FAIR VALUE MEASUREMENTS

3 Months Ended

Mar. 31, 2021

7.	FAIR VALUE MEASUREMENTS

ASC Topic 820, “Fair Value Measurements and Disclosures”, defines fair value, establishes a framework for measuring fair value, and sets forth disclosures about fair value measurements. ASC Topic 825, “Financial Instruments”, allows entities to choose to measure certain financial assets and liabilities at fair value. The Company has not elected the fair value option for any financial assets or liabilities.

ASC Topic 820 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. It also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. This Topic describes three levels of inputs that may be used to measure fair value:

Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2 – Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 – Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate the fair value:

Investment Securities: The fair values for available for sale investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent third party real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available for similar loans and collateral underlying such loans. Impaired loans resulted in a Level 3 classification of the inputs for determining fair value.

Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted in accordance with the allowance policy.

Mortgage Servicing Rights: Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively based on a valuation model that calculates the present value of estimated future net servicing income, resulting in a Level 3 classification.

Derivatives and Financial Instruments: The fair values of derivative financial instruments are based on derivative valuation models using market data inputs as of the valuation date (Level 2).

Assets and Liabilities Measured on a Recurring Basis:

Available for sale investment securities, derivatives and other financial instrument assets and equity securities included in other assets are the Company’s only balance sheet items that meet the disclosure requirements for instruments measured at fair value on a recurring basis. Disclosures are as follows in the tables below.

Fair Value Measurements at March 31, 2021 (in thousands):


	Fair Value Measurements at March 31, 2021 Using:
			Quoted Prices
			In Active
			Markets for		Significant Other		Significant
			Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets
U.S. treasury notes	$	9,135	$	—	$	9,135	$	—
U. S. government agencies		26,846		—		26,846		—
States and political subdivisions		66,278		—		66,278		—
Mortgage-backed - residential		115,675		—		115,675		—
Mortgage-backed-commercial		81,856		—		81,856		—
Asset-backed		48,776		—		48,776		—
Other		998				998
Derivatives		455		—		455		—
Equity Securities		293		293		—		—
Total	$	350,312	$	293	$	350,019	$	—

Financial Liabilities
Derivatives	$	1,083	$	—	$	1,083	$	—

Fair Value Measurements at December 31, 2020 (in thousands):


	Fair Value Measurements at December 31, 2020 Using:
			Quoted Prices
			In Active
			Markets for		Significant Other		Significant
			Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)
U.S. treasury notes	$	9,188	$	—	$	9,188	$	—
U. S. government agencies		23,298		—		23,298		—
States and political subdivisions		67,639		—		67,639		—
Mortgage-backed - residential		126,482		—		126,482		—
Mortgage-backed - commercial		74,551		—		74,551		—
Asset-backed		51,311		—		51,311		—
Other		1,025		—		1,025		—
Derivatives		501		—		501		—
Equity Securities		298		298		—		—
Total	$	354,293	$	298	$	353,995	$	—

Financial Liabilities
Derivatives	$	2,350	$	—	$	2,350	$	—

Assets measured at fair value on a non-recurring basis are summarized below (in thousands):


	Fair Value Measurements at March 31, 2021 Using :
			Quoted Prices
			In Active
			Markets for		Significant Other		Significant
			Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
(In thousands)	Value		(Level 1)		(Level 2)		(Level 3)
Description
Impaired loans:
Real estate mortgage:
1-4 family residential	$	799	—	$	—	$		799
Multi-family residential		792	—		—			792
Non-farm & non- residential		899	—		—			899
Other real estate owned, net:
Real estate mortgage:
1-4 family residential		61	—		—			61
Agricultural		233	—		—			233
Mortgage servicing rights		1,370	—		—			1,370


	Fair Value Measurements at December 31, 2020 Using :
				Quoted Prices
				In Active
				Markets for		Significant Other	Significant
				Identical		Observable	Unobservable
	Carrying			Assets		Inputs	Inputs
(In thousands)	Value			(Level 1)		(Level 2)	(Level 3)
Description
Impaired loans:
Real Estate Mortgage:
1-4 family residential	$	799	$	—	$	—	$	799
Multi-family residential		1,217		—		—		1,217
Non-farm & non - residential		899		—		—		899
Agricultural		694		—		—		694
Other real estate owned, net:
Real Estate Mortgage:
1-4 family residential		73		—		—		73
Commercial		145		—		—		145
Agriculturual		233		—		—		233
Mortgage servicing rights		1,459		—		—		1,459

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis as March 31, 2021 and December 31, 2020:


					Range
March 31, 2021		Fair	Valuation	Unobservable	(Weighted
(In thousands)		Value	Technique(s)	Input(s)	Average)

Impaired loans
Real estate mortgage:
1-4 family residential	$	799	sales comparison	adjustment for differences between the comparable sales	15%-15%	(15%)
Multi-family residential		792	sales price	adjustment for difference between book value and sales price	39%-39%	(39%)
Non-farm and non-residential		899	sales comparison	adjustment for differences between the comparable sales	50% -50%	(50)%
Other real estate owned:
Real estate mortgage:
1-4 family residential		61	sales comparison	adjustment for differences between the comparable sales	23% - 27%	(30)%
Agricultural		233	sales comparison	adjustment for differences between the comparable sales	0% - 26%	(14)%
Mortgage servicing rights		1,370	discounted cash flow	constant prepayment rates	8% - 40%	(21)%


				Range
December 31, 2020	Fair	Valuation	Unobservable	(Weighted
(In thousands)	Value	Technique(s)	Input(s)	Average)
Impaired loans
Real estate mortgage:
1-4 family-residential	799	sales comparison	adjustment for differences between the comparable sales	15% -15%	(15)%
Multi-family residential	1,217	income approach	capitalization rate	7% - 7%	(7)%
Non-farm and non-residential	899	sales comparison	adjust for differences between the comparable sales	50% - 50%	(50)%
Agricultural	694	sales comparison	adjustment for differences between the comparable sales	100% - 100%	(100)%
Other real estate owned:
Real estate mortgage:
1-4 family residential	73	sales comparison	adjustment for differences between the comparable sales	23% - 27%	(30)%
Commercial	145	sales comparison	adjustment for differences between the comparable sales	15%-15%	(15)%
Agricultural	233	sales comparison	adjustment for differences between the comparable sales	0% - 26%	(14)%
Mortgage servicing rights	1,459	discounted cash flow	constant prepayment rates	12% - 29%	(19)%

Fair Value of Financial Instruments

The carrying amounts and estimated fair values of financial instruments, as of March 31, 2021 and December 31, 2020 are as follows:

March 31, 2021


	Carrying
(in thousands)	Value		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	81,919	$	81,919	$	—	$	—	$	81,919
Interest bearing time deposits		2,070		2,070		—		—		2,070
Securities available for sale		349,564		—		349,564		—		349,564
Loans held for sale		2,695		—		2,759		—		2,759
Net Loans		755,635		—		—		762,575		762,575
Federal Home Loan Bank stock		7,072		—		—		—		N/A
Interest receivable		4,706		—		1,057		3,649		4,706
Derivative and financial instruments		455		—		455		—		455
Equity securities		293		293		—		—		293

Financial liabilities
Total deposits	$	1,025,695	$	854,474	$	171,892	$	—	$	1,026,366
Repurchase agreements		8,437		—		8,437		—		8,437
Short-term Federal Home Loan Bank advances		5,500		—		5,500		—		5,500
Long-term Federal Home Loan Bank advances		84,264		—		86,564		—		86,564
Subordinated debentures		7,217		—		—		7,214		7,214
Interest payable		531		—		521		10		531
Derivative and financial instruments		1,083		—		1,083		—		1,083

December 31, 2020


	Carrying
(in thousands)	Value		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	81,819	$	81,819	$	—	$	—	$	81,819
Interest bearing time deposits		2,070		2,070		—		—		2,070
Securities available for sale		349,564		—		349,564		—		349,564
Loans held for sale		2,695		—		2,752		—		2,752
Net Loans		755,635		—		—		756,908		756,908
Federal Home Loan Bank stock		7,072		—		—		—		N/A
Interest receivable		4,706		—		1,026		3,680		4,706
Derivative and financial instruments		455		—		455		—		455
Equity securities		293		293		—		—		292

Financial liabilities
Total deposits	$	1,025,695	$	898,303	$	127,916	$	—	$	1,026,219
Repurchase agreements		8,437		—		8,437		—		8,437
Short-term Federal Home Loan Bank advances		5,500		—		5,500		—		5,500
Long-term Federal Home Loan Bank advances		84,264		—		86,214		—		86,214
Subordinated debentures		7,217		—		—		7,212		7,212
Interest payable		531		—		521		10		531
Derivatives and financial instruments		1,083		—		1,083		—		164

- 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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KENTUCKY BANCSHARES INC /KY/ 10-Q