100,213		—
Municipal securities		389,849		—		378,965		10,884
Mortgage-backed securities		398,818		—		398,818		—
Corporate obligations		28,882		—		28,642		240
Total available-for-sale	$	927,205	$	9,443	$	906,638	$	11,124

December 31, 2019

			Fair Value Measurements Using
			Quoted Prices
			in
			Active
			Markets		Significant
			For		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
($ in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
Available-for-sale
U.S. Treasury	$	4,894	$	4,894	$	—	$	—
Obligations of U.S. Government agencies and sponsored entities		77,950		—		77,950		—
Municipal securities		258,982		—		248,637		10,345
Mortgage-backed securities		395,315		—		395,315		—
Corporate obligations		27,946		—		27,538		408
Total available-for-sale	$	765,087	$	4,894	$	749,440	$	10,753

The following is a reconciliation of activity for assets measured at fair value based on significant unobservable inputs (Level 3) information.

	Bank-Issued
	Trust
	Preferred
	Securities
($ in thousands)	2020		2019
Balance, January 1	$	408	$	874
Unrealized loss included in comprehensive income		(168)		(466)
Balance at June 30, 2020 and December 31, 2019	$	240	$	408

	Municipal Securities
($ in thousands)	2020		2019
Balance, January 1	$	10,345	$	7,574
Unrealized gain included in comprehensive income		539		2,771
Balance at June 30, 2020 and December 31, 2019	$	10,884	$	10,345

The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a recurring basis at June 30, 2020 and December 31, 2019. The following tables present quantitative information about recurring Level 3 fair value measurements ($ in thousands):

				Significant
	Fair		Valuation	Unobservable	Range of
Trust Preferred Securities	Value		Technique	Inputs	Inputs
June 30, 2020	$	240	Discounted cash flow	Probability of default	0.63% - 2.53%
December 31, 2019	$	408	Discounted cash flow	Probability of default	2.73% - 4.15%

				Significant
	Fair		Valuation	Unobservable	Range of
Municipal Securities	Value		Technique	Inputs	Inputs
June 30, 2020	$	10,884	Discounted cash flow	Discount Rate	0.60% - 2.95%
December 31, 2019	$	10,345	Discounted cash flow	Discount Rate	1.50% - 4.40%

The following table presents the fair value measurement of assets measured at fair value on a non-recurring basis and the level within the fair value hierarchy in which the fair value measurements were classified at June 30, 2020 and December 31, 2019.

June 30, 2020

			Fair Value Measurements Using
			Quoted
			Prices in
			Active
			Markets		Significant
			For		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
($ in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
Impaired loans	$	8,900	$	—	$	—	$	8,900
Other real estate owned		5,471		—		—		5,471

December 31, 2019

			Fair Value Measurements Using
			Quoted
			Prices in
			Active
			Markets		Significant
			For		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
($ in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
Impaired loans	$	11,337	$	—	$	—	$	11,337
Other real estate owned		7,299		—		—		7,299