Fair Value Measurements and Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2016

Fair Value Disclosures [Abstract]

Fair Value Measurements and Fair Value of Financial Instruments

Note 7 - Fair Value Measurements and 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:

FASB ASC 820-10-05 defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurements and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date.

FASB ASC 820-10-65 provides additional guidance for estimating fair value in accordance with FASB ASC 820-10-05 when the volume and level of activity for the asset or liability have significantly decreased. This ASC also includes guidance on identifying circumstances that indicate a transaction is not orderly.

FASB ASC 820-10-05 establishes a fair value hierarchy that prioritizes the inputs to valuation methods 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 820-10-05 are 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: Quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (for example, supported with little or no market activity).

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a recurring basis at September 30, 2016 and December 31, 2015:

Securities Available-for-Sale

Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 inputs include securities that have quoted prices in active markets for identical assets. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. Examples of instruments, which would generally be classified within Level 2 of the valuation hierarchy include municipal bonds and certain agency collateralized mortgage obligations. In certain cases where there is limited activity in the market for a particular instrument, assumptions must be made to determine the fair value of the instruments and these are classified as Level 3. When measuring fair value, the valuation techniques available under the market approach, income approach and/or cost approach are used. The Company’s evaluations are based on market data and the Company employs combinations of these approaches for its valuation methods depending on the asset class.

Derivatives

The fair value of derivatives are based on valuation models using observable market data as of the measurement date (level 2). Our derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rate, and volatility factors to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services.

Loans Held-for-sale

Loans held-for-sale are required to be measured at the lower of cost or fair value. Under FASB ASC 820-10-05, market value is to represent fair value. Management obtains quotes or bids on all or part of these loans directly from the purchasing financial institutions.

Loans Receivable

The fair value of performing loans, except residential mortgages, is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risks inherent in the loan. The estimate of maturity is based on the historical experience of the Bank with prepayments for each loan classification, modified as required by an estimate of the effect of current economic and lending conditions. For performing residential mortgage loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using discount rates based on secondary market sources adjusted to reflect differences in servicing and credit costs.

Off-Balance Sheet Financial Instruments

The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rate and the committed rates.

The fair value of financial standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

For financial assets and liabilities measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2016 and December 31, 2015 are as follows:

			September 30, 2016
			Fair Value Measurements at Reporting Date Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
			(Level 1)		(Level 2)		(Level 3)
(in thousands)
Recurring fair value measurements:
Assets
Investment securities:
available-for-sale:
Federal agency obligations	$	56,099	$	-	$	56,099	$	-
Residential mortgage pass-
through securities		63,404		-		63,404		-
Commercial mortgage pass-
through securities		4,369		-		4,369		-
Obligations of U.S. states and
political subdivision		141,361		-		123,026		18,335
Trust preferred securities		5,675		-		5,675		-
Corporate bonds and notes		38,293		-		38,293		-
Asset-backed securities		15,502		-		15,502		-
Certificates of deposit		988		-		988		-
Equity securities		425		425		-		-
Other securities		12,343		12,343		-		-
Total available-for-sale	$	338,459	$	12,768	$	307,356	$	18,335
Liabilities
Derivatives	$	1,212	$	-	$	1,212	$	-
Total liabilities	$	1,212	$	-	$	1,212	$	-

There were no transfers between Level 1, Level 2 and Level 3 during the three months ended September 30, 2016.

			December 31, 2015
			Fair Value Measurements at Reporting Date Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
			(Level 1)		(Level 2)		(Level 3)
(in thousands)
Recurring fair value measurements:
Assets
Investment securities:
available-for-sale:
Federal agency obligations	$	29,146	$	-	$	29,146	$	-
Residential mortgage pass-
through securities		44,910		-		44,910		-
Commercial mortgage pass-
through securities		2,972		-		2,972		-
Obligations of U.S. states and
political subdivision		8,357		-		8,357		-
Trust preferred securities		16,255		-		16,255		-
Corporate bonds and notes		53,976		-		53,976		-
Asset-backed securities		19,725		-		19,725		-
Certificates of deposit		1,905		-		1,905		-
Equity securities		374		374		-		-
Other securities		18,150		18,150		-		-
Total available-for-sale	$	195,770	$	18,524	$	177,246	$	-
Liabilities
Derivatives	$	131	$	-	$	131	$	-
Total liabilities	$	131	$	-	$	131	$	-

There were no transfers between Level 1, Level 2 and Level 3 during the year ended December 31, 2015.

Assets Measured at Fair Value on a Non-Recurring Basis

The Company may be required periodically to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from the application of lower of cost or fair value accounting or impairment write-downs of individual assets. The Company primarily utilized appraisal value less cost to sell and other unobservable market inputs to determine fair value of assets, and therefore, these valuations are classified as a Level 3 measurement. For assets measured at fair value on a non-recurring basis, the fair value measurements at September 30, 2016 and December 31, 2015 are as follows:

			Fair Value Measurements at Reporting Date Using
			Quoted
			Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	September 30,		Assets		Inputs		Inputs
Assets measured at fair value on a nonrecurring basis:	2016		(Level 1)		(Level 2)		(Level 3)
Impaired loans:	(in thousands)
Commercial	$	396	$	-	$	-	$	396
			Fair Value Measurements at Reporting Date Using
			Quoted
			Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	December 31,		Assets		Inputs		Inputs
Assets measured at fair value on a nonrecurring basis:	2015		(Level 1)		(Level 2)		(Level 3)
Impaired loans:	(in thousands)
Commercial	$	3,751	$	-	$	-	$	3,751

The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a non-recurring basis at September 30, 2016 and December 31, 2015.

Impaired loans. The value of the impaired loans above were measured based upon the fair value of the collateral of the loans. Smaller balance homogeneous loans that are collectively evaluated for impairment, such as residential mortgage loans and consumer loans, are specifically excluded from the impaired loan portfolio. Collateral dependent impaired loans are individually assessed to determine that each loan’s carrying value is not in excess of the fair value of the related collateral. Collateral dependent impaired loans at September 30, 2016 that required a valuation allowance were $0.9 million with a related valuation allowance of $0.5 million compared to $6.0 million with a related valuation allowance of $2.2 million at December 31, 2015.

Fair Value of Financial Instruments

FASB ASC 825-10 requires all entities to disclose the estimated fair value of their financial instrument assets and liabilities. For the Company, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in FASB ASC 825-10. Many of the Company’s financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. It is also the Company’s general practice and intent to hold its financial instruments to maturity and not to engage in trading or sales activities except for loans held-for-sale and investment securities available-for-sale. Therefore, significant estimations and assumptions, as well as present value calculations, were used by the Company for the purposes of this disclosure.

Cash and cash equivalents. The carrying amounts of cash and short-term instruments approximate fair values.

FHLB stock. It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

Investment Securities Held-to-Maturity. The fair value of the Company’s investment securities held-to-maturity was primarily measured using information from a third-party pricing service. If quoted prices were not available, fair values were estimated primarily by obtaining quoted prices for similar assets in active markets or through the use of pricing models. In cases where there may be limited or less transparent information provided by the Company’s third-party pricing service, fair value may be estimated by the use of secondary pricing services or through the use of non-binding third-party broker quotes.

Loans. The fair value of the Company’s loans was estimated by discounting the expected future cash flows using the current interest rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans were segregated by types such as commercial, residential and consumer loans. Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price and therefore, while permissible for presentation purposes under ASC 825-10, do not conform to ASC 820-10.

Interest-Bearing Deposits. The fair values of the Company’s interest-bearing deposits were estimated using discounted cash flow analyses. The discounted rates used were based on rates currently offered for deposits with similar remaining maturities. The fair values of the Company’s interest-bearing deposits do not take into consideration the value of the Company’s long-term relationships with depositors, which may have significant value.

Term Borrowings and Subordinated Debentures. The fair value of the Company’s long-term borrowings and subordinated debentures were calculated using a discounted cash flow approach and applying discount rates currently offered based on weighted remaining maturities.

Accrued Interest Receivable/Payable. The carrying amounts of accrued interest approximate fair value resulting in a level 2 or level 3 classification based on the level of the asset or liability with which the accrual is associated.

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of September 30, 2016 and December 31, 2015.

					Fair Value Measurements
	Carrying Amount		Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)
September 30, 2016
Financial assets
Cash and cash equivalents	$	233,794	$	233,794	$	233,794	$	-	$	-
Investment securities available-for-sale		338,459		338,459		12,768		307,356		18,335
Restricted investment in bank stocks		24,535		n/a		n/a		n/a		n/a
Net loans		3,407,861		3,421,539		-		-		3,421,539
Loans held-for-sale		15,112		15,112		-		15,112		-
Accrued interest receivable		12,497		12,497		-		1,895		10,602
Financial liabilities
Noninterest-bearing deposits		655,683		655,683		655,683		-		-
Interest-bearing deposits		2,613,266		2,601,221		-		2,601,221		-
Borrowings		481,337		486,503		-		486,503		-
Subordinated debentures, net		54,490		53,784		-		53,784		-
Derivatives		1,212		1,212		-		1,212		-
Accrued interest payable	$	4,600	$	4,600	$	-	$	4,600	$	-
December 31, 2015
Financial assets
Cash and cash equivalents	$	200,895	$	200,895	$	200,895	$	-	$	-
Investment securities available-for-sale		195,770		195,770		18,524		177,246		-
Investment securities held-to-maturity		224,056		230,558		29,226		182,774		18,558
Restricted investment in bank stocks		32,612		n/a		n/a		n/a		n/a
Net loans		3,072,435		3,059,343		-		-		3,059,343
Accrued interest receivable		12,545		12,545		68		2,699		9,778
Financial liabilities
Noninterest-bearing deposits		650,775		650,775		650,775		-		-
Interest-bearing deposits		2,140,191		2,137,149		-		2,137,149		-
Borrowings		671,587		674,131		-		674,131		-
Subordinated debentures, net		54,343		55,209		-		55,209		-
Derivatives		131		131		-		131		-
Accrued interest payable	$	4,387	$	4,387	$	-	$	4,387	$	-

The fair value of commitments to originate loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.

Changes in assumptions or estimation methodologies may have a material effect on these estimated fair values.

The Company’s remaining assets and liabilities, which are not considered financial instruments, have not been valued differently than has been customary with historical cost accounting. No disclosure of the relationship value of the Company’s core deposit base is required by FASB ASC 825-10.

Fair value estimates are based on existing balance sheet financial instruments, without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, there are certain significant assets and liabilities that are not considered financial assets or liabilities, deferred taxes, premises and equipment, and goodwill. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

Management believes that reasonable comparability between financial institutions may not be likely, due to the wide range of permitted valuation techniques and numerous estimates which must be made, given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.