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Note 13 - Fair Value and Interest Rate Risk
 9 Months Ended
Sep. 30, 2021
Notes to Financial Statements  
Fair Value Disclosures [Text Block]

Note 13.

Fair Value and Interest Rate Risk

 

Patriot measures the carrying value of certain financial assets and liabilities at fair value, as required by its policies as a financial institution and by US GAAP. The carrying values of certain assets and liabilities are measured at fair value on a recurring basis, such as available-for-sale securities; while other assets and liabilities are measured at fair value on a non-recurring basis due to external factors requiring management’s judgment to estimate potential losses of value resulting in asset impairments or the establishment of valuation reserves. Measuring assets and liabilities at fair value may result in fluctuations to carrying value that have a significant impact on the results of operations or other comprehensive income for the period and period over period.

 

Following is a detailed summary of the guidance provided by US GAAP regarding the application of fair value measurements and Patriot’s application thereof. Additionally, the following information includes detailed summaries of the effects fair value measurements have on the carrying amounts of asset and liabilities presented in the consolidated financial statements.

 

The objective of fair value measurement is to value an asset that may be sold or a liability that may be transferred at the estimated value which might be obtained in a transaction between unrelated parties under current market conditions. US GAAP establishes a framework for measuring assets and liabilities at fair value, as well as certain financial instruments classified in equity. The framework provides a fair value hierarchy, which prioritizes quoted prices in active markets for identical assets and liabilities and minimizes unobservable inputs, which are inputs for which market data are not available and that are developed by management using the best information available to develop assumptions about the value market participants might place on the asset to be sold or liability to be transferred.

 

The three levels of the fair value hierarchy consist of:

 

Level 1

Unadjusted quoted market prices for identical assets or liabilities in active markets that the entity has the ability to access at the measurement date (such as active exchange-traded equity securities and certain U.S. and government agency debt securities).

  

Level 2

Observable inputs other than quoted prices included in Level 1, such as:

-      Quoted prices for similar assets or liabilities in active markets (such as U.S. agency and government sponsored mortgage-backed securities)

-      Quoted prices for identical or similar assets or liabilities in less active markets (such as certain U.S. and government agency debt securities, and corporate and municipal debt securities that trade infrequently)

-      Other inputs that are observable for substantially the full term of the asset or liability (i.e. interest rates, yield curves, prepayment speeds, default rates, etc.).

  

Level 3

Valuation techniques that require unobservable inputs that are supported by little or no market activity and are significant to the fair value measurement of the asset or liability (such as pricing and discounted cash flow models that typically reflect management’s estimates of the assumptions a market participant would use in pricing the asset or liability).

 

A description of the valuation methodologies used for assets and liabilities recorded at fair value, and for estimating fair value for financial and non-financial instruments not recorded at fair value, is set forth below.

 

Cash and due from banks and accrued interest receivable and payable

The carrying amount is a reasonable estimate of fair value and accordingly these are classified as Level 1. These financial instruments are not recorded at fair value on a recurring basis.

 

Available-for-sale securities

The fair value of securities available for sale (carried at fair value) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities, but rather by relying on the securities' relationship to other benchmark quoted prices, or using unobservable inputs employing various techniques and assumptions (Level 3).

 

Other Investments

The Bank’s investment portfolio includes the Solomon Hess SBA Loan Fund totaling $4.45 million. This investment is utilized by the Bank to satisfy its Community Reinvestment Act (“CRA”) lending requirements. As this fund operates as a private fund, shares in the fund are not publicly traded but may be redeemed with 60 days’ notice at cost. For that reason, the carrying amount was considered comparable to fair value at both September 30, 2021 and December 31, 2020 due to its short-term nature.

 

Federal Reserve Bank Stock and Federal Home Loan Bank Stock

Shares in the Federal Reserve Bank (“FRB”) and Federal Home Loan Bank (“FHLB”) are purchased and redeemed based upon their $100 par value. The stocks are non-marketable equity securities, and as such, are considered restricted securities that are carried at cost.

 

Loans

The fair value of loans are estimated by discounting the future cash flows using the rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. We estimate the fair value of our loan portfolio using an exit price notion resulting in prior periods no longer being comparable. The exit price notion requires determination of the price at which willing market participants would transact at the measurement date under current market conditions depending on facts and circumstances, such as origination rates, credit risk, transaction costs, liquidity, national and regional market trends and other adjustments, utilizing publicly available rates and indices. The application of an exit price notion requires the use of significant judgment.

 

Loans Held for Sale

The fair value of loans held for sale is estimated by using a market approach that includes prices for loans sold awaiting settlement and other observable inputs. The Company has determined that the inputs used to value the loans held for sale fall within Level 2 of the fair value hierarchy.

 

SBA Servicing Asset

Servicing assets do not trade in an active, open market with readily observable prices. The Company estimates the fair value of servicing assets using discounted cash flow models incorporating numerous assumptions from the perspective of a market participant including market discount rates and prepayment speeds. Due to the significant unobservable input related to the servicing rights, the SBA servicing asset is classified within Level 3 of the valuation hierarchy.

 

Other Real Estate Owned

The fair value of OREO the Bank may obtain is based on current appraised property value less estimated costs to sell. When fair value is based on unadjusted current appraised value, OREO is classified within Level 2 of the fair value hierarchy. Patriot classifies OREO within Level 3 of the fair value hierarchy when unobservable inputs are used to determine adjustments to appraised values. Patriot does not record OREO at fair value on a recurring basis, but rather initially records OREO at fair value on a non-recurring basis and then monitors property and market conditions that may indicate a change in value is warranted.

 

Derivative asset (liability) - Interest Rate Swaps

The Company’s derivative assets and liabilities consist of transactions as part of management’s strategy to manage interest rate risk. The valuation of interest rate swap agreements does not contain any counterparty risk. The valuation of the Company’s interest rate swaps is obtained from a third-party pricing service and is determined using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis is based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves. The Company has determined that the inputs used to value its interest rate derivatives fall within Level 2 of the fair value hierarchy. See Notes 1 and 8 for additional disclosures on derivatives.

 

Deposits

The fair value of demand deposits, regular savings and certain money market deposits is the amount payable on demand at the reporting date.

 

The fair value of certificates of deposit and other time deposits is estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities, estimated using local market data, to a schedule of aggregated expected maturities on such deposits. Patriot does not record deposits at fair value on a recurring basis.

 

Senior Notes, Subordinated Notes, and Junior Subordinated Debt and Note Payable

Patriot does not record senior notes at fair value on a recurring basis. The fair value of the senior notes was estimated by discounting future cash flows at rates at which similar notes would be made. The carrying value is considered comparable to fair value.

 

Patriot does not record subordinated notes issued in September 2018 at fair value on a recurring basis. The fair value of the subordinated notes was estimated by discounting future cash flows at rates at which similar notes would be made. The carrying value is considered comparable to fair value.

 

Patriot does not record junior subordinated debt at fair value on a recurring basis. Junior subordinated debt reprices quarterly, as a result, the carrying amount is considered a reasonable estimate of fair value.

 

The Company considers its own credit worthiness in determining the fair value of its Senior Notes, Subordinated Notes, Notes Payable and Junior Subordinated Debt.

 

Federal Home Loan Bank Borrowings

The fair value of FHLB advances is estimated using a discounted cash flow calculation that applies current FHLB interest rates for advances of similar maturity to a schedule of maturities of such advances. Patriot does not record FHLB advances at fair value on a recurring basis.

 

Off-balance sheet financial instruments

Off-balance sheet financial instruments are based on interest rate changes and fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The off-balance-sheet financial instruments (i.e., commitments to extend credit) are insignificant and are not recorded on a recurring basis.

 

The following table provides a comparison of the carrying amounts and estimated fair values of Patriot’s financial assets and liabilities as of September 30, 2021 and December 31, 2020:

 

(In thousands)

   

September 30, 2021

  

December 31, 2020

 
  

Fair Value
Hierarchy

 

Carrying
Amount

  

Estimated
Fair Value

  

Carrying
Amount

  

Estimated
Fair Value

 

Financial Assets:

                  

Cash and noninterest bearing balances due from banks

 

Level 1

 $5,298  $5,298  $3,006  $3,006 

Interest-bearing deposits due from banks

 

Level 1

  40,967   40,967   31,630   31,630 

Available-for-sale securities

 

Level 2

  124,103   124,103   49,262   49,262 

Other investments

 

Level 2

  4,450   4,450   4,450   4,450 

Federal Reserve Bank stock

 

Level 2

  2,843   2,843   2,783   2,783 

Federal Home Loan Bank stock

 

Level 2

  5,009   5,009   4,503   4,503 

Loans receivable, net

 

Level 3

  704,459   705,272   719,596   716,822 

Loans held for sale

 

Level 2

  4,128   4,761   1,217   1,343 

SBA servicing assets

 

Level 3

  375   351   316   375 

Other real estate owned

 

Level 2

  -   -   1,906   1,906 

Accrued interest receivable

 

Level 2

  6,186   6,186   6,620   6,620 

Interest rate swap receivable

 

Level 2

  817   817   1,187   1,187 
                   

Financial assets, total

   $898,635  $900,057  $826,476  $823,887 
                   

Financial Liabilities:

                  

Demand deposits

 

Level 2

 $207,941  $207,941  $158,676  $158,676 

Savings deposits

 

Level 2

  102,365   102,365   98,635   98,635 

Money market deposits

 

Level 2

  165,671   165,671   146,389   146,389 

NOW accounts

 

Level 2

  34,528   34,528   30,529   30,529 

Time deposits

 

Level 2

  197,132   197,143   210,140   210,882 

Brokered deposits

 

Level 1

  27,036   27,075   41,287   41,643 

FHLB borrowings

 

Level 2

  110,000   115,014   90,000   97,293 

Senior notes

 

Level 2

  11,983   12,009   11,927   12,028 

Subordinated debt

 

Level 2

  9,803   10,030   9,782   10,125 

Junior subordinated debt owed to unconsolidated trust

 

Level 2

  8,116   8,116   8,110   8,110 

Note payable

 

Level 3

  842   825   994   997 

Accrued interest payable

 

Level 2

  666   666   572   572 

Interest rate swap liability

 

Level 2

  817   817   1,187   1,187 
                   

Financial liabilities, total

 $876,900  $882,200  $808,228  $817,066 

 

The carrying amount of cash and noninterest bearing balances due from banks, interest-bearing deposits due from banks, and demand deposits approximates fair value, due to the short-term nature and high turnover of these balances. These amounts are included in the table above for informational purposes.

 

In the normal course of its operations, Patriot assumes interest rate risk (i.e., the risk that general interest rate levels will fluctuate). As a result, the fair value of the Patriot’s financial assets and liabilities are affected when interest market rates change, which change may be either favorable or unfavorable. Management attempts to mitigate interest rate risk by matching the maturities of its financial assets and liabilities. However, borrowers with fixed rate obligations are less likely to prepay their obligations in a rising interest rate environment and more likely to prepay their obligations in a falling interest rate environment. Conversely, depositors receiving fixed rates are more likely to withdraw funds before maturity in a rising interest rate environment and less likely to do so in a falling interest rate environment. Management monitors market rates of interest and the maturities of its financial assets and financial liabilities, adjusting the terms of new loans and deposits in an attempt to minimize interest rate risk. Additionally, management mitigates its overall interest rate risk through its available funds investment strategy.

 

The following tables detail the financial assets measured at fair value on a recurring basis and the valuation techniques utilized relative to the fair value hierarchy, as of September 30, 2021 and December 31, 2020:

 

(In thousands)

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

  

Significant

Observable

Inputs
(Level 2)

  

Significant

Unobservable

Inputs
(Level 3)

  

Total

 

September 30, 2021:

                

U. S. Government agency and mortgage-backed securities

 $-  $89,018  $-  $89,018 

Corporate bonds

  -   20,222   -   20,222 

Subordinated notes

  -   4,670   -   4,670 

SBA loan pools

  -   9,634   -   9,634 

Municipal bonds

  -   559   -   559 

Available-for-sale securities

 $-  $124,103  $-  $124,103 
                 

Interest rate swap receivable

 $-  $817  $-  $817 
                 

Interest rate swap liability

 $-  $817  $-  $817 
                 

December 31, 2020:

                

U. S. Government agency mortgage-backed securities

 $-  $16,833  $-  $16,833 

Corporate bonds

  -   17,290   -   17,290 

Subordinated notes

  -   9,005   -   9,005 

SBA loan pools

  -   5,567   -   5,567 

Municipal bonds

  -   567   -   567 

Available-for-sale securities

 $-  $49,262  $-  $49,262 
                 

Interest rate swap receivable

 $-  $1,187  $-  $1,187 
                 

Interest rate swap liability

 $-  $1,187  $-  $1,187 

 

Patriot measures certain financial assets and financial liabilities at fair value on a non-recurring basis. When circumstances dictate (e.g., impairment of long-lived assets, other than temporary impairment of collateral value), the carrying values of such financial assets and financial liabilities are adjusted to fair value or fair value less costs to sell, as may be appropriate.

 

During the three and nine months ended September 30, 2021 and 2020, the Company had no transfers into or out of Levels 1, 2 or 3.

 

The table below presents the valuation methodology and unobservable inputs for level 3 assets measured at fair value on a non-recurring basis as of September 30, 2021 and December 31, 2020:

 

(In thousands)

 

Fair Value

 

Valuation Methodology

 

Unobservable Inputs

 

Range of Inputs

 

September 30, 2021:

             

Impaired loans, net

 $26,341 

Real Estate Appraisals

 

Discount for appraisal type

  5.8%-20% 
              

SBA servicing assets

  351 

Discounted Cash Flows

 

Market discount rates

  14.73%-14.90% 
              

December 31, 2020:

             

Impaired loans, net

 $22,971 

Real Estate Appraisals

 

Discount for appraisal type

  5.8%-20% 
              

Other Real Estate Owned

  1,906 

Real Estate Appraisals

 

Discount for appraisal type

   5.84%  
              

SBA servicing assets

  375 

Discounted Cash Flows

 

Market discount rates

  14.73%-14.90% 

 

Patriot discloses fair value information about financial instruments, whether or not recognized in the consolidated balance sheet, for which it is practicable to estimate that value. Certain financial instruments are excluded from disclosure requirements and, accordingly, the aggregate fair value amounts presented do not necessarily represent the complete underlying value of financial instruments included in the consolidated financial statements.

 

The estimated fair value amounts have been measured as of September 30, 2021 and December 31, 2020, and have not been reevaluated or updated for purposes of these consolidated financial statements subsequent to those respective dates. As such, the estimated fair values of the financial instruments measured may be different than if they had been subsequently valued.

 

The information presented should not be interpreted as an estimate of the total fair value of Patriot’s assets and liabilities, since only a portion of Patriot’s assets and liabilities are required to be measured at fair value for financial reporting purposes. Due to the wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between Patriot’s fair value disclosures and those of other bank holding companies may not be meaningful.