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FAIR VALUE

9 Months Ended

Sep. 30, 2023

NOTE K: FAIR VALUE

Accounting standards establish a framework for measuring fair value and require certain disclosures about such fair value instruments. It defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e. exit price). Inputs used to measure fair value are classified into the following hierarchy:


● Level 1 -	Quoted prices in active markets for identical assets or liabilities.
● Level 2 -	Quoted prices in active markets for similar assets or liabilities, or quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.
● Level 3 -	Significant valuation assumptions not readily observable in a market.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The following tables set forth the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis. There were no transfers between any of the levels for the periods presented.


		September 30, 2023
											Total Fair
(000’s omitted)		Level 1			Level 2			Level 3			Value
Available-for-sale investment securities:
U.S. Treasury and agency securities		$	1,921,264		$	58,175		$	0		$	1,979,439
Obligations of state and political subdivisions			0			434,465			0			434,465
Government agency mortgage-backed securities			0			337,071			0			337,071
Corporate debt securities			0			7,174			0			7,174
Government agency collateralized mortgage obligations			0			9,487			0			9,487
Total available-for-sale investment securities			1,921,264			846,372			0			2,767,636
Equity securities			320			0			0			320
Mortgage loans held for sale			0			604			0			604
Commitments to originate real estate loans for sale			0			0			13			13
Forward sales commitments			0			10			0			10
Total		$	1,921,584		$	846,986		$	13		$	2,768,583


		December 31, 2022
											Total Fair
(000’s omitted)		Level 1			Level 2			Level 3			Value
Available-for-sale investment securities:
U.S. Treasury and agency securities		$	3,178,189		$	65,348		$	0		$	3,243,537
Obligations of state and political subdivisions			0			504,297			0			504,297
Government agency mortgage-backed securities			0			384,633			0			384,633
Corporate debt securities			0			7,114			0			7,114
Government agency collateralized mortgage obligations			0			12,270			0			12,270
Total available-for-sale investment securities			3,178,189			973,662			0			4,151,851
Equity securities			419			0			0			419
Commitments to originate real estate loans for sale			0			0			5			5
Forward sales commitments			0			5			0			5
Interest rate swap agreements asset			0			1			0			1
Interest rate swap agreements liability			0			(1)			0			(1)
Total		$	3,178,608		$	973,667		$	5		$	4,152,280

The valuation techniques used to measure fair value for the items in the table above are as follows:

●

Available-for-sale investment securities and equity securities – The fair values of available-for-sale investment securities are based upon quoted prices, if available. If quoted prices are not available, fair values are measured using quoted market prices for similar securities or model-based valuation techniques. Level 1 securities include U.S. Treasury obligations and marketable equity securities that are traded by dealers or brokers in active over-the-counter markets. Level 2 securities include U.S. agency securities, mortgage-backed securities issued by government-sponsored entities, municipal securities and corporate debt securities that are valued by reference to prices for similar securities or through model-based techniques in which all significant inputs, such as reported trades, trade execution data, interest rate swap yield curves, market prepayment speeds, credit information, market spreads, and security’s terms and conditions, are observable. See Note D for further disclosure of the fair value of investment securities.

●

Mortgage loans held for sale – The Company has elected to value loans held for sale at fair value in order to more closely match the gains and losses associated with loans held for sale with the gains and losses on forward sales contracts. Accordingly, the impact on the valuation will be recognized in the Company’s consolidated statements of income. All mortgage loans held for sale are current and in performing status. The fair value of mortgage loans held for sale is determined using quoted secondary-market prices of loans with similar characteristics and, as such, has been classified as a Level 2 valuation. The unpaid principal value of mortgage loans held for sale was approximately $0.6 million at September 30, 2023. There were no mortgage loans held for sale at December 31, 2022. Mortgage loans held for sale are included in other assets in the consolidated statements of condition. The unrealized gain on mortgage loans held for sale was recognized in mortgage banking revenues in the consolidated statements of income and is immaterial.

●

Forward sales commitments – The Company enters into forward sales commitments to sell certain residential real estate loans. Such commitments are considered to be derivative financial instruments and, therefore, are carried at estimated fair value in the other asset or other liability section of the consolidated statements of condition. The fair value of these forward sales commitments is primarily measured by obtaining pricing from certain government-sponsored entities and reflects the underlying price the entity would pay the Company for an immediate sale on these mortgages. As such, these instruments are classified as Level 2 in the fair value hierarchy.

●

Commitments to originate real estate loans for sale – The Company enters into various commitments to originate residential real estate loans for sale. Such commitments are considered to be derivative financial instruments and, therefore, are carried at estimated fair value in the other asset or other liability section of the consolidated statements of condition. The estimated fair value of these commitments is determined using quoted secondary market prices obtained from certain government-sponsored entities. Additionally, accounting guidance requires the expected net future cash flows related to the associated servicing of the loan to be included in the fair value measurement of the derivative. The expected net future cash flows are based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. Such assumptions include estimates of the cost of servicing loans, appropriate discount rate and prepayment speeds. The determination of expected net cash flows is considered a significant unobservable input contributing to the Level 3 classification of commitments to originate real estate loans for sale.

●

Interest rate swap agreements – The interest rate swaps are reported at their fair value utilizing Level 2 inputs from third parties. The fair value of the interest rate swaps are determined using prices obtained from a third party advisor. The fair value measurement of the interest rate swap is determined by netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on the expectation of future interest rates derived from observed market interest rate curves.

The changes in Level 3 assets measured at fair value on a recurring basis are immaterial.

The fair value information of assets and liabilities measured on a non-recurring basis presented below is not as of the period-end, but rather as of the date the fair value adjustment was recorded closest to the date presented.


		September 30, 2023												December 31, 2022
											Total Fair												Total Fair
(000’s omitted)		Level 1			Level 2			Level 3			Value			Level 1			Level 2			Level 3			Value
Individually assessed loans		$	0		$	0		$	3,014		$	3,014		$	0		$	0		$	0		$	0
Other real estate owned			0			0			578			578			0			0			503			503
Mortgage servicing rights			0			0			309			309			0			0			1,169			1,169
Contingent consideration			0			0			(2,950)			(2,950)			0			0			(2,800)			(2,800)
Total		$	0		$	0		$	951		$	951		$	0		$	0		$	(1,128)		$	(1,128)

Loans are generally not recorded at fair value on a recurring basis. Periodically, the Company records nonrecurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Nonrecurring adjustments also include certain impairment amounts for collateral-dependent loans calculated when establishing the allowance for credit losses. Such amounts are generally based on the fair value of the underlying collateral supporting the loan and, as a result, the carrying value of the loan less the calculated valuation amount does not necessarily represent the fair value of the loan. Real estate collateral is typically valued using independent appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace, adjusted for non-observable inputs. Thus, the resulting nonrecurring fair value measurements are generally classified as Level 3. Estimates of fair value used for other collateral supporting commercial loans generally are based on assumptions not observable in the marketplace and, therefore, such valuations are classified as Level 3.

Other real estate owned (“OREO”) is valued at the time the loan is foreclosed upon and the asset is transferred to OREO. The value is based primarily on third party appraisals, less costs to sell. The appraisals are sometimes further discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the customer and customer’s business. Such discounts are significant, ranging from 9.0% to 73.8% at September 30, 2023 and result in a Level 3 classification of the inputs for determining fair value. OREO is reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above. The Company recovers the carrying value of OREO through the sale of the property. The ability to affect future sales prices is subject to market conditions and factors beyond the Company’s control and may impact the estimated fair value of a property.

Originated mortgage servicing rights are recorded at their fair value at the time of sale of the underlying loan, and are amortized in proportion to and over the estimated period of net servicing income. The fair value of mortgage servicing rights is based on a valuation model incorporating inputs that market participants would use in estimating future net servicing income. Such inputs include estimates of the cost of servicing loans, appropriate discount rate and prepayment speeds and are considered to be unobservable and contribute to the Level 3 classification of mortgage servicing rights. In accordance with GAAP, the Company must record impairment charges, on a nonrecurring basis, when the carrying value of a mortgage servicing rights class exceeds its estimated fair value. Impairment is recognized through a valuation allowance. There is a valuation allowance of approximately $1.2 million and $0.7 million at September 30, 2023 and December 31, 2022, respectively.

The Company has recorded contingent consideration liabilities that arise from acquisition activity. The contingent consideration is recorded at fair value at the date of acquisition. The valuation of contingent consideration is calculated using an income approach method, which provides an estimation of the fair value of an asset or liability based on future cash flows over a discrete projection period, discounted to present value using an appropriate rate of return. The assumptions used in the valuation calculation are based on significant unobservable inputs, therefore such valuations are classified as Level 3.

The contingent consideration related to the Fringe Benefits Design of Minnesota, Inc. (“FBD”) acquisition completed in 2021 was revalued at June 30, 2023. The range of the undiscounted amounts the Company could pay under the agreement remained at between zero and $2.7 million. Key assumptions include (1) a discount rate of 6.91% applied to present value the payment, and (2) probability of achievement of retained revenue level of 37.8%. Based on the results of the June 2023 revaluation, the Company recorded a reduction to the fair value of the contingent consideration of $0.1 million which is included in the consolidated statements of income as an acquisition-related contingent consideration adjustment. The adjusted fair value at June 30, 2023 was $1.0 million. No adjustments were made to the fair value of the contingent consideration related to the FBD acquisition during the three months ended September 30, 2023.

The contingent consideration related to the Thomas Gregory Associates Insurance Brokers, Inc. (“TGA”) acquisition completed by OneGroup in 2021 was revalued at June 30, 2023. The range of the undiscounted amounts the Company could pay under the agreement remained at between zero and $3.4 million. Key assumptions include (1) a discount rate range of 6.73% to 6.94% applied to present value the payment, and (2) probability of achievement of retained revenue level of 86.1%. Based on the results of the June 2023 revaluation, the Company recorded an increase to the fair value of the contingent consideration of $1.1 million which is included in the consolidated statements of income as an acquisition-related contingent consideration adjustment. The adjusted fair value at June 30, 2023 was $2.8 million. In the third quarter of 2023, the first of the two required payments were made on the contingent consideration in the amount of $2.4 million, based on actual retained revenue results. An additional $0.1 million adjustment was recorded to adjust the fair value of the remaining contingent consideration liability, resulting in a fair value of $0.5 million at September 30, 2023.

The Company determines fair values based on quoted market values, where available, estimates of present values, or other valuation techniques. Those techniques are significantly affected by the assumptions used, including, but not limited to, 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, may not be realized in immediate settlement of the instrument. The significant unobservable inputs used in the determination of fair value of assets classified as Level 3 on a recurring or non-recurring basis are as follows:


									Significant Unobservable
		Fair Value at							Input Range
(000’s omitted, except per loan data)		September 30, 2023			Valuation Technique		Significant Unobservable Inputs		(Weighted Average)
Individually assessed loans		$	3,014		Fair value of collateral		Estimated cost of disposal/market adjustment			27.2	%
Other real estate owned			578		Fair value of collateral		Estimated cost of disposal/market adjustment			9.0% – 73.8% (38.5%)
Commitments to originate real estate loans for sale			13		Discounted cash flow		Embedded servicing value			1.0	%
Mortgage servicing rights			309		Discounted cash flow		Weighted average constant prepayment rate			5.6% - 6.1% (5.6%)
							Weighted average discount rate			5.3% - 5.7% (5.7%)
							Adequate compensation		$	7/loan
Contingent consideration			(2,950)		Discounted cash flow		Discount rate			6.7% - 6.9% (6.9%)
							Probability of achievement			37.8% - 100.0% (70.9%)


									Significant Unobservable
		Fair Value at							Input Range
(000's omitted, except per loan data)		December 31, 2022			Valuation Technique		Significant Unobservable Inputs		(Weighted Average)
Other real estate owned		$	503		Fair value of collateral		Estimated cost of disposal/market adjustment			9.0% - 72.8% (35.7%)
Commitments to originate real estate loans for sale			5		Discounted cash flow		Embedded servicing value			1.0	%
Mortgage servicing rights			1,169		Discounted cash flow		Weighted average constant prepayment rate			2.9% - 3.3% (2.9%)
							Weighted average discount rate			4.6% - 4.9% (4.9%)
							Adequate compensation		$	7/loan
Contingent consideration			(2,800)		Discounted cash flow		Discount rate			5.9% - 6.2% (6.1%)
							Probability of achievement			44.9% - 53.5% (50.1%)

The significant unobservable inputs used in the determination of the fair value of assets classified as Level 3 have an inherent measurement uncertainty that, if changed, could result in higher or lower fair value measurements of these assets as of the reporting date. The weighted average of the estimated cost of disposal/market adjustment for other real estate owned was calculated by dividing the total of the differences between the appraisal values of the real estate and the book values of the real estate divided by the totals of the appraisal values of the real estate. The weighted average of the constant prepayment rate for mortgage servicing rights was calculated by adding the constant prepayment rates used in each loan pool weighted by the balance in each loan pool. The weighted average of the discount rate for mortgage servicing rights was calculated by adding the discount rates used in each loan pool weighted by the balance in each loan pool. The weighted average of the discount rate for the contingent consideration was calculated by adding the discount rates used for the calculation of the fair value of each payment of contingent consideration, weighted by the amount of the payment as part of the total fair value of contingent consideration. The weighted average of the probability of achievement was determined by calculating the proportion of the probability-weighted payment of the total maximum payment, weighted by the amount of the payment as part of the total fair value of contingent consideration.

Certain financial instruments and all nonfinancial instruments are excluded from fair value disclosure requirements. 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 other financial instruments that are not accounted for at fair value at September 30, 2023 and December 31, 2022 are presented below. The table presented below excludes other financial instruments for which the carrying value approximates fair value including cash and cash equivalents, accrued interest receivable and accrued interest payable.


		September 30, 2023						December 31, 2022
		Carrying			Fair			Carrying			Fair
(000’s omitted)		Value			Value			Value			Value
Financial assets:
Net loans		$	9,385,121		$	8,836,726		$	8,748,335		$	8,696,185
Held-to-maturity securities			1,125,540			990,660			1,079,695			1,034,795
Financial liabilities:
Deposits			13,030,788			12,997,731			13,012,308			12,981,487
Overnight borrowings			0			0			768,400			768,400
Securities sold under agreement to repurchase, short-term			330,252			330,252			346,652			346,652
Other Federal Home Loan Bank borrowings			316,837			313,111			19,474			19,377
Subordinated notes payable			0			0			3,249			3,249

The following is a further description of the principal valuation methods used by the Company to estimate the fair values of its financial instruments.

Loans have been classified as a Level 3 valuation. Fair values for variable rate loans that reprice frequently are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flows and interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.

Held-to-maturity U.S. Treasury and agency securities have been classified as a Level 1 valuation. The fair values of held-to-maturity U.S. Treasury and agency investment securities are based upon quoted prices, if available. If quoted prices are not available, fair values are measured using quoted market prices for similar securities or model-based valuation techniques. Held-to-maturity government agency mortgage-backed securities have been classified as a Level 2 valuation. The fair values of held-to-maturity government agency mortgage-backed securities are based on current market rates for similar products.

Deposits have been classified as a Level 2 valuation. The fair value of demand deposits, interest-bearing checking deposits, savings accounts and money market deposits is the amount payable on demand at the reporting date. The fair value of time deposit obligations are based on current market rates for similar products.

Borrowings and subordinated notes payable have been classified as a Level 2 valuation. The fair value of overnight borrowings and securities sold under agreement to repurchase, short-term, is the amount payable on demand at the reporting date. Fair values for other FHLB borrowings and subordinated notes payable are estimated using discounted cash flows and interest rates currently being offered on similar securities. The difference between the carrying values of subordinated notes payable, and their fair values, are not material as of the reporting dates.

Other financial assets and liabilities – cash and cash equivalents have been classified as a Level 1 valuation, while accrued interest receivable and accrued interest payable have been classified as a Level 2 valuation. The fair values of each approximate the respective carrying values because the instruments are payable on demand or have short-term maturities and present relatively low credit risk and interest rate risk.

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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