Fair Value Measurements

The following methods and assumptions were used to estimate fair value disclosures. All financial instruments are held for other than trading purposes.

Cash and cash equivalents: Due to the short-term nature of these instruments, the carrying amounts reported in the balance sheet represent their fair values.

Investment securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Investments in Federal Home Loan Bank stock are recorded at cost, which also represents fair value.

Loans held for sale: Due to the short term nature of these instruments, the carrying amounts reported in the balance sheet represent their fair values.

Loans: Fair values were generally determined by discounting both principal and interest cash flows on pools of loans expected to be collected using a discount rate for similar instruments with adjustments that the Company believes a market participant would consider in determining fair value. The Company estimates the cash flows expected to be collected using internal credit risk, interest rate and prepayment risk models that incorporate the Corporation’s best estimate of current key assumptions, such as default rates, loss severity and prepayment speeds for the life of the loan. The carrying value of loans is presented net of the Allowance (see Note 6). Impaired loans are carried at fair value. Specific valuation allowances are included in the Allowance.

Purchased receivables: Fair values for purchased receivables are based on their carrying amounts due to their short duration and repricing frequency. Generally, purchased receivables have a duration of less than one year.

Mortgage servicing rights: MSRs are measured at fair value on a recurring basis. These assets are classified as Level 3 as quoted

prices are not available. In order to determine the fair value of MSRs, the present value of net expected future cash flows is estimated. Assumptions used include market discount rates, anticipated prepayment speeds, escrow calculations, delinquency rates, and ancillary fee income net of servicing costs. The model assumptions are also compared to publicly filed information from several large MSR holders, as available.

Accrued interest receivable: Due to the short-term nature of these instruments, the carrying amounts reported in the balance sheet represent their fair values.

Deposits: The fair value for deposits with stated maturities was determined by discounting contractual cash flows using current market rates for instruments with similar maturities. For deposits with no stated maturities; the carrying value was considered to approximate fair value and does not take into account the significant value of the cost advantage and stability of the Company's long-term relationships with depositors.

Accrued interest payable: Due to the short-term nature of these instruments, the carrying amounts reported in the balance sheet represent their fair values.

Securities sold under repurchase agreements: Fair values for securities sold under repurchase agreements are based on their carrying amounts due to their short duration and repricing frequency.

Borrowings: Due to the short-term nature of these instruments, the carrying amount of short-term borrowings reported in the balance sheet approximate the fair value. Fair values for long-term borrowings are estimated using a discounted cash flow calculation that applies currently offered interest rates to a schedule of aggregate expected monthly payments.

Accrued liability, RML acquisition payments: The carrying value of the accrued liability for estimated acquisition payments represents management's estimate of amounts owed to the sellers that are earned, but unpaid, as of the balance sheet date. Adjustments to the liability are reported in other operating expense. Due to the short-term nature of this liability, the carrying amounts reported in the consolidated balance sheets represents their fair values.

Junior subordinated debentures: Fair value adjustments for junior subordinated debentures are based on discounted cash flows to maturity using current interest rates for similar financial instruments. Management utilized a market approach to determine the appropriate discount rate for junior subordinated debentures.

Derivative Instruments: The fair value of the interest rate lock commitments are estimated using quoted or published market prices for similar instruments, adjusted for factors such as pull-through rate assumptions based on historical information, where appropriate. The pull-through rate assumptions are considered Level 3 valuation inputs and are significant to the interest rate lock commitment valuation; as such, the interest rate lock commitment derivatives are classified as Level 3. Interest rate contracts are valued in a model, which uses as its basis a discounted cash flow technique incorporating credit valuation adjustments to reflect nonperformance risk in the measurement of fair value. Although the Bank has determined that the majority of inputs used to value its interest rate derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of December 31, 2017, the Bank has assessed the significance of the impact of these adjustments on the overall valuation of its interest rate positions and has determined that they are not significant to the overall valuation of its interest rate derivatives. As a result, the Bank has classified its interest rate derivative valuations in Level 2 of the fair value hierarchy.

Assets subject to nonrecurring adjustment to fair value: The Company is also required to measure certain assets such as equity method investments, goodwill, intangible assets, impaired loans, and other real estate owned (“OREO”) at fair value on a nonrecurring basis in accordance with GAAP. Any nonrecurring adjustments to fair value usually result from the writedown of individual assets.

The Company uses either in-house evaluations or external appraisals to estimate the fair value of OREO and impaired loans as of each reporting date. In-house appraisals are considered Level 3 inputs and external appraisals are considered Level 2 inputs. The Company’s determination of which method to use is based upon several factors. The Company takes into account compliance with legal and regulatory guidelines, the amount of the loan, the size of the assets, the location and type of property to be valued and how critical the timing of completion of the analysis is to the assessment of value. Those factors are balanced with the level of internal expertise, internal experience and market information available, versus external expertise available such as qualified appraisers, brokers, auctioneers and equipment specialists.

The Company uses external sources to estimate fair value for projects that are not fully constructed as of the date of valuation. These projects are generally valued as if complete, with an appropriate allowance for cost of completion, including contingencies developed from external sources such as vendors, engineers and contractors. The Company believes that recording other real estate owned that is not fully constructed based on as if complete values is more appropriate than recording other real estate owned that is not fully constructed using as is values. We concluded that as-is-complete values are appropriate for these types of projects based on the accounting guidance for capitalization of project costs and subsequent measurement of the value of real estate. GAAP specifically states that estimates and cost allocations must be reviewed at the end of each reporting period and reallocated based on revised estimates. The Company adjusts the carrying value of other real estate owned in accordance with this guidance for increases in estimated cost to complete that exceed the fair value of the real estate at the end of each reporting period.

Commitments to extend credit and standby letters of credit: The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligation with the counterparties at the reporting date.

Limitations: Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Estimated fair values as of the periods indicated are as follows:



	December 31, 2017				December 31, 2016
(In Thousands)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Level 1 inputs:
Cash, due from banks and deposits in other banks		$77,841		$77,841		$50,551		$50,551
Investment securities	59,117		59,117		43,486		43,486

Level 2 inputs:
Investment securities	253,633		253,633		288,632		288,655
Investment in Federal Home Loan Bank Stock	2,115		2,115		1,965		1,965
Accrued interest receivable	4,385		4,385		3,734		3,734
Interest rate swaps	261		261		71		71

Level 3 inputs:
Loans and loans held for sale	999,445		1,001,346		1,018,611		1,026,350
Purchased receivables, net	22,231		22,231		20,491		20,491
Interest rate lock commitments	873		873		1,137		1,137
Mortgage servicing rights	7,305		7,305		4,157		4,157

Financial liabilities:
Level 2 inputs:
Deposits		$1,258,283		$1,257,670		$1,267,653		$1,266,995
Securities sold under repurchase agreements	27,746		27,746		27,607		27,607
Borrowings	7,362		7,308		4,338		4,186
Accrued interest payable	24		24		64		64
Interest rate swaps	77		77		71		71
Retail interest rate contracts	—		—		78		78
Level 3 inputs:
Accrued liability, RML acquisition payments	—		—		186		186
Junior subordinated debentures	10,310		9,856		18,558		18,398

The following table sets forth the balances as of the periods indicated of assets measured at fair value on a recurring basis:



(In Thousands)	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2017
Assets:
Available for sale securities
U.S. Treasury and government sponsored entities		$249,461		$49,878		$199,583		$—
Municipal securities	14,421		—		14,421		—
Corporate bonds	37,132		3,508		33,624		—
Collateralized loan obligations	6,005		—		6,005		—
Preferred stock	5,731		5,731		—		—
Total available for sale securities		$312,750		$59,117		$253,633		$—
Interest rate swaps		$261		$—		$261		$—
Interest rate lock commitments	873		—		—		873
Mortgage servicing rights	7,305		—		—		7,305
Total other assets		$8,439		$—		$261		$8,178
Liabilities:
Interest rate swaps		$77		$—		$77		$—
Total other liabilities		$77		$—		$77		$—
December 31, 2016
Assets:
Available for sale securities
U.S. Treasury and government sponsored entities		$263,361		$30,063		$233,298		$—
Municipal securities	18,157		—		18,157		—
U.S. Agency mortgage-backed securities	2		—		2		—
Corporate bonds	44,732		8,456		36,276		—
Preferred stock	4,967		4,967		—		—
Total available for sale securities		$331,219		$43,486		$287,733		$—
Interest rate swaps		$71		$—		$71		$—
Interest rate lock commitments	1,137		—		—		1,137
Mortgage servicing rights	4,157		—		—		4,157
Total other assets		$5,365		$—		$71		$5,294
Liabilities:
Interest rate swaps		$71		$—		$71		$—
Retail interest rate contracts	78		—		78		—
Total other liabilities		$149		$—		$149		$—

The following table provides a reconciliation of the assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the years ended December 31, 2017 and 2016:



(In Thousands)	Beginning balance		Change included in earnings			Purchases and issuances		Sales and settlements			Ending balance
December 31, 2017
Interest rate lock commitments		$1,137		($1,615	)		$15,084		($13,733	)		$873
Mortgage servicing rights	4,157		2			3,146		—			7,305
Total		$5,294		($1,613	)		$18,230		($13,733	)		$8,178
December 31, 2016
Interest rate lock commitments		$1,514		($2,063	)		$20,612		($18,926	)		$1,137
Mortgage servicing rights	1,654		(526		)	3,029		—			4,157
Total		$3,168		($2,589	)		$23,641		($18,926	)		$5,294

During 2017 and 2016, no impairment or valuation adjustment was recognized for assets recognized at fair value on a nonrecurring basis, except for certain assets as shown in the following table. For loans measured for impairment, the Company classifies fair value measurements using observable inputs, such as external appraisals, as Level 2 valuations in the fair value hierarchy, and unobservable inputs, such as in-house evaluations, as Level 3 valuations in the fair value hierarchy.



(In Thousands)	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2017
Loans measured for impairment		$7,988		$—		$—		$7,988
Other real estate owned	3,927		—		—		3,927
Other assets - equity method investment	2,292		—		—		2,292
Total		$14,207		$—		$—		$14,207
December 31, 2016
Loans measured for impairment		$9,222		$—		$—		$9,222
Other real estate owned	1,700		—		—		1,700
Total		$10,922		$—		$—		$10,922

The following table presents the losses resulting from nonrecurring fair value adjustments for the periods ended December 31, 2017 and 2016, respectively:



(In Thousands)	2017		2016		2015
Loans measured for impairment		$352		$270		$269
Other real estate owned	904		187		361
Other operating expense - impairment on equity method investment	686		—		—
Total loss from nonrecurring measurements		$1,942		$457		$630

Assets and Liabilities Measured at Fair Value Using Significant Unobservable Inputs (Level 3)

The following table provides a description of the valuation technique, unobservable input, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a nonrecurring basis at December 31, 2017 and 2016:



Financial Instrument	Valuation Technique	Unobservable Input	Weighted Average or Rate Range
December 31, 2017
Loans measured for impairment	In-house valuation of collateral	Discount rate	32% - 40%
	Discounted cash flow	Discount rate	7	%
Other real estate owned	Fair value of collateral	Estimated capital costs to complete improvements	25% - 32%
Interest rate lock commitment	External pricing model	Pull through rate	93.05	%
Mortgage servicing rights	Discounted cash flow	Constant prepayment rate	8.94% - 11.34%
		Discount rate	9.42% - 10.05%
December 31, 2016
Loans measured for impairment	In-house valuation of collateral	Discount rate	49% - 100%
	Discounted cash flow	Discount rate	7	%
Other real estate owned	Fair value of collateral	Estimated capital costs to complete improvements	11.50% - 25%
Interest rate lock commitment	External pricing model	Pull through rate	93	%
Mortgage servicing rights	Discounted cash flow	Constant prepayment rate	11.2% - 21.29%
		Discount rate	9.21% - 10.75%