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Fair Value of Financial Instruments and Fair Value Measurements

6 Months Ended

Jun. 30, 2021

Fair Value Disclosures [Abstract]

Fair Value of Financial Instruments and Fair Value Measurements

9. 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, 2021 and December 31, 2020, including methods and assumptions utilized, are set forth below:

(Dollars in thousands)		As of June 30, 2021
		Carrying
		amount				Level 1				Level 2				Level 3				Total
Financial assets:
Cash and cash equivalents		$	131,018			$	131,018			$	-			$	-			$	131,018
Investment securities available-for-sale			343,944				36,646				307,298				-				343,944
Bank stocks, at cost			3,220				n/a				n/a				n/a				n/a
Loans, net			673,696				-				-				685,738				685,738
Loans held for sale			10,952				-				10,952				-				10,952
Accrued interest receivable			4,351				89				1,644				2,618				4,351
Derivative financial instruments			1,103				-				1,103				-				1,103

Financial liabilities:
Non-maturity deposits		$	(962,024	)		$	(962,024	)		$	-			$	-			$	(962,024	)
Certificates of deposit			(115,739	)			-				(115,877	)			-				(115,877	)
Subordinated debentures			(21,651	)			-				(16,208	)			-				(16,208	)
Other borrowings			(4,534	)			-				(4,534	)			-				(4,534	)
Accrued interest payable			(148	)			-				(148	)			-				(148	)

		As of December 31, 2020
		Carrying
		amount				Level 1				Level 2				Level 3				Total
Financial assets:
Cash and cash equivalents		$	84,818			$	84,818			$	-			$	-			$	84,818
Investment securities available-for-sale			297,270				2,037				295,233				-				297,270
Bank stocks, at cost			4,473				n/a				n/a				n/a				n/a
Loans, net			702,782				-				-				718,071				718,071
Loans held for sale			15,533				-				15,533				-				15,533
Accrued interest receivable			4,885				-				1,697				3,188				4,885
Derivative financial instruments			1,796				-				1,796				-				1,796

Financial liabilities:
Non-maturity deposits		$	(882,277	)		$	(882,277	)		$	-			$	-			$	(882,277	)
Certificates of deposit			(133,750	)			-				(134,048	)			-				(134,048	)
Subordinated debentures			(21,651	)			-				(15,232	)			-				(15,232	)
Other borrowings			(6,371	)			-				(6,371	)			-				(6,371	)
Accrued interest payable			(168	)			-				(168	)			-				(168	)
Derivative financial instruments			(466	)			-				(466	)			-				(466	)

Transfers

The Company did not transfer any assets or liabilities among levels during the three or six months ended June 30, 2021 or during the year ended December 31, 2020.

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, 2021 and December 31, 2020, allocated to the appropriate fair value hierarchy:

(Dollars in thousands) As of June 30, 2021

Fair value hierarchy

Total Level 1 Level 2 Level 3

Assets:

Available-for-sale investment securities:

U. S. treasury securities $ 36,646 $ 36,646 $ - $ -

U. S. federal agency obligations 22,852 - 22,852 -

Municipal obligations, tax exempt 140,526 - 140,526 -

Municipal obligations, taxable 38,779 - 38,779 -

Agency mortgage-backed securities 99,936 - 99,936 -

Certificates of deposit 5,205 - 5,205 -

Loans held for sale 10,952 - 10,952 -

Derivative financial instruments 1,103 - 1,103 -

As of December 31, 2020

Fair value hierarchy

Total Level 1 Level 2 Level 3

Assets:

Available-for-sale investment securities:

U. S. treasury securities $ 2,037 $ 2,037 $ - $ -

U. S. federal agency obligations 18,924 - 18,924 -

Municipal obligations, tax exempt 142,676 - 142,676 -

Municipal obligations, taxable 49,535 - 49,535 -

Agency mortgage-backed securities 78,638 - 78,638 -

Certificates of deposit 5,460 - 5,460 -

Loans held for sale 15,533 - 15,533 -

Derivative financial instruments 1,796 - 1,796 -

Liability:

Derivative financial instruments (466 ) - (466 ) -

The Company’s investment securities classified as available-for-sale include U.S. treasury securities, U.S. federal agency obligations, municipal obligations, agency mortgage-backed securities and certificates of deposit. Quoted exchange prices are available for the Company’s U.S treasury securities, which are classified as Level 1. U.S. federal agency securities and agency mortgage-backed securities 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 obligations 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.

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.

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. Changes in the fair value of mortgage loans originated and intended for sale in the secondary market and derivative financial instruments are included in gains on sales of loans.

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

As of As of

June 30, December 31,

(Dollars in thousands) 2021 2020

Aggregate fair value $ 10,952 $ 15,533

Contractual balance 10,843 15,151

Gain $ 109 $ 382

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. The total amount of gains from changes in fair value of derivative financial instruments included in earnings were as follows:

(Dollars in thousands) 2021 2020 2021 2020

Three months ended Six months ended

June 30, June 30,

(Dollars in thousands) 2021 2020 2021 2020

Total change in fair value $ (654 ) $ 2,006 $ (227 ) $ 1,972

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

The Company does not record 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 $14.8 million and $12.5 million, with an allocated allowance of $1.2 million and $266,000, at June 30, 2021 and December 31, 2020, 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 table presents quantitative information about Level 3 fair value measurements measured at fair value on a nonrecurring basis as of June 30, 2021 and December 31, 2020.

Fair value Valuation technique Unobservable inputs Range

(Dollars in thousands)

As of June 30, 2021

Impaired loans:

Commercial real estate $ 4,951 Sales comparison Adjustment to appraised value 15%-20 %

Commercial 70 Sales comparison Adjustment to comparable sales 0%-72 %

Agriculture 1,436 Sales comparison Adjustment to appraised value 0 %

Real estate owned:

One-to-four family residential real estate - Sales comparison Adjustment to appraised value 100 %

As of December 31, 2020

Impaired loans:

Commercial real estate $ 3,640 Sales comparison Adjustment to appraised value 20 %

Commercial 74 Sales comparison Adjustment to comparable sales 0%-69 %

Agriculture 9 Sales comparison Adjustment to appraised value 20 %

Real estate owned:

One-to-four family residential real estate 48 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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