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Fair Value Measurements

6 Months Ended

Jun. 30, 2020

Note 12. Fair Value Measurements

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. ASC Topic 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1 Quoted prices in active exchange markets for identical assets or liabilities; also includes certain U.S. Treasury and other U.S. Government and agency securities actively traded in over-the-counter markets.

Level 2 Observable inputs other than Level 1 including quoted prices for similar assets or liabilities, quoted prices in less active markets, or other observable inputs that can be corroborated by observable market data; also includes derivative contracts whose value is determined using a pricing model with observable market inputs or can be derived principally from or corroborated by observable market data. This category generally includes certain U.S. Government and agency securities, corporate debt securities, derivative instruments, and residential mortgage loans held for sale.

Level 3 Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation; also includes observable inputs for single dealer nonbinding quotes not corroborated by observable market data. This category generally includes certain private equity investments, retained interests from securitizations, and certain collateralized debt obligations.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis as of June 30, 2020 (unaudited) and December 31, 2019.


			Significant		Significant
			Other		Other
			Observable		Unobservable
	Quoted Prices		Inputs		Inputs		Total
(dollars in thousands)	(Level 1)		(Level 2)		(Level 3)		(Fair Value)
June 30, 2020
Assets:
Investment securities available-for-sale:
U. S. agency securities	$	—	$	117,054	$	—	$	117,054
Residential mortgage backed securities		—		531,528		—		531,528
Municipal bonds		—		90,694		—		90,694
Corporate bonds		—		—		32,920		32,920
Other equity investments		—		—		198		198
Loans held for sale		—		68,433		—		68,433
Interest Rate Caps		—		4,454		—		4,454
Total assets measured at fair value on a recurring basis as of June 30, 2020	$	—	$	812,163	$	33,118	$	845,281
Liabilities:
Interest rate swap derivatives	$	—	$	1,330	$	—	$	1,330
Derivative liability		—		150		—		150
Interest Rate Caps		—		4,748		—		4,748
Total liabilities measured at fair value on a recurring basis as of June 30, 2020	$	—	$	6,228	$	—	$	6,228
December 31, 2019
Assets:
Investment securities available-for-sale:
U. S. agency securities	$	—	$	179,794	$	—	$	179,794
Residential mortgage backed securities		—		543,852		—		543,852
Municipal bonds		—		73,931		—		73,931
Corporate bonds		—		—		10,733		10,733
U.S. Treasury		—		34,855		—		34,855
Other equity investments		—		—		198		198
Loans held for sale		—		56,707		—		56,707
Interest Rate Caps		—		317		—		317
Mortgage banking derivatives		—		—		280		280
Total assets measured at fair value on a recurring basis as of December 31, 2019	$	—	$	889,456	$	11,211	$	900,667
Liabilities:
Interest rate swap derivatives	$	—	$	203	$	—	$	203
Derivative liability		—		86		—		86
Interest Rate Caps		—		312		—		312
Mortgage banking derivatives		—		—		66		66
Total liabilities measured at fair value on a recurring basis as of December 31, 2019	$	—	$	601	$	66	$	667

Investment Securities Available-for-Sale: Investment securities available-for-sale 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 value is measured using independent pricing models or other model-based valuation techniques such as the 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 U.S. agency debt securities, mortgage backed securities issued by Government Sponsored Entities (“GSE’s”) and municipal bonds. Securities classified as Level 3 include securities in less liquid markets, the carrying amounts approximate the fair value.

Loans held for sale: The Company has elected to carry loans held for sale at fair value. This election reduces certain timing differences in the Consolidated Statement of Operations and better aligns with the management of the portfolio from a business perspective. Fair value is derived from secondary market quotations for similar instruments. Gains and losses on sales of residential mortgage loans are recorded as a component of noninterest income in the Consolidated Statements of Operations. Gains and losses on sales of multifamily FHA securities are recorded as a component of noninterest income in the Consolidated Statements of Operations. As such, the Company classifies loans subjected to fair value adjustments as Level 2 valuation.

The following tables summarize the difference between the aggregate fair value and the aggregate unpaid principal balance for loans held for sale measured at fair value as of June 30, 2020 (unaudited) and December 31, 2019.


	June 30, 2020
			Aggregate
			Unpaid
			Principal
(dollars in thousands)	Fair Value		Balance		Difference
Loans held for sale	$	68,433	$	67,397	$	1,036


	December 31, 2019
			Aggregate
			Unpaid
			Principal
(dollars in thousands)	Fair Value		Balance		Difference
Loans held for sale	$	56,707	$	55,834	$	873

No residential mortgage loans held for sale were 90 or more days past due or on nonaccrual status as of June 30, 2020 or December 31, 2019.

Interest rate swap derivatives: These derivative instruments consist of interest rate swap agreements, which are accounted for as cash flow hedges under ASC 815. The Company’s derivative position is classified within Level 2 of the fair value hierarchy and is valued using models generally accepted in the financial services industry and that use actively quoted or observable market input values from external market data providers and/or non-binding broker-dealer quotations. The fair value of the derivatives is determined using discounted cash flow models. These models’ key assumptions include the contractual terms of the respective contract along with significant observable inputs, including interest rates, yield curves, nonperformance risk and volatility. Derivative contracts are executed with a Credit Support Annex, which is a bilateral agreement that requires collateral postings when the market value exceeds certain threshold limits. These agreements protect the interests of the Company and its counterparties should either party suffer a credit rating deterioration.

Credit Risk Participation Agreements: The Company enters into credit risk participation agreements (“RPAs”) with institutional counterparties, under which the Company assumes its pro-rata share of the credit exposure associated with a borrower’s performance related to interest rate derivative contracts. The fair value of RPAs is calculated by determining the total expected asset or liability exposure of the derivatives to the borrowers and applying the borrowers’ credit spread to that exposure. Total expected exposure incorporates both the current and potential future exposure of the derivatives, derived from using observable inputs, such as yield curves and volatilities. Accordingly, RPAs fall within Level 2.

Interest Rate Caps: The Company entered into an interest rate cap agreement ("cap") with an institutional counterparty, under which the Company will receive cash if and when market rates exceed the cap's strike rate. The fair value of the cap is calculated by determining the total expected asset or liability exposure of the derivatives. Total expected exposure incorporates both the current and potential future exposure of the derivative, derived from using observable inputs, such as yield curves and volatilities. Accordingly, the cap falls within Level 2.

Mortgage banking derivatives: The Company relies on a third-party pricing service to value its mortgage banking derivative financial assets and liabilities, which the Company classifies as a Level 3 valuation. The external valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale includes grouping the interest rate lock commitments by interest rate and terms, applying an estimated pull-through rate based on historical experience, and then multiplying by quoted investor prices determined to be reasonably applicable to the loan commitment groups based on interest rate, terms, and rate lock expiration dates of the loan commitment groups. The Company also relies on an external valuation model to estimate the fair value of its forward commitments to sell residential mortgage loans (i.e., an estimate of what the Company would receive or pay to terminate the forward delivery contract based on market prices for similar financial instruments), which includes matching specific terms and maturities of the forward commitments against applicable investor pricing.

The following is a reconciliation of activity for assets and liabilities measured at fair value based on Significant Other Unobservable Inputs (Level 3):


	Investment		Mortgage Banking
(dollars in thousands)	Securities		Derivatives		Total
Assets:
Beginning balance at January 1, 2020	$	10,931	$	280	$	11,211
Realized gain (loss) included in earnings		442		(280)		162
Unrealized gain included in other comprehensive income		1,280		—		1,280
Purchases of available-for-sale securities		41,547		—		41,547
Principal redemption		(21,082)		—		(21,082)
Ending balance at June 30, 2020	$	33,118	$	—	$	33,118

Liabilities:
Beginning balance at January 1, 2020	$	—	$	66	$	66
Realized loss included in earnings		—		(66)		(66)
Principal redemption		—		—		—
Ending balance at June 30, 2020	$	—	$	—	$	—


	Investment		Mortgage Banking
(dollars in thousands)	Securities		Derivatives		Total
Assets:
Beginning balance at January 1, 2019	$	9,794	$	229	$	10,023
Realized (loss) gain included in earnings		(20)		51		31
Unrealized gain included in other comprehensive income		131		—		131
Purchases of available-for-sale securities		4,030		—		4,030
Principal redemption		(3,004)		—		(3,004)
Ending balance at December 31, 2019	$	10,931	$	280	$	11,211

Liabilities:
Beginning balance at January 1, 2019	$	—	$	269	$	269
Realized gain included in earnings		—		(203)		(203)
Principal redemption		—		—		—
Ending balance at December 31, 2019	$	—	$	66	$	66

The other equity securities classified as Level 3 consist of equity investments in the form of common stock of two local banking companies which are not publicly traded, and for which the carrying amount approximates fair value.

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company measures certain assets at fair value on a nonrecurring basis and the following is a general description of the methods used to value such assets.

At June 30, 2020, substantially all of the Company’s individually evaluated loans were evaluated based upon the fair value of the collateral. In accordance with ASC Topic 820, individually evaluated loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3.

Pre Adoption of CECL: The Company did not record loans at fair value on a recurring basis; however, from time to time, a loan was considered impaired and an allowance for loan loss was established. The Company considered a loan impaired when it was probable that the Company would be unable to collect all amounts due according to the original contractual terms of the note agreement, including both principal and interest. Management had determined that nonaccrual loans and loans that had their terms restructured in a TDR met this impaired loan definition. Once a loan was identified as individually impaired, management measures impairment in accordance with ASC Topic 310, “Receivables.” The fair value of impaired loans was estimated using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring a specific allowance represented loans for which the fair value of expected repayments or collateral exceeded the recorded investment in such loans.

Other real estate owned: Other real estate owned is initially recorded at fair value less estimated selling costs. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral, which the Company classifies as a Level 3 valuation. Assets measured at fair value on a nonrecurring basis are included in the table below:


			Significant		Significant
			Other		Other
			Observable		Unobservable
	Quoted Prices		Inputs		Inputs		Total
(dollars in thousands)	(Level 1)		(Level 2)		(Level 3)		(Fair Value)
June 30, 2020
Commercial	$	—	$	—	$	18,047	$	18,047
Income producing - commercial real estate		—		—		27,295		27,295
Owner occupied - commercial real estate		—		—		10,815		10,815
Real estate mortgage - residential		—		—		7,960		7,960
Construction - commercial and residential		—		—		5,385		5,385
Home equity		—		—		600		600
Other consumer		—		—		6		6
Other real estate owned		—		—		8,237		8,237
Total assets measured at fair value on a nonrecurring basis as of June 30, 2020	$	—	$	—	$	78,345	$	78,345


			Significant		Significant
			Other		Other
			Observable		Unobservable
	Quoted Prices		Inputs		Inputs		Total
(dollars in thousands)	(Level 1)		(Level 2)		(Level 3)		(Fair Value)
December 31, 2019
Impaired loans:
Commercial	$	—	$	—	$	10,100	$	10,100
Income producing - commercial real estate		—		—		11,948		11,948
Owner occupied - commercial real estate		—		—		6,934		6,934
Real estate mortgage - residential		—		—		4,981		4,981
Construction - commercial and residential		—		—		11,409		11,409
Home equity		—		—		387		387
Other real estate owned		—		—		1,487		1,487
Total assets measured at fair value on a nonrecurring basis as of December 31, 2019	$	—	$	—	$	47,246	$	47,246

Fair Value of Financial Instruments

The Company discloses fair value information about financial instruments for which it is practicable to estimate the value, whether or not such financial instruments are recognized on the balance sheet. Fair value is the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation, and is best evidenced by quoted market price, if one exists.

Quoted market prices, if available, are shown as estimates of fair value. Because no quoted market prices exist for a portion of the Company’s financial instruments, the fair value of such instruments has been derived based on management’s assumptions with respect to future economic conditions, the amount and timing of future cash flows and estimated discount rates. Different assumptions could significantly affect these estimates. Accordingly, the net realizable value could be materially different from the estimates presented below. In addition, the estimates are only indicative of individual financial instrument values and should not be considered an indication of the fair value of the Company taken as a whole.

The estimated fair value of the Company’s financial instruments at June 30, 2020 and December 31, 2019 are as follows:


					Fair Value Measurements
							Significant
							Other		Significant
					Quoted		Observable		Unobservable
	Carrying				Prices		Inputs		Inputs
(dollars in thousands)	Value		Fair Value		(Level 1)		(Level 2)		(Level 3)
June 30, 2020
Assets
Cash and due from banks	$	12,199	$	12,199	$	—	$	12,199	$	—
Federal funds sold		25,466		25,466		—		25,466		—
Interest bearing deposits with other banks		598,377		598,377		—		598,377		—
Investment securities		772,394		772,394		—		719,212		53,182
Federal Reserve and Federal Home Loan Bank stock		40,018		40,018		—		40,018		—
Loans held for sale		68,433		68,433		—		68,433		—
Loans		7,912,965		7,828,639		—		—		7,828,639
Bank owned life insurance		75,913		75,913		—		75,913		—
Annuity investment		14,480		14,480		—		14,480		—
Interest Rate Caps		4,454		4,454		—		4,454		—

Liabilities
Noninterest bearing deposits		2,416,058		2,416,058		—		2,416,058		—
Interest bearing deposits		4,366,421		4,366,421		—		4,366,421		—
Certificates of deposit		1,153,493		1,149,418		—		1,149,418		—
Customer repurchase agreements		31,198		31,198		—		31,198		—
Borrowings		567,882		548,808		—		548,808		—
Interest rate swap derivatives		1,330		1,330				1,330		—
Derivative liability		150		150		—		150		—
Interest Rate Caps		4,748		4,748		—		4,748		—

December 31, 2019
Assets
Cash and due from banks	$	7,539	$	7,539	$	—	$	7,539	$	—
Federal funds sold		38,987		38,987		—		38,987		—
Interest bearing deposits with other banks		195,447		195,447		—		195,447		—
Investment securities		843,363		843,363		—		832,432		10,931
Federal Reserve and Federal Home Loan Bank stock		35,194		35,194		—		35,194		—
Loans held for sale		56,707		56,707		—		56,707		—
Loans		7,472,090		7,550,249		—		—		7,550,249
Bank owned life insurance		75,724		75,724		—		75,724		—
Annuity investment		14,697		14,697		—		14,697		—
Interest Rate Caps		280		280		—		280		—

Liabilities
Noninterest bearing deposits		2,064,367		2,064,367		—		2,064,367		—
Interest bearing deposits		3,876,985		3,876,985		—		3,876,985		—
Certificates of deposit		1,283,039		1,291,688		—		1,291,688		—
Customer repurchase agreements		30,980		30,980		—		30,980		—
Borrowings		467,687		328,330		—		328,330		—
Interest rate swap derivatives		203		203				203		—
Derivative liability		86		86		—		86		—
Interest Rate Caps		312		312		—		312		—
Mortgage banking derivatives		66		66		—		—		66