NOTE 12 — FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair Value is the exchange price that would be received for an asset or paid to transfer a liability (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. There are 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 Company used the following methods and significant assumptions to estimate fair value:

Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2), using matrix pricing. Matrix pricing is a mathematical technique commonly used to price debt securities that are not actively traded, values debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to the other benchmark quoted securities (Level 2 inputs). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3 inputs). A third-party is engaged to obtain the discounted cash flows and the resulting fair value. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available for similar loans and collateral underlying such loans. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairments and adjusted accordingly.

Assets and liabilities measured at fair value on a recurring basis are summarized below (dollars in thousands):


	Fair Value Measurement using:
			Quoted Prices
			in Active		Significant
			Markets		Other		Significant
	Carrying		For Identical		Observable		Unobservable
	Amount		Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)
At December 31, 2018
Residential mortgage-backed securities	$	21,397	$	—	$	21,397	$	—
Residential collateralized mortgage obligation		2,116		—		2,116		—
Commercial mortgage-backed securities issued by government sponsored entities		5,849		—		5,849		—
Municipal bond		1,077		—		1,077		—
CRA Mutual Fund		2,110		2,110		—		—

	Fair Value Measurement using:
			Quoted Prices
			in Active		Significant
			Markets		Other		Significant
	Carrying		For Identical		Observable		Unobservable
	Amount		Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)

At December 31, 2017
Residential mortgage-backed securities	$	24,684	$	—	$	24,684	$	—
Residential collateralized mortgage obligation		2,706		—		2,706		—
Commercial collateralized mortgage obligation		1,550		—		1,550		—
Municipal bond		1,109		—		1,109		—
CRA Mutual Fund		2,108		2,108		—		—

There were no transfers between Level 1 and Level 2 during 2018 or 2017.

There are no loans that are measured at fair value on a non-recurring basis at December 31, 2018 and December 31, 2017.

Carrying amount and estimated fair values of financial instruments at December 31, 2018 and 2017 were as follows (dollars in thousands):


			Fair Value Measurement Using:
			Quoted Prices
			in Active		Significant
			Markets		Other		Significant
	Carrying		For Identical		Observable		Unobservable		Total Fair
At December 31, 2018	Amount		Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)		Value
Assets:
Cash and due from banks	$	9,246	$	9,246	$	—	$	—	$	9,246
Overnight deposits		223,704		223,704		—		—		223,704
Securities available for sale		32,549		2,110		30,439		—		32,549
Securities held to maturity		4,571		—		4,403		—		4,403
Loans, net		1,846,274		—		—		1,796,462		1,796,462
Other investments
FRB Stock		7,250		N/A		N/A		N/A		N/A
FHLB Stock		9,537		N/A		N/A		N/A		N/A
SBA Loan Fund		5,000		N/A		N/A		N/A		N/A
Disability Opportunity Fund		500		—		500		—		500
Accrued interest receivable		5,507		—		127		5,380		5,507

Financial Liabilities:
Deposits without stated maturities	$	1,563,553	$	1,563,553	$	—	$	—	$	1,563,553
Deposits with stated maturities		97,001		—		96,859		—		96,859
Federal Home Loan Bank of New York advances		185,000		—		184,999		—		184,999
Trust preferred securities payable		20,620		—		—		19,821		19,821
Subordinated debt, net of issuance cost		24,545		—		25,125		—		25,125
Accrued interest payable		1,282		13		1,044		225		1,282


			Fair Value Measurement Using:
			Quoted Prices
			in Active		Significant
			Markets		Other		Significant
	Carrying		For Identical		Observable		Unobservable		Total Fair
At December 31, 2017	Amount		Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)		Value
Assets:
Cash and due from banks	$	6,790	$	6,790	$	—	$	—	$	6,790
Overnight deposits		254,441		254,441		—		—		254,441
Securities available for sale		32,157		2,108		30,049		—		32,157
Securities held to maturity		5,428		—		5,330		—		5,330
Loans, net		1,405,009		-		—		1,410,860		1,410,860
Other investments		—
FRB Stock		3,911		N/A		N/A		N/A		N/A
FHLB Stock		2,766		N/A		N/A		N/A		N/A
SBA Loan Fund		5,000		N/A		N/A		N/A		N/A
Certificates of deposit		2,000		2,000		—		—		2,000
Accrued interest receivable		4,421		11		116		4,294		4,421
Liabilities:
Deposits without stated maturities	$	1,324,110	$	1,324,110	$	—	$	—	$	1,324,110
Deposits with stated maturities		80,245		-		80,079		-		80,079
Federal Home Loan Bank of New York advances		42,198		-		42,188		-		42,188
Trust preferred securities payable		20,620		-		-		19,997		19,997
Subordinated debt, net of issuance cost		24,489		—		25,500		—		25,500
Accrued interest payable		749		27		258		464		749

The methods and assumptions used to estimate fair value are described as follows:

Cash and Due from Banks and Overnight Deposits: Carrying amounts of cash approximate fair value, since these instruments are either payable on demand or have short-term maturities and as such are classified as Level 1.

Securities Available for Sale and Held to Maturity: If available, the estimated fair values are based on independent dealer quotations on nationally recognized securities exchanges and are classified as Level 1. For securities where quoted prices are not available, fair value is based on 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 resulting in a Level 2 classification.

Other Investments: It is not practicable to determine the fair value of FHLB and FRB stock, and investments in Solomon Hess SBA Loan Fund, due to restrictions placed on transferability.

Loans: Fair values of loans, excluding loans held for sale are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality establishing discount factors for these types of loans and resulting in a Level 3 classification. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

Deposits without stated maturities: The fair values disclosed for demand deposits (e.g. interest and non-interest checking, savings and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the recording date (i.e., their carrying amount) resulting in a Level 1 price.

Deposits with stated maturities: The estimated fair values of certificates of deposit are based on discounted cash flow calculations that use a replacement cost of funds approach to establishing discount rates for certificate of deposit maturities resulting in a Level 2 classification.

FHLB Advances: Represents FHLB advances for which the estimated fair values are based on discounted cash flow calculations that use a replacement cost of funds approach to establishing discount rates for funding maturities resulting in a Level 2 classification for all other maturity terms.

Trust Preferred Securities Payable: The estimated fair value is based on estimates using market data for debt securities with similar risk and takes into consideration the features of the debentures, which is an unobservable input resulting in a Level 3 classification.

Subordinated Debt: The fair value of subordinated debt is estimated using discounted cash flow analyses based on then current borrowing rates for similar types of borrowing arrangements (deemed a Level 2 valuation), and is provided to the Company independently by a market maker in the underlying security.

Accrued Interest Receivable and Payable: For these short-term instruments, the carrying amount is a reasonable estimate of the fair value resulting in a Level 1, 2 or 3 classification consistent with the underlying asset or liability the interest is associated with.

Off-Balance-Sheet Liabilities: The fair value of off-balance-sheet commitments to extend credit is estimated using fees currently charged to enter into similar agreements. The fair value is immaterial as of December 31, 2018 and 2017.

Fair value estimates are made at specific points in time and are based on existing on-and off-balance sheet financial instruments. These estimates are subjective in nature and dependent on a number of significant assumptions associated with each financial instrument or group of financial instruments, including estimates of discount rates, risks associated with specific financial instruments, estimates of future cash flows, and relevant available market information. Changes in assumptions could significantly affect the estimates. In addition, fair value estimates do not reflect the value of anticipated future business, premiums or discounts that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument, or the tax consequences of realizing gains or losses on the sale of financial instruments.