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 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 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 end of each trading day. Level 2 of the valuation hierarchy includes securities issued by U.S. Government sponsored enterprises, mortgage-backed securities, collateralized mortgage obligations, corporate and municipal bonds and certain equity securities. 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. 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.

Certain corporate bonds owned by the Corporation are classified as Level 3 as they are not traded in active markets. The fair value of each bond is estimated by benchmarking similar transactions of structure, yield and credit which are owned by the Corporation and are actively traded in the market.

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. If, upon the Corporation’s review or in comparing with another service, a material difference between pricing evaluations were to exist, the Corporation may submit an inquiry to the current pricing service regarding the data used to determine the valuation of a particular security. If the Corporation determines there is market information that would support a different valuation than from the current pricing service’s evaluation, the Corporation may utilize and change the security's valuation. There were no material differences in valuations noted at December 31, 2017.

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. Interest rate swaps and mortgage banking derivative financial instruments are classified within Level 2 of the valuation hierarchy. Credit derivatives are valued based on credit worthiness of the underlying borrower which is a significant unobservable input and therefore classified in Level 3 of the valuation hierarchy.

Two commercial loans, associated with interest rate swaps are classified in Level 3 of the valuation hierarchy since lending credit risk is not an observable input for these loans. The unrealized gain on the two loans was $51 thousand at December 31, 2017.

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 of estimated future contingent payments based on projected revenue of the acquired business affecting the contingent consideration liability will be recorded through noninterest expense. Changes in the original assumptions utilized at the time the acquisition closes and identified during the measurement period are recorded in accordance with ASC Topic 805 as an adjustment to goodwill. 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 conclusion for the earn-out period ending June 30, 2017 resulted in a reversal of a prior noninterest expense accrual of $301 thousand primarily during the second quarter of 2017.

The following table presents the assets and liabilities measured at fair value on a recurring basis at December 31, 2017 and 2016, classified using the fair value hierarchy:



	At December 31, 2017
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets/ Liabilities at Fair Value
Assets:
Available-for-sale securities:
U.S. government corporations and agencies	$	—	$	16,961	$	—	$	16,961
State and political subdivisions	—		78,297		—		78,297
Residential mortgage-backed securities	—		185,421		—		185,421
Collateralized mortgage obligations	—		3,602		—		3,602
Corporate bonds	—		79,190		27,986		107,176
Money market mutual funds	5,985		—		—		5,985
Equity securities	1,076		—		—		1,076
Total available-for-sale securities	7,061		363,471		27,986		398,518
Loans*	—		—		1,958		1,958
Interest rate swap*	—		13		—		13
Interest rate locks with customers*	—		527		—		527
Forward loan sale commitments*	—		61		—		61
Total assets	$	7,061	$	364,059	$	29,944	$	401,064
Liabilities:
Contingent consideration liability	$	—	$	—	$	339	$	339
Interest rate swaps*	—		50		—		50
Credit derivatives*	—		—		36		36
Total liabilities	$	—	$	50	$	375	$	425



	At December 31, 2016
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets/ Liabilities at Fair Value
Assets:
Available-for-sale securities:
U.S. government corporations and agencies	$	—	$	32,266	$	—	$	32,266
State and political subdivisions	—		88,350		—		88,350
Residential mortgage-backed securities	—		198,570		—		198,570
Collateralized mortgage obligations	—		4,554		—		4,554
Corporate bonds	—		79,420		28,778		108,198
Money market mutual funds	10,784		—		—		10,784
Equity securities	915		—		—		915
Total available-for-sale securities	11,699		403,160		28,778		443,637
Loans*	—		—		2,138		2,138
Interest rate locks with customers*	—		801		—		801
Forward loan sale commitments*	—		257		—		257
Total assets	$	11,699	$	404,218	$	30,916	$	446,833
Liabilities:
Contingent consideration liability	$	—	$	—	$	5,999	$	5,999
Interest rate swaps*	—		319		—		319
Credit derivatives*	—		—		9		9
Total liabilities	$	—	$	319	$	6,008	$	6,327

*Such financial instruments are recorded at fair value as further described in Note 17, "Derivative Instruments."

The following table includes a rollfoward of corporate bonds, loans and credit derivatives for which the Corporation utilized Level 3 inputs to determine fair value on a recurring basis for year ended December 31, 2017 and 2016.



	For the Year Ended December 31, 2017
(Dollars in thousands)	Balance at December 31, 2016			Purchases/additions			Sales		Payments received			Premium amortization, net		(Decrease) increase in value			Balance at December 31, 2017
Corporate bonds	$	28,778		$	—		$	—	$	—		$	—	$	(792	)	$	27,986
Loans	2,138			—			—		(137		)	—		(43		)	1,958
Credit derivatives	(9		)	(430		)	—		—			—		403			(36		)
Net total	$	30,907		$	(430	)	$	—	$	(137	)	$	—	$	(432	)	$	29,908



	For the Year Ended December 31, 2016
(Dollars in thousands)	Balance at December 31, 2015		Purchases/additions			Sales		Payments received			Premium amortization, net		(Decrease) increase in value			Balance at December 31, 2016
Corporate bonds	—		—			—		—			—		—			28,778
Loans	—		2,313			—		(65		)	—		(110		)	2,138
Credit derivatives	—		(102		)	—		—			—		93			(9		)
Net total	$	—	$	2,211		$	—	$	(65	)	$	—	$	(17	)	$	30,907

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 years ended December 31, 2017 and 2016:



	For the Year Ended December 31, 2017
(Dollars in thousands)	Balance at December 31, 2016		Contingent Consideration from New Acquisition		Payment of Contingent Consideration		Adjustment of Contingent Consideration			Balance at December 31, 2017
Sterner Insurance Associates	$	331	$	—	$	30	$	(301	)	$	—
Girard Partners	5,668		—		5,383		54			339
Total contingent consideration liability	$	5,999	$	—	$	5,413	$	(247	)	$	339



	For the Year Ended December 31, 2016
(Dollars in thousands)	Balance at December 31, 2015		Contingent Consideration from New Acquisition*		Payment of Contingent Consideration		Adjustment of Contingent Consideration		Balance at December 31, 2016
Sterner Insurance Associates	$	1,144	$	—	$	1,325	$	512	$	331
Girard Partners	4,241		—		967		2,394		5,668
John T. Fretz Insurance Agency	192		—		260		68		—
Total contingent consideration liability	$	5,577	$	—	$	2,552	$	2,974	$	5,999

*Includes adjustments during the measurement period in accordance with ASC Topic 805.

The Corporation may be required to periodically 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 December 31, 2017 and 2016:



	At December 31, 2017
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets at Fair Value
Impaired loans held for investment	$	—	$	—	$	28,351	$	28,351
Impaired leases held for investment	—		—		1,250		1,250
Other real estate owned	—		—		1,843		1,843
Total	$	—	$	—	$	30,194	$	30,194



	At December 31, 2016
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets at Fair Value
Impaired loans held for investment	$	—	$	—	$	43,680	$	43,680
Other real estate owned	—		—		4,969		4,969
Total	$	—	$	—	$	48,649	$	48,649

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 December 31, 2017 and 2016. The disclosed fair values are classified using the fair value hierarchy.



	At December 31, 2017
(Dollars in thousands)	Level 1		Level 2			Level 3		Fair Value			Carrying Amount
Assets:
Cash and short-term interest-earning assets	$	75,409	$	—		$	—	$	75,409		$	75,409
Held-to-maturity securities	—		55,320			—		55,320			55,564
Federal Home Loan Bank, Federal Reserve Bank and other stock	N/A		N/A			N/A		N/A			27,204
Loans held for sale	—		1,676			—		1,676			1,642
Net loans and leases held for investment	—		—			3,547,451		3,547,451			3,566,953
Servicing rights	—		—			10,046		10,046			6,573
Total assets	$	75,409	$	56,996		$	3,557,497	$	3,689,902		$	3,733,345
Liabilities:
Deposits:
Demand and savings deposits, non-maturity	$	2,980,170	$	—		$	—	$	2,980,170		$	2,980,170
Time deposits	—		574,737			—		574,737			574,749
Total deposits	2,980,170		574,737			—		3,554,907			3,554,919
Short-term borrowings	—		105,431			—		105,431			105,431
Long-term debt	—		156,834			—		156,834			155,828
Subordinated notes	—		98,075			—		98,075			94,331
Total liabilities	$	2,980,170	$	935,077		$	—	$	3,915,247		$	3,910,509
Off-Balance-Sheet:
Commitments to extend credit	$	—	$	(2,414	)	$	—	$	(2,414	)	$	—



	At December 31, 2016
(Dollars in thousands)	Level 1		Level 2			Level 3		Fair Value			Carrying Amount
Assets:
Cash and short-term interest-earning assets	$	57,825	$	—		$	—	$	57,825		$	57,825
Held-to-maturity securities	—		24,871			—		24,871			24,881
Federal Home Loan Bank, Federal Reserve Bank and other stock	N/A		N/A			N/A		N/A			24,869
Loans held for sale	—		5,943			—		5,943			5,890
Net loans and leases held for investment	—		—			3,193,886		3,193,886			3,222,569
Servicing rights	—		—			9,548		9,548			6,485
Total assets	$	57,825	$	30,814		$	3,203,434	$	3,292,073		$	3,342,519
Liabilities:
Deposits:
Demand and savings deposits, non-maturity	$	2,631,378	$	—		$	—	$	2,631,378		$	2,631,378
Time deposits	—		628,096			—		628,096			626,189
Total deposits	2,631,378		628,096			—		3,259,474			3,257,567
Short-term borrowings	—		195,572			—		195,572			196,171
Long-term debt	—		130,157			—		130,157			127,522
Subordinated notes	—		95,188			—		95,188			94,087
Total liabilities	$	2,631,378	$	1,049,013		$	—	$	3,680,391		$	3,675,347
Off-Balance-Sheet:
Commitments to extend credit	$	—	$	(2,218	)	$	—	$	(2,218	)	$	—

The following valuation methods and assumptions were used by the Corporation in estimating the 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, federal funds sold 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.

Federal Home Loan Bank, Federal Reserve Bank and other stock: It is not practical to determine the fair values of Federal

Home Loan Bank, Federal Reserve Bank and other stock, due to restrictions placed on their transferability.

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 December 31, 2017 and 2016.

Loans and leases held for investment: The fair values for loans and leases held for investment 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 since credit risk is not an observable input.

Impaired loans and leases held for investment: For impaired loans and leases, the Corporation uses a variety of techniques to measure fair value, such as using the current appraised value of the collateral, agreements of sale, discounting the contractual cash flows, and analyzing market data that the Corporation may adjust due to specific characteristics of the loan/lease or collateral. At December 31, 2017, impaired loans held for investment had a carrying amount of $28.5 million with a valuation allowance of $131 thousand. At December 31, 2016, impaired loans held for investment had a carrying amount of $43.9 million with a valuation allowance of $235 thousand. The Corporation had impaired leases of $1.3 million with no reserve at December 31, 2017. The Corporation had no impaired leases at December 31, 2016.

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 are classified within Level 3 in the fair value hierarchy based upon management’s assessment of the inputs. 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. The Corporation also records servicing rights on small business administration (SBA) loans. At December 31, 2017 and December 31, 2016, servicing rights had a carrying amount of $6.6 million and $6.5 million, respectively, with no valuation allowance.

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. In accordance with ASC Topic 350, the Corporation performed a qualitative assessment of goodwill during the fourth quarter of 2017 and determined it was more likely than not that the fair value of the Corporation, including each of the identified reporting units, was more than its carrying amount; therefore, the Corporation did not need to perform the two-step impairment test for the Corporation or the reporting units. The Corporation also completed an impairment test for other intangible assets during the fourth quarter of 2017. There was no impairment of goodwill or identifiable intangibles recorded.

Other real estate owned: The fair value of other real estate owned (OREO) is originally estimated based upon the appraised value less estimated costs to sell. The fair value less cost to sell becomes the "original cost" of the OREO asset. Subsequently, OREO is reported as the lower of the original cost and the current the fair value less cost to sell. Capital improvement expenses associated with the construction or repair of the property are capitalized as part of the cost of the OREO asset; however, the capitalized expenses may not increase the OREO asset's recorded value to an amount greater than the asset's fair value after improvements and less cost to sell. New appraisals are generally obtained on an annual basis. During 2017, two properties had write-downs totaling $199 thousand and seven properties were sold at a net gain of $383 thousand which were both included in other noninterest income in the statement of income. Other real estate owned is classified within Level 3 of the valuation hierarchy due to the unique characteristics of the collateral for each loan.

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 short-term borrowings are estimated using current market rates for similar borrowings and are classified within Level 2 in the fair value hierarchy.

Long-term debt: The fair value of long-term debt is estimated by using discounted cash flow analysis, based on current market rates for debt with similar terms and remaining maturities. Long-term debt is classified within Level 2 in the fair value hierarchy.

Subordinated notes: The fair value of subordinated notes are estimated by discounting the principal balance using the treasury yield curve for the term to the call date as the Corporation has the option to call the subordinated notes. The subordinated notes 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.