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Fair Value of Financial Instruments and Fair Value Measurements

6 Months Ended

Jun. 30, 2018

Fair Value Disclosures [Abstract]

Fair Value of Financial Instruments and Fair Value Measurements

8. Fair Value of Financial Instruments and Fair Value Measurements

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (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. There are three levels of inputs that may be used to measure fair values:

Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2 – Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 – Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Fair value estimates of the Company’s financial instruments as of June 30, 2018 and December 31, 2017, including methods and assumptions utilized, are set forth below:

(Dollars in thousands)		As of June 30, 2018
		Carrying
		amount				Level 1				Level 2				Level 3				Total
Financial assets:
Cash and cash equivalents		$	19,883			$	19,883			$	-			$	-			$	19,883
Investment securities available-for-sale			398,137				1,952				396,185				-				398,137
Bank stocks, at cost			6,034				n/a				n/a				n/a				n/a
Loans, net			461,396				-				-				480,331				480,331
Loans held for sale, net			11,764				-				11,764				-				11,764
Derivative financial instruments			695				-				695				-				695
Accrued interest receivable			4,459				20				2,279				2,160				4,459

Financial liabilities:
Non-maturity deposits		$	(642,106	)		$	(642,106	)		$	-			$	-			$	(642,106	)
Time deposits			(123,185	)			-				(120,775	)			-				(120,775	)
FHLB borrowings			(85,600	)			-				(85,613	)			-				(85,613	)
Subordinated debentures			(21,584	)			-				(19,522	)			-				(19,522	)
Other borrowings			(8,417	)			-				(8,417	)			-				(8,417	)
Derivative financial instruments			(97	)			-				(97	)			-				(97	)
Accrued interest payable			(349	)			-				(349	)			-				(349	)

		As of December 31, 2017
		Carrying
		amount				Level 1				Level 2				Level 3				Total
Financial assets:
Cash and cash equivalents		$	16,584			$	16,584			$	-			$	-			$	16,584
Investment securities available-for-sale			387,983				1,998				385,985				-				387,983
Bank stocks, at cost			5,423				n/a				n/a				n/a				n/a
Loans, net			433,743				-				-				436,910				436,910
Loans held for sale			6,535				-				6,535				-				6,535
Derivative financial instruments			395				-				395				-				395
Accrued interest receivable			4,409				20				2,234				2,155				4,409

Financial liabilities:
Non-maturity deposits			(642,281	)			(642,281	)			-				-				(642,281	)
Time deposits			(123,277	)			-				(121,298	)			-				(121,298	)
FHLB borrowings			(31,600	)			-				(31,706	)			-				(31,706	)
Subordinated debentures			(21,484	)			-				(19,134	)			-				(19,134	)
Other borrowings			(13,509	)			-				(13,509	)			-				(13,509	)
Accrued interest payable			(274	)			-				(274	)			-				(274	)

Methods and Assumptions Utilized

The carrying amount of cash and cash equivalents is considered to approximate fair value.

The Company’s investment securities classified as available-for-sale include U.S. treasury securities, U.S. federal agency securities, municipal obligations, agency mortgage-backed securities, certificates of deposits and common stocks. Quoted exchange prices are available for the Company’s U.S treasury securities and common stock investments, which are classified as Level 1. U.S. federal agency securities and agency mortgage-backed obligations are priced utilizing industry-standard models that consider various assumptions, including time value, yield curves, 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. These measurements are classified as Level 2. Municipal securities are valued using a type of matrix, or grid, pricing in which securities are benchmarked against U.S. treasury rates based on credit rating. These model and matrix measurements are classified as Level 2 in the fair value hierarchy.

The Company’s common stock investments are valued based on quoted exchange prices and classified as Level 1. As of January 1, 2018, the common stocks were transferred out of the available-for-sale classification. The common stock investments were sold during the second quarter of 2018.

It is not practical to determine the fair value of bank stocks due to restrictions placed on the transferability of FHLB and FRB stock.

Effective January 1, 2018, the estimated fair value of the Company’s loan portfolio is based on the segregation of loans by collateral type, interest terms, and maturities. The fair value is estimated based on discounting scheduled and estimated cash flows through maturity using appropriate market inputs to arrive at a discount rate that reflects exit pricing as prescribed in ASC Topic 820. The market inputs utilize market trading information in the calculation of loan fair values and is classified as Level 3. Prior to January 1, 2018, the fair value was estimated based on discounting scheduled and estimated cash flows through maturity using an appropriate risk-adjusted yield curve to approximate current interest rates for each category and was classified as Level 3. No adjustment was made to the interest rates for changes in credit risk of performing loans where there are no known credit concerns. The fair values of impaired loans were generally based on market prices for similar assets determined through independent appraisals or discounted values of independent appraisals and brokers’ opinions of value. The difference in methodologies may make the fair value of loans not comparable between current year and prior year periods.

Mortgage loans originated and intended for sale in the secondary market are carried at fair value. The mortgage loan valuations are based on quoted secondary market prices for similar loans and are classified as Level 2.

The carrying amounts of accrued interest receivable and payable are considered to approximate fair value.

The estimated fair value of deposits with no stated maturity, such as non-interest-bearing demand deposits, savings, money market accounts, and checking accounts, is equal to the amount payable on demand. The fair value of interest-bearing time deposits is based on the discounted value of contractual cash flows of such deposits. The discount rate is tied to the FHLB yield curve plus an appropriate servicing spread. Fair value measurements based on discounted cash flows are classified as Level 2. These fair values do not incorporate the value of core deposit intangibles which may be associated with the deposit base.

The fair value of advances from the FHLB, subordinated debentures, and other borrowings is estimated using current yield curves for similar borrowings adjusted for the Company’s current credit spread and classified as Level 2.

The Company’s derivative financial instruments consist of interest rate lock commitments and corresponding forward sales contracts on mortgage loans held for sale. The fair values of these derivatives are based on quoted prices for similar loans in the secondary market. The market prices are adjusted by a factor, based on the Company’s historical data and its judgment about future economic trends, which considers the likelihood that a commitment will ultimately result in a closed loan. These instruments are classified as Level 2. The amounts are included in other assets or other liabilities on the consolidated balance sheets and gains on sales of loans, net in the consolidated statements of earnings.

Off-Balance-Sheet Financial Instruments

The fair value of letters of credit and commitments to extend credit is based on the fees currently charged to enter into similar agreements. The aggregate amount of these fees is not material.

Transfers

The Company did not transfer any assets or liabilities among levels during the six months ended June 30, 2018 or during the year ended December 31, 2017.

Valuation Methods for Instruments Measured at Fair Value on a Recurring Basis

The following tables represent the Company’s financial instruments that are measured at fair value on a recurring basis at June 30, 2018 and December 31, 2017 allocated to the appropriate fair value hierarchy:

(Dollars in thousands)						As of June 30, 2018
						Fair value hierarchy
		Total				Level 1				Level 2				Level 3
Assets:
Available-for-sale investment securities:
U. S. treasury securities		$	1,952			$	1,952			$	-			$	-
U. S. federal agency obligations			13,677				-				13,677				-
Municipal obligations, tax exempt			179,539				-				179,539				-
Municipal obligations, taxable			54,640				-				54,640				-
Agency mortgage-backed securities			140,549				-				140,549				-
Certificates of deposit			7,780				-				7,780				-
Loans held for sale			11,764				-				11,764				-
Derivative financial instruments			695				-				695				-
Liability:
Derivative financial instruments			(97	)			-				(97	)			-

						As of December 31, 2017
						Fair value hierarchy
		Total				Level 1				Level 2				Level 3
Assets:
Available-for-sale investment securities:
U. S. treasury securities		$	1,990			$	1,990			$	-			$	-
U. S. federal agency obligations			16,492				-				16,492				-
Municipal obligations, tax exempt			184,738				-				184,738				-
Municipal obligations, taxable			57,976				-				57,976				-
Agency mortgage-backed securities			117,555				-				117,555				-
Certificates of deposit			9,224				-				9,224				-
Common stocks			8				8				-				-
Loans held for sale			6,535				-				6,535				-
Derivative financial instruments			395				-				395				-

Changes in the fair value of available-for-sale securities are included in other comprehensive income to the extent the changes are not considered other-than-temporary impairments. Other-than-temporary impairment tests are performed on a quarterly basis and any decline in the fair value of an individual security below its cost that is deemed to be other-than-temporary results in a write-down of that security’s cost basis.

The aggregate fair value, contractual balance (including accrued interest), and gain on loans held for sale were as follows:

		As of				As of
(Dollars in thousands)		June 30, 2018				December 31, 2017
Aggregate fair value		$	11,764			$	6,535
Contractual balance			11,484				6,420
Gain		$	280			$	115

The total amount of gains from changes in fair value of loans held for sale included in earnings were as follows:

		Three months ended								Six months ended
		June 30,								June 30,
(Dollars in thousands)		2018				2017				2018				2017
Interest income		$	98			$	79			$	146			$	124
Change in fair value			264				60				165				169
Total change in fair value		$	362			$	139			$	311			$	293

Valuation Methods for Instruments Measured at Fair Value on a Non-recurring Basis

The Company does not value its loan portfolio at fair value. Collateral-dependent impaired loans are generally carried at the lower of cost or fair value of the collateral, less estimated selling costs. Collateral values are determined based on appraisals performed by qualified licensed appraisers hired by the Company and then further adjusted if warranted based on relevant facts and circumstances. The appraisals may utilize a single valuation approach or a combination of approaches including the comparable sales and income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Impaired loans are reviewed and evaluated at least quarterly for additional impairment and adjusted accordingly, based on the same factors identified above. The carrying value of the Company’s impaired loans was $9.0 million and $9.8 million, with an allocated allowance of $853,000 and $642,000, at June 30, 2018 and December 31, 2017, respectively.

Real estate owned includes assets acquired through, or in lieu of, foreclosure and land previously acquired for expansion. Real estate owned is initially recorded at the fair value of the collateral less estimated selling costs. Subsequent valuations are updated periodically and are based upon independent appraisals, third party price opinions or internal pricing models. The appraisals may utilize a single valuation approach or a combination of approaches including the comparable sales and income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Real estate owned is reviewed and evaluated at least annually for additional impairment and adjusted accordingly, based on the same factors identified above.

The following tables represent the Company’s financial instruments that are measured at fair value on a non-recurring basis as of June 30, 2018 and December 31, 2017 allocated to the appropriate fair value hierarchy:

(Dollars in thousands)
						As of June 30, 2018												Total
						Fair value hierarchy												(losses)/
		Total				Level 1				Level 2				Level 3				gains
Assets:
Impaired loans:
One-to-four family residential real estate		$	171			$	-			$	-			$	171			$	(15	)
Commercial real estate			1,779				-				-				1,779				2
Commercial			1,301				-				-				1,301				(338	)
Agriculture			233				-				-				233				(1	)

						As of December 31, 2017												Total
						Fair value hierarchy												(losses)/
		Total				Level 1				Level 2				Level 3				gains
Assets:
Impaired loans:
One-to-four family residential real estate		$	171			$	-			$	-			$	171			$	(73	)
Construction and land			1,499				-				-				1,499				(102	)
Commercial real estate			33				-				-				33				12
Commercial			1,600				-				-				1,600				(304	)
Agriculture			264				-				-				264				65
Real estate owned:
One-to-four family residential real estate			325				-				-				325				(68	)
Commercial real estate			85				-				-				85				(50	)

The following table presents quantitative information about Level 3 fair value measurements for impaired loans measured at fair value on a non-recurring basis as of June 30, 2018 and December 31, 2017.

(Dollars in thousands)
		Fair value				Valuation technique		Unobservable inputs		Range
As of June 30, 2018
Impaired loans:
One-to-four family residential real estate		$	171			Sales comparison		Adjustment to appraised value			7%-50	%
Commercial real estate			1,799			Sales comparison		Adjustment to appraised value			7%-25	%
Commercial			1,301			Sales comparison		Adjustment to comparable sales			10%-25	%
Agriculture			233			Sales comparison		Adjustment to appraised value			0%-50	%

As of December 31, 2017
Impaired loans:
One-to-four family residential real estate		$	171			Sales comparison		Adjustment to appraised value			16%-50	%
Construction and land			1,499			Sales comparison		Adjustment to appraised value			0%-25	%
Commercial real estate			33			Sales comparison		Adjustment to appraised value			0%-91	%
Commercial			1,600			Sales comparison		Adjustment to comparable sales			15%-50	%
Agriculture			264			Sales comparison		Adjustment to appraised value			0%-50	%
Real estate owned:
One-to-four family residential real estate			325			Sales comparison		Adjustment to appraised value			10	%
Commercial real estate			85			Sales comparison		Adjustment to appraised value			10	%

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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