Quarterly report pursuant to Section 13 or 15(d)

Note 14 - Fair Value

v3.20.1
Note 14 - Fair Value
3 Months Ended
Mar. 31, 2020
Notes to Financial Statements  
Fair Value Disclosures [Text Block]
Note
1
4
- Fair Value
The Fair Value Measurements Topic establishes a hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The Topic describes
three
levels of inputs that
may
be used to measure fair value:
 
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 reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
 
The fair values of securities available-for-sale are determined on a recurring basis by obtaining quoted prices on nationally recognized securities exchanges or pricing models utilizing significant observable inputs such as matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Different judgments and assumptions used in pricing could result in different estimates of value. In certain cases where market data is
not
readily available because of a lack of market activity or little public disclosure, values
may
be based on unobservable inputs and classified in Level
3
of the fair value hierarchy.
 
At the end of each reporting period, securities held in the investment portfolio are evaluated on an individual security level for other-than-temporary impairment in accordance with GAAP. Impairment is other-than-temporary if the decline in the fair value is below its amortized cost and it is probable that all amounts due according to the contractual terms of a debt security will
not
be received. Significant judgments are required in determining impairment, which include making assumptions regarding the estimated prepayments, loss assumptions and the change in interest rates. The Bancorp considers the following factors when determining an other-than-temporary impairment for a security: the length of time and the extent to which the market value has been less than amortized cost; the financial condition and near-term prospects of the issuer; the underlying fundamentals of the relevant market and the outlook for such market for the near future; an assessment of whether the Bancorp (
1
) has the intent to sell the debt securities or (
2
) more likely than
not
will be required to sell the debt securities before their anticipated market recovery. If either of these conditions is met, management will recognize other-than-temporary impairment. If, in management’s judgment, an other-than-temporary impairment exists, the cost basis of the security will be written down for the credit loss, and the unrealized loss will be transferred from accumulated other comprehensive loss as an immediate reduction of current earnings.
     
The Bancorp’s management utilizes a specialist to perform an other-than-temporary impairment analysis for each of its pooled trust preferred securities. The analysis is performed annually during
December
and utilizes analytical models used to project future cash flows for the pooled trust preferred securities based on current assumptions for prepayments, default and deferral rates, and recoveries. The projected cash flows are then tested for impairment consistent with GAAP. The other-than-temporary impairment testing compares the present value of the cash flows from quarter to quarter to determine if there is a “favorable” or “adverse” change. Other-than-temporary impairment is recorded if the projected present value of cash flows is lower than the book value of the security. To perform the annual other-than-temporary impairment analysis, management utilizes current reports issued by the trustee, which contain principal and interest tests, waterfall distributions, note valuations, collection detail and credit ratings for each pooled trust preferred security. In addition, a detailed review of the performing collateral was performed. Based on current market conditions and a review of the trustee reports, management performed an analysis of the pooled trust preferred securities and
no
additional impairment was taken at
December 31, 2019.
A specialist will be used to review all pooled trust preferred securities again at
December 31, 2020.
 
The table below shows the credit loss roll forward on a year-to-date basis for the Bancorp’s pooled trust preferred securities that have been classified with other-than-temporary impairment:
 
   
(Dollars in Thousands)
 
   
Collateralized
 
   
debt obligations
 
   
other-than-temporary
 
(Dollars in thousands)
 
impairment
 
Ending balance, December 31, 2019
  $
173
 
Additions not previously recognized
   
-
 
Ending balance, March 31, 2020
  $
173
 
 
At
March 31, 2020,
trust preferred securities with a cost basis of
$2.2
million continue to be in “payment in kind” status. These trust preferred securities classified as “payment in kind” are a result of
not
receiving the scheduled quarterly interest payments. For these trust preferred securities in “payment in kind” status, management anticipates to receive the unpaid contractual interest payments from the issuer, because of the self-correcting cash flow waterfall provisions within the structure of the securities. When a tranche senior to the Bancorp’s position fails the coverage test, the Bancorp’s interest cash flows are paid to the senior tranche and recorded as a reduction of principal. The coverage test represents an over collateralization target by stating the balance of the performing collateral as a percentage of the balance of the Bancorp’s tranche, plus the balance of all senior tranches. The principal reduction in the senior tranche continues until the appropriate coverage test is passed. As a result of the principal reduction in the senior tranche, more cash is available for future payments to the Bancorp’s tranche. Consistent with GAAP, management considered the failure of the issuer of the security to make scheduled interest payments in determining whether a credit loss existed. Management will
not
capitalize the “payment in kind” interest payments to the book value of the securities and will keep these securities in non-accrual status until the quarterly interest payments resume on a consistent basis.
 
Assets and Liabilities Measured at Fair Value on a Recurring Basis
There were
no
transfers to or from Levels
1
and
2
during the
three
months ended
March 31, 2020.
Assets measured at fair value on a recurring basis are summarized below:
 
           
Fair Value Measurements at March 31, 2020 Using
 
(Dollars in thousands)
 
 
 
Estimated
Fair
Value
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Available-for-sale debt securities:
                               
Money market fund
  $
16,553
    $
16,553
    $
-
    $
-
 
residential mortgage-backed securities
   
158,938
     
-
     
158,938
     
-
 
Municipal securities
   
117,123
     
-
     
117,123
     
-
 
Collateralized debt obligations
   
773
     
-
     
-
     
773
 
Total securities available-for-sale
  $
293,387
    $
16,553
    $
276,061
    $
773
 
 
 
           
Fair Value Measurements at December 31, 2019 Using
 
(Dollars in thousands)
 
 
 
Estimated
Fair
Value
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Available-for-sale debt securities:
                               
Money market fund
  $
9,670
    $
9,670
    $
-
    $
-
 
U.S. government sponsored entities
   
13,058
     
-
     
13,058
     
-
 
Collateralized mortgage obligations and residential mortgage-backed securities
   
150,988
     
-
     
150,988
     
-
 
Municipal securities
   
102,427
     
-
     
102,427
     
-
 
Collateralized debt obligations
   
1,076
     
-
     
-
     
1,076
 
Total securities available-for-sale
  $
277,219
    $
9,670
    $
266,473
    $
1,076
 
 
A roll forward of available-for-sale securities, which require significant adjustment based on unobservable data, are presented in the following table:
 
(Dollars in thousands)
 
Estimated Fair Value
Measurements Using
Significant Unobservable
Inputs (Level 3)
 
   
Available-for-
sale securities
 
Beginning balance, January 1, 2019
  $
2,049
 
Principal payments
   
(38
)
Total unrealized gains, included in other comprehensive income
   
52
 
Transfers in and/or (out) of Level 3
   
(987
)
Ending balance, December 31, 2019
  $
1,076
 
         
Beginning balance, January 1, 2020
  $
1,076
 
Principal payments
   
(5
)
Total unrealized losses, included in other comprehensive income
   
(298
)
Sale out of Level 3
   
-
 
Ending balance, March 31, 2020
  $
773
 
 
Assets measured at fair value on a non-recurring basis are summarized below:
 
           
(Dollars in thousands)
 
           
Fair Value Measurements at March 31, 2020 Using
 
(Dollars in thousands)
 
 
 
Estimated
Fair
Value
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Impaired loans
  $
6,774
    $
-
    $
-
    $
6,774
 
Foreclosed real estate
   
1,032
     
-
     
-
     
1,032
 
 
           
(Dollars in thousands)
 
           
Fair Value Measurements at December 31, 2019 Using
 
(Dollars in thousands)
 
 
 
Estimated
Fair
Value
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Impaired loans
  $
7,052
    $
-
    $
-
    $
7,052
 
Foreclosed real estate
   
1,083
     
-
     
-
     
1,083
 
 
The fair value of impaired loans with specific allocations of the allowance for loan losses or loans for which charge-offs have been taken is generally based on a present value of cash flows or, for collateral dependent loans, based on recent real estate appraisals. Appraisals
may
utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. The recorded investment in impaired loans was approximately
$7.2
million and the related specific reserves totaled approximately
$377
thousand, resulting in a fair value of impaired loans totaling approximately
$6.8
million, at
March 31, 2020.
The recorded investment of impaired loans was approximately
$7.2
million and the related specific reserves totaled approximately
$166
thousand, resulting in a fair value of impaired loans totaling approximately
$7.1
million, at
December 31, 2019.
Fair value is determined, where possible, using market prices derived from an appraisal or evaluation, which are considered to be Level
2
inputs. However, certain assumptions and unobservable inputs are often used by the appraiser, therefore, qualifying the assets as Level
3
in the fair value hierarchy. The fair value of foreclosed real estate is similarly determined by using the results of recent real estate appraisals. The numerical range of unobservable inputs for these valuation assumptions is
not
meaningful to this presentation.
 
The following table shows carrying values and related estimated fair values of financial instruments as of the dates indicated. Estimated fair values are further categorized by the inputs used to measure fair value. Items that are
not
financial instruments are
not
included.
 
   
March 31, 2020
   
Estimated Fair Value Measurements at March 31, 2020 Using
 
(Dollars in thousands)
 
 
 
Carrying
Value
   
Estimated
Fair Value
   
Quoted Prices in
Active Markets for Identical Assets
(Level 1)
   
Significant
Other Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
Financial assets:
                                       
Cash and cash equivalents
  $
42,146
    $
42,146
    $
42,146
    $
-
    $
-
 
Certificates of deposit in other financial institutions
   
1,741
     
1,715
     
-
     
1,715
     
-
 
Securities available-for-sale
   
293,387
     
293,387
     
16,553
     
276,061
     
773
 
Loans held-for-sale
   
5,375
     
5,553
     
5,553
     
-
     
-
 
Loans receivable, net
   
909,451
     
904,358
     
-
     
-
     
904,358
 
Federal Home Loan Bank stock
   
3,912
     
3,912
     
-
     
3,912
     
-
 
Interest rate swap agreements
   
3,282
     
3,282
     
-
     
3,282
     
-
 
Accrued interest receivable
   
4,114
     
4,114
     
-
     
4,114
     
-
 
                                         
Financial liabilities:
                                       
Non-interest bearing deposits
   
185,219
     
185,219
     
185,219
     
-
     
-
 
Interest bearing deposits
   
976,423
     
978,115
     
661,953
     
316,162
     
-
 
Repurchase agreements
   
12,991
     
12,999
     
11,213
     
1,786
     
-
 
Borrowed funds
   
14,000
     
14,197
     
-
     
14,197
     
-
 
Interest rate swap agreements
   
3,282
     
3,282
     
-
     
3,282
     
-
 
Accrued interest payable
   
94
     
94
     
-
     
94
     
-
 
 
 
   
December 31, 2019
   
Estimated Fair Value Measurements at December 31, 2019 Using
 
(Dollars in thousands)
 
 
 
Carrying
Value
   
Estimated
Fair Value
   
Quoted Prices in
Active Markets for Identical Assets
(Level 1)
   
Significant
Other Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
Financial assets:
                                       
Cash and cash equivalents
  $
47,258
    $
47,258
    $
47,258
    $
-
    $
-
 
Certificates of deposit in other financial institutions
   
2,170
     
2,137
     
-
     
2,137
     
-
 
Securities available-for-sale
   
277,219
     
277,219
     
9,670
     
266,473
     
1,076
 
Loans held-for-sale
   
6,091
     
6,204
     
6,204
     
-
     
-
 
Loans receivable, net
   
897,870
     
917,174
     
-
     
-
     
917,174
 
Federal Home Loan Bank stock
   
3,912
     
3,912
     
-
     
3,912
     
-
 
Interest rate swap agreements
   
1,358
     
1,358
     
-
     
1,358
     
-
 
Accrued interest receivable
   
4,029
     
4,029
     
-
     
4,029
     
-
 
                                         
Financial liabilities:
                                       
Non-interest bearing deposits
   
172,094
     
172,094
     
172,094
     
-
     
-
 
Interest bearing deposits
   
982,276
     
982,241
     
654,573
     
327,668
     
-
 
Repurchase agreements
   
11,499
     
11,499
     
9,721
     
1,778
     
-
 
Borrowed funds
   
14,000
     
14,108
     
-
     
14,108
     
-
 
Interest rate swap agreements
   
1,358
     
1,358
     
-
     
1,358
     
-
 
Accrued interest payable
   
179
     
179
     
-
     
179
     
-
 
 
The following methods were used to estimate the fair value of financial instruments presented in the preceding table for the periods ended
March 31, 2020,
and
December 31, 2019:
 
Cash and cash equivalent carrying amounts approximate fair value. Certificates of deposits in other financial institutions carrying amounts approximate fair value (Level
2
). The fair values of securities available-for-sale are obtained from broker pricing (Level
2
), with the exception of collateralized debt obligations, which are valued by a
third
-party specialist (Level
3
). Loans held-for-sale comprise residential mortgages and are priced based on values established by the secondary mortgage markets (Level
1
). The estimated fair value for net loans receivable is based on the exit price notion which is the exchange price that would be received to transfer the loans at the most advantageous market price in an orderly transaction between market participants on the measurement date (Level
3
). Federal Home Loan Bank stock is estimated at book value due to restrictions that limit the sale or transfer of the security. Interest rate swap agreements, both assets and liabilities, are valued by a
third
-party pricing agent using an income approach (Level
2
). Fair values of accrued interest receivable and payable approximate book value, as the carrying values are determined using the observable interest rate, balance, and last payment date.
 
Non-interest and interest bearing deposits, which include checking, savings, and money market deposits, are estimated to have fair values based on the amount payable as of the reporting date (Level
1
). The fair value of fixed-maturity certificates of deposit (included in interest bearing deposits) are based on estimates of the rate the Bancorp would pay on similar deposits, applied for the time period until maturity (Level
2
). Estimated fair values for short-term repurchase agreements, which represent sweeps from demand deposits to accounts secured by pledged securities, are estimated based on the amount payable as of the reporting date (Level
1
). Longer-term repurchase agreements, with contractual maturity dates of
three
months or more, are based on estimates of the rate the Bancorp would pay on similar deposits, applied for the time period until maturity (Level
2
). Short-term borrowings are generally only held overnight, therefore, their carrying amount is a reasonable estimate of fair value (Level
1
). The fair value of FHLB Advances are estimated by discounting the future cash flows using quoted rates from the FHLB for similar advances with similar maturities (Level
2
). The estimated fair value of other financial instruments, and off-balance sheet loan commitments, approximate cost and are
not
considered significant to this presentation.