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FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS

9 Months Ended

Sep. 30, 2020

FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS

FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS

13. FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS

The Corporation measures certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB topic 820, “Fair Value Measurements and Disclosures” establishes a framework for measuring fair value that includes a hierarchy used to classify the inputs used in measuring fair value. The hierarchy prioritizes the inputs used in determining valuations into three levels. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. The levels of the fair value hierarchy are as follows:

Level 1 – Fair value is based on unadjusted quoted prices in active markets that are accessible to the Corporation for identical assets or liabilities. These generally provide the most reliable evidence and are used to measure fair value whenever available.

Level 2 – Fair value is based on significant inputs, other than Level 1 inputs, that are observable either directly or indirectly for substantially the full term of the asset or liability through corroboration with observable market data. Level 2 inputs include quoted market prices in active markets for similar assets or liabilities, quoted market prices in markets that are not active for identical or similar assets or liabilities and other observable inputs.

Level 3 – Fair value is based on significant unobservable inputs. Examples of valuation methodologies that would result in Level 3 classification include option pricing models, discounted cash flows and other similar techniques.

The Corporation monitors and evaluates available data relating to fair value measurements on an ongoing basis and recognizes transfers among the levels of the fair value hierarchy as of the date of an event or change in circumstances that affects the valuation method chosen. Examples of such changes may include the market for a particular asset or liability becoming active or inactive, changes in the availability of quoted prices, or changes in the availability of other market data.

At September 30, 2020 and December 31, 2019, assets and liabilities measured at fair value and the valuation methods used are as follows:


		September 30, 2020
		Quoted
		Prices			Other
		in Active			Observable			Unobservable			Total
		Markets			Inputs			Inputs			Fair
(In Thousands)		(Level 1)			(Level 2)			(Level 3)			Value
Recurring fair value measurements, assets:
AVAILABLE-FOR-SALE DEBT SECURITIES:
Obligations of the U.S. Treasury		$	0		$	12,226		$	0		$	12,226
Obligations of U.S. Government agencies			0			16,355			0			16,355
Obligations of states and political subdivisions:
Tax-exempt			0			109,668			0			109,668
Taxable			0			44,195			0			44,195
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities			0			46,211			0			46,211
Residential collateralized mortgage obligations			0			69,337			0			69,337
Commercial mortgage-backed securities			0			42,553			0			42,553
Total available for sale debt Securities			0			340,545			0			340,545
Marketable equity security			1,003			0			0			1,003
Servicing rights			0			0			1,437			1,437
Interest rate swap agreements, assets			0			7,478			0			7,478
Total recurring fair value measurements, assets		$	1,003		$	348,023		$	1,437		$	350,463

Recurring fair value measurements, liabilities,
Interest rate swap agreements, liabilities		$	0		$	7,478		$	0		$	7,478

Nonrecurring fair value measurements, assets:
Impaired loans with a valuation allowance			0			0			8,085			8,085
Valuation allowance			0			0			(651)			(651)
Impaired loans, net			0			0			7,434			7,434
Foreclosed assets held for sale			0			0			2,369			2,369
Total nonrecurring fair value measurements, assets		$	0		$	0		$	9,803		$	9,803


		December 31, 2019
		Quoted
		Prices			Other
		in Active			Observable			Unobservable			Total
		Markets			Inputs			Inputs			Fair
(In Thousands)		(Level 1)			(Level 2)			(Level 3)			Value
Recurring fair value measurements, assets:
AVAILABLE-FOR-SALE DEBT SECURITIES:
Obligations of U.S. Government agencies		$	0		$	17,000		$	0		$	17,000
Obligations of states and political subdivisions:
Tax-exempt			0			70,760			0			70,760
Taxable			0			36,303			0			36,303
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities			0			59,210			0			59,210
Residential collateralized mortgage obligations			0			114,723			0			114,723
Commercial mortgage-backed securities			0			48,727			0			48,727
Total available-for-sale debt securities			0			346,723			0			346,723
Marketable equity security			979			0			0			979
Servicing rights			0			0			1,277			1,277
Total recurring fair value measurements		$	979		$	346,723		$	1,277		$	348,979

Nonrecurring fair value measurements, assets
Impaired loans with a valuation allowance		$	0		$	0		$	3,375		$	3,375
Valuation allowance			0			0			(1,051)			(1,051)
Impaired loans, net			0			0			2,324			2,324
Foreclosed assets held for sale			0			0			2,886			2,886
Total nonrecurring fair value measurements, assets		$	0		$	0		$	5,210		$	5,210

Management’s evaluation and selection of valuation techniques and the unobservable inputs used in determining the fair values of assets valued using Level 3 methodologies include sensitive assumptions. Other market participants might use substantially different assumptions, which could result in calculations of fair values that would be substantially different than the amount calculated by management.

At September 30, 2020 and December 31, 2019, quantitative information regarding valuation techniques and the significant unobservable inputs used for assets measured on a recurring basis using unobservable inputs (Level 3 methodologies) are as follows:


		Fair Value at
		9/30/2020			Valuation		Unobservable					Method or Value As of
Asset		(In Thousands)			Technique		Input(s)					9/30/2020
Servicing rights		$	1,437		Discounted cash flow		Discount rate			12.50	%	Rate used through modeling period
							Loan prepayment speeds			354.00	%	Weighted-average PSA
							Servicing fees			0.25	%	of loan balances
										4.00	%	of payments are late
										5.00	%	late fees assessed
									$	1.94		Miscellaneous fees per account per month
							Servicing costs		$	6.00		Monthly servicing cost per account
									$	24.00		Additional monthly servicing cost per loan on loans more than 30 days delinquent
										1.50	%	of loans more than 30 days delinquent
										3.00	%	annual increase in servicing costs


		Fair Value at
		12/31/2019			Valuation		Unobservable					Method or Value As of
Asset		(In Thousands)			Technique		Input(s)					12/31/2019
Servicing rights		$	1,277		Discounted cash flow		Discount rate			12.50	%	Rate used through modeling period
							Loan prepayment speeds			183.00	%	Weighted-average PSA
							Servicing fees			0.25	%	of loan balances
										4.00	%	of payments are late
										5.00	%	late fees assessed
									$	1.94		Miscellaneous fees per account per month
							Servicing costs		$	6.00		Monthly servicing cost per account
									$	24.00		Additional monthly servicing cost per loan on loans more than 30 days delinquent
										1.50	%	of loans more than 30 days delinquent
										3.00	%	annual increase in servicing costs

The fair value of servicing rights is affected by expected future interest rates. Increases (decreases) in future expected interest rates tend to increase (decrease) the fair value of the Corporation’s servicing rights because of changes in expected prepayment behavior by the borrowers on the underlying loans. Unrealized gains (losses) in fair value of servicing rights are included in Loan servicing fees, net, in the unaudited consolidated statements of income.

Following is a reconciliation of activity for Level 3 assets measured at fair value on a recurring basis:


(In Thousands)		Three Months Ended						Nine Months Ended
		September 30, 2020			September 30, 2019			September 30, 2020			September 30, 2019
Servicing rights balance, beginning of period		$	1,284		$	1,322		$	1,277		$	1,404
Originations of servicing rights			374			70			777			136
Unrealized losses included in earnings			(221)			(164)			(617)			(312)
Servicing rights balance, end of period		$	1,437		$	1,228		$	1,437		$	1,228

Loans are classified as impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Foreclosed assets held for sale consist of real estate acquired by foreclosure. For impaired commercial loans secured by real estate and foreclosed assets held for sale, estimated fair values are determined primarily using values from third-party appraisals. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property. For commercial and industrial and agricultural loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging data or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.

At September 30, 2020 and December 31, 2019, quantitative information regarding valuation techniques and the significant unobservable inputs used for nonrecurring fair value measurements using Level 3 methodologies are as follows:


(In Thousands, Except															Weighted
Percentages)					Valuation										Average
		Balance at			Allowance at			Fair Value at			Valuation		Unobservable		Discount at
Asset		9/30/2020			9/30/2020			9/30/2020			Technique		Inputs		9/30/2020

Impaired loans:
Residential mortgage loans - first and junior liens		$	1,516		$	170		$	1,346		Sales comparison		Discount to appraised value		31	%
Commercial:
Commercial loans secured by real estate			6,497			409			6,088		Sales comparison		Discount to appraised value		38	%
Commercial and industrial			72			72			0		Liquidation of assets		Discount to appraised value		100	%
Total impaired loans		$	8,085		$	651		$	7,434
Foreclosed assets held for sale - real estate:
Residential (1-4 family)		$	104		$	0		$	104		Sales comparison		Discount to appraised value		47	%
Commercial real estate			2,265			0			2,265		Sales comparison		Discount to appraised value		34	%
Total foreclosed assets held for sale		$	2,369		$	0		$	2,369


(In Thousands, Except															Weighted
Percentages)					Valuation										Average
		Balance at			Allowance at			Fair Value at			Valuation		Unobservable		Discount at
Asset		12/31/2019			12/31/2019			12/31/2019			Technique		Inputs		12/31/2019

Impaired loans:
Residential mortgage loans - first and junior liens		$	732		$	176		$	556		Sales comparison		Discount to appraised value		30	%
Commercial:
Commercial and industrial			106			89			17		Sales comparison		Discount to appraised value		69	%
Commercial and industrial			798			60			738		Liquidation of accounts receivable		Discount to borrower's financial statement value		15	%
Commercial construction and land			1,261			678			583		Sales comparison		Discount to appraised value		47	%
Loans secured by farmland			478			48			430		Sales comparison		Discount to appraised value		46	%
Total impaired loans		$	3,375		$	1,051		$	2,324
Foreclosed assets held for sale - real estate:
Residential (1-4 family)		$	292		$	0		$	292		Sales comparison		Discount to appraised value		46	%
Land			70			0			70		Sales comparison		Discount to appraised value		53	%
Commercial real estate			2,524			0			2,524		Sales comparison		Discount to appraised value		39	%
Total foreclosed assets held for sale		$	2,886		$	0		$	2,886

Certain of the Corporation’s financial instruments are not measured at fair value in the consolidated financial statements. In cases where quoted market prices are not available, 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 estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements. Therefore, the aggregate fair value amounts presented may not represent the underlying fair value of the Corporation.

The estimated fair values, and related carrying amounts, of the Corporation’s financial instruments that are not recorded at fair value are as follows:


(In Thousands)		Fair Value		September 30, 2020						December 31, 2019
		Hierarchy		Carrying			Fair			Carrying			Fair
		Level		Amount			Value			Amount			Value
Financial assets:
Cash and cash equivalents		Level 1		$	168,148		$	168,148		$	31,122		$	31,122
Certificates of deposit		Level 2			6,330			6,567			4,080			4,227
Restricted equity securities (included in Other Assets)		Level 2			12,179			12,179			10,321			10,321
Loans, net		Level 3			1,680,617			1,686,087			1,172,386			1,181,000
Accrued interest receivable		Level 2			8,296			8,296			5,001			5,001

Financial liabilities:
Deposits with no stated maturity		Level 2			1,440,602			1,440,602			877,965			877,965
Time deposits		Level 2			430,912			434,978			374,695			376,738
Short-term borrowings		Level 2			40,870			40,902			86,220			86,166
Long-term borrowings		Level 2			102,787			105,336			52,127			52,040
Subordinated debt		Level 2			16,572			16,680			6,500			6,499
Accrued interest payable		Level 2			563			563			311			311

The Corporation has commitments to extend credit and has issued standby letters of credit. Standby letters of credit are conditional guarantees of performance by a customer to a third party. Estimates of the fair value of these off-balance sheet items were not made because of the short-term nature of these arrangements and the credit standing of the counterparties.

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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