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Note 18 - Fair Value Measurements and Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2023

Notes to Financial Statements

Fair Value Disclosures [Text Block]

NOTE 18 - FAIR VALUE MEASUREMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS

In accordance with accounting guidance, the Company groups its financial assets and financial liabilities measured 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 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 are described as follows:

Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2 - 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 instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, prepayment speeds, volatilities, etc.) or model-based valuation techniques where all significant assumptions are observable, either directly or indirectly, in the market.

Level 3 - Valuation is generated from model-based techniques where one or more significant inputs are not observable, either directly or indirectly, in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques may include use of matrix pricing, discounted cash flow models, and similar techniques.

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value:

Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1) or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2).

Other Real Estate Owned: Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (“OREO”) are measured at the lower of carrying amount or fair value, less costs to sell. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized. Fair values are generally based on third party appraisals of the property which are commonly adjusted by management to reflect an expectation of the amount to be ultimately collected and selling costs (Level 3).

Appraisals for OREO are performed by state licensed appraisers (for commercial properties) or state certified appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. When a Notice of Default is recorded, an appraisal report is ordered. Once received, a member of the credit administration department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison to independent data sources such as recent market data or industry-wide statistics for residential appraisals. Commercial appraisals are sent to an independent third party to review. The Company also compares the actual selling price of collateral that has been sold to the most recent appraised value to determine what additional adjustments, if any, should be made to the appraisal values on any remaining other real estate owned to arrive at fair value. If the existing appraisal is older than twelve months a new appraisal report is ordered. No significant adjustments to appraised values have been made as a result of this comparison process prior to OREO sale date.

Interest Rate Lock Contracts and Forward Mortgage Loan Sale Contracts: The fair values of interest rate lock contracts and forward mortgage loan sale contracts are determined by loan lock-in rate, loan funded rate, market interest rate, fees to be collected from the borrower, fees and costs associated with the origination of the loan, expiration timing, sale price, and the value of the retained servicing. The Company classified these derivatives as Level 3 due to management’s estimate of market rate, cost and expiration timing on these contracts.

Collateral-dependent individually evaluated loans: Collateral-dependent individually evaluated loans are carried at fair value when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the original loan agreement and the loan has been written down to the fair value of its underlying collateral, net of expected disposition costs where applicable. There were $2.6 million write-down on collateral-dependent loans that were individually evaluated to the fair value for the first nine months of 2023. There was no collateral-dependent loan that was individually evaluated and written down to the fair value as of December 31, 2022.

The following table provides the hierarchy and fair value for each major category of assets and liabilities measured at fair value at September 30, 2023 and December 31, 2022:

*(dollars in thousands)*		*Fair Value Measurements Using:*
September 30, 2023		*Level 1*				*Level 2*				*Level 3*				*Total*
Assets measured at fair value:
On a recurring basis:
Securities available for sale
Government agency securities		$	—			$	7,894			$	—			$	7,894
SBA agency securities			—				7,261				—				7,261
Mortgage-backed securities			—				33,437				—				33,437
Collateralized mortgage obligations			—				138,694				—				138,694
Commercial paper			—				129,073				—				129,073
Corporate debt securities			—				29,806				—				29,806
Municipal securities			—				8,213				—				8,213
Interest Rate Lock Contracts			—				—				9				9
Forward Mortgage Loan Sale Contracts			—				—				16				16
		$	—			$	354,378			$	25			$	354,403
On a non-recurring basis:
Other real estate owned		$	—			$	—			$	284			$	284

December 31, 2022		*Level 1*				*Level 2*				*Level 3*				*Total*
Assets measured at fair value:
On a recurring basis:
Securities available for sale
Government agency securities		$	—			$	4,495			$	—			$	4,495
SBA agency securities			—				2,411				—				2,411
Mortgage-backed securities			—				42,928				—				42,928
Collateralized mortgage obligations			—				111,593				—				111,593
Commercial paper			—				49,537				—				49,537
Corporate debt securities			—				37,012				—				37,012
Municipal securities			—				8,854				—				8,854
Forward Mortgage Loan Sale Contracts			—				—				18				18
		$	—			$	256,830			$	18			$	256,848
On a non-recurring basis:
Other real estate owned		$	—			$	—			$	577			$	577

No write-downs to OREO were recorded for the nine months ended September 30, 2023 or for the year ended December 31, 2022.

Quantitative information about the Company's OREO non-recurring Level 3 fair value measurements at September 30, 2023 and December 31, 2022 is as follows:

OREO consisted of one single-family residence with a fair value of $284,000 as of September 30, 2023 and two single-family residences with a fair value of $577,000 as of December 31, 2022. On September 1, 2023, OREO with a book value of $293,000 was sold for a gain of $190,000. OREO was evaluated by third party appraisals with unobservable input of management adjustment in the range of 5%-6% to reflect current conditions and selling costs.

Interest Rate Lock Commitments ("IRLCs"): Agreements under which the Company agrees to extend credit to a borrower under certain specified terms and conditions in which the interest rate and the maximum amount of the loan are set prior to funding. Under the agreement, the Company commits to lend funds to a potential borrower (subject to the Company’s approval of the loan) on a fixed or adjustable rate basis, regardless of whether interest rates change in the market, or on a floating rate basis. As such, outstanding IRLCs are subject to interest rate risk and related price risk during the period from the date of issuance through the date of loan funding, cancelling or expiration. Loan commitments generally range between 30 and 90 days; however, the borrower is not obligated to obtain the loan. The Company is subject to fallout risk related to IRLCs, which is realized if approved borrowers choose not to close on the loans within the terms of the IRLCs. The Company uses best efforts commitments to substantially eliminate these risks. Historical commitment-to-closing ratios are considered to estimate the quantity of mortgage loans that will fund within the terms of the IRLCs.

The FASB ASC provides that IRLCs on mortgage loans that will be held for resale are derivatives and must be accounted for at fair value on the balance sheet (if material). FASB ASC Topic 820 – Fair Value Measurements and Disclosures specifies how these derivatives are to be valued. Consequently, the Company has elected to account for these obligations at fair value.

Forward Mortgage Loan Sale Contracts ("FMLSCs"): The Company is subject to interest rate and price risk on its mortgage loans held for sale (“HFS”) from the loan funding date until the date the loan is sold. Best efforts commitments which fix the forward sales price that will be realized in the secondary market are used to eliminate the interest rate and price risk to the Company. To avoid interest rate risk, the Company will enter into FMLSCs at the time they make an interest rate lock commitment to the buyer. They can enter into mortgage loan sales commitments on a “mandatory” or “best efforts” basis. Mandatory commitments provide that the loan must be delivered or the commitment be “paired off.” In general, best efforts commitments provide that the loan be delivered if and when it closes.

Quantitative information about the Company's recurring Level 3 fair value measurements as of September 30, 2023 and December 31, 2022 is as follows:

At December 31, 2022, fair value for IRLCs and FMLSCs totaled $18,000. All IRLCs and FMLSCs at December 31, 2022 were funded and sold to Fannie Mae in the first three months of 2023. Changes in fair value were $7,000 in 2023. Fair value for IRLCs and FMLSCs totaled $25,000 at September 30, 2023.

The fair value measurements of IRLCs and FMLSCs were primarily based on the buy price from borrowers ranging from 99 to 100, the sale price to Fannie Mae ranging from 99 to 102, and the significant unobservable inputs using margin cost rate of ranging from 0.50% to 0.50%.

Forward commitments, also known as forward loan sales commitments, are considered to be derivatives under FASB ASC Topic 815 (Derivatives and Hedging) because they meet all of the following criteria:

●

They have a specified underlying (the contractually specified price for the loans)

●

They have a notional amount (the committed loan principal amount)

●

They require little or no initial net investment

●

They require or permit net settlement as the institution via a pair-off transaction or the payment of a pair-off fee.

The fair value of a financial instrument is the amount at which the asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire holdings of a particular financial instrument. Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, involve uncertainties and matters of judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on financial instruments both on and off the balance sheet without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Additionally, tax consequences related to the realization of the unrealized gains and losses can have a potential effect on fair value estimates and have not been considered in many of the estimates.

Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the fair values presented. Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent limitations in any estimation technique.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Management maximizes the use of observable inputs and attempts to minimize the use of unobservable inputs when determining fair value measurements. Estimated fair values are disclosed for financial instruments for which it is practicable to estimate fair value. These estimates are made at a specific point in time based on relevant market data and information about the financial instruments. These estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.

The Company uses the following methods and assumptions to estimate the fair value of each class of financial instruments:

For cash and due from banks, Federal funds sold, and cash equivalents, the carrying amount is assumed to be a reasonable estimate of fair value, a Level 1 measurement.

For short-term investments and interest-bearing deposits, the carrying amount is assumed to be a reasonable estimate of fair value, a Level 1 measurement.

Securities available for sale and held-to-maturity are measured by using quoted market prices for similar securities or dealer quotes, a Level 2 measurement. This category generally includes U.S. Government agency securities, U.S. Government sponsored entities, state and municipal securities, mortgage backed securities, collateralized mortgage obligations and corporate bonds.

Equity securities fair value are measured based on unobservable inputs at the reporting date, a Level 3 measurement. Equity securities are comprised of affordable housing investment funds and other restricted stocks.

Fair values are estimated for portfolios of loans with similar financial characteristics. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and non-performing categories. The fair values are based primarily on third-party vendor pricing to determine fair values based on the exit price notion.

The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan, a Level 3 measurement.

The fair value of impaired loans is calculated based on the net realizable fair value of the collateral or the observable market price of the most recent sale or quoted price from HFS loans. The Company does not record loans at fair value on a recurring basis. Nonrecurring fair value adjustments to collateral dependent impaired loans are recorded based on the adjusted appraised value of the collateral, a Level 3 measurement.

The Company records HFS loans at fair value based on quoted prices from third party sale analysis, existing sale agreements, or appraisal reports adjusted by sales commission assumption, a Level 2 measurement.

Mortgage and SBA servicing rights are calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan, a Level 3 measurement.

The fair value of demand deposits, savings accounts, and certain money market deposits is assumed to be the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits with similar remaining maturities, a Level 2 measurement.

The fair value of commitments to extend credit and standby letters of credit, interest rate lock commitments and forward mortgage loan sales contracts is estimated using the fees currently charged to enter into similar agreements. Unobservable inputs that reflect the Company's own assumptions about the assumptions that market participants would use in pricing an asset or liability result in a Level 3 measurement.

The fair value of FHLB advances is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk, a Level 3 measurement.

Subordinated debentures fair value is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk, a Level 3 measurement.

The fair value of long-term debt is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk, a Level 3 measurement.

Fair value is estimated in accordance with ASC Topic 825. Fair value estimates are made at specific points in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Bank’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Bank’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

The fair value hierarchy level and estimated fair value of significant financial instruments at September 30, 2023 and December 31, 2022 are summarized as follows:


			*September 30, 2023*								*December 31, 2022*
	*Fair Value*		*Carrying*				*Fair*				*Carrying*				*Fair*
*(dollars in thousands)*	*Hierarchy*		*Value*				*Value*				*Value*				*Value*
Financial Assets:
Cash and due from banks	Level 1		$	330,791			$	330,791			$	83,548			$	83,548
Interest-earning deposits in other financial institutions	Level 1			600				600				600				600
Investment securities - AFS	Level 2			354,378				354,378				256,830				256,830
Investment securities - HTM	Level 2			5,214				4,750				5,729				5,563
Mortgage loans held for sale	Level 1			62				57				—				—
Loans, net	Level 3			3,078,522				3,023,903				3,295,373				3,251,464
Equity securities	Level 3			22,235				22,235				22,238				22,238
Servicing assets	Level 3			8,439				19,486				9,521				21,712
Accrued Interest Receivable	Level 1/2/3			14,008				14,008				14,536				14,536

			*Carrying*				*Fair*				*Carrying*				*Fair*
Derivative assets:			*Value*				*Value*				*Value*				*Value*
Interest Rate Lock Contracts	Level 3		$	9			$	9			$	—			$	—
Forward Mortgage Loan Sale Contracts	Level 3			16				16				18				18

			*Carrying*				*Fair*				*Carrying*				*Fair*
Financial Liabilities:			*Value*				*Value*				*Value*				*Value*
Deposits	Level 2		$	3,154,072			$	3,120,299			$	2,977,683			$	2,960,529
FHLB advances	Level 3			150,000				142,576				220,000				210,470
Long-term debt	Level 3			174,019				130,154				173,585				132,709
Subordinated debentures	Level 3			14,884				14,561				14,720				14,195
Accrued Interest Payable	Level 2/3			11,333				11,333				3,711				3,711

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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