Note 13 - Fair Value Measurements

6 Months Ended

Jun. 30, 2023

Notes to Financial Statements

Fair Value Disclosures [Text Block]

Note 13. Fair Value Measurements

In determining fair value, FNCB uses various valuation approaches, including market, income and cost approaches. Accounting standards establish a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability, which are developed based on market data obtained from sources independent of FNCB. Unobservable inputs reflect FNCB’s knowledge about the assumptions the market participants would use in pricing an asset or liability, which are developed based on the best information available in the circumstances.

The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). A financial asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

● Level 1 valuation is based upon unadjusted quoted market prices for identical instruments traded in active markets;

● Level 2 valuation is based upon quoted market prices for similar instruments traded in active markets, quoted market prices for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by market data; and

● Level 3 valuation is derived from other valuation methodologies including discounted cash flow models and similar techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in determining fair value.

A description of the valuation methodologies used for assets recorded at fair value is set forth below.

Available-for-Sale Debt Securities

The estimated fair values for FNCB’s investments in obligations of U.S Treasury securities, U.S. government agencies, obligations of state and political subdivisions, government-sponsored agency CMOs and mortgage-backed securities, private collateralized mortgage obligations, asset-backed securities and negotiable certificates of deposit are obtained by FNCB from a nationally recognized pricing service.  This pricing service develops estimated fair values by analyzing like securities and applying available market information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing (Level 2 inputs), to prepare valuations. Matrix pricing 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.  The fair value measurements consider observable data that may include, among other things, dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, and are based on market data obtained from sources independent from FNCB.  The Level 2 investments in FNCB’s portfolio are priced using those inputs that, based on the analysis prepared by the pricing service, reflect the assumptions that market participants would use to price the assets.  Management has determined that the Level 2 designation is appropriate for these securities because, as with most fixed-income securities, those in FNCB’s portfolio are not exchange-traded, and such non-exchange-traded fixed income securities are typically priced by correlation to observed market data.  FNCB has reviewed the pricing service’s methodology to confirm its understanding that such methodology results in a valuation based on quoted market prices for similar instruments traded in active markets, quoted markets for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which the significant assumptions can be corroborated by market data as appropriate to a Level 2 designation.

For those securities for which the inputs used by an independent pricing service were derived from unobservable market information, FNCB evaluated the appropriateness and quality of each price.  Management reviewed the volume and level of activity for all classes of securities and attempted to identify transactions which may not be orderly or reflective of a significant level of activity and volume.  For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing service may be adjusted, as necessary, to estimate fair value (fair values based on Level 3 inputs).  If applicable, the adjustment to fair value was derived based on present value cash flow model projections obtained from third party providers using assumptions similar to those incorporated by market participants.

At June 30, 2023, FNCB owned 30 corporate debt securities with an aggregate amortized cost and fair value of $35.1 million and $30.4 million, respectively. At June 30, 2023, the market for four corporate debt securities with an amortized cost and fair value of $8.0 million and $6.6 million, respectively, was not active, based on transaction criteria for similar instruments.  FNCB obtained valuations for these securities from a third-party service provider that prepared the valuations using a market approach that incorporates identifying a population of transactions for similar instruments and incorporating an evaluation to capture credit risk associated with these bonds. Management takes measures to validate the service providers’ analysis and is actively involved in the valuation process, including reviewing and the population and evaluation of credit risk. Management believes this approach to be a conservative approach as it takes into consideration securities that have longer maturities or longer call dates, issuers with smaller asset sizes, and securities with smaller issue amounts. These factors are typically considered to be factors that would add credit spread to a bond, thus resulting in a higher required yield. Management believes the valuation results from this market approach to be consistent with pricing and data for similar deals at June 30, 2023. FNCB considers the inputs used in the market approach to be unobservable Level 3 inputs because, while inputs are based on actual transactions, the relative number of transactions in the population is small and subjective assumptions are used in considering factors considered to incorporate credit spreads into the price determination. Management will continue to monitor the market for these securities to assess the market activity and the availability of observable inputs and will continue to apply these controls and procedures to the valuations received from FNCB's third-party service provider.

Equity Securities

The estimated fair values of equity securities are determined by obtaining quoted prices on nationally recognized exchanges (Level 1 inputs).

Derivative Contracts

FNCB's derivative liabilities are reported at fair value utilizing Level 2 inputs. Values of these instruments are obtained through an independent pricing source utilizing information which may include market observed quotations for swaps, interest rates, forward rates and rate volatility. Derivative contracts create exposure to interest rate movements as well as risks from the potential of non-performance of the counterparty.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following tables present the financial assets and liabilities that were measured at fair value on a recurring basis at June 30, 2023, and  December 31, 2022, and the fair value hierarchy of the respective valuation techniques utilized by FNCB to determine the fair value:

	Fair Value Measurements at June 30, 2023
			Quoted Prices in Active Markets		Significant Other Observable		Significant Other Unobservable
			for Identical Assets		Inputs		Inputs
(in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
Financial assets:
Available-for-sale debt securities:
U.S. treasuries	$	32,302	$	-	$	32,302	$	-
Obligations of state and political subdivisions		208,735		-		208,735		-
U.S. government/government-sponsored agencies:
Collateralized mortgage obligations - residential		77,451		-		77,451		-
Collateralized mortgage obligations - commercial		3,313		-		3,313		-
Mortgage-backed securities		17,963		-		17,963		-
Private collateralized mortgage obligations		68,241		-		68,241		-
Corporate debt securities		30,385		-		23,786		6,599
Asset-backed securities		13,836		-		13,836		-
Negotiable certificates of deposit		651		-		651		-
Subtotal available-for-sale debt securities		452,877		-		446,278		6,599
Equity securities, at fair value		6,337		6,337		-		-
Derivative assets		2,192		-		2,192		-
Total financial assets	$	461,406	$	6,337	$	448,470	$	6,599
Financial liabilities:
Derivative liabilities	$	1,417	$	-	$	1,417	$	-
Total financial liabilities	$	1,417	$	-	$	1,417	$	-

	Fair Value Measurements at December 31, 2022
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Other Unobservable Inputs
(in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
Financial assets:
Available-for-sale debt securities:
U.S. treasuries	$	32,134	$	-	$	32,134	$	-
Obligations of state and political subdivisions		220,782		-		220,782		-
U.S. government/government-sponsored agencies:
Collateralized mortgage obligations - residential		80,407		-		80,407		-
Collateralized mortgage obligations - commercial		3,329		-		3,329		-
Mortgage-backed securities		20,663		-		20,663		-
Private collateralized mortgage obligations		72,507		-		72,507		-
Corporate debt securities		30,672		-		22,736		7,936
Asset-backed securities		14,941		-		14,941		-
Negotiable certificates of deposit		656		-		656		-
Subtotal available-for-sale debt securities		476,091		-		468,155		7,936
Equity securities, at fair value		7,717		7,717		-		-
Derivative assets		2,104		-		2,104
Total financial assets	$	485,912	$	7,717	$	470,259	$	7,936
Financial liabilities:
Derivative liabilities	$	931	$	-	$	931	$	-
Total financial liabilities	$	931	$	-	$	931	$	-

There were two securities transferred between hierarchy levels during the three and six months ended June 30, 2023. There was one corporate debt security transferred from Level 3 hierarchy to Level 2 during the six months ended June 30, 2022. The market for the transferred securities was previously not active and management obtained fair values from an independent third party that utilized a discounted cash flow model. Subsequently, in the period of transfer, management was able to obtain fair values for these securities from the independent pricing service used to price the remainder of the portfolio using significant other observable inputs. 

The following table presents a reconciliation and consolidated statement of operations classifications of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3), which consisted entirely of corporate debt securities, for the three and six months ended June 30, 2023 and 2022.

Fair Value Measurements
Using Significant Unobservable Inputs (Level 3)
	Corporate Debt Securities						Corporate Debt Securities
	For the Three Months Ended June 30,						For the Six Months Ended June 30,
(in thousands)	2023			2022			2023			2022
Balance, beginning of period	$	8,012		$	11,265		$	7,936		$	12,345
Additions		-			-			-			-
Redemptions		-			(2,066	)		-			(2,066	)
Transfer to Level 2		(853	)		-			(853	)		(756	)
Sales		-			-			-			-
Total gains (losses) (realized/unrealized):
Included in earnings		-			-			-			-
Included in other comprehensive loss		(560	)		(1,169	)		(484	)		(1,493	)
Balance at June 30,	$	6,599		$	8,030		$	6,599		$	8,030

Assets Measured at Fair Value on a Non-Recurring Basis

The following tables present assets and liabilities measured at fair value on a non-recurring basis at June 30, 2023 and additional quantitative information about the valuation techniques and inputs utilized by FNCB to determine fair value. All assets were measured using Level 3 inputs.

	June 30, 2023
	Fair Value Measurement						Quantitative Information
	Recorded		Valuation		Fair		Valuation	Unobservable	Value/
(in thousands)	Investment		Allowance		Value		Technique	Inputs	Range
Individually evaluated loans - collateral dependent	$	2,743	$	-	$	2,743	Appraisal of collateral	Selling costs		10.0	%
Individually evaluated loans - other		664		-		664	Discounted cash flows	Discount rate		3.13% - 9.50%

The following tables present assets and liabilities measured at fair value on a non-recurring basis at  December 31, 2022, prior to the adoption of ASU 2016-13, and additional quantitative information about the valuation techniques and inputs utilized by FNCB to determine fair value. All assets were measured using Level 3 inputs.

	December 31, 2022
	Fair Value Measurement						Quantitative Information
	Recorded		Valuation		Fair		Valuation	Unobservable	Value/
(in thousands)	Investment		Allowance		Value		Technique	Inputs	Range
Individually evaluated loans - collateral dependent	$	1,902	$	8	$	1,894	Appraisal of collateral	Selling costs		10.0	%
Individually evaluated loans - other		5,698		26		5,672	Discounted cash flows	Discount rate		3.00% - 10.25%

The fair value of collateral-dependent impaired loans is determined through independent appraisals or other reasonable offers, which generally include various Level 3 inputs which are not identifiable. Management reduces the appraised value by the estimated costs to sell the property and may adjust the appraised values as necessary to consider any declines in real estate values since the time of the appraisal. For impaired loans that are not collateral-dependent, fair value is determined using the discounted cash flow method. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance or is charged off. The amount shown is the balance of impaired loans, net of any charge-offs and the related allowance for credit losses.

The following table summarizes the estimated fair values of FNCB’s financial instruments using an exit price notion at June 30, 2023 and at December 31, 2022.  FNCB discloses fair value information about financial instruments, whether or not recognized in the statements of financial condition, for which it is practicable to estimate that value. The fair value of financial instruments that are not measured at fair value in the financial statements were based on the exit price notion. The following estimated fair value amounts have been determined using available market information and appropriate valuation methodologies. However, management judgment is required to interpret data and develop fair value estimates. Accordingly, the estimates below are not necessarily indicative of the amounts FNCB could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

	Fair Value	June 30, 2023				December 31, 2022
(in thousands)	Measurement	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial assets:
Cash and cash equivalents	Level 1	$	105,000	$	105,000	$	41,916	$	41,916
Available-for-sale debt securities	See previous table		452,877		452,877		476,091		476,091
Equity securities	Level 1		6,337		6,337		7,717		7,717
Restricted stock	Level 2		9,325		9,325		8,545		8,545
Loans held for sale	Level 2		-		-		60		60
Loans and leases, net	Level 3		1,187,722		1,136,605		1,110,124		1,079,266
Accrued interest receivable	Level 2		6,329		6,329		5,957		5,957
Servicing rights	Level 3		211		610		254		621
Derivative assets	Level 2		2,049		2,192		1,946		2,104
Financial liabilities:
Deposits	Level 2		1,476,064		1,470,879		1,420,647		1,416,272
Borrowed funds	Level 2		242,022		241,655		182,360		182,108
Accrued interest payable	Level 2		1,089		1,089		171		171
Derivative liabilities	Level 2		1,433		1,417		921		931