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Fair Value of Financial Instruments and Fair Value Measurements
 9 Months Ended
Sep. 30, 2022
Fair Value Disclosures [Abstract]  
Fair Value of Financial Instruments and Fair Value Measurements

11. 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 September 30, 2022 and December 31, 2021, including methods and assumptions utilized, are set forth below:

 

                          
   As of September 30, 2022 
   Carrying                 
   amount   Level 1   Level 2   Level 3   Total 
Financial assets:                         
Cash and cash equivalents  $49,234   $49,234   $-   $-   $49,234 
Interest-bearing deposits at other banks   8,844    -    8,844    -    8,844 
Investment securities available-for-sale   484,106    127,445    356,661    -    484,106 
Bank stocks, at cost   6,641    n/a     n/a     n/a     n/a  
Loans, net   702,138    -    -    688,972    688,972 
Loans held for sale   2,741    -    2,741    -    2,741 
Mortgage servicing rights   3,980    -    10,425    -    10,425 
Accrued interest receivable   4,726    357    1,890    2,479    4,726 
Derivative financial instruments   366    -    366    -    366 
                          
Financial liabilities:                         
Non-maturity deposits  $(1,023,903)  $(1,023,903)  $-   $-   $(1,023,903)
Certificates of deposit   (93,234)   -    (90,912)   -    (90,912)
FHLB borrowings   (74,900)   -    (74,900)   -    (74,900)
Subordinated debentures   (21,651)   -    (17,733)   -    (17,733)
Other borrowings   (16,349)   -    (16,502)   -    (16,502)
Accrued interest payable   (248)   -    (248)   -    (248)

 


                          
   As of December 31, 2021 
   Carrying                 
   amount   Level 1   Level 2   Level 3   Total 
Financial assets:                         
Cash and cash equivalents  $189,213   $189,213   $-   $-   $189,213 
Interest-bearing deposits at other banks   7,378    -    7,378    -    7,378 
Investment securities available-for-sale   380,717    42,675    338,042    -    380,717 
Bank stocks, at cost   2,905    n/a     n/a     n/a     n/a  
Loans, net   653,233    -    -    663,625    663,625 
Loans held for sale   4,795    -    4,795    -    4,795 
Mortgage servicing rights   4,193    -    6,722    -    6,722 
Accrued interest receivable   4,405    107    1,666    2,632    4,405 
Derivative financial instruments   494    -    494    -    494 
                          
Financial liabilities:                         
Non-maturity deposits  $(1,042,374)  $(1,042,374)  $-   $-   $(1,042,374)
Certificates of deposit   (106,107)   -    (105,935)   -    (105,935)
Subordinated debentures   (21,651)   -    (16,375)   -    (16,375)
Other borrowings   (7,403)   -    (7,403)   -    (7,403)
Accrued interest payable   (125)   -    (125)   -    (125)

 

Transfers

 

The Company did not transfer any assets or liabilities among levels during the nine months ended September 30, 2022 or during the year ended December 31, 2021.

 

 

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 September 30, 2022 and December 31, 2021, allocated to the appropriate fair value hierarchy:

 

                     
(Dollars in thousands)      As of September 30, 2022 
       Fair value hierarchy 
   Total   Level 1   Level 2   Level 3 
Assets:                    
Available-for-sale investment securities:                    
U. S. treasury securities  $127,445   $127,445   $-   $- 
U. S. federal agency obligations   4,979    -    4,979    - 
Municipal obligations, tax exempt   128,392    -    128,392    - 
Municipal obligations, taxable   61,959    -    61,959    - 
Agency mortgage-backed securities   161,331    -    161,331    - 
Loans held for sale   2,741    -    2,741    - 
Derivative financial instruments   366    -    366    - 

 

                     
       As of December 31, 2021 
       Fair value hierarchy 
   Total   Level 1   Level 2   Level 3 
Assets:                
Available-for-sale investment securities:                    
U. S. treasury securities  $42,675   $42,675   $-   $- 
U. S. federal agency obligations   17,195    -    17,195    - 
Municipal obligations, tax exempt   137,984    -    137,984    - 
Municipal obligations, taxable   40,046    -    40,046    - 
Agency mortgage-backed securities   142,817    -    142,817    - 
Loans held for sale   4,795    -    4,795    - 
Derivative financial instruments   494    -    494    - 

 

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 
   September 30,   December 31, 
(Dollars in thousands)  2022   2021 
Aggregate fair value  $2,741   $4,795 
Contractual balance   2,740    4,651 
Gain  $1   $144 

 

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:

 

                 
   Three months ended   Nine months ended 
   September 30,   September 30, 
(Dollars in thousands)  2022   2021   2022   2021 
Total change in fair value  $(100)  $(279)  $(128)  $(506)

 

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 $5.7 million and $6.7 million at September 30, 2022 and December 31, 2021, respectively. The Company’s impaired loans with an allowance for loan losses was $811,000 and $509,000, with an allocated allowance of $693,000 and $504,000, at September 30, 2022 and December 31, 2021, 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 September 30, 2022 and December 31, 2021.

 

(Dollars in thousands)              
   Fair value   Valuation technique  Unobservable inputs  Range 
As of September 30, 2022              
Impaired loans:                
Commercial  $118    Sales comparison   Adjustment to comparable value   0%-25 %
                 
As of December 31, 2021                
Impaired loans:                
Commercial  $5    Sales comparison   Adjustment to comparable value   0%