Fair Value Disclosures

Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. The Corporation determines the fair value of its financial instruments based on the fair value hierarchy. The Corporation maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Corporation. Unobservable inputs are inputs that reflect the Corporation’s assumptions that the market participants would use in pricing the asset or liability based on the best information available in the circumstances, including assumptions about risk. Three levels of inputs are used to measure fair value. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input significant to the fair value measurement. Transfers between levels are recognized at the end of the reporting period.

Level 1: Valuations are based on quoted prices in active markets for identical assets or liabilities that the Corporation can access at the measurement date. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

Level 2: Valuations are based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

Level 3: Valuations are based on inputs that are unobservable and significant to the overall fair value measurement. Assets and liabilities utilizing Level 3 inputs include: financial instruments whose value is determined using pricing models, discounted cash-flow methodologies, or similar techniques, as well as instruments for which the fair value calculation requires significant management judgment or estimation.

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Investment Securities

Where quoted prices are available in an active market for identical instruments, investment securities are classified within Level 1 of the valuation hierarchy. Level 1 investment securities include U.S. Treasury securities, most equity securities and money market mutual funds. Mutual funds are registered investment companies which are valued at net asset value of shares on a market exchange at the close of business at period end. 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 securities issued by U.S. Government sponsored enterprises, mortgage-backed securities, collateralized mortgage obligations, corporate and municipal bonds and certain equity securities. In cases where there is limited activity or less transparency around inputs to the valuation, investment securities are classified within Level 3 of the valuation hierarchy.

Fair values for securities are determined using independent pricing services and market-participating brokers. The Corporation’s independent pricing service utilizes evaluated pricing models that vary by asset class and incorporate available trade, bid and other market information for structured securities, cash flow and, when available, loan performance data. Because many fixed income securities do not trade on a daily basis, the pricing service’s evaluated pricing applications apply information as applicable through processes, such as benchmarking of like securities, sector groupings, and matrix pricing, to prepare evaluations. If at any time, the pricing service determines that it does have not sufficient verifiable information to value a particular security, the Corporation will utilize valuations from another pricing service. Management has a sufficient understanding of the third party service’s valuation models, assumptions and inputs used in determining the fair value of securities to enable management to maintain an appropriate system of internal control.

On a quarterly basis, the Corporation reviews changes, as submitted by the pricing service, in the market value of its security portfolio. Individual changes in valuations are reviewed for consistency with general interest rate movements and any known credit concerns for specific securities. Additionally, on an annual basis, the Corporation has its security portfolio priced by a second pricing service to determine consistency with another market evaluator, except for municipal bonds which are priced by another service provider on a sample basis. If, upon the Corporation’s review or in comparing with another servicer, a material difference between pricing evaluations were to exist, the Corporation may submit an inquiry to its current pricing service regarding the data used to make the valuation of a particular security. If the Corporation determines it has market information that would support a different valuation than its current pricing service’s evaluation it can submit a challenge for a change to that security’s valuation. There were no material differences in valuations noted at September 30, 2014.

Derivative Financial Instruments

The fair values of derivative financial instruments are based upon the estimated amount the Corporation would receive or pay to terminate the contracts or agreements, taking into account current interest rates and, when appropriate, the current creditworthiness of the counterparties. Derivative financial instruments are classified within Level 2 of the valuation hierarchy.

Contingent Consideration Liability

The Corporation estimates the fair value of the contingent consideration liability by using a discounted cash flow model of future contingent payments based on projected revenue related to the acquired business. The estimated fair value of the contingent consideration liability is reviewed on a quarterly basis and any valuation adjustments resulting from a change in the discount rate or change of estimated future contingent payments based on projected revenue of the acquired business affecting the contingent consideration liability will be recorded through noninterest expense. Due to the significant unobservable input related to the projected revenue, the contingent consideration liability is classified within Level 3 of the valuation hierarchy. An increase in the projected revenue may result in a higher fair value of the contingent consideration liability. Alternatively, a decrease in the projected revenue may result in a lower estimated fair value of the contingent consideration liability.

For the Sterner Insurance Associates acquisition, the potential cash payments that could result from the contingent consideration arrangement range from $0 to a maximum of $5.7 million over the three-year period ending June 30, 2017.

For the Girard Partners acquisition, the potential cash payments that could result from the contingent consideration arrangement range from $0 to a maximum of $14.5 million cumulative over the five-year period ending December 31, 2018.

For the John T. Fretz Insurance Agency acquisition, the remaining potential future cash payments that could result from the contingent consideration arrangement range from $0 to a maximum of $620 thousand cumulative over the two-year period ending April 30, 2016.

For the Javers Group acquisition, the Corporation recorded a reduction to the contingent liability during the second quarter of 2013 which resulted in a reduction of other noninterest expense of $959 thousand. The adjustment reflects that revenue levels necessary for an earn-out payment in the first year post-acquisition were not met and that revenue growth levels necessary to qualify for subsequent years’ earn-out payments to be made are remote. Therefore, as of September 30, 2014, the fair value of this contingent consideration liability is $0. The Javers’ original contingent consideration arrangement ranged from $0 to a maximum of $1.7 million cumulative over the three-year period ending June 30, 2015.

The following table presents the assets and liabilities measured at fair value on a recurring basis at September 30, 2014 and December 31, 2013, classified using the fair value hierarchy:



	At September 30, 2014
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets/ Liabilities at Fair Value
Assets:
Available-for-sale securities:
U.S. treasuries	$	4,790	$	—	$	—	$	4,790
U.S. government corporations and agencies	—		122,403		—		122,403
State and political subdivisions	—		106,407		—		106,407
Residential mortgage-backed securities	—		13,553		—		13,553
Collateralized mortgage obligations	—		6,475		—		6,475
Corporate bonds	—		42,975		—		42,975
Money market mutual funds	6,442		—		—		6,442
Equity securities	1,257		—		—		1,257
Total available-for-sale securities	12,489		291,813		—		304,302
Interest rate locks with customers	—		660		—		660
Total assets	$	12,489	$	292,473	$	—	$	304,962
Liabilities:
Contingent consideration liability	$	—	$	—	$	6,669	$	6,669
Forward loan sale commitments	—		90		—		90
Total liabilities	$	—	$	90	$	6,669	$	6,759



	At December 31, 2013
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets/ Liabilities at Fair Value
Assets:
Available-for-sale securities:
U.S. treasuries	$	4,708	$	—	$	—	$	4,708
U.S. government corporations and agencies	—		128,148		—		128,148
State and political subdivisions	—		107,657		—		107,657
Residential mortgage-backed securities	—		35,480		—		35,480
Collateralized mortgage obligations	—		7,201		—		7,201
Corporate bonds	—		33,840		—		33,840
Money market mutual funds	16,900		—		—		16,900
Equity securities	2,347		—		—		2,347
Total available-for-sale securities	23,955		312,326		—		336,281
Interest rate locks with customers	—		321		—		321
Forward loan sale commitments	—		25		—		25
Total assets	$	23,955	$	312,672	$	—	$	336,627
Liabilities:
Contingent consideration liability	$	—	$	—	$	501	$	501
Total liabilities	$	—	$	—	$	501	$	501

At September 30, 2014 and December 31, 2013, the Corporation had no assets measured at fair value on a recurring basis utilizing Level 3 inputs.

The following table presents the change in the balance of the contingent consideration liability related to acquisitions for which the Corporation utilized Level 3 inputs to determine fair value on a recurring basis for the nine months ended September 30, 2014 and 2013:



	Nine Months Ended September 30, 2014
(Dollars in thousands)	Balance at December 31, 2013		Contingent Consideration from New Acquisition		Payment of Contingent Consideration			Adjustment of Contingent Consideration		Balance at September 30, 2014
Girard Partners	$	—	$	5,470	$	—		$	197	$	5,667
John T. Fretz Insurance Agency	501		—		(310		)	154		345
Sterner Insurance Associates	$	—	$	635	$	—		$	22	657
Total contingent consideration liability	$	501	$	6,105	$	(310	)	$	373	$	6,669



	Nine Months Ended September 30, 2013
(Dollars in thousands)	Balance at December 31, 2012		Contingent Consideration from New Acquisition		Payment of Contingent Consideration		Adjustment of Contingent Consideration			Balance at September 30, 2013
Javers Group	$	903	$	—	$	—	$	(903	)	$	—
John T. Fretz Insurance Agency	—		454		—		29			483
Total contingent consideration liability	$	903	$	454	$	—	$	(874	)	$	483

The Corporation may be required periodically to measure certain assets and liabilities at fair value on a non-recurring basis in accordance with GAAP. These adjustments to fair value usually result from the application of lower of cost or market accounting or impairment charges of individual assets. The following table represents assets measured at fair value on a non-recurring basis at September 30, 2014 and December 31, 2013:



	At September 30, 2014
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets/Liabilities at Fair Value
Impaired loans held for investment	$	—	$	—	$	57,937	$	57,937
Total	$	—	$	—	$	57,937	$	57,937



	At December 31, 2013
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets/Liabilities at Fair Value
Impaired loans held for investment	$	—	$	—	$	55,370	$	55,370
Total	$	—	$	—	$	55,370	$	55,370

The following table presents assets and liabilities and off-balance sheet items not measured at fair value on a recurring or non-recurring basis in the Corporation’s consolidated balance sheets but for which the fair value is required to be disclosed at September 30, 2014 and December 31, 2013. The disclosed fair values are classified using the fair value hierarchy.



	At September 30, 2014
(Dollars in thousands)	Level 1		Level 2			Level 3		Fair Value			Carrying Amount
Assets:
Cash and short-term interest-earning assets	$	68,408	$	—		$	—	$	68,408		$	68,408
Held-to-maturity securities	—		57,101			—		57,101			56,476
Loans held for sale	—		2,199			—		2,199			2,156
Net loans and leases held for investment	—		—			1,526,454		1,526,454			1,518,037
Mortgage servicing rights	—		—			7,337		7,337			5,425
Other real estate owned	—		955			—		955			955
Total assets	$	68,408	$	60,255		$	1,533,791	$	1,662,454		$	1,651,457
Liabilities:
Deposits:
Demand and savings deposits, non-maturity	$	1,598,967	$	—		$	—	$	1,598,967		$	1,598,967
Time deposits	—		263,317			—		263,317			261,176
Total deposits	1,598,967		263,317			—		1,862,284			1,860,143
Short-term borrowings	—		34,728			—		34,728			38,005
Total liabilities	$	1,598,967	$	298,045		$	—	$	1,897,012		$	1,898,148
Off-Balance-Sheet:
Commitments to extend credit	$	—	$	(1,408	)	$	—	$	(1,408	)	$	—



	At December 31, 2013
(Dollars in thousands)	Level 1		Level 2			Level 3		Fair Value			Carrying Amount
Assets:
Cash and short-term interest-earning assets	$	69,169	$	—		$	—	$	69,169		$	69,169
Held-to-maturity securities	—		66,853			—		66,853			66,003
Loans held for sale	—		2,267			—		2,267			2,267
Net loans and leases held for investment	—		—			1,477,945		1,477,945			1,461,620
Mortgage servicing rights	—		7,188			—		7,188			5,519
Other real estate owned	—		1,650			—		1,650			1,650
Total assets	$	69,169	$	77,958		$	1,477,945	$	1,625,072		$	1,606,228
Liabilities:
Deposits:
Demand and savings deposits, non-maturity	$	1,573,709	$	—		$	—	$	1,573,709		$	1,573,709
Time deposits	—		268,909			—		268,909			270,789
Total deposits	1,573,709		268,909			—		1,842,618			1,844,498
Short-term borrowings	—		35,687			—		35,687			37,256
Total liabilities	$	1,573,709	$	304,596		$	—	$	1,878,305		$	1,881,754
Off-Balance-Sheet:
Commitments to extend credit	$	—	$	(1,357	)	$	—	$	(1,357	)	$	—

The following valuation methods and assumptions were used by the Corporation in estimating its fair value for financial instruments measured at fair value on a non-recurring basis and financial instruments not measured at fair value on a recurring or non-recurring basis in the Corporation’s consolidated balance sheets but for which the fair value is required to be disclosed:

Cash and short-term interest-earning assets: The carrying amounts reported in the balance sheet for cash and due from banks, interest-earning deposits with other banks, and other short-term investments approximates those assets’ fair values. Cash and short-term interest-earning assets are classified within Level 1 in the fair value hierarchy.

Held-to-maturity securities: Fair values for the held-to-maturity investment securities are estimated by using pricing models or quoted prices of securities with similar characteristics and are classified in Level 2 in the fair value hierarchy.

Loans held for sale: The fair value of the Corporation’s mortgage loans held for sale are generally determined using a pricing model based on current market information obtained from external sources, including interest rates, bids or indications provided by market participants on specific loans that are actively marketed for sale. These loans are primarily residential mortgage loans and are generally classified in Level 2 due to the observable pricing data. Loans held for sale are carried at the lower of cost or estimated fair value. There were no valuation adjustments for loans held for sale at September 30, 2014 and December 31, 2013.

Loans and leases held for investment: The fair values for loans are estimated using discounted cash flow analyses, using a discount rate based on current interest rates at which similar loans with similar terms would be made to borrowers and include components for credit risk, operating expense and embedded prepayment options. An overall valuation adjustment is made for specific credit risks in addition to general portfolio risk and is significant to the valuation. As permitted, the fair value of the loans and leases are not based on the exit price concept as discussed in the first paragraph of this note. Loans and leases are classified within Level 3 in the fair value hierarchy.

Impaired loans held for investment: Impaired loans held for investment include those collateral-dependent loans for which the practical expedient was applied, resulting in a fair-value adjustment to the loan. Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or fair value. Fair value is measured based on the value of the collateral securing these loans less costs to sell and is classified at a Level 3 in the fair value hierarchy. The fair value of collateral is based on appraisals performed by qualified licensed appraisers hired by the Corporation. At September 30, 2014, impaired loans held for investment had a carrying amount of $59.1 million with a valuation allowance of $1.1 million. At December 31, 2013, impaired loans held for investment had a carrying amount of $58.3 million with a valuation allowance of $3.0 million.

Mortgage servicing rights: The Corporation estimates the fair value of mortgage servicing rights using discounted cash flow models that calculate the present value of estimated future net servicing income. The model uses readily available prepayment speed assumptions for the interest rates of the portfolios serviced. Mortgage servicing rights were classified within Level 2 of the valuation hierarchy at December 31, 2013. The Corporation’s valuation model has not changed from December 31, 2013; however, management’s assessment of the inputs has resulted in mortgage servicing rights being classified within Level 3 of the valuation hierarchy at September 30, 2014. The Corporation reviews the mortgage servicing rights portfolio on a quarterly basis for impairment and the mortgage servicing rights are carried at the lower of amortized cost or estimated fair value. At September 30, 2014, mortgage servicing rights had a carrying amount of $5.4 million with no valuation allowance. At December 31, 2013, mortgage servicing rights had a carrying amount of $5.8 million with a valuation allowance of $250 thousand.

Goodwill and other identifiable assets: Certain non-financial assets subject to measurement at fair value on a non-recurring basis include goodwill and other identifiable intangible assets. During the nine months ended September 30, 2014, there were no triggering events that required valuation of goodwill and other identifiable intangible assets.

Other real estate owned: The fair value of other real estate owned is estimated based upon its appraised value less costs to sell. The real estate is stated at an amount equal to the loan balance prior to foreclosure, plus costs incurred for improvements to the property but no more than the fair value of the property, less estimated costs to sell. New appraisals are generally obtained on an annual basis. Other real estate owned is classified within Level 2 of the valuation hierarchy.

Deposit liabilities: The fair values for demand and savings accounts, with no stated maturities, is the amount payable on demand at the reporting date (carrying value) and are classified within Level 1 in the fair value hierarchy. The fair values for time deposits with fixed maturities are estimated by discounting the final maturity using interest rates currently offered for deposits with similar remaining maturities. Time deposits are classified within Level 2 in the fair value hierarchy.

Short-term borrowings: The fair value of customer repurchase agreements and federal funds purchased are estimated using current market rates for similar borrowings and are classified within Level 2 in the fair value hierarchy.

Off-balance-sheet instruments: Fair values for the Corporation’s off-balance-sheet instruments are based on the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing and are classified within Level 2 in the fair value hierarchy.