Quarterly report pursuant to Section 13 or 15(d)

Note 14 - Fair Value

v3.20.2
Note 14 - Fair Value
9 Months Ended
Sep. 30, 2020
Notes to Financial Statements  
Fair Value Disclosures [Text Block]

Note 14 - 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 semi-annually during June and 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 semi-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 June 30, 2020. 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, September 30, 2020

  $ 173  

 

 

At September 30, 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 nine months ended September 30, 2020. Assets measured at fair value on a recurring basis are summarized below:

 

           

Fair Value Measurements at September 30, 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

  $ 26,789     $ 26,789     $ -     $ -  

U.S. government sponsored entities

    4,989             4,989        

Collateralized mortgage obligations and residential mortgage-backed securities

    128,963       -       128,963       -  

Municipal securities

    162,561       -       162,561       -  

Collateralized debt obligations

    879       -       -       879  

Total securities available-for-sale

  $ 324,181     $ 26,789     $ 296,513     $ 879  

 

 

 

           

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

    (16 )

Total unrealized losses, included in other comprehensive income..

    (181 )

Sale out of Level 3

    -  

Ending balance, September 30, 2020

  $ 879  

 

Assets measured at fair value on a non-recurring basis are summarized below:

 

           

(Dollars in thousands)

 
           

Fair Value Measurements at September 30, 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

  $ 10,985     $ -     $ -     $ 10,985  

Foreclosed real estate

    501       -       -       501  

 

           

(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 $12.3 million and the related specific reserves totaled approximately $1.3 million, resulting in a fair value of impaired loans totaling approximately $11.0 million, at September 30, 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.

 

   

September 30, 2020

   

Estimated Fair Value Measurements at September 30, 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

  $ 84,447     $ 84,447     $ 84,447     $ -     $ -  

Certificates of deposit in other financial institutions

    1,901       1,872       -       1,872       -  

Securities available-for-sale

    324,181       324,181       4,989       318,313       879  

Loans held-for-sale

    5,538       5,721       5,721       -       -  

Loans receivable, net

    965,226       986,847       -       -       986,847  

Federal Home Loan Bank stock

    3,918       3,918       -       3,918       -  

Interest rate swap agreements

    4,062       4,062       -       4,062       -  

Accrued interest receivable

    4,714       4,714       -       4,714       -  
                                         

Financial liabilities:

                                       

Non-interest bearing deposits

    258,170       258,170       258,170       -       -  

Interest bearing deposits

    1,022,486       1,023,402       737,047       286,355       -  

Repurchase agreements

    19,145       19,149       17,411       1,738       -  

Borrowed funds

    12,000       12,072       -       12,072       -  

Interest rate swap agreements

    4,062       4,062       -       4,062       -  

Accrued interest payable

    62       62       -       62       -  

 

   

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 September 30, 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.