18. Fair Value Measurements

ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing an asset or liability. As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs are unobservable inputs for the asset or liability, which is typically based on an entity’s own assumptions, as there is little, if any, related market activity.

In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. The Company evaluates fair value measurement inputs on an ongoing basis in order to determine if there is a change of sufficient significance to warrant a transfer between levels. For example, changes in market activity or the addition of new unobservable inputs could, in the Company’s judgment, cause a transfer to either a higher or lower level.

A description of the valuation methodologies used for financial instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Available for Sale Securities – At December 31, 2016, the Company holds, as part of its investment portfolio, available for sale securities reported at fair value consisting of municipal securities, corporate debt securities, and TPS. The fair value of the majority of municipal securities are determined using widely accepted valuation techniques including matrix pricing and broker-quote based applications. Inputs include benchmark yields, reported trades, issuer spreads, prepayment speeds and other relevant items. As a result, the Company has determined that these valuations fall within Level 2 of the fair value hierarchy. The Company also holds TPS that are recorded at fair value based on unadjusted quoted market prices for identical securities in an active market. The majority of the TPS are actively traded in the market and as a result, the Company has determined that the valuation of these securities falls within Level 1 of the fair value hierarchy. The Company holds certain TPS and corporate debt securities for which unadjusted market prices are not available or the market is not active and are therefore classified as Level 2 or 3. In the second quarter of 2016, the Company transferred a TPS from Level 2 to Level 3 due to the lack of recent market activity. The Company uses broker-dealer quotes, valuations based on similar but not identical securities, or the most recent market trade (which may not be current) to price these securities. Unrealized gains on TPS Level 3 transfers and total net unrealized gains recognized in AOCI at December 31, 2016 and 2015 were immaterial.

Derivative Financial Instruments – The Company uses interest-rate swaps as part of its cash flow strategy to manage its interest-rate risk. The valuation of these instruments is determined using widely accepted valuation techniques as discussed further below. The fair values of interest-rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves.

Pursuant to guidance in ASC 820, credit valuation adjustments are incorporated into the valuation to appropriately reflect both the Company’s own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings and thresholds.

The Company uses Level 2 and Level 3 inputs to determine the valuation of its derivatives portfolio. The valuation of derivative instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs (Level 2 inputs), including interest rate curves and implied volatilities. The estimates of fair value are made using a standardized methodology that nets the discounted expected future cash receipts and cash payments (based on observable market inputs). Level 3 inputs include the credit valuation adjustments which use estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. At December 31, 2016 and 2015, the Company assessed the impact of the Level 3 inputs on the overall derivative valuations in terms of the significance of the credit valuation adjustments in basis points and as a percentage of the overall derivative portfolio valuation and the overall notional value. The Company’s assessment determined that credit valuation adjustments were not significant to the overall valuation of the portfolio. In addition, the significance of the credit value adjustments and overall derivative portfolio to the Company’s financial statements was considered. As a result of the insignificance of the credit value adjustments to the derivative portfolio valuations and the Company’s financial statements, the Company classified the derivative valuations in their entirety in Level 2.

The Company uses foreign exchange forward contracts to mitigate exchange-rate risk arising from the Company’s foreign currency holdings to support its international banking product offering. Fair value measurements of these assets or liabilities are priced based on spot and forward foreign currency rates and the credit worthiness of the contract counterparty. These contracts are classified in Level 2.

The following tables present the Company’s assets and liabilities measured at fair value on a recurring basis at December 31, 2016 and 2015, aggregated by the level in the fair value hierarchy within which those measurements fall.


			Fair value measurements using:
			Quoted prices in		Significant other		Significant
			active markets for		observable		unobservable
	Balance at		identical assets		inputs		inputs
(in thousands)	December 31, 2016		(Level 1)		(Level 2)		(Level 3)
Assets
Available for sale securities:
Trust preferred securities	$	37,624	$	4,283	$	23,893	$	9,448
Corporate debt securities		92,077		-		92,077		-
Municipal securities		3,280		-		3,280		-
Total available for sale securities	$	132,981	$	4,283	$	119,250	$	9,448

Derivatives:
Fair value hedge	$	476	$	-	$	476	$	-
Non-designated hedges		2,755		-		2,755		-
Foreign exchange forward contracts		52		-		52		-
Total derivative assets	$	3,283	$	-	$	3,283	$	-

Liabilities
Derivatives:
Cash flow hedge	$	7,639	$	-	$	7,639	$	-
Fair value hedge		845		-		845		-
Non-designated hedges		2,736		-		2,736		-
Foreign exchange forward contracts		5		-		5		-
Total derivative liabilities	$	11,225	$	-	$	11,225	$	-


			Fair value measurements using:
			Quoted prices in		Significant other		Significant
			active markets for		observable		unobservable
	Balance at		identical assets		inputs		inputs
(in thousands)	December 31, 2015		(Level 1)		(Level 2)		(Level 3)
Assets
Available for sale securities:
Trust preferred securities	$	46,083	$	13,090	$	27,183	$	5,810
Corporate debt securities		103,736		-		103,736		-
Municipal securities		3,866		-		3,866		-
Total available for sale securities	$	153,685	$	13,090	$	134,785	$	5,810

Derivatives:
Cash flow hedge	$	578	$	-	$	578	$	-
Fair value hedge		117		-		117		-
Non-designated hedges		3,092		-		3,092		-
Foreign exchange forward contracts		109		-		109		-
Total derivative assets	$	3,896	$	-	$	3,896	$	-

Liabilities
Derivatives:
Cash flow hedge	$	4,981	$	-	$	4,981	$	-
Fair value hedge		1,574		-		1,574		-
Non-designated hedges		3,275		-		3,275		-
Foreign exchange forward contracts		59		-		59		-
Total derivative liabilities	$	9,889	$	-	$	9,889	$	-

A reconciliation of the beginning and ending balances of assets measured at fair value, on a recurring basis, using Level 3 inputs follows:


	For the year ended December 31,
(in thousands)	2016		2015
Beginning balance	$	5,810	$	6,754
Transfers and purchases		3,276		-
Net accretion		89		60
Sales / calls / maturities		-		(985)
Unrealized gain (loss) included in comprehensive income		273		(19)
Ending balance	$	9,448	$	5,810

Assets and liabilities measured on a nonrecurring basis

Fair value is used on a nonrecurring basis to evaluate certain financial assets and financial liabilities in specific circumstances. Similarly, fair value is used on a nonrecurring basis for nonfinancial assets and nonfinancial liabilities such as foreclosed assets, other real estate owned, intangible assets, nonfinancial assets and liabilities evaluated in a goodwill impairment analysis and other nonfinancial assets measured at fair value for purposes of assessing impairment. A description of the valuation methodologies used for financial and nonfinancial assets and liabilities measured at fair value, as well as the general classification of such assets and liabilities pursuant to the valuation hierarchy, is set forth below.

Impaired Loans – Certain collateral-dependent impaired loans are reported at the fair value of the underlying collateral. Impairment is measured based on the fair value of the collateral, which is typically derived from appraisals that take into consideration prices in observed transactions involving similar assets and similar locations. Each appraisal is updated on an annual basis, either through a new appraisal, a new evaluation, or through the Company’s comprehensive internal review process. Appraised values are reviewed and monitored internally and fair value is assessed at least quarterly or more frequently when circumstances occur that indicate a change in fair value has occurred. The Company classified these impaired loans as Level 3.

Other Real Estate Owned (OREO) – OREO represents real property taken by the Company either through foreclosure or through a deed in lieu thereof from the borrower. The fair value of OREO is based on property appraisals adjusted at management’s discretion to reflect a further decline in the fair value of properties since the time the appraisal analysis was performed. The inputs used to determine the fair value of OREO fall within Level 3. The Company may include within OREO other repossessed assets received as partial satisfaction of a loan. Other repossessed assets are not material and do not typically have readily determinable market values and are considered Level 3 inputs.

The following tables present the Company’s nonfinancial assets measured at fair value on a nonrecurring basis at December 31, 2016 and 2015, aggregated by the level in the fair value hierarchy within which those measurements fall.


			Fair value measurements using:
			Quoted prices in		Significant other		Significant
			active markets for		observable		unobservable
			identical assets		inputs		inputs
(in thousands)	Total		(Level 1)		(Level 2)		(Level 3)
At December 31, 2016
Impaired loans	$	1,425	$	-	$	-	$	1,425
OREO	$	5,351	$	-	$	-	$	5,351

At December 31, 2015
Impaired loans	$	6,296	$	-	$	-	$	6,296
OREO	$	5,351	$	-	$	-	$	5,351

Gains and losses, which include the provision for losses on impaired loans, recorded in relation to assets and liabilities measured on a nonrecurring basis are presented below:


	Gain (loss) for the year ended
	December 31,
(in thousands)	2016		2015		2014
Impaired loans	$	2,831	$	(5,980)	$	(353)
OREO		-		69		1,459

In accordance with ASC 310, the fair value of OREO recorded as an asset is reduced by estimated selling costs. The following table is a reconciliation of the fair value measurement of OREO disclosed pursuant to ASC 820 to the amount recorded on the condensed consolidated balance sheet:


	At December 31,
(in thousands)	2016		2015
OREO recorded at fair value	$	5,351	$	5,351
Estimated selling costs		(272)		(272)
OREO	$	5,079	$	5,079

Valuation adjustments on OREO and additional gains or losses at the time OREO is sold are recognized in current earnings under the caption “Net gain on securities, other assets and other real estate owned.” Below is a summary of OREO transactions for the years ended December 31, 2016 and 2015


(in thousands)	2016		2015
Beginning OREO balance	$	5,079	$	5,819
Additions		-		-
Sales		-		(809)
Net gain on sale and valuation adjustments		-		69
Ending OREO balance	$	5,079	$	5,079

The following table provides information describing the valuation processes used to determine recurring and nonrecurring fair value measurements categorized within Level 3 of the fair value hierarchy.


	At December 31, 2016
	Fair Value					Weighted
Category	(in thousands)		Valuation Technique		Unobservable Input	Average	Range
Trust preferred securities	$	9,448	Market approach		Discount to carrying value using broker quotes or observable prices on similar securities	13%	1% to 28%

Impaired loans:
Commercial	$	1,057	Sales comparison	(1)	Management discount for asset type	59%	0% - 76%
Real estate - mortgage		269	Sales comparison	(2)	Sales comparison adjustments	18%	NA
Consumer		99	Sales comparison	(2)	Sales comparison adjustments	(1)%	(11)% - 10%
Total impaired loans	$	1,425
OREO:
Commercial	$	190	Property appraisals	(2)	Management discount for property type	0%	0%
Construction & land		5,161	Property appraisals	(2)	Management discount for property type	17%	NA
Total OREO	$	5,351


	At December 31, 2015

	Fair Value					Weighted
Category	(in thousands)		Valuation Technique		Unobservable Input	Average	Range
Trust preferred securities	$	5,810	Market approach		Discount to carrying value using broker quotes or observable prices on similar securities	15%	1% to 18%

Impaired loans:
Commercial	$	5,006	Sales comparison	(1)	Management discount for asset type	47%	0% to 81%
Commercial		667	Sales comparison	(2)	Sales comparison adjustments	(32)%	NA
Real estate - mortgage		487	Sales comparison	(2)	Sales comparison adjustments	12%	(15)% to 17%
Construction & land		27	Sales comparison	(2)	Sales comparison adjustments	(24)%	NA
Consumer		109	Sales comparison	(2)	Sales comparison adjustments	11%	(2)% to 14%
Total impaired loans	$	6,296
OREO:
Commercial	$	190	Property appraisals	(2)	Management discount for property type	0%	0%
Construction & land		5,161	Property appraisals	(2)	Management discount for property type	17%	NA
Total OREO	$	5,351

(1)

Discount represents management discounts applied to market valuation of various business assets, including accounts receivable and inventory.

(2)

The fair value of OREO and collateral-dependent impaired loans is based on third-party property appraisals. The majority of the appraisals utilize at least two valuation approaches or a combination of approaches including a market approach, where prices and other relevant information generated by market transactions involving similar or comparable properties are used to determine fair value. Appraisals may include an ‘as is’ and ‘upon completion’ valuation scenarios. Adjustments are routinely made in the appraisal process by third-party appraisers to adjust for differences between the comparable sales and income data. Adjustments also result from the consideration of relevant economic and demographic factors with the potential to affect property values. Also, prospective values are based on the market conditions which exist at the date of inspection combined with informed forecasts based on current trends in supply and demand for the property types under appraisal. Positive adjustments disclosed in this table represent increases to the sales comparison and negative adjustment represent decreases.

The following table includes the estimated fair value of the Company’s financial instruments. The methodologies for estimating the fair value of financial assets and financial liabilities measured at fair value on a recurring and nonrecurring basis are discussed above. The methodologies for estimating the fair value for other financial assets and financial liabilities are discussed below. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data in order to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts at December 31, 2016 and 2015.


	December 31, 2016				December 31, 2015
	Carrying		Estimated		Carrying		Estimated
(in thousands)	value		fair value		value		fair value
Financial assets:
Cash and cash equivalents	$	96,050	$	96,050	$	67,312	$	67,312
Investment securities available for sale		132,981		132,981		153,685		153,685
Investment securities held to maturity		366,041		363,178		346,666		345,576
Other investments		11,365		11,365		12,461		12,461
Loans — net		2,900,812		2,868,091		2,658,519		2,647,448
Accrued interest receivable		12,223		12,223		10,362		10,362
Derivatives		3,283		3,283		3,896		3,896

Financial liabilities:
Deposits	$	3,029,783	$	3,029,226	$	2,741,712	$	2,741,366
Securities sold under agreements to repurchase		27,639		26,101		47,459		45,474
Short-term borrowings		106,230		106,230		132,000		132,000
Accrued interest payable		1,038		1,038		1,134		1,134
Subordinated notes payable		59,111		58,681		59,031		59,080
Junior subordinated debentures		72,166		72,166		72,166		72,166
Derivatives		11,225		11,225		9,889		9,889

The fair value estimation methodologies utilized by the Company for financial instruments and the classification level within the fair value hierarchy that those instruments fall are summarized as follows:

Cash and Cash Equivalents — The carrying amount of cash and cash equivalents is a reasonable estimate of fair value which is classified as Level 2.

Other Investments — Included in this category are the Company’s investment in the FHLB and other equity method investments. Due to restrictions on transferability, it is not practical to estimate fair value on the FHLB investment which is reported at carrying value. The fair value of other equity method investments approximates fair value and is classified as Level 2.

Loans — The fair value of loans is estimated by discounting future contractual cash flows using estimated market rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. In computing the estimate of fair value for all loans, the estimated cash flows and/or carrying value have been reduced by specific and general reserves for loan losses. The fair value of loans disclosed in the table above, which is not the exit price, is classified as Level 3 within the fair value hierarchy.

Accrued Interest Receivable/Payable — The fair value of accrued interest receivable/payable approximates the carrying amount due to the short-term nature of these amounts and is classified in the same level hierarchy as the underlying assets/liabilities.

Deposits — The fair value of certificates of deposit is estimated by discounting the expected life using an index of the U.S. Treasury curve. Non-maturity deposits are reflected at their carrying value for purposes of estimating fair value. The fair value of all deposits is classified as Level 2.

Securities Sold Under Agreements to Repurchase — Estimated fair value is based on discounting cash flows and is classified as Level 2.

Short-Term Borrowings — The estimated fair value of short-term borrowings approximates their carrying value, due to their short-term nature and is classified as Level 2.

Subordinated Notes Payable — The estimated fair value of subordinated notes payable is based on discounting cash flows for comparable instruments and is classified as Level 3.

Junior Subordinated Debentures — The estimated fair value of junior subordinated debentures approximates their carrying value, due to the variable interest rate paid on the debentures and is classified as Level 2.

Commitments to Extend Credit and Standby Letters of Credit — The Company’s off-balance sheet commitments are funded at current market rates at the date they are drawn upon. It is management’s opinion that the fair value of these commitments would approximate their carrying value, if drawn upon, and are classified as Level 3.

The fair value estimates presented herein are based on pertinent information available to management at December 31, 2016 and 2015. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.