Fair Value of Financial Assets and Liabilities

9 Months Ended

Sep. 30, 2022

Fair Value of Financial Assets and Liabilities [Abstract]

Fair Value of Financial Assets and Liabilities

Note 7 – Fair Value of Financial Assets and Liabilities

Fair Value Measurements

ASC 820, Fair Value Measurements, defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. ASC 820 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs.  In this standard, the FASB clarifies the principle that fair value should be based on the exit price when pricing the asset or liability. In support of this principle, ASC 820 establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy is as follows:

Level 1 Inputs – Quoted prices in active markets for identical assets or liabilities.

Level 2 Inputs – 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 assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 Inputs – Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in determining an exit price for the assets or liabilities.

Recurring Measurements

The following tables present the fair value measurements of assets recognized in the accompanying balance sheets measured at fair value on a recurring basis as of September 30, 2022 and December 31, 2021 and indicate the level within the fair value hierarchy of the valuation techniques.

			Fair Value Measurements at September 30, 2022 Using
(in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets measured – recurring basis
Available-for-sale securities:
U.S. Treasury and government agencies	$	401,772	$	362,015	$	39,757	$	0
State and political subdivisions		258,076		0		258,076		0
U.S. government sponsored agency mortgage-backed securities		549,039		0		549,039		0
Asset-backed securities		89,705		0		89,705		0
Equity securities at fair value		1,969		0		0		1,969
Mortgage servicing rights		8,576		0		0		8,576

			Fair Value Measurements at December 31, 2021 Using
(in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets measured – recurring basis
Available-for-sale securities:
U.S. Treasury and government agencies	$	295,770	$	242,214	$	53,556	$	0
State and political subdivisions		334,203		0		334,203		0
U.S. government sponsored agency mortgage-backed securities		730,809		0		730,809		0
Asset-backed securities		94,647		0		94,647		0
Equity securities at fair value		2,253		0		0		2,253
Mortgage servicing rights		6,774		0		0		6,774

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy. These valuation methodologies were applied to all of CTBI’s financial assets carried at fair value. CTBI had no liabilities measured and recorded at fair value as of September 30, 2022 and December 31, 2021. There have been no significant changes in the valuation techniques during the quarter ended September 30, 2022. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Available-for-Sale Securities

Securities classified as AFS are reported at fair value on a recurring basis. U.S. Treasury and government agencies are classified as Level 1 of the valuation hierarchy where quoted market prices are available in the active market on which the individual securities are traded.

If quoted market prices are not available, CTBI obtains fair value measurements from an independent pricing service, such as Interactive Data, which utilizes pricing models to determine fair value measurement. CTBI reviews the pricing quarterly to verify the reasonableness of the pricing.  The fair value measurements consider observable data that may include 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, among other factors. U.S. Treasury and government agencies, state and political subdivisions, U.S. government sponsored agency mortgage-backed securities, and asset-backed securities are classified as Level 2 inputs.

In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy. Fair value determinations for Level 3 measurements are estimated on a quarterly basis where assumptions used are reviewed to ensure the estimated fair value complies with accounting standards generally accepted in the United States.

Equity Securities at Fair Value

As of September 30, 2022 and December 31, 2021, the only securities owned by CTBI that were valued using Level 3 criteria are Visa Class B Stock (included in equity securities at fair value). Fair value for Visa Class B Stock is determined by an independent third party utilizing assumptions about factors such as quarterly common stock dividend payments, the conversion of the securities to the relevant Class A Stock shares subject to the prevailing conversion rate, and conversion date. We have concluded the third party assumptions, processes, and conclusions to be reasonable and appropriate in determining the fair value of this asset. See the table below for inputs and valuation techniques used for Level 3 equity securities.

Mortgage Servicing Rights

Mortgage servicing rights (“MSRs”) do not trade in an active, open market with readily observable prices. CTBI reports MSRs at fair value on a recurring basis with subsequent remeasurement of MSRs based on change in fair value.

In determining fair value, CTBI utilizes the expertise of an independent third party. Accordingly, fair value is determined by the independent third party by utilizing assumptions about factors such as mortgage interest rates, discount rates, mortgage loan prepayment speeds, market trends, and industry demand. Due to the nature of the valuation inputs, MSRs are classified within Level 3 of the hierarchy. Fair value determinations for Level 3 measurements of MSRs are tested for impairment on a quarterly basis where assumptions used are reviewed to ensure the estimated fair value complies with accounting standards generally accepted in the United States. We have reviewed the assumptions, processes, and conclusions of the third party provider. We have determined these assumptions, processes, and conclusions to be reasonable and appropriate in determining the fair value of this asset. See the table below for inputs and valuation techniques used for Level 3 MSRs.

Level 3 Reconciliation

Following is a reconciliation of the beginning and ending balances of recurring fair value measurements, for the periods indicated, using significant unobservable (Level 3) inputs:

	Three Months Ended September 30, 2022						Three Months Ended September 30, 2021
(in thousands)	Equity Securities at Fair Value			Mortgage Servicing Rights			Equity Securities at Fair Value			Mortgage Servicing Rights
Beginning balance	$	2,128		$	8,220		$	2,523		$	5,899
Total unrealized gains (losses)
Included in net income		(159	)		504			(62	)		141
Issues		0			103			0			407
Settlements		0			(251	)		0			(182	)
Ending balance	$	1,969		$	8,576		$	2,461		$	6,265
Total gains (losses) for the period included in net income attributable to the change in unrealized gains or losses related to assets still held at the reporting date	$	(159	)	$	504		$	(62	)	$	141

	Nine Months Ended September 30, 2022						Nine Months Ended September 30, 2021
(in thousands)	Equity Securities at Fair Value			Mortgage Servicing Rights			Equity Securities at Fair Value			Mortgage Servicing Rights
Beginning balance	$	2,253		$	6,774		$	2,471		$	4,068
Total unrealized gains (losses)
Included in net income		(284	)		1,955			(10	)		1,042
Issues		0			555			0			1,817
Settlements		0			(708	)		0			(662	)
Ending balance	$	1,969		$	8,576		$	2,461		$	6,265
Total gains (losses) for the period included in net income attributable to the change in unrealized gains or losses related to assets still held at the reporting date	$	(284	)	$	1,955		$	(10	)	$	1,042

Realized and unrealized gains and losses for items reflected in the table above are included in net income in the consolidated statements of income as follows:

Noninterest Income
	Three Months Ended					Nine Months Ended
	September 30					September 30
(in thousands)	2022		2021			2022		2021
Total gains (losses)	$	94	$	(103	)	$	963	$	370

Nonrecurring Measurements

The following tables present the fair value measurements of assets recognized in the accompanying balance sheets measured at fair value on a nonrecurring basis as of September 30, 2022 and December 31, 2021 and indicate the level within the fair value hierarchy of the valuation techniques.

			Fair Value Measurements at September 30, 2022 Using
(in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets measured – nonrecurring basis
Collateral dependent loans	$	4,809	$	0	$	0	$	4,809
Other real estate owned		597		0		0		597

			Fair Value Measurements at December 31, 2021 Using
(in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets measured – nonrecurring basis
Collateral dependent loans	$	1,238	$	0	$	0	$	1,238
Other real estate owned		1,487		0		0		1,487

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheet, as well as the general classification of such assets pursuant to the valuation hierarchy.  For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Collateral Dependent Loans

The estimated fair value of collateral-dependent loans is based on the appraised fair value of the collateral, less estimated cost to sell. Collateral-dependent loans are classified within Level 3 of the fair value hierarchy.

CTBI considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect the fair value. Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary by the Chief Credit Officer. Appraisals are reviewed for accuracy and consistency by the Chief Credit Officer. Appraisers are selected from the list of approved appraisers maintained by management. The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral. These discounts and estimates are developed by the Chief Credit Officer by comparison to historical results.

Loans considered collateral dependent are loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral when the borrower is experiencing financial difficulty in accordance with ASC 326-20-35-5. Quarter-to-date fair value adjustments on collateral- dependent loans disclosed above were $0.9 million, $0.4 million, and $0.1 million for the quarters ended September 30, 2022, December 31, 2021, and September 30, 2021, respectively.  Year-to-date adjustments were $1.2 million, $0.7 million, and $0.8 million for the nine months ended September 30, 2022, the year ended December 31, 2021, and the nine months ended September 30, 2021, respectively.

Other Real Estate Owned

In accordance with the provisions of ASC 360, Property, Plant, and Equipment, other real estate owned (“OREO”) is carried at the lower of fair value at acquisition date or current estimated fair value, less estimated cost to sell when the real estate is acquired. Estimated fair value of OREO is based on appraisals or evaluations. OREO is classified within Level 3 of the fair value hierarchy. Long-lived assets are subject to nonrecurring fair value adjustments to reflect subsequent partial write-downs that are based on the observable market price or current appraised value of the collateral. There were no quarter-to-date fair value adjustments on OREO disclosed above for the quarter ended September 30, 2022 while the adjustments were $0.2 million and $0.1 million for the quarters ended December 31, 2021, and September 30, 2021, respectively.  Year-to-date adjustments were $0.2 million, $0.3 million, and $0.1 million for the nine months ended September 30, 2022, for the year ended December 31, 2021, and for the nine months ended September 30, 2021, respectively.

Our policy for determining the frequency of periodic reviews is based upon consideration of the specific properties and the known or perceived market fluctuations in a particular market and is typically between 12 and 18 months but generally not more than 24 months.  Appraisers are selected from the list of approved appraisers maintained by management.

Unobservable (Level 3) Inputs

The following tables present quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements at September 30, 2022 and December 31, 2021.

	Quantitative Information about Level 3 Fair Value Measurements
(in thousands)	Fair Value at September 30, 2022		Valuation Technique(s)	Unobservable Input	Range (Weighted Average)
Equity securities at fair value	$	1,969	Discount cash flows, computer pricing model	Discount rate		8.0% - 12.0% (10.0%)
				Conversion date	Dec 2024 – Dec 2028 (Dec 2026)
Mortgage servicing rights	$	8,576	Discount cash flows, computer pricing model	Constant prepayment rate		7.0% - 24.9% (7.1%)
				Probability of default		0.0% - 100.0% (1.2%)
				Discount rate		9.5% - 11.7% (10.0%)
Collateral dependent loans	$	4,809	Market comparable properties	Marketability discount		33.0% - 46.0% (39.0%)
Other real estate owned	$	597	Market comparable properties	Comparability adjustments		0.0% - 10.0% (10.0%)

	Quantitative Information about Level 3 Fair Value Measurements
(in thousands)	Fair Value at December 31, 2021		Valuation Technique(s)	Unobservable Input	Range (Weighted Average)
Equity securities at fair value	$	2,253	Discount cash flows, computer pricing model	Discount rate		8.0% - 12.0% (10.0%)
				Conversion date	Dec 2024 – Dec 2028 (Dec 2026)
Mortgage servicing rights	$	6,774	Discount cash flows, computer pricing model	Constant prepayment rate		7.0% - 26.7% (10.0%)
				Probability of default		0.0% - 75.0% (1.4%)
				Discount rate		10.0% - 11.5% (10.1%)
Collateral-dependent loans	$	1,238	Market comparable properties	Marketability discount		20.0% - 62.0% (41.0%)
Other real estate owned	$	1,487	Market comparable properties	Comparability adjustments		10.0% - 45.5% (15.1%)

Uncertainty of Fair Value Measurements

The following is a discussion of the uncertainty of fair value measurements, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement, and how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.

Equity Securities at Fair Value

Fair value for equity securities is derived based on unobservable inputs, such as the discount rate, quarterly dividends payable to the Visa Class B common stock, and the prevailing conversion rate at the conversion date. The most recent conversion rate of 1.6059 and the most recent dividend rate of 0.6022 were used to derive the fair value estimate. Significant increases (decreases) in either of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for discount rate is accompanied by a directionally opposite change in the fair value estimate.

Mortgage Servicing Rights

Fair value for MSRs is derived based on unobservable inputs, such as prepayment speeds of the underlying loans generated using the Andrew Davidson Prepayment Model, FHLMC/FNMA guidelines, the weighted average life of the loan, the discount rate, the weighted average coupon, and the weighted average default rate. Significant increases (decreases) in either of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for prepayment speeds is accompanied by a directionally opposite change in the assumption for interest rates.

Fair Value of Financial Instruments

The following table presents estimated fair value of CTBI’s financial instruments as of September 30, 2022 and indicates the level within the fair value hierarchy of the valuation techniques.  In accordance with the adoption of ASU 2016-01, the fair values as of September 30, 2022 were measured using an exit price notion.

			Fair Value Measurements at September 30, 2022 Using
(in thousands)	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets:
Cash and cash equivalents	$	259,629	$	259,629	$	0	$	0
Certificates of deposit in other banks		245		0		245		0
Debt securities available-for-sale		1,298,592		362,015		936,577		0
Equity securities at fair value		1,969		0		0		1,969
Loans held for sale		1,043		1,065		0		0
Loans, net		3,586,183		0		0		3,540,716
Federal Home Loan Bank stock		6,676		0		6,676		0
Federal Reserve Bank stock		4,887		0		4,887		0
Accrued interest receivable		16,513		0		16,513		0
Financial liabilities:
Deposits	$	4,535,068	$	1,481,078	$	3,064,938	$	0
Repurchase agreements		230,123		0		0		230,238
Federal funds purchased		500		0		500		0
Advances from Federal Home Loan Bank		360		0		381		0
Long-term debt		57,841		0		0		50,759
Accrued interest payable		2,501		0		2,501		0
Unrecognized financial instruments:
Letters of credit	$	0	$	0	$	0	$	0
Commitments to extend credit		0		0		0		0
Forward sale commitments		0		0		0		0

The following table presents estimated fair value of CTBI’s financial instruments as of December 31, 2021 and indicates the level within the fair value hierarchy of the valuation techniques.

			Fair Value Measurements at December 31, 2021 Using
(in thousands)	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets:
Cash and cash equivalents	$	311,756	$	311,756	$	0	$	0
Certificates of deposit in other banks		245		0		245		0
Debt securities available-for-sale		1,455,429		242,214		1,213,215		0
Equity securities at fair value		2,253		0		0		2,253
Loans held for sale		2,632		2,693		0		0
Loans, net		3,367,057		0		0		3,480,803
Federal Home Loan Bank stock		8,139		0		8,139		0
Federal Reserve Bank stock		4,887		0		4,887		0
Accrued interest receivable		15,415		0		15,415		0
Financial liabilities:
Deposits	$	4,344,292	$	1,331,103	$	3,043,339	$	0
Repurchase agreements		271,088		0		0		271,186
Federal funds purchased		500		0		500		0
Advances from Federal Home Loan Bank		375		0		400		0
Long-term debt		57,841		0		0		45,854
Accrued interest payable		1,016		0		1,016		0
Unrecognized financial instruments:
Letters of credit	$	0	$	0	$	0	$	0
Commitments to extend credit		0		0		0		0
Forward sale commitments		0		0		0		0