Fair Value of Financial Instruments

6 Months Ended

Dec. 31, 2021

NOTE 4 – Fair Value of Financial Instruments

Fair value is the price that would be received to sell an asset or paid to transfer liabilities in an orderly transaction between market participants at the measurement date (exit price) and establishes a framework for measuring fair value.

To determine fair value the Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Company is able to classify fair value balances based on the observability of those inputs. The guidance establishes a fair value hierarchy that prioritizes the inputs 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 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy are as follows:

> Level 1 - Fair value is based upon quoted prices (unadjusted) for identical assets or liabilities in active markets. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. Level 1 primarily consists of financial instruments such as listed equities and U.S. Treasury securities.

> Level 2 - Fair value is based upon quoted prices for similar, but not identical, assets and liabilities in active markets, and other inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. This also includes quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability, or inputs that are derived principally from or corroborated by observable market data.

> Level 3 - Fair value is based upon financial models using primarily unobservable inputs. Unobservable inputs reflect the Company's own assumptions about the assumptions that market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

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.

Assets

Available for sale securities. Where quoted prices for securities are available in an active market, those securities are classified within Level 1 of the valuation hierarchy. If such quoted market prices are not available, then fair values are estimated using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. Examples of securities with similar characteristics, which would generally be classified within Level 2 of the valuation hierarchy, include certain AAA-rated U.S. government sponsored agency securities, municipal obligations, and mortgage-backed securities. A security using financial models based upon primarily unobservable inputs, such as commercial paper, would generally be classified within Level 3 of the valuation hierarchy.

Loans. The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses may be established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the collateral exceeds the recorded investments in such loans and for which carrying amount will remain at amortized cost. Impaired loans where an allowance is established based on the fair value of

collateral or expected cash flows require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, less selling costs, the Company records the impaired loan as a non-recurring Level 3 valuation.

Other real estate owned, net. Assets on which the underlying collateral has been repossessed are initially recorded at the fair market value of the real estate acquired less estimated costs to sell, establishing a new cost basis.

Subsequently, other real estate owned is 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, less selling costs, the Company records the repossessed asset as a non-recurring Level 3 valuation.

The following tables set forth, by level within the fair value hierarchy, the Company's financial assets that were accounted for at fair value on a recurring and non-recurring basis as of December 31, 2021 and June 30, 2021, respectively. According to fair value guidance, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to their fair value measurement. The Company's assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels.

The following table presents assets measured at fair value on a recurring basis:


	Fair Value as of December 31, 2021
	Level 1		Level 2		Level 3		Total
Securities classified as available for sale:
Obligations of states and political subdivisions	$	—	$	30,457,298	$	—	$	30,457,298
US government agency obligations		—		5,575,899		—		5,575,899
Mortgage-backed securities		—		1,180,781		—		1,180,781
Municipal leases		—		998,590		—		998,590
Certificates of deposit		—		820,658		—		820,658
Total	$	—	$	39,033,226	$	—	$	39,033,226


	Fair Value as of June 30, 2021
	Level 1		Level 2		Level 3		Total
Securities classified as available for sale:
Obligations of states and political subdivisions	$	—	$	23,775,999	$	—	$	23,775,999
US government agency obligations		—		5,981,978		—		5,981,978
Mortgage-backed securities		—		1,274,916		—		1,274,916
Municipal leases		—		1,002,989		—		1,002,989
Certificates of deposit		—		832,818		—		832,818
Total	$	—	$	32,868,700	$	—	$	32,868,700

Assets measured at fair value on non-recurring basis:


	Fair Value as of December 31, 2021
	Level 1		Level 2		Level 3		Total
Impaired loans with a valuation allowance, net	$	—	$	—	$	108,652	$	108,652
Other real estate owned, net		—		—		167,590		167,590
Total	$	—	$	—	$	276,242	$	276,242


	Fair Value as of June 30, 2021
	Level 1		Level 2		Level 3		Total
Impaired loans with a valuation allowance, net	$	—	$	—	$	116,906	$	116,906
Other real estate owned, net		—		—		167,590		167,590
Total	$	—	$	—	$	284,496	$	284,496

Loans with a carrying amount of $193,000 and $206,000 were considered impaired as of December 31, 2021 and June 30, 2021 and a specific allowance for loan losses of $84,000 and $89,000, respectively, was established against these loans.

Other real estate owned with carrying amounts of approximately $168,000 was determined to be at their fair value as of December 31, 2021 and June 30, 2021.

The following presents quantitative information about nonrecurring Level 3 fair value measurements:


	As of December 31, 2021
	Fair Value		Valuation Technique	Unobservable Input(s)	Range/Weighted Average
Impaired loans with a valuation allowance, net	$	108,652	Market price or appraised value	Discount on appraised values for selling costs	5% - 15%
Other real estate owned, net	$	167,590	Market price or appraised value	Discount on appraised values for selling costs	5% - 15%


	As of June 30, 2021
	Fair Value		Valuation Technique	Unobservable Input(s)	Range/Weighted Average
Impaired loans with a valuation allowance, net	$	116,906	Market price or appraised value	Discount on appraised values for selling costs	5% - 15%
Other real estate owned, net	$	167,590	Market price or appraised value	Discount on appraised values for selling costs	5% - 15%

- 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.

+ References + Details

TEB Bancorp, Inc. 10-Q