FASB Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements, provides the framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under FASB ASC Topic 820 are described as follows:

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. The tables below present the balances of financial assets and liabilities measured at fair value on a recurring and nonrecurring basis as of March 31, 2023 and September 30, 2022.


	Carrying Value
	Level 1		Level 2		Level 3		Total

	(In thousands)
March 31, 2023:
Assets Measured – Recurring Basis:
Securities available for sale:
U.S. Treasury bills and notes	$	—	$	28,682	$	—	$	28,682
Agency mortgage-backed		—		27,185		—		27,185
Agency CMO		—		13,852		—		13,852
Privately-issued CMO		—		409		—		409
Privately-issued ABS		—		504		—		504
SBA certificates		—		11,600		—		11,600
Municipal		—		250,657		—		250,657
Subordinated debt		—		2,000		—		2,000
Total securities available for sale	$	—	$	334,889	$	—	$	334,889
Residential mortgage loans held for sale	$	—	$	36,257	$	—	$	36,257
Derivative assets (included in other assets)	$	—	$	19	$	1,354	$	1,373
Equity securities (included in other assets)	$	139	$	—	$	—	$	139
Residential mortgage servicing rights	$	—	$	—	$	61,194	$	61,194

Liabilities Measured – Recurring Basis:
Derivative liabilities (included in other liabilities)	$	—	$	541	$	7	$	548

Assets Measured – Nonrecurring Basis:
Collateral dependent loans:
Residential real estate	$	—	$	—	$	—	$	—
Commercial real estate		—		—		—		—
SBA commercial real estate		—		—		—		—
Multifamily		—		—		—		—
Commercial business		—		—		29		29
SBA commercial business		—		—		419		419
Consumer		—		—		—		—
Total impaired loans	$	—	$	—	$	448	$	448


	Carrying Value
	Level 1		Level 2		Level 3		Total

	(In thousands)
September 30, 2022:
Assets Measured – Recurring Basis
Securities available for sale:
U.S. Treasury bills and notes	$	—	$	27,295	$	—	$	27,295
Agency mortgage-backed		—		27,500		—		27,500
Agency CMO		—		14,821		—		14,821
Privately-issued CMO		—		470		—		470
Privately-issued ABS		—		569		—		569
SBA certificates		—		12,012		—		12,012
Municipal bonds		—		233,850		—		233,850
Total securities available for sale	$	—	$	316,517	$	—	$	316,517
Residential mortgage loans held for sale	$	—	$	38,579	$	—	$	38,579
Derivative assets (included in other assets)	$	—	$	872	$	158	$	1,030
Equity securities (included in other assets)	$	103	$	—	$	—	$	103
Residential mortgage servicing rights	$	—	$	—	$	63,263	$	63,263

Liabilities Measured – Recurring Basis
Derivative liabilities (included in other liabilities)	$	—	$	31	$	396	$	427

Assets Measured – Nonrecurring Basis
Collateral dependent loans:
Residential real estate	$	—	$	—	$	—	$	—
Commercial real estate		—		—		—		—
SBA commercial real estate		—		—		2,574		2,574
Multifamily		—		—		—		—
Commercial business		—		—		46		46
SBA commercial business		—		—		290		290
Consumer		—		—		—		—
Total impaired loans	$	—	$	—	$	2,910	$	2,910
SBA loan servicing rights	$	—	$	—	$	3,790	$	3,790

Fair value is based upon quoted market prices where available. If quoted market prices are not available, fair value is based on internally developed models or obtained from third parties that primarily use, as inputs, observable market-based parameters or a matrix pricing model that employs the Bond Market Association’s standard calculations for cash flow and price/yield analysis and observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value, or at the lower of cost or fair value. These adjustments may include unobservable parameters. Any such valuation adjustments have been applied consistently over time.

The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. There have been no changes in the valuation techniques and related inputs used for assets measured at fair value on a recurring and nonrecurring basis during the six-month period ended March 31, 2023.

Securities Available for Sale and Equity Securities. Securities classified as available for sale and equity securities are reported at fair value on a recurring basis. These securities are classified as Level 1 of the valuation hierarchy where quoted market prices from reputable third-party brokers are available in an active market. If quoted market prices are not available, the Company obtains fair value measurements from an independent pricing service. These securities are reported using Level 2 inputs and the fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, U.S. government and agency yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the security’s terms and conditions, among other factors. For securities where quoted market prices, market prices of similar securities or prices from an independent third party pricing service are not available, fair values are calculated using discounted cash flows or other market indicators and are classified within Level 3 of the fair value hierarchy. Changes in fair value of equity securities are reported in noninterest income. Changes in fair value of securities available for sale are recorded in other comprehensive income, net of income tax effect.

Residential Mortgage Loans Held for Sale. The Company has elected to record its residential mortgage loans held for sale at fair value in accordance with FASB ASC 825-10. The fair value of residential mortgage loans held for sale is based on specific prices of the underlying contracts for sale to investors or current secondary market prices for loans with similar characteristics, and is classified as Level 2 in the fair value hierarchy.

SBA and Single Tenant Net Lease Loans Held for Sale. SBA and single tenant net lease loans held for sale are carried at the lower of cost or market value. At September 30, 2022, the fair value of SBA loans held for sale was obtained from an independent third party pricing firm based on specific prices of the underlying contracts for sale to investors or current secondary market prices for loans with similar characteristics, and was classified as Level 2 in the fair value hierarchy. The fair value of SBA loans held for sale reflects management’s estimate based on the weighted average price of SBA loans sold to investors during the current quarter, and is classified as Level 3 in the fair value hierarchy. At March 31, 2023, the fair value of single tenant net lease loans held for sale is estimated to approximate carrying value and is classified as Level 3 in the fair value hierarchy. At March 31, 2023 and September 30, 2022, the Company did not have any SBA or single tenant net lease loans held for sale measured at fair value on a nonrecurring basis.

Derivative Financial Instruments. Derivative financial instruments consist of mortgage banking interest rate lock commitments and forward mortgage loan sale commitments. The fair value of forward mortgage loan sale commitments is obtained from an independent third party and is based on the gain or loss that would occur if the Company were to pair-off the sales transaction with the investor. The fair value of forward mortgage loan sale commitments is classified as Level 2 in the fair value hierarchy.

The fair value of interest rate lock commitments is also obtained from an independent third party and is based on investor prices for the underlying loans or current secondary market prices for loans with similar characteristics, less estimated costs to originate the loans and adjusted for the anticipated funding probability (pull-through rate). The fair value of interest rate lock commitments is classified as Level 3 in the fair value hierarchy.

The table below presents a reconciliation of derivative assets and liabilities (interest rate lock commitments) measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three- and six-month periods ended March 31, 2023 and 2022:


	Three Months Ended				Six Months Ended
	March 31,				March 31,
(In thousands)	2023		2022		2023		2022

Beginning balance	$	362	$	1,740	$	(238)	$	1,567
Unrealized gains (losses) recognized in earnings, net of settlements		986		(4,663)		1,586		(4,490)

Ending balance	$	1,348	$	(2,923)	$	1,348	$	(2,923)

The realized and unrealized gains recognized in earnings in the table above are included in mortgage banking income on the accompanying consolidated statements of income. Gains recognized in earnings for the six-month period ended March 31, 2023 attributable to Level 3 derivative assets and liabilities held at the balance sheet date were $1.3 million. Losses recognized in earnings for the six-month period ended March 31, 2022 attributable to Level 3 derivative assets and liabilities held at the balance sheet date were $2.9 million.

The table below presents information about significant unobservable inputs (Level 3) used in the valuation of derivative financial instruments measured at fair value on a recurring basis as of March 31, 2023 and September 30, 2022.

Residential Mortgage Servicing Rights. The current market for residential MSRs is not sufficiently liquid to provide participants with quoted market prices. Therefore, the Company uses a discounted cash flow valuation model from an independent third party to determine the fair value of residential MSRs. The discounted cash flow model approach consists of projecting expected servicing cash flows and calculating the present value. The key assumptions used in the valuation of residential MSRs include mortgage prepayment speeds, discount rates and loan servicing costs. Due to the nature of the valuation inputs, residential MSRs are classified within Level 3 of the valuation hierarchy. A reconciliation of residential MSRs measured at fair value on a recurring basis using significant unobservable inputs (Level 3) and a summary of the significant unobservable inputs used in the residential MSR valuations is presented in Note 3. Changes in the fair value of residential MSRs are included in mortgage banking income in the accompanying consolidated statements of income.

Collateral Dependent Loans. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly. In accordance with accounting standards, only impaired loans for which an allowance for loan loss has been established or a partial charge-off recorded require classification in the fair value hierarchy.

The fair value of impaired loans is based on the fair value of the underlying collateral less estimated costs to sell. Collateral may be real estate and/or business assets, including equipment, inventory and/or accounts receivable. The fair value of the collateral is generally determined based on real estate appraisals or other independent evaluations by qualified professionals, adjusted for estimated costs to sell the property, costs to complete or repair the property and other factors to reflect management’s estimate of the fair value of the collateral given the current market conditions and the condition of the collateral. The fair value of impaired loans is classified as Level 3 in the fair value hierarchy. At March 31, 2023 and September 30, 2022, the significant unobservable inputs used in the fair value measurement of impaired loans were as follows:

During the three- and six -month periods ended March 31, 2023, the Company recognized provisions for loan losses on impaired loans of $364,000 and $564,000, respectively. During the three- and six-month periods ended March 31, 2022, the Company recognized provisions for loan losses on impaired loans of $457,000 and $1.1 million, respectively.

SBA and Nonresidential Loan Servicing Rights. SBA loan servicing rights represent the value associated with servicing SBA loans that have been sold. The fair value of SBA loan servicing rights is determined on a quarterly basis by an independent third party valuation model using market-based discount rate and prepayment assumptions, and is classified as Level 3 in the fair value hierarchy. At March 31, 2023, there were no SBA loan servicing rights measured at fair value. At September 30, 2022, the significant unobservable inputs used in the fair value measurement of SBA loan servicing rights measured at fair value were as follows:

Impairment of the SBA loan servicing rights is recognized on a quarterly basis through a valuation allowance to the extent that fair value is less than the carrying amount. The Company reversed impairment charges of $530,000 and $179,000 on SBA loan servicing rights for the three- and six-month periods ended March 31, 2023 and 2022, respectively. The Company reversed impairment charges of $47,000 and $6,000 on SBA loan servicing rights for the three- and six-month periods ended March 31, 2022, respectively.

Nonresidential mortgage loan servicing rights represent the value associated with servicing single tenant net lease loans that have been sold. The fair value of nonresidential mortgage loan servicing rights is determined by management on a quarterly basis using a discounted cash flow model, and is classified as Level 3 in the fair value hierarchy. At March 31, 2023 and September 30, 2022, the Company did not have any nonresidential mortgage loan servicing rights measured at fair value on a nonrecurring basis. The Company did not recognize any impairment charges on nonresidential mortgage loan servicing rights for the three- and six-month periods ended March 31, 2023 and 2022.

Other Real Estate Owned. Other real estate owned held for sale is reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly. The fair value of other real estate owned is classified as Level 3 in the fair value hierarchy.

Other real estate owned is reported at fair value, less estimated costs to dispose of the property. The fair values are determined by real estate appraisals, which are then generally discounted by management in order to reflect management’s estimate of the fair value of the property given current market conditions and the condition of the property. At March 31, 2023 and September 30, 2022, the Company did not have any other real estate owned measured at fair value on a nonrecurring basis. The Company did not recognize any charges to write down other real estate owned to fair value for the three- and six -month periods ended March 31, 2023 and 2022.

There were no transfers into or out of the Company’s Level 3 financial assets of the fair value hierarchy for the three- and six -month period ended March 31, 2023.

Financial Instruments Recorded Using Fair Value Option. Under FASB ASC 825-10, the Company may elect to report most financial instruments and certain other items at fair value on an instrument-by-instrument basis, with changes in fair value reported in income. The election is made at the acquisition date of an eligible financial asset or financial liability, and may not be revoked once made.

The Company has elected the fair value option for substantially all of its residential mortgage loans held for sale. These loans are intended for sale and the Company believes that the fair value is the best indicator of the resolution of these loans. Interest income is recorded based on the contractual terms of the loans and in accordance with the Company’s policy on loans held for investment. None of these loans were 90 days or more past due, nor were any on nonaccrual status, as of March 31, 2023 and September 30, 2022.

The table below presents the difference between the aggregate fair value and the aggregate remaining principal balance for residential mortgage loans held for sale for which the fair value option had been elected as of March 31, 2023 and September 30, 2022.

The table below presents gains and losses and interest included in earnings related to financial assets measured at fair value under the fair value option for the three- and six- month periods ended March 31, 2023 and 2022:


	Three Months Ended				Six Months Ended
	March 31,				March 31,
(In thousands)	2023		2022			2023		2022

Gains (losses) – included in mortgage banking income	$	282	$	(2,544)	$	950	$	(921)
Interest income		389		959		817		1,953

	$	671	$	(1,585)	$	1,767	$	1,032

GAAP requires disclosure of fair value information about financial instruments for interim reporting periods, whether or not recognized in the consolidated balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The carrying amounts and estimated fair values of the Company’s financial instruments are as follows.


	Carrying		Fair Value Measurements Using:
	Amount		Level 1		Level 2		Level 3

	(In thousands)
March 31, 2023:
Financial assets:
Cash and due from banks	$	17,955	$	17,955	$	—	$	—
Interest-bearing deposits with banks		23,855		23,855		—		—
Interest-bearing time deposits		1,626		—		1,626		—
Securities available for sale		334,889		—		334,889		—
Securities held to maturity		1,428		—		1,458		—
Residential mortgage loans held for sale		36,257		—		36,257		—
SBA loans held for sale		12,526		—		—		13,594
Loans, net		1,598,440		—		—		1,505,196
FRB and FHLB stock		23,589		N/A		N/A		N/A
Accrued interest receivable		9,873		—		9,873		—
Residential mortgage loan servicing rights		61,194		—		—		61,194
Nonresidential mortgage loan servicing rights		124		—		—		124
SBA loan servicing rights		3,727		—		—		3,944
Derivative assets (included in other assets)		1,373		—		19		1,354
Equity securities (included in other assets)		139		139		—		—

Financial liabilities:
Deposits		1,542,882		—		—		1,538,368
Borrowings from FHLB		437,795		—		428,680		—
Subordinated notes		50,330		—		49,430		—
Accrued interest payable		2,654		—		2,654		—
Advance payments by borrowers for taxes and insurance		1,093		—		1,093		—
Derivative liabilities (included in other liabilities)		548		—		541		7


	Carrying		Fair Value Measurements Using:
	Amount		Level 1		Level 2		Level 3

	(In thousands)
September 30, 2022:
Financial assets:
Cash and due from banks	$	18,312	$	18,312	$	—	$	—
Interest-bearing deposits with banks		23,353		23,353		—		—
Interest-bearing time deposits		1,613		—		1,613		—
Securities available for sale		316,517		—		316,517		—
Securities held to maturity		1,558		—		1,593		—
Residential mortgage loans held for sale		38,579		—		38,579		—
SBA loans held for sale		21,883		—		24,010		—
Loans, net		1,474,544		—		—		1,402,222
FRB and FHLB stock		20,004		N/A		N/A		N/A
Accrued interest receivable		8,332		—		8,332		—
SBA loan servicing rights		3,790		—		—		3,790
Residential mortgage loan servicing rights		63,263		—		—		63,263
Nonresidential mortgage loan servicing rights		141		—		—		141
SBA loan servicing rights		3,790		—		—		3,789
Derivative assets (included in other assets)		1,030		—		872		158
Equity securities (included in other assets)		103		103		—		—

Financial liabilities:
Deposits		1,515,834		—		—		1,510,792
Borrowings from FHLB		307,303		—		302,090		—
Subordinated note		50,217		—		48,685		—
Other borrowings		37,989		—		—		37,989
Accrued interest payable		1,302		—		1,302		—
Advance payments by borrowers for taxes and insurance		1,207		—		1,207		—
Derivative liabilities (included in other liabilities)		427		—		31		396