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Fair Value of Assets and Liabilities | 9 Months Ended
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Sep. 30, 2019
Fair Value of Assets and Liabilities |
Fair Value of Assets and Liabilities | NOTE 19 Fair Value of Assets and Liabilities The Company categorizes its assets and liabilities measured at estimated fair value into a three level hierarchy based on the priority of the inputs to the valuation technique used to determine estimated fair value. The estimated fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used in the determination of the estimated fair value measurement fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the estimated fair value measurement. Assets and liabilities valued at estimated fair value are categorized based on the following inputs to the valuation techniques as follows: Level 1—Inputs that utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that an entity has the ability to access. Level 2—Inputs that include 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. Estimated fair values for these instruments are estimated using pricing models, quoted prices of investment securities with similar characteristics, or discounted cash flows. Level 3—Inputs that are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. Subsequent to initial recognition, the Company may re‑measure the carrying value of assets and liabilities measured on a nonrecurring basis to estimated fair value. Adjustments to estimated fair value usually result when certain assets are impaired. Such assets are written down from their carrying amounts to their estimated fair value. Professional standards allow entities the irrevocable option to elect to measure certain financial instruments and other items at estimated fair value for the initial and subsequent measurement on an instrument‑by‑instrument basis. The Company adopted the policy to value certain financial instruments at estimated fair value. The Company has not elected to measure any existing financial instruments at estimated fair value; however, it may elect to measure newly acquired financial instruments at estimated fair value in the future. Recurring Basis The Company uses estimated fair value measurements to record estimated fair value adjustments to certain assets and liabilities and to determine estimated fair value disclosures. The following tables present the balances of the assets and liabilities measured at estimated fair value on a recurring basis as of September 30, 2019 and December 31, 2018:
|  | September 30, 2019
(dollars in thousands) |  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Trading securities |  |  |  |  |  |  |  |  |  |  |  |
U.S. treasury and government agencies |  | $ | — |  | $ | — |  | $ | — |  | $ | —
Available-for-sale and equity securities |  |  |  |  |  |  |  |  |  |  |  |
U.S. treasury and government agencies |  | $ | — |  | $ | 21,602 |  | $ | — |  | $ | 21,602
Obligations of state and political agencies |  |  | — |  |  | 47,856 |  |  | — |  |  | 47,856
Mortgage backed securities |  |  |  |  |  |  |  |  |  |  |  |
Residential agency |  |  | — |  |  | 169,337 |  |  | — |  |  | 169,337
Commercial |  |  | — |  |  | 32,652 |  |  | — |  |  | 32,652
Asset backed securities |  |  | — |  |  | 157 |  |  | — |  |  | 157
Corporate bonds |  |  | — |  |  | 7,112 |  |  | — |  |  | 7,112
Equity securities |  |  | 2,675 |  |  | — |  |  | — |  |  | 2,675
Total available-for-sale and equity securities |  | $ | 2,675 |  | $ | 278,716 |  | $ | — |  | $ | 281,391
Other assets |  |  |  |  |  |  |  |  |  |  |  |
Derivatives |  | $ | — |  | $ | 2,483 |  | $ | — |  | $ | 2,483
Other liabilities |  |  |  |  |  |  |  |  |  |  |  |
Derivatives |  | $ | — |  | $ | 104 |  | $ | — |  | $ | 104
|  | December 31, 2018
(dollars in thousands) |  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Trading securities |  |  |  |  |  |  |  |  |  |  |  |
U.S. treasury and government agencies |  | $ | — |  | $ | 1,539 |  | $ | — |  | $ | 1,539
Available-for-sale and equity securities |  |  |  |  |  |  |  |  |  |  |  |
U.S. treasury and government agencies |  | $ | — |  | $ | 19,142 |  | $ | — |  | $ | 19,142
Obligations of state and political agencies |  |  | — |  |  | 66,387 |  |  | — |  |  | 66,387
Mortgage backed securities |  |  |  |  |  |  |  |  |  |  |  |
Residential agency |  |  | — |  |  | 126,998 |  |  | — |  |  | 126,998
Commercial |  |  | — |  |  | 28,767 |  |  | — |  |  | 28,767
Asset backed securities |  |  | — |  |  | 399 |  |  | — |  |  | 399
Corporate bonds |  |  | — |  |  | 8,481 |  |  | — |  |  | 8,481
Equity securities |  |  | 3,165 |  |  | — |  |  | — |  |  | 3,165
Total available-for-sale and equity securities |  | $ | 3,165 |  | $ | 250,174 |  | $ | — |  | $ | 253,339
Other assets |  |  |  |  |  |  |  |  |  |  |  |
Derivatives |  | $ | — |  | $ | 12 |  | $ | — |  | $ | 12
Other liabilities |  |  |  |  |  |  |  |  |  |  |  |
Derivatives |  | $ | — |  | $ | 7 |  | $ | — |  | $ | 7
The following is a description of the valuation methodologies used for instruments measured at estimated fair value on a recurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy. Investment Securities When available, the Company uses quoted market prices to determine the estimated fair value of investment securities; such items are classified in Level 1 of the estimated fair value hierarchy. For the Company’s investment securities for which quoted prices are not available for identical investment securities in an active market, the Company determines estimated fair value utilizing vendors who apply matrix pricing for similar bonds for which no prices are observable or may compile prices from various sources. These models are primarily industry‑standard models that consider various assumptions, including time value, yield curve, volatility factors, prepayment speeds, default rates, loss severity, current market, and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace. Estimated fair values from these models are verified, where possible, against quoted prices for recent trading activity of assets with similar characteristics to the security being valued. Such methods are generally classified as Level 2. However, when prices from independent sources vary, cannot be obtained, or cannot be corroborated, a security is generally classified as Level 3. Derivatives All of the Company’s derivatives are traded in over‑the‑counter markets where quoted market prices are not readily available. For these derivatives, estimated fair value is measured using internally developed models that use primarily market observable inputs, such as yield curves and option volatilities, and accordingly, classify as Level 2. Examples of Level 2 derivatives are basic interest rate swaps and forward contracts. Any remaining derivative estimated fair value measurements using significant assumptions that are unobservable are classified as Level 3. Level 3 derivatives include interest rate lock commitments written for residential mortgage loans that are held for sale. Nonrecurring Basis Certain assets are measured at estimated fair value on a nonrecurring basis. These assets are not measured at estimated fair value on an ongoing basis; however, they are subject to estimated fair value adjustments in certain circumstances, such as when there is evidence of impairment or a change in the amount of previously recognized impairment. Net impairment related to nonrecurring estimated fair value measurements of certain assets as of September 30, 2019 and December 31, 2018 consisted of the following:
|  | September 30, 2019
(dollars in thousands) |  | Level 2 |  | Level 3 |  | Total |  | Impairment
Loans held for sale |  | $ | 66,021 |  | $ | — |  | $ | 66,021 |  | $ | —
Loans held for branch sale |  |  | — |  |  | — |  |  | — |  |  | —
Impaired loans |  |  | — |  |  | 3,050 |  |  | 3,050 |  |  | 2,107
Foreclosed assets |  |  | — |  |  | 84 |  |  | 84 |  |  | —
Servicing rights |  |  | — |  |  | 4,146 |  |  | 4,146 |  |  | —
|  | December 31, 2018
(dollars in thousands) |  | Level 2 |  | Level 3 |  | Total |  | Impairment
Loans held for sale |  | $ | 14,486 |  | $ | — |  | $ | 14,486 |  | $ | —
Loans held for branch sale |  |  | — |  |  | 32,031 |  |  | 32,031 |  |  | —
Impaired loans |  |  | — |  |  | 4,022 |  |  | 4,022 |  |  | 2,538
Foreclosed assets |  |  | — |  |  | 204 |  |  | 204 |  |  | 245
Servicing rights |  |  | — |  |  | 4,623 |  |  | 4,623 |  |  | —
Loans Held for Sale Loans originated and held for sale are carried at the lower of cost or estimated fair value. The Company obtains quotes or bids on these loans directly from purchasing financial institutions. Typically these quotes include a premium on the sale and thus these quotes indicate estimated fair value of the held for sale loans is greater than cost. On January 15, 2019, the Bank entered into an agreement with a third party to sell the loans of two branch locations in Duluth, Minnesota, and on April 26, 2019, the Bank completed the sale. As of December 31, 2018, the loans were held for branch sale and totaled $32.0 million. The estimated fair value in the table above was based on the agreed upon purchase price in the sales contract. The measurements were classified as Level 3. Impairment losses for loans held for sale that are carried at the lower of cost or estimated fair value, represent additional net write‑downs during the period to record these loans at the lower of cost or estimated fair value, subsequent to their initial classification as loans held for sale. Impaired Loans In accordance with the provisions of the loan impairment guidance, loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms are measured for impairment. Allowable methods for estimating fair value include using the estimated fair value of the collateral for collateral dependent loans or, where a loan is determined not to be collateral dependent, using a discounted cash flow method. The estimated fair value method requires obtaining a current independent appraisal of the collateral and applying a discount factor, if necessary, to the appraised value and including costs to the sell. Because many of these inputs are not observable, the measurements are classified as Level 3. Foreclosed Assets Foreclosed assets are recorded at estimated fair value based on property appraisals, less estimated selling costs, at the date of the transfer with any impairment amount charged to the allowance for loan losses. Subsequent to the transfer, foreclosed assets are carried at the lower of cost or estimated fair value, less estimated selling costs with changes in the estimated fair value or any impairment amount recorded in other noninterest expense. Fair value measurements may be based upon appraisals, third‑party price opinions, or internally developed pricing methods. These measurements are classified as Level 3. Servicing Rights Servicing rights do not trade in an active market with readily observable prices. Accordingly, the estimated fair value of servicing rights is determined using a valuation model that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, and late fees. Servicing rights are carried at lower of cost or market value, and therefore can be subject to estimated fair value measurements on a nonrecurring basis. Estimated fair value measurements of servicing rights use significant unobservable inputs and accordingly, are classified as Level 3. The Company obtains the estimated fair value of servicing rights from an independent third party pricing service and records the unadjusted estimated fair values in the financial statements. The valuation techniques and significant unobservable inputs used to measure Level 3 estimated fair values as of September 30, 2019, and December 31, 2018, were as follows:
|  |  |  |  |  | September 30, 2019 |
(dollars in thousands) |  |  |  |  |  |  |  |  |  | Weighted |
Asset Type |  | Valuation Technique |  | Unobservable Input |  | Fair Value |  | Range |  | Average |
Impaired loans |  | Appraisal value |  | Property specific adjustment |  | 3,050 |  | N/A |  | N/A |
Foreclosed assets |  | Appraisal value |  | Property specific adjustment |  | 84 |  | N/A |  | N/A |
Servicing rights |  | Discounted cash flows |  | Prepayment speed assumptions |  | 4,146 |  | 154-270 |  | 194 |
|  |  |  | Discount rate |  |  |  | 9.5 | % | 9.5 | %
|  |  |  |  |  | December 31, 2018 |
(dollars in thousands) |  |  |  |  |  |  |  |  |  | Weighted |
Asset Type |  | Valuation Technique |  | Unobservable Input |  | Fair Value |  | Range |  | Average |
Loans held for branch sale |  | Discounted cash flows |  | Sales agreement |  | 32,031 |  | N/A |  | N/A |
Impaired loans |  | Appraisal value |  | Property specific adjustment |  | 4,022 |  | N/A |  | N/A |
Foreclosed assets |  | Appraisal value |  | Property specific adjustment |  | 204 |  | N/A |  | N/A |
Servicing rights |  | Discounted cash flows |  | Prepayment speed assumptions |  | 4,623 |  | 104 - 211 |  | 130 |
|  |  |  | Discount rate |  |  |  | 10.5 | % | 10.5 | %
Disclosure of estimated fair value information about financial instruments, for which it is practicable to estimate that value, is required whether or not recognized in the consolidated balance sheets. In cases in which quoted market prices are not available, estimated fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimate of future cash flows. In that regard, the derived estimated fair value estimates cannot be substantiated by comparison to independent markets and, in many cases could not be realized in immediate settlement of the instruments. Certain financial instruments, with an estimated fair value that is not practicable to estimate and all non‑financial instruments, are excluded from the disclosure requirements. Accordingly, the aggregate estimated fair value amounts presented do not necessarily represent the underlying value of the Company. The following disclosures represent financial instruments in which the ending balances, as of September 30, 2019 and December 31, 2018, were not carried at estimated fair value in their entirety on the consolidated balance sheets. Cash and Cash Equivalents and Accrued Interest The carrying amounts reported in the consolidated balance sheets approximate those assets and liabilities estimated fair values. Loans For variable‑rate loans that reprice frequently and with no significant change in credit risk, estimated fair values are based on carrying values. The estimated fair values of other loans are estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Bank‑Owned Life Insurance Bank‑owned life insurance is carried at the amount due upon surrender of the policy, which is also the estimated fair value. This amount was provided by the insurance companies based on the terms of the underlying insurance contract. Deposits The estimated fair values of demand deposits are, by definition, equal to the amount payable on demand at the consolidated balance sheet date. The estimated fair values of fixed‑rate certificates of deposit are estimated using a discounted cash flow calculation that applies current incremental interest rates being offered on certificates of deposit to a schedule of aggregated expected monthly maturities of the outstanding certificates of deposit. Deposits Held for Sale On January 15, 2019, the Bank entered into an agreement with a third party to sell the deposits of two branch locations in Duluth, Minnesota, and on April 26, 2019, the Bank completed the sale. As of December 31, 2018, the deposits were held for sale and totaled $24.2 million. The estimated fair value in the table below was based on the carrying value of the deposits, less the premium the Bank received, in accordance with the purchase agreement. Short‑Term Borrowings and Long‑Term Debt For variable‑rate borrowings that reprice frequently, estimated fair values are based on carrying values. The estimated fair value of fixed‑rate borrowings are estimated using discounted cash flow analysis, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. Off‑Balance Sheet Credit‑Related Commitments Off‑balance sheet credit related commitments are generally of short‑term nature. The contract amount of such commitments approximates their estimated fair value since the commitments are comprised primarily of unfunded loan commitments which are generally priced at market at the time of funding. The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments are as follows:
|  | September 30, 2019
|  | Carrying |  | Estimated Fair Value
(dollars in thousands) |  | Amount |  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Financial Assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents |  | $ | 61,174 |  | $ | 61,174 |  | $ | — |  | $ | — |  | $ | 61,174
Loans |  |  | 1,663,103 |  |  | — |  |  | — |  |  | 1,658,151 |  |  | 1,658,151
Accrued interest receivable |  |  | 7,412 |  |  | 7,412 |  |  | — |  |  | — |  |  | 7,412
Bank-owned life insurance |  |  | 31,364 |  |  | — |  |  | 31,364 |  |  | — |  |  | 31,364
Financial Liabilities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Noninterest-bearing transaction |  | $ | 537,951 |  | $ | — |  | $ | 537,951 |  | $ | — |  | $ | 537,951
Interest-bearing transaction |  |  | 1,102,409 |  |  | — |  |  | 1,102,409 |  |  | — |  |  | 1,102,409
Time deposits |  |  | 192,753 |  |  | — |  |  | — |  |  | 192,869 |  |  | 192,869
Short-term borrowings |  |  | — |  |  | — |  |  | — |  |  | — |  |  | —
Long-term debt |  |  | 58,775 |  |  | — |  |  | 58,285 |  |  | — |  |  | 58,285
Accrued interest payable |  |  | 1,879 |  |  | 1,879 |  |  | — |  |  | — |  |  | 1,879
|  | December 31, 2018
|  | Carrying |  | Estimated Fair Value
(dollars in thousands) |  | Amount |  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Financial Assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents |  | $ | 40,651 |  | $ | 40,651 |  | $ | — |  | $ | — |  | $ | 40,651
Loans |  |  | 1,679,676 |  |  | — |  |  | — |  |  | 1,663,401 |  |  | 1,663,401
Accrued interest receivable |  |  | 7,645 |  |  | 7,645 |  |  | — |  |  | — |  |  | 7,645
Bank-owned life insurance |  |  | 30,763 |  |  | — |  |  | 30,763 |  |  | — |  |  | 30,763
Financial Liabilities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Noninterest-bearing transaction |  | $ | 550,640 |  | $ | — |  | $ | 550,640 |  | $ | — |  | $ | 550,640
Interest-bearing transaction |  |  | 1,053,869 |  |  | — |  |  | 1,053,869 |  |  | — |  |  | 1,053,869
Time deposits |  |  | 170,587 |  |  | — |  |  | — |  |  | 172,616 |  |  | 172,616
Deposits held for sale |  |  | 24,197 |  |  | — |  |  | — |  |  | 22,019 |  |  | 22,019
Short-term borrowings |  |  | 93,460 |  |  | 93,460 |  |  | — |  |  | — |  |  | 93,460
Long-term debt |  |  | 58,824 |  |  | — |  |  | 59,988 |  |  | — |  |  | 59,988
Accrued interest payable |  |  | 720 |  |  | 720 |  |  | — |  |  | — |  |  | 720

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- Definition The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information. + References Reference 1: http://www.xbrl.org/2003/role/disclosureRef -Publisher FASB -Name Accounting Standards Codification -Topic 820 -SubTopic 10 -Section 50 -Paragraph 2 -URI http://asc.fasb.org/extlink&oid=117815213&loc=d3e19207-110258 + Details
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