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Fair Value of Assets and Liabilities

3 Months Ended

Mar. 31, 2021

Fair Value of Assets and Liabilities

NOTE 9: Fair Value of Assets and Liabilities

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an 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. U.S. GAAP requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. U.S. GAAP also establishes a fair value hierarchy which prioritizes the valuation inputs into three broad levels. Based on the underlying inputs, each fair value measurement in its entirety is reported in one of the three levels. These levels are:

●

Level 1—Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 assets and liabilities include debt securities traded in an active exchange market, as well as U.S. Treasury securities.

●

Level 2—Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

●

Level 3—Valuation is determined using model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect the Corporation’s estimates of assumptions that market participants would use in pricing the respective asset or liability. Valuation techniques may include the use of pricing models, discounted cash flow models and similar techniques.

U.S. GAAP allows an entity the irrevocable option to elect fair value (the fair value option) for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Corporation has elected to use fair value accounting for its entire portfolio of loans held for sale (LHFS).

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following describes the valuation techniques and inputs used by the Corporation in determining the fair value of certain assets recorded at fair value on a recurring basis in the financial statements.

Securities available for sale. The Corporation primarily values its investment portfolio using Level 2 fair value measurements, but may also use Level 1 or Level 3 measurements if required by the composition of the portfolio. At

March 31, 2021 and December 31, 2020, the Corporation’s entire investment securities portfolio was comprised of securities available for sale, which were valued using Level 2 fair value measurements. The Corporation has contracted with third party portfolio accounting service vendors for valuation of its securities portfolio. The vendors’ sources for security valuation are ICE Data Services (ICE) and Thomson Reuters Pricing Service (TRPS). Each source provides opinions, known as evaluated prices, as to the value of individual securities based on model-based pricing techniques that are partially based on available market data, including prices for similar instruments in active markets and prices for identical assets in markets that are not active. ICE provides evaluated prices for the Corporation’s obligations of states and political subdivisions category of securities. ICE uses proprietary pricing models and pricing systems, mathematical tools and judgment to determine an evaluated price for a security based upon a hierarchy of market information regarding that security or securities with similar characteristics. TRPS provides evaluated prices for the Corporation’s U.S. government agencies and corporations, mortgage-backed, and corporate categories of securities. Fixed-rate callable securities of the U.S. government agencies and corporations category are individually evaluated on an option adjusted spread basis for callable issues or on a nominal spread basis incorporating the term structure of agency market spreads and the appropriate risk free benchmark curve for non-callable issues. Pass-through mortgage-backed securities (MBS) in the mortgage-backed category are grouped into aggregate categories defined by issuer program, weighted average coupon, and weighted average maturity. Each aggregate is benchmarked to relative to-be-announced mortgage-backed securities (TBA securities) or other benchmark prices. TBA securities prices are obtained from market makers and live trading systems. Collateralized mortgage obligations in the mortgage-backed category are individually evaluated based upon a hierarchy of security specific information and market data regarding that security or securities with similar characteristics. Each evaluation is determined using an option adjusted spread and prepayment model based on volatility-driven, multi-dimensional spread tables. Fixed-rate securities issued by the Small Business Association in the mortgage backed category are individually evaluated based upon a hierarchy of security specific information and market data regarding that security or securities with similar characteristics.

Investments in small business investment company funds. The Corporation holds an investment in a small business investment company fund, which is recorded at fair value and included in other assets in the Consolidated Balance Sheets. Changes in fair value are recognized in net income. At March 31, 2021 and December 31, 2020, the fair value of the Corporation’s investment in small business investment companies, based on net asset value, was $1.44 million and $1.48 million, respectively. Investments in small business investment company funds measured at net asset value are not presented in the tables below related to fair value measurements. Changes in fair value of small business investment company funds resulted in the recognition of unrealized gains of $45,000 for the three months ended March 31, 2021. There were no unrealized gains or losses on investments in small business investment company funds recorded during the three months ended March 31, 2020.

Loans held for sale. Fair value of the Corporation’s LHFS is based on observable market prices for similar instruments traded in the secondary mortgage loan markets in which the Corporation conducts business. The Corporation’s portfolio of LHFS is classified as Level 2.

Derivative asset - IRLCs. The Corporation recognizes IRLCs at fair value. Fair value of IRLCs is based on either (i) the price of the underlying loans obtained from an investor for loans that will be delivered on a best efforts basis or (ii) the observable price for individual loans traded in the secondary market for loans that will be delivered on a mandatory basis. All of the Corporation’s IRLCs are classified as Level 2.

Derivative asset/liability – interest rate swaps on loans. The Corporation recognizes interest rate swaps at fair value. The Corporation has contracted with a third party vendor to provide valuations for these interest rate swaps using standard valuation techniques. All of the Corporation’s interest rate swaps on loans are classified as Level 2.

Derivative asset/liability – cash flow hedges. The Corporation recognizes cash flow hedges at fair value. The fair value of the Corporation’s cash flow hedges is determined using the discounted cash flow method. All of the Corporation’s cash flow hedges are classified as Level 2.

Derivative asset/liability – forward sales of TBA securities. The Corporation recognizes forward sales of TBA securities at fair value. The fair value of forward sales of TBA securities is based on prices obtained from market makers and live

trading systems for TBA securities of similar issuer programs, coupons and maturities. All of the Corporation’s forward sales of TBA securities are classified as Level 2.

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis.


	March 31, 2021
	Fair Value Measurements Classified as						Assets/Liabilities at
(Dollars in thousands)	Level 1		Level 2		Level 3		Fair Value
Assets:
Securities available for sale
U.S. government agencies and corporations	$	—	$	53,681	$	—	$	53,681
Mortgage-backed securities		—		150,518		—		150,518
Obligations of states and political subdivisions		—		103,154		—		103,154
Corporate and other debt securities		—		13,932		—		13,932
Total securities available for sale		—		321,285		—		321,285
Loans held for sale		—		177,350		—		177,350
Derivatives
IRLC		—		4,026		—		4,026
Interest rate swaps on loans		—		4,841		—		4,841
Forward sales of TBA securities		—		75		—		75
Total assets	$	—	$	507,577	$	—	$	507,577

Liabilities:
Derivatives
Interest rate swaps on loans	$	—	$	4,841	$	—	$	4,841
Cash flow hedges		—		891		—		891
Total liabilities	$	—	$	5,732	$	—	$	5,732


	December 31, 2020
	Fair Value Measurements Classified as						Assets/Liabilities at
(Dollars in thousands)	Level 1		Level 2		Level 3		Fair Value
Assets:
Securities available for sale
U.S. government agencies and corporations	$	—	$	48,282	$	—	$	48,282
Mortgage-backed securities		—		123,714		—		123,714
Obligations of states and political subdivisions		—		102,805		—		102,805
Corporate and other debt securities		—		11,588		—		11,588
Total securities available for sale		—		286,389		—		286,389
Loans held for sale		—		214,266		—		214,266
Derivatives
IRLC		—		4,582		—		4,582
Interest rate swaps on loans		—		8,185		—		8,185
Total assets	$	—	$	513,422	$	—	$	513,422

Liabilities:
Derivatives
Interest rate swaps on loans	$	—	$	8,185	$	—	$	8,185
Cash flow hedges		—		1,882		—		1,882
Forward sales of TBA securities		—		47		—		47
Total liabilities	$	—	$	10,114	$	—	$	10,114

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The Corporation may be required, from time to time, to measure and recognize certain assets at fair value on a nonrecurring basis in accordance with U.S. GAAP. The following describes the valuation techniques and inputs used by the Corporation in determining the fair value of certain assets recorded at fair value on a nonrecurring basis in the financial statements.

Impaired loans. The Corporation does not record loans held for investment at fair value on a recurring basis. However, there are instances when a loan is considered impaired and an allowance for loan losses is established. The Corporation measures impairment either based on the fair value of the loan using the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent, or using the present value of expected future cash flows discounted at the loan’s effective interest rate, which is not a fair value measurement. The Corporation maintains a valuation allowance to the extent that this measure of the impaired loan is less than the recorded investment in the loan. When an impaired loan is measured at fair value based solely on observable market prices or a current appraisal without further adjustment for unobservable inputs, the Corporation records the impaired loan as a nonrecurring fair value measurement classified as Level 2. However, if based on management’s review, additional discounts to observed market prices or appraisals are required or if observable inputs are not available, the Corporation records the impaired loan as a nonrecurring fair value measurement classified as Level 3.

Impaired loans that are measured based on expected future cash flows discounted at the loan’s effective interest rate rather than the market rate of interest, are not recorded at fair value and are therefore excluded from fair value disclosure requirements.

Other Real Estate Owned (OREO). Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less estimated costs to sell at the date of foreclosure. Initial fair value is based upon appraisals the Corporation obtains from independent licensed appraisers. Subsequent to foreclosure, management periodically performs valuations of the foreclosed assets based on updated appraisals, general market conditions, recent sales of similar properties, length of time the properties have been held, and our ability and intent with regard to continued ownership of the properties. The Corporation may incur additional write-downs of foreclosed assets to fair value less estimated costs to sell if valuations indicate a further deterioration in market conditions. As such, the Corporation records OREO as a nonrecurring fair value measurement classified as Level 3.

The following table presents the balances of assets measured at fair value on a nonrecurring basis. At March 31, 2021 and December 31, 2020 there were no impaired loans that were measured at fair value.


	March 31, 2021
	Fair Value Measurements Classified as						Assets at Fair
(Dollars in thousands)	Level 1		Level 2		Level 3		Value
Other real estate owned, net	$	—	$	—	$	72	$	72
Total	$	—	$	—	$	72	$	72


	December 31, 2020
	Fair Value Measurements Classified as						Assets at Fair
(Dollars in thousands)	Level 1		Level 2		Level 3		Value
Other real estate owned, net	$	—	$	—	$	72	$	72
Total	$	—	$	—	$	72	$	72

The following table presents quantitative information about Level 3 fair value measurements for financial assets measured at fair value on a nonrecurring basis as of March 31, 2021 and December 31, 2020:


	Fair Value Measurements
(Dollars in thousands)	Fair Value		Valuation Technique(s)	Unobservable Inputs	Range (Weighted Average)¹
At March 31, 2021:
Other real estate owned, net	$	72	Appraisals	Discount to reflect current market conditions and estimated selling costs	75%-80% (79%)
Total	$	72

At December 31, 2020:
Other real estate owned, net	$	72	Appraisals	Discount to reflect current market conditions and estimated selling costs	75% - 80% (79%)
Total	$	72

1	The weighted average of unobservable inputs is calculated based on the relative asset fair values.

Fair Value of Financial Instruments

FASB ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments, including those financial assets and financial liabilities that are not required to be measured and reported at fair value on a recurring or nonrecurring basis. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Corporation. The Corporation uses the exit price notion in calculating the fair values of financial instruments not measured at fair value on a recurring basis.

The following tables reflect the carrying amounts and estimated fair values of the Corporation’s financial instruments whether or not recognized on the Consolidated Balance Sheets at fair value.

Carrying

Fair Value Measurements at March 31, 2021 Classifed as

Total Fair

(Dollars in thousands)

Value

Level 1

Level 2

Level 3

Value

Financial assets:

Cash and short-term investments

147,438

—

147,438

Securities available for sale

321,285

—

321,285

—

321,285

Loans, net

1,346,003

—

1,331,249

Loans held for sale

177,350

—

177,350

—

177,350

Derivatives

IRLC

4,026

—

4,026

—

4,026

Interest rate swaps on loans

4,841

—

4,841

—

4,841

Forward sales of TBA securities

—

Bank-owned life insurance

20,332

—

20,332

—

20,332

Accrued interest receivable

7,723

—

7,723

Financial liabilities:

Demand and savings deposits

1,373,882

—

1,373,882

Time deposits

458,100

—

461,981

—

461,981

Borrowings

73,328

—

72,267

—

72,267

Derivatives

Cash flow hedges

891

—

891

—

891

Interest rate swaps on loans

4,841

—

4,841

—

4,841

Accrued interest payable

734

—

734


	Carrying		Fair Value Measurements at December 31, 2020 Classifed as						Total Fair
(Dollars in thousands)	Value		Level 1		Level 2		Level 3		Value
Financial assets:
Cash and short-term investments	$	86,669	$	86,669	$	—	$	—	$	86,669
Securities available for sale		286,389		—		286,389		—		286,389
Loans, net		1,313,250		—		—		1,308,569		1,308,569
Loans held for sale		214,266		—		214,266		—		214,266
Derivatives
IRLC		4,582		—		4,582		—		4,582
Interest rate swaps on loans		8,185		—		8,185		—		8,185
Bank-owned life insurance		20,205		—		20,205		—		20,205
Accrued interest receivable		8,103		8,103		—		—		8,103
Financial liabilities:
Demand and savings deposits		1,282,590		1,282,590		—		—		1,282,590
Time deposits		469,583		—		474,154		—		474,154
Borrowings		69,864		—		71,119		—		71,119
Derivatives
Cash flow hedges		1,882		—		1,882		—		1,882
Interest rate swaps on loans		8,185		—		8,185		—		8,185
Forward sales of TBA securities		47		—		47				47
Accrued interest payable		1,109		1,109		—		—		1,109

- 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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