Fair Value Measurements

The Company uses its best judgment in estimating the fair value of its financial instruments and certain nonfinancial assets; however, there are inherent weaknesses in any estimation technique due to assumptions that are susceptible to significant change. Therefore, for substantially all financial instruments and certain nonfinancial assets, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sale transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective period-ends and have not been reevaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments and certain nonfinancial assets subsequent to the respective reporting dates may be different than the amounts reported at each period-end.

Fair value is 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. The Company uses the following fair value hierarchy in selecting inputs with the highest priority given to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements):

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability;

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity).

As required, financial and certain nonfinancial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following table sets forth the Company's financial assets that were measured at fair value on a recurring basis by level within the fair value hierarchy:



			Fair Value Measurements at Reporting Date Using
Description			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	Total		(Level 1)		(Level 2)		(Level 3)
March 31, 2015
U.S. Government agency securities	$	33,541	$	—	$	33,541	$	—
Residential MBSs	58,729		—		58,729		—
Agency CMOs	363,519		—		363,519		—
Municipal securities	30,236		—		30,236		—
Securities available for sale	$	486,025	$	—	$	486,025	$	—



			Fair Value Measurements at Reporting Date Using
Description			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	Total		(Level 1)		(Level 2)		(Level 3)
December 31, 2014
U.S. Government agency securities	$	32,788	$	—	$	32,788	$	—
Residential MBSs	60,149		—		60,149		—
Agency CMOs	405,009		—		405,009		—
Municipal securities	30,092		—		30,092		—
Securities available for sale	$	528,038	$	—	$	528,038	$	—

As of March 31, 2015 and December 31, 2014, the Company did not have any liabilities that were measured at fair value on a recurring basis.

Impaired Loans (Generally Carried at Fair Value)

Impaired loans that are measured at fair value on a nonrecurring basis include collateral dependent loans for which an impairment has been recorded by the Company based on the fair value of the loan's collateral, net of expected selling costs. Fair value is generally determined based upon independent third party appraisals or valuations of the collateral properties. The discount rates used on collateral dependent loans vary based on the type of collateral. The range of discount rates used for real estate collateral ranged from 10% to 30% at March 31, 2015 as compared to 10% to 35% at December 31, 2014; the weighted-average rate was 19% as of March 31, 2015 as compared to 20% at December 31, 2014. Inventory is generally discounted at 50%, equipment is generally discounted by 30% to 50% and accounts receivable are generally discounted by 20%. These assets are included as Level 3 fair values, based upon the lowest level of unobservable input that is significant to the fair value measurements. The fair value consists of the loan balance less any valuation allowance. The valuation allowance amount is calculated as the difference between the recorded investment in a loan and the discounted collateral value.

At March 31, 2015, the cumulative fair value of 12 impaired collateral-dependent loans with individual allowance allocations totaled $7.2 million, net of valuation allowances of $5.7 million, and the fair value of impaired loans that were partially charged off during the first three months of 2015 totaled $244,000 at March 31, 2015, net of charge-offs of $119,000. At December 31, 2014, the cumulative fair value of nine impaired loans with individual allowance allocations totaled $3.9 million, net of valuation allowances of $5.6 million, and the fair value of impaired collateral dependent loans that were partially charged off during 2014 totaled $5.3 million at December 31, 2014, net of charge-offs of $2.4 million. The Company's impaired loans are more fully discussed in Note 4.

Foreclosed Assets (Carried at Lower of Cost or Fair Value)

The fair value of real estate acquired through foreclosure is based on independent third party appraisals of the properties, less estimated selling costs. A standard discount rate of 15%, to cover estimated costs to sell the property, is generally used on the most recent appraisal to determine the fair value of the real estate. These assets are included as Level 3 fair values, based upon the lowest level of unobservable input that is significant to the fair value measurements. At March 31, 2015 and December 31, 2014, there were no foreclosed assets with a valuation allowance recorded subsequent to initial foreclosure.

The determination of the fair value of assets measured on a nonrecurring basis is sensitive to changes in economic conditions and can fluctuate in a relatively short period of time. For assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used were as follows:



			Fair Value Measurements at Reporting Date Using
Description			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	Total		(Level 1)		(Level 2)		(Level 3)
March 31, 2015
Impaired collateral dependent loans with specific allocations	$	7,168	$	—	$	—	$	7,168
Impaired collateral dependent loans net of partial charge-offs	244		—		—		244
Total	$	7,412	$	—	$	—	$	7,412



			Fair Value Measurements at Reporting Date Using
Description			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	Total		(Level 1)		(Level 2)		(Level 3)
December 31, 2014
Impaired collateral dependent loans with specific allocations	$	3,882	$	—	$	—	$	3,882
Impaired collateral dependent loans net of partial charge-offs	5,263		—		—		5,263
Total	$	9,145	$	—	$	—	$	9,145

The Company's policy is to recognize transfers between levels as of the beginning of the period. There were no transfers between Levels 1 and 2 or between Levels 2 and 3 for the three months ended March 31, 2015.

The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company's assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company's disclosures and those of other companies may not be meaningful. The following valuation techniques were used to estimate the fair values of the Company's financial instruments at March 31, 2015 and December 31, 2014:

Cash and Cash Equivalents (Carried at Cost)

Cash and cash equivalents include cash and balances due from banks, all of which have original maturities of 90 days or less. The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets' fair values.

Securities

The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities' relationship to other benchmark prices. In determining fair market values for its portfolio holdings, the Company receives information from a third party provider which management evaluates and corroborates. Under the current guidance, these values are considered Level 2 inputs, based upon mathematically derived matrix pricing and observed data from similar assets. They are not Level 1 direct quotes, nor do they reflect Level 3 inputs that would be derived from internal analysis or judgment. As the Company does not manage a trading portfolio and typically only sells from its AFS portfolio in order to manage interest rate risk or credit exposure, direct quotes, or street bids, are warranted on an as-needed basis only.

Loans Held for Sale (Carried at Lower of Cost or Fair Value)

The fair value of loans held for sale is determined, when possible, using quoted secondary-market prices. If no such quoted prices exist, the fair value of a loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of that loan. Loans held for sale at March 31, 2015 and December 31, 2014 did not have any write-downs to fair value and were carried at cost.

Loans Receivable (Carried at Cost)

The fair value of loans receivable, excluding all nonaccrual loans and accruing loans deemed impaired loans with specific loan allowances, are estimated using a discounted cash flow analysis, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the respective loans. Projected future cash flows are calculated based upon contractual maturity, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.

Restricted Investments in Bank Stock (Carried at Cost)

The carrying amount of restricted investments in bank stock approximates fair value and considers the limited marketability of such securities. The restricted investments in bank stock consisted of FHLB and Atlantic Community Bankers Bank (ACBB) stock at March 31, 2015 and December 31, 2014.

Accrued Interest Receivable and Payable (Carried at Cost)

The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.

Deposit Liabilities (Carried at Cost)

The fair values disclosed for demand deposits (e.g., interest and noninterest-bearing checking) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair value of savings and money market accounts are reported based on the carrying amount. Fair values for fixed-rate certificates of deposits (CDs) are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Short-Term Borrowings (Carried at Cost)

The carrying amounts of short-term borrowings approximate their fair values.

Long-Term Debt (Carried at Cost)

The fair value of long-term debt was estimated using a discounted cash flow analysis, based on quoted prices from a third party broker for new debt with similar characteristics, terms and remaining maturity.

Off-Balance Sheet Financial Instruments (Disclosed at Cost)

Fair values for the Company's off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties' credit standing.

The estimated fair values of the Company's financial instruments were as follows:



Fair Value Measurements at March 31, 2015
					Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	Carrying Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
Financial assets:
Cash and cash equivalents	$	58,398	$	58,398	$	58,398	$	—	$	—
Securities	809,107		809,081		—		809,081		—
Loans, held for sale	5,613		5,628		—		—		5,628
Loans receivable, net	1,977,955		1,985,025		—		—		1,985,025
Restricted investments in bank stock	16,021		16,021		—		—		16,021
Accrued interest receivable	7,644		7,644		7,644		—		—
Financial liabilities:
Deposits	$	2,411,519	$	2,413,948	$	—	$	—	$	2,413,948
Short-term borrowings	246,986		246,986		246,986		—		—
Long-term debt	25,000		24,909		—		—		24,909
Accrued interest payable	425		425		425		—		—
Off-balance sheet instruments:
Standby letters of credit	$	—	$	—	$	—	$	—	$	—
Commitments to extend credit	—		—		—		—		—



Fair Value Measurements at December 31, 2014
					Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	Carrying Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
Financial assets:
Cash and cash equivalents	$	42,832	$	42,832	$	42,832	$	—	$	—
Securities	853,032		847,961		—		847,961		—
Loans, held for sale	4,996		5,037		—		—		5,037
Loans receivable, net	1,973,536		1,980,846		—		—		1,980,846
Restricted investments in bank stock	15,223		15,223		—		—		15,223
Accrued interest receivable	7,349		7,349		7,349		—		—
Financial liabilities:
Deposits	$	2,380,672	$	2,383,085	$	—	$	—	$	2,383,085
Short-term borrowings	333,475		333,475		333,475		—		—
Accrued interest payable	325		325		325		—		—
Off-balance sheet instruments:
Standby letters of credit	$	—	$	—	$	—	$	—	$	—
Commitments to extend credit	—		—		—		—		—