Note 11 - Fair Value and Interest Rate Risk

9 Months Ended

Sep. 30, 2018

Notes to Financial Statements

Fair Value Disclosures [Text Block]

Note

11:

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, federal funds sold, short-term investments, 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

$4.5

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.

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. In connection with the adoption of ASU

2016

-

01

on

January 1, 2018,

we refined our methodology to 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.

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

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

June 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.

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.

Contingent Consideration Liability

The Company estimates the fair value of the contingent consideration liability by using a discounted cash flow model of future contingent payments based on interest income related to the acquired PCI loans. The estimated fair value of the contingent consideration liability is reviewed on a quarterly basis and any valuation adjustments resulting from a change of estimated future contingent payments based on interest income of the acquired PCI loans affecting the contingent consideration liability will be recorded through noninterest expense. Due to the significant unobservable input related to the interest income, the contingent consideration liability is classified within Level

3

of the valuation hierarchy. An increase in the interest income

may

result in a higher fair value of the contingent consideration liability. Alternatively, a decrease in the interest income

may

result in a lower estimated fair value of the contingent consideration liability.

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 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,

 

2018

and

December 

31,

 

2017:

(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, 2018:
U. S. Government agency mortgage-backed securities	$	-		21,235		-		21,235
Corporate bonds		-		13,007		-		13,007
Subordinated notes		-		4,525		-		4,525
U.S. Treasury notes		-		1,497		-		1,497
Available-for-sale securities	$	-		40,264		-		40,264
Contingent consideration liability	$	-		-		477		477
December 31, 2017:
U. S. Government agency mortgage-backed securities	$	-		7,224		-		7,224
Corporate bonds		-		13,804		-		13,804
Subordinated notes		-		4,548		-		4,548
Available-for-sale securities	$	-		25,576		-		25,576

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.

The table below presents the valuation methodology and unobservable inputs for level

3

assets measures at fair value on a non-recurring basis as of

September 

30,

 

2018

and

December 

31,

 

2017:

(In thousands)	Fair Value		Valuation Methodology	Unobservable Inputs	Range of Inputs
September 30, 2018:
Impaired loans, net including PCI loans	$	10,173	Real Estate Appraisals	Discount for appraisal type	0%	-	8%
Other Real Estate Owned		991	Real Estate Appraisals	Discount for appraisal type		14%
December 31, 2017:
Impaired loans	$	6,500	Real Estate Appraisals	Discount for appraisal type	0%	-	8%

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,

 

2018

and

December 

31,

 

2017,

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.

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,

 

2018

and

December 

31,

 

2017:

(In thousands)		September 30, 2018				December 31, 2017
	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	$	5,596		5,596		3,582		3,582
Interest-bearing deposits due from banks	Level 1		43,636		43,636		45,659		45,659
U. S. Government agency mortgage-backed securities	Level 2		21,235		21,235		7,224		7,224
Corporate bonds	Level 2		13,007		13,007		13,804		13,804
Subordinated notes	Level 2		4,525		4,525		4,548		4,548
U.S. Treasury notes	Level 2		1,497		1,497		-		-
Other investments	Level 2		4,450		4,450		4,450		4,450
Federal Reserve Bank stock	Level 2		2,833		2,833		2,502		2,502
Federal Home Loan Bank stock	Level 2		4,928		4,928		5,889		5,889
Loans receivable, net	Level 3		756,649		748,988		713,350		702,816
Accrued interest receivable	Level 2		3,612		3,612		3,496		3,496
Financial assets, total		$	861,968		854,307		804,504		793,970
Financial Liabilities:
Demand deposits	Level 2	$	81,687		81,687		81,197		81,197
Savings deposits	Level 2		100,294		100,294		135,975		135,975
Money market deposits	Level 2		62,314		62,314		16,575		16,575
NOW accounts	Level 2		24,827		24,827		25,476		25,476
Time deposits	Level 2		284,390		282,671		240,087		239,219
Brokered deposits	Level 1		166,020		165,437		138,129		137,870
FHLB and correspondent bank borrowings	Level 2		90,000		89,266		120,000		120,218
Senior notes	Level 2		11,759		11,108		11,703		11,249
Subordinated debt	Level 2		9,720		9,158		-		-
Junior subordinated debt owed to unconsolidated trust	Level 2		8,092		8,092		8,086		8,086
Note payable	Level 3		1,436		1,245		1,580		1,416
Accrued interest payable	Level 2		1,563		1,563		569		569
Contingent consideration liability	Level 3		477		477		-		-
Financial liabilities, total		$	842,579		838,139		779,377		777,850

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.

Off-balance-sheet instruments

Loan commitments on which the committed interest rate is less than the current market rate were insignificant at

September 

30,

 

2018

and

December 

31,

 

2017.

The estimated fair value of fee income on letters of credit at

September 

30,

 

2018

and

December 

31,

 

2017

was insignificant.