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Fair Value Measurements and Fair Value of Financial Instruments
 6 Months Ended
Jun. 30, 2017
Fair Value Disclosures [Abstract]  
Fair Value Measurements and Fair Value of Financial Instruments

Note 7. Fair Value Measurements and Fair Value of Financial Instruments

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 asset or liability in an orderly transaction between market participants on the measurement date.

FASB ASC 820-10-05 defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurements and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date.

FASB ASC 820-10-65 provides additional guidance for estimating fair value in accordance with FASB ASC 820-10-05 when the volume and level of activity for the asset or liability have significantly decreased. This ASC also includes guidance on identifying circumstances that indicate a transaction is not orderly.

FASB ASC 820-10-05 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 FASB ASC 820-10-05 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 for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

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

An asset’s 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. 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.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

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, 2017 and December 31, 2016:

Securities Available-for-Sale

Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 inputs include securities that have quoted prices in active markets for identical assets. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. Examples of instruments, which would generally be classified within Level 2 of the valuation hierarchy include municipal bonds and certain agency collateralized mortgage obligations. In certain cases where there is limited activity in the market for a particular instrument, assumptions must be made to determine the fair value of the instruments and these are classified as Level 3. When measuring fair value, the valuation techniques available under the market approach, income approach and/or cost approach are used. The Company’s evaluations are based on market data and the Company employs combinations of these approaches for its valuation methods depending on the asset class.

Derivatives

The fair value of derivatives are based on valuation models using observable market data as of the measurement date (level 2). Our derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rate, and volatility factors to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services.

For financial assets and liabilities measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at June 30, 2017 and December 31, 2016 are as follows:

June 30, 2017
Fair Value Measurements at Reporting Date Using
Quoted Prices
in Active Significant
                Markets for Other Significant
Identical         Observable         Unobservable
Assets Inputs Inputs
(Level 1) (Level 2) (Level 3)
    (dollars in thousands)
Recurring fair value measurements:
Assets
Securities:
Available-for-sale:
Federal agency obligations $ 59,645 $      - $      59,645 $      -
Residential mortgage pass-through securities 140,400 - 140,400 -
Commercial mortgage pass-through securities 4,173 - 4,173 -
Obligations of U.S. states and political subdivisions 136,354 - 118,371 17,983
Trust preferred securities 4,586 - 4,586 -
Corporate bonds and notes 30,288 - 30,288 -
Asset-backed securities 13,281 - 13,281 -
Certificates of deposit 629 - 629 -
Equity securities 604 604 - -
Other securities 12,170 12,170 - -
Total available-for-sale $      402,130 $ 12,774 $ 371,373 $ 17,983
Derivatives 45 - 45 -
Total Assets $ 402,175 $ 12,774 $ 371,418 $ 17,983

December 31, 2016
Fair Value Measurements at Reporting Date Using
Quoted Prices
in Active Significant
Markets for Other Significant
          Identical      Observable      Unobservable
Assets Inputs Inputs
(Level 1) (Level 2) (Level 3)
(dollars in thousands)
Recurring fair value measurements:
Assets
Securities:
Available-for-sale:
Federal agency obligations $      52,837 $      - $      52,837 $      -
Residential mortgage pass-through securities 72,497 - 72,497 -
Commercial mortgage pass-through securities 4,209 - 4,209 -
Obligations of U.S. states and political subdivisions 150,605 - 132,387 18,218
Trust preferred securities 5,666 - 5,666 -
Corporate bonds and notes 36,928 - 36,928 -
Asset-backed securities 14,583 - 14,583 -
Certificates of deposit 983 - 983 -
Equity securities 568 568 - -
Other securities 14,414 14,414 - -
Total available-for-sale $ 353,290 $ 14,982 $ 320,090 $ 18,218
Derivatives 88 - 88 -
Total assets $ 353,378 $ 14,982 $ 320,178 $ 18,218

There were no transfers between Level 1 and Level 2 during the quarter ended June 30, 2017 and during the year ended December 31, 2016.

Assets Measured at Fair Value on a Non-Recurring Basis

The Company may be required periodically to measure certain assets at fair value on a non-recurring basis in accordance with GAAP. These adjustments to fair value usually result from the application of lower of cost or fair value accounting or impairment write-downs of individual assets. The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a non-recurring basis at June 30, 2017 and December 31, 2016:

Loans Held-for-Sale

Residential mortgage loans, originated and intended for sale in the secondary market, are carried at the lower of aggregate cost or estimated fair value as determined by outstanding commitments from investors. For these loans originated and intended for sale, gains and losses on loan sales (sale proceeds minus carrying value) are recorded in other income and direct loan origination costs and fees are deferred at origination of the loan and are recognized in other income upon sale of the loan. Management obtains quotes or bids on all or part of these loans directly from the purchasing financial institutions (Level 2).

Other loans held-for-sale are carried at the lower of aggregate cost or estimated fair value. A portion of these loans, taxi medallion loans, have no material observable trading in any market. The approach to determining fair value involved several steps, including a detailed collateral analysis of the underlying medallions, performance projections for individual loans, discounted cash flow modeling and consideration of indicative bids, which at June 30, 2017 did not necessarily contemplate whole loan sales (Level 3).

Impaired Loans

The Company may record adjustments to the carrying value of loans based on fair value measurements, generally as partial charge-offs of the uncollectible portions of these loans. These adjustments also include certain impairment amounts for collateral dependent loans calculated in accordance with GAAP. Impairment amounts are generally based on the fair value of the underlying collateral supporting the loan and, as a result, the carrying value of the loan less the calculated impairment amount applicable to that loan does not necessarily represent the fair value of the loan. Real estate collateral is valued using independent appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable by market participants. However, due to the substantial judgment applied and limited volume of activity as compared to other assets, fair value is based on Level 3 inputs. Estimates of fair value used for collateral supporting commercial loans generally are based on assumptions not observable in the market place and are also based on Level 3 inputs.

For assets measured at fair value on a non-recurring basis, the fair value measurements at June 30, 2017 and December 31, 2016 are as follows:

Fair Value Measurements at Reporting Date Using
Quoted
Prices
in Active Significant
                Markets for         Other         Significant
Identical Observable Unobservable
Assets Inputs Inputs
Assets measured at fair value on a nonrecurring basis: June 30, 2017 (Level 1) (Level 2) (Level 3)
Impaired loans: (dollars in thousands)
Commercial real estate $      1,432 $      - $      - $      1,432
 
Loans held-for-sale:
Commercial 50,891 - - 50,891
 
Fair Value Measurements at Reporting Date Using
Quoted
Prices
in Active Significant
Markets for Other Significant
Identical Observable Unobservable
December 31, Assets Inputs Inputs
Assets measured at fair value on a nonrecurring basis: 2016 (Level 1) (Level 2) (Level 3)
Impaired loans: (dollars in thousands)
Commercial real estate $ 1,099 $ - $ - $ 1,099
 
Loans held-for-sale:
Commercial 70,105 - 4,509 65,596
Commercial real estate 7,712 - 7,712 -

Impaired loans – Collateral dependent impaired loans at June 30, 2017 that required a valuation allowance were $0.8 million with a related valuation allowance of $0.1 million compared to $1.2 million with a related valuation allowance of $0.1 million at December 31, 2016.

Loans held-for-sale - Loans held-for-sale at June 30, 2017 that required a valuation allowance were $63.2 million with a related valuation allowance of $12.3 million compared to $65.6 million with no valuation allowance at December 31, 2016.

Assets Measured With Significant Unobservable Level 3 Inputs

Recurring basis

The tables below present a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended June 30, 2017 and year ended December 31, 2016:

Municipal
Securities
(dollars in thousands)
Beginning balance, January 1, 2017 $ 18,218
Other(1) -
Principal paydowns (235 )
Ending balance, June 30, 2017 $ 17,983
 
Municipal
Securities
(dollars in thousands)
Beginning balance, January 1, 2016 $                    -
Other(1) 18,335
Principal paydowns (117 )
Ending balance, December 31, 2016 $ 18,218

(1) Includes transfers from held-to-maturity to available-for-sale designation

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, 2017 and December 31, 2016. The table below provides quantitative information about significant unobservable inputs used in fair value measurements within Level 3 hierarchy.

June 30, 2017

Valuation Unobservable
        Fair Value         Techniques         Input         Range
Securities available-for-sale: (dollars in thousands)
Municipal securities $     17,983 Discounted Cash Discount Rate 2.8%
Flows
 
December 31, 2016
Valuation Unobservable
Fair Value Techniques Input Range
Securities available-for-sale: (dollars in thousands)
Municipal securities $     18,218 Discounted Cash Discount Rate 2.8%
Flows

Non-recurring basis

The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a non-recurring basis for the periods presented. The tables below provide quantitative information about significant unobservable inputs used in fair value measurements within Level 3 hierarchy.

June 30, 2017

Valuation
Techniques Unobservable
Type Fair Value (weightings) Input Range (weighted average)
(dollars in thousands)
Impaired loans:
Commercial real estate $ 1,432 Appraisals of
collateral value		 Comparable sales 0% - 15% (6%)
 
Loans held-for-sale:      
Commercial taxi medallion loans $ 50,891 Market approach Indications under securitized 37 - 100 (45)
(70%) transactions expressed as a
price to unpaid principal
balance
Discounted cash
flows (30%) Discount Rate 14%
 
December 31, 2016
Valuation
Techniques Unobservable
Type Fair Value       (weightings)       Input       Range (weighted average)
(dollars in thousands)
Impaired loans:
Commercial real estate $ 1,099 Appraisals of Comparable sales 0% - 15% (6%)
collateral value
 
Loans held-for-sale:
Commercial taxi medallion loans $ 65,596 Market approach Indications under securitized 40 - 100 (59)
(70%) transactions expressed as a
price to unpaid principal
balance
Discounted cash
flows (30%) Discount Rate 14%

Fair Value of Financial Instruments

FASB ASC 825-10 requires all entities to disclose the estimated fair value of their financial instrument assets and liabilities. For the Company, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in FASB ASC 825-10. Many of the Company’s financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. It is also the Company’s general practice and intent to hold its financial instruments to maturity and not to engage in trading or sales activities except for loans held-for-sale and securities available-for-sale. Therefore, significant estimations and assumptions, as well as present value calculations, were used by the Company for the purposes of this disclosure.

Cash and Cash Equivalents. The carrying amounts of cash and short-term instruments approximate fair values.

FHLB stock. It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

Loans. The fair value of the Company’s loans was estimated by discounting the expected future cash flows using the current interest rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans were segregated by types such as commercial, residential and consumer loans. Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price and therefore, while permissible for presentation purposes under ASC 825-10, do not conform to ASC 820-10.

Deposits. The carrying amounts of deposits with no stated maturities (i.e., noninterest-bearing, savings, NOW, and money market deposits) are assigned fair values equal to the carrying amounts payable on demand. The fair value of time deposits is based on the discounted value of contractual cash flows using estimated rates currently offered for alternative funding sources of similar remaining maturity.

Term Borrowings and Subordinated Debentures. The fair value of the Company’s long-term borrowings and subordinated debentures were calculated using a discounted cash flow approach and applying discount rates currently offered based on weighted remaining maturities.

Accrued Interest Receivable/Payable. The carrying amounts of accrued interest approximate fair value resulting in a level 2 or level 3 classification based on the level of the asset or liability with which the accrual is associated.

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of June 30, 2017 and December 31, 2016:

Fair Value Measurements
Quoted
Prices in
Active Significant
Markets for Other Significant
Identical Observable Unobservable
Carrying Fair Assets Inputs Inputs
Amount Value (Level 1) (Level 2) (Level 3)
(dollars in thousands)
June 30, 2017
Financial assets:
Cash and due from banks      $      146,508      $      146,508      $      146,508      $      -      $      -
Securities available-for-sale 402,130 402,130 12,774 371,373 17,983
Restricted investment in bank stocks 32,152 n/a n/a n/a n/a
Loans held-for-sale 51,124 51,124 - 233 50,891
Net loans 3,733,171 3,740,586 - - 3,740,586
Derivatives 45 45 - 45 -
Accrued interest receivable 13,194 13,194 - 1,744 11,450
   
Financial liabilities:
Noninterest-bearing deposits 695,522 695,522 695,522 - -
Interest-bearing deposits 2,734,851 2,735,530 1,753,548 981,982 -
Borrowings 626,173 627,854 - 627,854 -
Subordinated debentures 54,616 56,542 - 56,542 -
Accrued interest payable 6,044 6,044 - 6,044 -
  
December 31, 2016
Financial assets:
Cash and due from banks $ 200,399 $ 200,399 $ 200,399 $ - $ -
Securities available-for-sale 353,290 353,290 14,982 320,090 18,218
Restricted investment in bank stocks 24,310 n/a n/a n/a n/a
Loans held-for-sale 78,005 78,005 - 12,409 65,596
Net loans 3,450,088 3,462,138 - - 3,462,138
Derivatives 88 88 - 88 -
Accrued interest receivable 12,965 12,965 - 2,026 10,939
   
Financial liabilities:
Noninterest-bearing deposits 694,977 694,977 694,977 - -
Interest-bearing deposits 2,649,294 2,649,717 1,681,044 968,673 -
Borrowings 476,280 478,286 - 478,286 -
Subordinated debentures 54,534 55,901 - 55,901 -
Accrued interest payable 4,142 4,142 - 4,142 -

The fair value of commitments to originate loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date. The fair value of commitments to originate loans is immaterial and not included in the tables above.

Changes in assumptions or estimation methodologies may have a material effect on these estimated fair values.

The Company’s remaining assets and liabilities, which are not considered financial instruments, have not been valued differently than has been customary with historical cost accounting. No disclosure of the relationship value of the Company’s core deposit base is required by FASB ASC 825-10.

Fair value estimates are based on existing balance sheet financial instruments, without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, there are certain significant assets and liabilities that are not considered financial assets or liabilities, such as deferred taxes, premises and equipment, and goodwill. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

Management believes that reasonable comparability between financial institutions may not be likely, due to the wide range of permitted valuation techniques and numerous estimates which must be made, given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.