Fair Value Measurement

6 Months Ended

Jun. 30, 2019

FAIR VALUE MEASUREMENT

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale and derivative financial instruments are recorded at fair value on a recurring basis. From time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, loans held-for-sale, other real estate and assets held-for-sale. Additionally, the Company is required to disclose, but not record, the fair value of other financial instruments.

Fair Value Hierarchy

The Company groups assets and liabilities 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. These levels are:

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

Following is a description of valuation methodologies used for assets and liabilities which are either recorded or disclosed at fair value.

Cash and cash equivalents—The carrying value of cash and due from banks, federal funds sold and interest-bearing deposits in other banks, and time deposits in other banks approximate fair value.

Debt Securities—Securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange and Treasury securities that are traded by dealers or brokers in active over-the-counter market and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds, corporate debt securities and asset-backed securities and are valued based on observable inputs that include: quoted market prices for similar assets, quoted market prices that are not in an active market, or other inputs that are observable in the market and can be corroborated by observable market data for substantially the full term of the securities. Securities classified as Level 3 include asset-backed securities in less liquid markets. Securities classified as Level 3 are valued based on estimates obtained from broker-dealers and are not directly observable.

Loans held for sale—Loans held for sale are carried at the lower of carrying value or fair value. Fair value is based upon quotes or bids on these loans directly from the purchaser.

Loans—For disclosure purposes, the fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made. For variable rate loans, the carrying amount is a reasonable estimate of fair value. The Company does not record loans at fair value on a recurring basis.

The fair value of impaired loans is estimated based on discounted contractual cash flows or underlying collateral values, where applicable. A loan is determined to be impaired if the Company believes it is probable that all principal and interest amounts due according to the terms of the note will not be collected as scheduled. The fair value of impaired loans is determined in accordance with ASC 310-10, Accounting by Creditors for Impairment of a Loan, and generally results in a specific reserve established through a charge to the provision for loan losses. Losses on impaired loans are charged to the allowance when management believes the uncollectability of a loan is confirmed. Management has determined that the majority of impaired loans are Level 3 assets due to the extensive use of market appraisals

Cash Surrender Value of Life Insurance Policies—Fair value for life insurance cash surrender value is based on cash surrender values indicated by the insurance companies.

Other Real Estate—Other real estate properties are adjusted to fair value upon transfer of the loans to other real estate, and annually thereafter to insure other real estate assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the other real estate as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and adjusts the appraisal value by taking an additional discount for market conditions and there is no observable market prices, the Company records the other real estate asset as nonrecurring Level 3.

Derivative Instruments—The fair value of derivatives are determined by an independent valuation firm and are estimated using prices of financial instruments with similar characteristics. As a result, they are classified within Level 2 of the fair value hierarchy.

Deposits—The fair value of demand deposits, savings accounts, NOW accounts, and money market deposits is the carrying amount at the reporting date. The fair value of fixed maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities. The estimated fair value does not include customer related intangibles.

Securities Sold Under Agreements to Repurchase—The fair value approximates the carrying value of repurchase agreements due to their short-term nature.

Federal Home Loan Bank Advances—The fair value approximates carrying amount because of the short maturity of these instruments.

Junior Subordinated Debentures—For junior subordinated debentures that bear interest on a floating basis, the fair value approximates carrying amount. For junior subordinated debentures that bear interest on a fixed rate basis, the fair value is estimated using a discounted cash flow analysis that applies interest rates currently being offered on similar types of borrowings.

Off-Balance-Sheet Instruments—Because commitments to extend credit and standby letters of credit are generally short-term and made using variable rates, the carrying value and estimated fair value associated with these instruments are immaterial for disclosure.

The following table presents the fair value measurements of certain assets and liabilities measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall (in thousands):



	Recurring Basis Fair Value Measurements
	June 30, 2019
	Fair Value		Level 1		Level 2		Level 3
Financial assets:
U.S. Government agencies	$	3,042	$	—	$	3,042	$	—
State, county, and municipal securities	12,733		$	—	12,733		$	—
Mortgage-backed securities	400,079		—		400,079		—
Corporate debt securities	9,784		—		9,784		—
Derivative assets	669		$	—	669		$	—
Total recurring assets at fair value	$	426,307	$	—	$	426,307	$	—

	Recurring Basis Fair Value Measurements
	December 31, 2018
	Fair Value		Level 1		Level 2		Level 3
Financial assets:
U.S. Government agencies	$	3,072	$	—	$	3,072	$	—
State, county, and municipal securities	44,088		$	—	44,088		$	—
Mortgage-backed securities	365,877		—		365,877		—
Corporate debt securities	24,717		—		24,717		—
Derivative assets	1,067		$	—	1,067		$	—
Total recurring assets at fair value	$	438,821	$	—	$	438,821	$	—

The following table presents the fair value measurements of certain assets and liabilities measured at fair value on a non-recurring basis and the level within the fair value hierarchy in which the fair value measurements fall (dollars in thousands):



	Nonrecurring Basis Fair Value Measurements
	June 30, 2019
	Fair Value		Level 1		Level 2		Level 3
Financial assets:
Impaired loans	$	4,307	$	—	$	—	$	4,307
Loans held for sale	10,304		—		10,304		—
Other real estate	387		—		—		387
Assets held for sale	1,024		—		1,024		—
Total nonrecurring assets at fair value	$	16,022	$	—	$	11,328	$	4,694

	Nonrecurring Basis Fair Value Measurements
	December 31, 2018
	Fair Value		Level 1		Level 2		Level 3
Financial assets:
Impaired loans	$	3,086	$	—	$	—	$	3,086
Loans held for sale	23,876		—		23,876		—
Other real estate	1,067		—		—		1,067
Assets held for sale	1,024		—		1,024		—
Total nonrecurring assets at fair value	$	29,053	$	—	$	24,900	$	4,153

The inputs used to determine estimated fair value of impaired loans include market conditions, loan terms, underlying collateral characteristics and discount rates. The inputs used to determine fair value of OREO include market conditions, estimated marketing period or holding period, underlying collateral characteristics and discount rates.

For the six months ended June 30, 2019 and the year ended December 31, 2018, there was not a change in the methods and significant assumptions used to estimate fair value for assets carried at fair value.

The following table shows significant unobservable inputs used in the fair value measurement of Level 3 assets (dollars in thousands):



	Fair Value at
Description	June 30, 2019		Technique	Unobservable Inputs
Impaired loans	$	4,307	Third party appraisals	Collateral discounts and estimated costs to sell
Other real estate	387		Third party appraisals	Collateral discounts and estimated costs to sell

	Fair Value at
Description	December 31, 2018		Technique	Unobservable Inputs
Impaired loans	$	3,086	Third party appraisals	Collateral discounts and estimated costs to sell
Other real estate	1,067		Third party appraisals	Collateral discounts and estimated costs to sell

Limitations

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 Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on many judgments. 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. Fair value estimates are based on existing on and off-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

The carrying amounts and estimated fair values of the Company’s financial instruments are as follows at June 30, 2019 and December 31, 2018 (dollars in thousands):



	Fair Value Measurements
	June 30, 2019
	Carrying Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	243,430	$	243,430	$	—	$	—
Securities available-for-sale	425,638		—		425,638		—
Securities held-to-maturity	33,219		—		33,363		—
Loans, net	851,908		—		—		862,519
Derivative assets	669		—		669		—
Cash surrender value of life insurance	15,248		—		15,248		—
Financial liabilities:
Non-interest-bearing deposits	$	399,619	$	—	$	399,619	$	—
Interest-bearing deposits	1,023,770		—		847,109		178,554
Securities sold under agreements to repurchase	7,816		7,816		—		—
FHLB borrowings	27,500		—		27,500		—
Other borrowings	22,167		—		22,167		—

	December 31, 2018
	Carrying Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	205,371	$	205,371	$	—	$	—
Available-for-sale securities	437,754		—		437,754		—
Securities held-to-maturity	37,759		—		36,974		—
Loans, net	882,355		—		—		885,054
Derivative assets	1,067		—		1,067		—
Cash surrender value of life insurance	15,135		—		15,135		—
Financial liabilities:
Non-interest-bearing deposits	$	383,167	$	—	$	383,167	$	—
Interest-bearing deposits	1,068,904		—		888,806		177,794
Securities sold under agreements to repurchase	11,220		11,220		—		—
FHLB borrowings	27,500		—		27,500		—
Other borrowings	22,167		—		22,167		—

- Definition

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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MIDSOUTH BANCORP INC 10-Q