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Fair Value Measurements

9 Months Ended

Sep. 30, 2023

Note 10 – Fair Value Measurements

Fair value estimates are made at a specific point in time, based on relevant market information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time of our entire holdings of a particular financial instrument. Because no market exists for a significant portion of our financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment, and therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on-and-off 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.

The methods of determining the fair value of assets and liabilities presented in this footnote are consistent with our methodologies disclosed in Note 1 - Summary of Significant Accounting Policies of the Notes to the Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of the 2022 Form 10-K.

Assets Measured on a Recurring Basis

As required by accounting standards, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following measurements are made on a recurring basis.

Available-for-sale investment securities – Available-for-sale investment securities 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 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 I securities include those traded on an active exchange, such as the New York Stock Exchange and money market funds. Level II securities include mortgage-backed securities issued by government sponsored entities and private label entities, municipal bonds, United States Treasury securities that are traded by dealers or brokers in inactive over-the-counter markets and corporate debt securities. There have been no changes in valuation techniques for the three and nine months ended September 30, 2023. Valuation techniques are consistent with techniques used in prior periods. Certain local municipal securities related to tax increment financing (“TIF”) are independently valued and classified as Level III instruments. We classified investments in government securities as Level II instruments and valued them using the market approach.

Equity securities – Certain equity securities 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 the present value of future cash flows, adjusted for the security's credit rating, prepayment assumptions and other factors such as credit loss assumptions. The valuation methodologies utilized may include significant unobservable inputs. There have been no changes in valuation techniques for the three and nine months ended September 30, 2023. Valuation techniques are consistent with techniques used in prior periods.

Interest rate swaps – Interest rate swaps are recorded at fair value based on third-party vendors who compile prices from various sources and may determine the fair value of identical or similar instruments by using pricing models that consider observable market data.

Fair value hedges – Treated like an interest rate swap, fair value hedges are recorded at fair value based on third-party vendors who compile prices from various sources and may determine fair value of identical or similar instruments by using pricing models that consider observable market data.

Bank-owned life insurance - Life insurance where the bank is both the policy beneficiary and owner. Bank-owned life insurance is recorded at fair value on a recurring basis, and increases in cash surrender, contract value and net insurance proceeds at maturity are recorded as other income.

Embedded derivatives — Accounted for and recorded separately from the underlying contract as a derivative at fair value on a recurring basis. Fair values are determined using the Monte Carlo model valuation technique. The valuation methodology utilized includes significant unobservable inputs.

The following tables present assets and liabilities reported on the consolidated statements of financial condition at their fair value on a recurring basis as of the periods shown by level within the fair value hierarchy:


	September 30, 2023
(Dollars in thousands)	Level I		Level II		Level III		Total
Assets:
United States government agency securities	$	—	$	37,140	$	—	$	37,140
United States sponsored mortgage-backed securities	—		60,481		—		60,481
United States treasury securities	98,100		—		—		98,100
Municipal securities	—		81,484		17,140		98,624
Corporate debt securities	—		8,901		—		8,901

Other securities	—		791		—		791
Equity securities	4,647		—		—		4,647
Loans held-for-sale	—		7,603		—		7,603
Interest rate swaps	—		12,974		—		12,974
Fair value hedge	—		204		—		204
Bank-owned life insurance	—		44,109		—		44,109
Embedded derivative	—		—		648		648
Liabilities:
Interest rate swaps	—		10,609		—		10,609


	December 31, 2022
(Dollars in thousands)	Level I		Level II		Level III		Total
Assets:
United States government agency securities	$	—	$	44,814	$	—	$	44,814
United States sponsored mortgage-backed securities	—		56,571		—		56,571
United States treasury securities	—		120,909		—		120,909
Municipal securities	—		103,293		35,343		138,636
Corporate debt securities	—		10,560		—		10,560
Other securities	—		824		—		824
Equity securities	5,382		—		—		5,382

Interest rate swaps	—		8,427		—		8,427
Bank-owned life insurance	—		43,239		—		43,239
Embedded derivative	—		—		787		787
Liabilities:
Interest rate swaps	—		8,427		—		8,427
Fair value hedge	—		572		—		572

The following table represents recurring Level III assets as of the periods shown:


(Dollars in thousands)	Municipal Securities		Embedded Derivatives		Total
Balance at June 30, 2023	$	34,418	$	648	$	35,066
Realized and unrealized income included in earnings	45		—		45
Purchase of securities	250		—		250
Maturities/calls	(17,389)		—		(17,389)
Unrealized loss included in other comprehensive income (loss)	(184)		—		(184)
Balance at September 30, 2023	$	17,140	$	648	$	17,788

Balance at December 31, 2022	$	35,343	$	787	$	36,130
Realized and unrealized income (loss) included in earnings	46		(139)		(93)
Purchase of securities	250		—		250
Maturities/calls	(18,156)		—		(18,156)

Unrealized loss included in other comprehensive income (loss)	(343)		—		(343)
Balance at September 30, 2023	$	17,140	$	648	$	17,788

Balance at June 30, 2022	$	37,035	$	—	$	37,035
Realized and unrealized gain included in earnings	—		—		—
Purchase of securities	—		—		—
Maturities/calls	(66)		—		(66)
Unrealized loss included in other comprehensive income (loss)	(1,840)		—		(1,840)
Balance at September 30, 2022	$	35,129	$	—	$	35,129

Balance at December 31, 2021	$	41,763	$	—	$	41,763
Realized and unrealized gains included in earnings	8		—		8
Purchase of securities	1,048		—		1,048
Maturities/calls	(3,141)		—		(3,141)
Unrealized loss included in other comprehensive income	(4,550)		—		(4,550)
Balance at September 30, 2022	$	35,129	$	—	$	35,129

Assets Measured on a Nonrecurring Basis

We may be required, from time to time, to measure certain financial assets, financial liabilities, non-financial assets and non-financial liabilities at fair value on a nonrecurring basis in accordance with U.S. GAAP. These include assets that are measured at the lower of cost or market value that were recognized at fair value below cost at the end of the period. Certain non-financial assets measured at fair value on a non-recurring basis include foreclosed assets (upon initial recognition or subsequent impairment) and intangible assets and other non-financial long-lived assets measured at fair value for impairment assessment. Non-financial assets measured at fair value on a nonrecurring basis during 2023 and 2022 include certain foreclosed assets which, upon initial recognition, were remeasured and reported at fair value through a charge-off to the allowance for possible loan losses and certain foreclosed assets which, subsequent to their initial recognition, were remeasured at fair value through a write-down included in other noninterest expense.

Collateral-dependent loans - Certain loans receivable are evaluated individually for credit loss when the borrower is experiencing financial difficulties and repayment is expected to be provided substantially through the operation or sale of collateral. Estimated credit losses are based on the fair value of the collateral, adjusted for costs to sell. Collateral values are estimated using Level II inputs based on observable market data or Level III inputs based on customized discounting criteria. For a majority of collateral-dependent real estate related loans, we obtain a current external appraisal. Other valuation techniques are used as well, including internal valuations, comparable property analysis and contractual sales information.

Loans held-for-sale - The fair value of loans held-for-sale is determined, when possible, using quoted secondary-market prices or investor commitments. If no such quoted price exists, the fair value of a loan is determined using quoted prices for a similar asset

or assets, adjusted for the specific attributes of that loan, which would be used by other market participants. If the fair value at the reporting date exceeds the amortized cost of a loan, the loan is reported at amortized cost.

Other real estate owned – Other real estate owned, which is obtained through the Bank’s foreclosure process, is valued utilizing the appraised collateral value. Collateral values are estimated using Level II inputs based on observable market data or Level III inputs based on customized discounting criteria. At the time the foreclosure is completed, we obtain a current external appraisal.

Other debt securities – Certain debt securities are recorded at fair value on a nonrecurring basis. These other debt securities are securities without a readily determinable fair value and are measured at cost minus impairment, if any, plus or minus any changes resulting from observable price changes in orderly transactions, as defined, for identical or similar investments of the same issuer.

Equity securities – Certain equity securities are recorded at fair value on a nonrecurring basis. Equity securities without a readily determinable fair value are measured at cost minus impairment, if any, plus or minus any changes resulting from observable price changes in orderly transactions, as defined, for identical or similar investments of the same issuer.

The following table presents the fair value of these assets as of the periods shown:


	September 30, 2023
(Dollars in thousands)	Level I		Level II		Level III		Total
Collateral-dependent loans	$	—	$	—	$	3,113	$	3,113
Other real estate owned	—		—		906		906
Other debt securities	—		—		7,500		7,500
Equity securities	—		—		36,188		36,188


	December 31, 2022
(Dollars in thousands)	Level I		Level II		Level III		Total
Impaired loans	$	—	$	—	$	14,117	$	14,117
Other real estate owned	—		—		1,194		1,194
Other debt securities	—		—		7,500		7,500
Equity securities	—		—		33,362		33,362

The following tables present quantitative information about the Level III significant unobservable inputs for assets and liabilities measured at fair value as of the periods shown:


	Quantitative Information about Level III Fair Value Measurements
(Dollars in thousands)	Fair Value		Valuation Technique	Unobservable Input	Range
September 30, 2023
Nonrecurring measurements:
Collateral-dependent loans	$	3,113	Appraisal of collateral 1	Appraisal adjustments 2	0% - 20%
				Liquidation expense 2	6%

Other real estate owned	$	906	Appraisal of collateral 1	Appraisal adjustments 2	0% - 20%
				Liquidation expense 2	6%

Other debt securities	$	7,500	Net asset value	Cost, less impairment	0%

Equity securities	$	36,188	Net asset value	Cost, less impairment	0%

Recurring measurements:
Municipal securities 5	$	17,140	Appraisal of bond 3	Bond appraisal adjustment 4	5% - 15%

Embedded derivatives	$	648	Monte Carlo pricing model	Deferred payment	$0 - $49.1 million
				Volatility	59%
				Term	4.75 years
				Risk free rate	3.59%

December 31, 2022
Nonrecurring measurements:
Impaired loans	$	14,117	Appraisal of collateral 1	Appraisal adjustments 2	0% - 20%
				Liquidation expense 2	6%

Other real estate owned	$	1,194	Appraisal of collateral 1	Appraisal adjustments 2	0% - 20%
				Liquidation expense 2	6%

Other debt securities	$	7,500	Net asset value	Cost, less impairment	0%

Equity securities	$	33,362	Net asset value	Cost, less impairment	0%

Recurring measurements:
Municipal securities 5	$	35,343	Appraisal of bond 3	Bond appraisal adjustment 4	5% - 15%

Embedded derivatives	$	787	Monte Carlo pricing model	Deferred payment	$0 - $51.9 million
				Volatility	58%
				Term	5 years
				Risk free rate	3.95%

1 Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level III inputs that are not identifiable.

2 Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

3 Fair value is determined through independent analysis of liquidity, rating, yield and duration.

4 Appraisals may be adjusted for qualitative factors, such as local economic conditions, liquidity, marketability and legal structure.

5 Municipal securities classified as Level III instruments are comprised of TIF bonds related to certain local municipal securities.

- 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.

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