Accounting guidance under GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an 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. This accounting guidance also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available for sale and equity securities with readily determinable fair values are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, loans held for sale and other real estate owned (foreclosed assets). These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Under fair value accounting guidance, assets and liabilities are grouped at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine their fair values. These hierarchy levels are:

Level 1 inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.

Level 2 inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs – Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

Below is a discussion on the Company’s assets measured at fair value on a recurring basis.

Fair value measurement for investment securities available for sale is based on quoted prices from an independent pricing service. The fair value measurements consider observable data that may include present value of future cash flows, prepayment assumptions, credit loss assumptions and other factors. The Company classifies its investments in U.S. Treasury securities, if any, as Level 1 in the fair value hierarchy, and it classifies its investments in U.S. Government agencies securities and mortgage-backed securities issued or guaranteed by U.S. Government sponsored entities as Level 2.

Fair value measurement for subordinated debt is based on recent issuance rates of subordinated debt offerings over the prior 3 months for issuers of a relative size. A liquidity premium was added to the assumed market spreads to reflect exit pricing and the marketability/liquidity costs contained with consummating an orderly transaction. Although these securities have readily available fair market values, the Company determined that they should be classified as level 2 investments in the fair value hierarchy due to not being considered traded in a highly active market.

Fair value measurement for equity securities is based on quoted market prices retrieved by the Company via on-line resources. Although these securities have readily available fair market values, the Company determined that they should be classified as level 2 investments in the fair value hierarchy due to not being considered traded in a highly active market.

Loans held for sale (LHFS) are carried at fair value, which is determined based on Mark to Trade (MTT) for allocated/committed loans or Mark to Market (MTM) analysis for unallocated/uncommitted loans based on third-party pricing models.

The fair value of mortgage servicing rights (MSRs) is determined using a valuation model administered by a third party that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, default rates, cost to service (including delinquency and foreclosure costs), escrow account earnings, contractual servicing fee income, and other ancillary income such as late fees. Management reviews all significant assumptions on a quarterly basis. Mortgage loan prepayment speed, a key assumption in the model, is the annual rate at which borrowers are forecasted to repay their mortgage loan principal. The discount rate used to determine the present value of estimated future net servicing income, another key assumption in the model, is an estimate of the required rate of return investors in the market would require for an asset with similar risk. Both assumptions can, and generally will, change as market conditions and interest rates change.

The significant unobservable inputs used in the fair value measurement of the reporting entity’s residential MSRs are prepayment speeds, probability of default, rate of return, and cost of servicing. Significant increases/decreases in any of those inputs in isolation would have resulted in a significantly lower/higher fair value measurement. Generally, a change in the assumption used for prepayment speeds would have been accompanied by a directionally similar change in the markets, i.e. the 10-Year Treasury, and in the probability of default.

We utilize a third-party specialist model to estimate the fair value of our IRLCs, which are valued based upon mortgage securities (TBA) prices less estimated costs to process and settle the loan. Fair value is adjusted for the estimated probability of the loan closing with the borrower.

(1)

The weighted average was calculated with reference to the principal balance of the underlying mortgages.

(2)

PSA = Public Securities Association Standard Prepayment Model

The following table presents activity in MSRs for the three months ended March 31, 2022.


(Dollars in thousands)	March 31, 2022
Beginning balance	$	4,087
Servicing rights reulting from sales of loans		472
Valuation adjustment		554
Ending balance	$	5,113

The following table presents activity in the IRLCs for the three months ended March 31, 2022.


(Dollars in thousands)	March 31, 2022
Beginning balance	$	380
Valuation adjustment		(163)
Ending balance	$	217

Forward Contracts

To avoid interest rate risk, we hedge the open locked/closed position with TBA forward trades. On a regular basis, we allocate disbursed loans to mandatory commitments with government-sponsored enterprises (“GSE”) and private investors delivering the loans within 120 days of origination to maximize interest earnings. For a small percentage of our business, we enter into best efforts forward sales commitments with investors at the time we make an IRLC to a borrower. Once a loan has been closed and funded, the best efforts commitments convert to mandatory forward sales commitments. The mandatory commitments are derivatives, and we measure and report them at fair value. Fair value is based on the gain or loss that would occur if we were to pair-off the transaction with the investor at the measurement date. This is a level 2 input. We have elected to measure and report best efforts commitments at fair value using a valuation methodology similar to that used for mandatory commitments.

Market assumptions utilized in the fair value measurement of the reporting entity’s residential mortgage derivatives, inclusive of IRLCs, Closed Loan Inventory, TBA derivative trades, and Mandatory Forwards may be subject to investor overlays that may result in a significantly lower fair value measurement. Generally such overlays are announced with advanced notice in order to include the risk adjuster, however there are times when announcements are mandated resulting in a lower fair value measurement. Additionally market assumptions such as spec pool payups may result in a significantly higher fair value measurement at time of loan allocation to specific trades.

The following tables present the recorded amount of assets measured at fair value on a recurring basis at March 31, 2022 and December 31, 2021. No assets were transferred from one hierarchy level to another during the first three months of 2022 or 2021.


					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
March 31, 2022
Assets:
Securities available for sale:
U.S. Government agencies	$	21,255	$	—	$	21,255	$	—
Mortgage-backed		83,442		—		83,442		—
Other Debt Securities		1,998		—		1,998		—
		106,695		—		106,695		—

Equity securities		1,305		—		1,305		—


TBA securities		838		—		838		—
LHFS		12,906		—		12,906		—
MSRs		5,113		—		—		5,113
IRLCs		217		—		—		217

Total assets at fair value	$	127,074	$	—	$	121,744	$	5,330

Liabilities:
TBA securities	$	6	$	—	$	6	$	—

Total liabilities at fair value	$	6	$	—	$	6	$	—


					Significant
					Other		Significant
			Quoted		Observable		Unobservable
			Prices		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
December 31, 2021
Assets:
Securities available for sale:
U.S. Government agencies	$	22,305	$	—	$	22,305	$	—
Mortgage-backed		92,637		—		92,637		—
Other Debt Securities		2,040		—		2,040		—
		116,982		—		116,982		—

Equity securities		1,372		—		1,372		—


TBA securities		55		—		55		—
LHFS		37,749		—		37,749		—
MSRs		4,087		—		—		4,087
IRLCs		380		—		—		380

Total assets at fair value	$	160,625	$	—	$	156,158	$	4,467

Liabilities:
TBA securities	$	41	$	—	$	41	$	—

Total liabilities at fair value	$	41	$	—	$	41	$	—

Below is a discussion on the Company’s assets measured at fair value on a nonrecurring basis.

Impaired Loans

Loans are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts according to the contractual terms of the loan agreement when due. Loan impairment is measured using the present value of expected cash flows, the loan’s observable market price or the fair value of the collateral (less selling costs) if the loans are collateral dependent and these are considered Level 3 in the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The value of business equipment, inventory and accounts receivable, discounted on management’s review and analysis. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and the client’s business.

Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the factors identified above. Valuation techniques are consistent with those techniques applied in prior periods.

Other Real Estate Owned (Foreclosed Assets)

Foreclosed assets are adjusted for fair value upon transfer of loans to foreclosed assets establishing a new cost basis. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. The estimated fair value for foreclosed assets included in Level 3 are determined by independent market based appraisals and other available market information, less costs to sell, that may be reduced further based on market expectations or an executed sales agreement. If the fair value of the collateral deteriorates subsequent to the initial recognition, the Company records the foreclosed asset as a non-recurring Level 3 adjustment. Valuation techniques are consistent with those techniques applied in prior periods.

The following tables set forth the Company’s financial and nonfinancial assets subject to fair value adjustments (impairment) on a nonrecurring basis at March 31, 2022 and December 31, 2021, that are valued at the lower of cost or market. Assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.


	Quantitative Information about Level 3 Fair Value Measurements
								Weighted
(Dollars in thousands)	Fair Value		Valuation Technique		Unobservable Input		Range	Average (3)
March 31, 2022
Nonrecurring measurements:

Impaired loans	$	617	Appraisal of collateral	(1)	Liquidation expense	(2)	10%	(10%)

Impaired loans	$	1,878	Discounted cash flow analysis	(1)	Discount rate		6% - 7.25%	(6%)

Other real estate owned	$	561	Appraisal of collateral	(1)	Appraisal adjustments	(2)	0% - 20%	(7%)


	Quantitative Information about Level 3 Fair Value Measurements
								Weighted
(Dollars in thousands)	Fair Value		Valuation Technique		Unobservable Input		Range	Average (3)
December 31, 2021
Nonrecurring measurements:

Impaired loans	$	617	Appraisal of collateral	(1)	Liquidation expense	(2)	10%	(10%)

Impaired loans	$	2,026	Discounted cash flow analysis	(1)	Discount rate		4% - 7.25%	(6%)

Other real estate owned	$	532	Appraisal of collateral	(1)	Appraisal adjustments	(2)	20% - 40%	(35%)

(1)Fair value is generally determined through independent appraisals of the underlying collateral (impaired loans and OREO) or discounted cash flow analyses (impaired loans), which generally include various level III inputs which are not identifiable.

(2)Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

(3)Unobservable inputs were weighted by the relative fair value of the instruments.

The carrying amounts and estimated fair values of the Company’s financial instruments not carried at fair value on the Company’s Consolidated Balance Sheets are presented in the following table. Fair values for March 31, 2022 and December 31, 2021 were estimated using an exit price notion.


	March 31, 2022				December 31, 2021
			Estimated				Estimated
	Carrying		Fair		Carrying		Fair
(Dollars in thousands)	Amount		Value		Amount		Value
Financial assets
Level 1 inputs
Cash and cash equivalents	$	570,976	$	570,976	$	583,613	$	583,613

Level 2 inputs
Investment securities available for sale	$	106,695	$	106,695	$	116,982	$	116,982
Investment securities held to maturity		407,138		390,541		404,594		401,524
Equity securities		1,305		1,305		1,372		1,372
Restricted securities		9,894		9,894		4,159		4,159
LHFS		12,906		12,906		37,749		37,749
TBA securities		838		838		55		55
Cash surrender value on life insurance		58,186		58,186		47,935		47,935

Level 3 inputs
Loans, net	$	2,166,396	$	2,140,286	$	2,105,231	$	2,106,373
MSRs		5,113		5,113		4,087		4,087
IRLCs		217		217		380		380

Financial liabilities
Level 2 inputs
Deposits:
Noninterest-bearing demand	$	876,415	$	876,415	$	927,497	$	927,497
Checking plus interest		695,407		695,407		524,143		524,143
Money market		726,858		726,858		889,099		889,099
Savings		309,926		309,926		225,546		225,546
Club		745		745		388		388
Certificates of deposit		459,144		459,171		459,563		461,135
Securities sold under retail repurchase agreement		—		—		4,143		4,143
Advances from FHLB - long-term		10,094		10,052		10,135		10,187
Subordinated debt		42,840		45,430		42,762		44,876
TBA Securities		6		6		41		41