Fair Value Measurements

Fair value pursuant to FASB ASC 820-10, Fair Value Measurements and Disclosures, is the exchange price, in an orderly transaction that is not a forced liquidation or distressed sale, between market participants to sell an asset or transfer a liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or liability. FASB ASC 820-10 provides a consistent definition of fair value which focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity specific inputs. In addition, FASB ASC 820-10 provides a framework for measuring fair value and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. Transfers between levels of the fair value hierarchy are recognized on the actual dates of the event or circumstances that caused the transfer, which generally coincides with the Corporation’s monthly and/or quarterly valuation process.

The standard describes three levels of inputs that may be used to measure fair values:


Level 1.	Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.


Level 2.	Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.


Level 3.	Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Corporation used the following methods to determine the fair value of each type of financial instrument:

Investment securities: Fair values for securities available-for-sale are obtained from an independent pricing service. The prices are not adjusted. The independent pricing service uses industry-standard models to price U.S. Government agency obligations and mortgage backed securities that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Securities of obligations of state and political subdivisions are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate based on credit rating.

Substantially all assumptions used by the independent pricing service are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace (Level 2). For securities not traded in active markets, the Corporation utilizes the services of an independent valuation firm (Level 3).

Residential loans held for sale: The fair value of loans held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan (Level 2).

Derivative financial instruments: Derivative instruments are used to hedge residential mortgage loans held for sale and the related interest-rate lock commitments and include forward commitments to sell mortgage loans and mortgage backed securities as further described in Note 11. The fair values of derivative financial instruments are based on derivative market data inputs as of the valuation date and the underlying value of mortgage loans for interest rate lock commitments (Level 3).

Derivative instruments are also in the form of interest rate swaps and an interest rate cap. Interest rate swaps and the cap are recorded at fair value based on third party vendors who compile prices from various sources and may determine fair value of identical or similar instruments by using pricing models that consider observable market data (Level 2). The interest rate swaps and cap are further described in Note 16.

Impaired loans: The fair values of impaired loans are measured on a nonrecurring basis as the fair value of the loan’s collateral for collateral-dependent loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The use of discounted cash flow models and management’s best judgment are significant inputs in arriving at the fair value measure of the underlying collateral (Level 3).

Other real estate owned: The fair value of other real estate owned, which consists of real estate that has been foreclosed, is recorded at the lower of fair value less selling expenses or the book balance prior to foreclosure. Write downs are provided for subsequent declines in value and are recorded in other operating expenses (Level 2).

Assets and liabilities measured at fair value under FASB ASC 820-10 on a recurring and non-recurring basis, including financial assets and liabilities for which the Corporation has elected the fair value option as of September 30, 2017 and December 31, 2016 are summarized below:



(In Thousands)	September 30, 2017
Description	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial Assets - Recurring
Available-for-sale investment securities
U.S. Government agencies	$	26,059	$	—	$	26,059	$	—
Municipals	101,409		—		101,409		—
Mortgage backed securities	246,915		—		246,915		—
Asset backed securities	8,723		—		4,402		4,321
Corporate bonds	8,551		—		8,551		—
Certificates of deposit	1,993		—		1,993		—
CRA mutual fund	1,390		—		1,390		—
Total available-for-sale investment securities	395,040		—		390,719		4,321

Residential loans held for sale	26,234		—		26,234		—
Derivative assets	487		—		51		436
Total Financial Assets - Recurring	$	421,761	$	—	$	417,004	$	4,757

Financial Liabilities - Recurring
Derivative liabilities	$	71	$	—	$	44	$	27

Financial Assets - Non-Recurring
OREO	$	1,980	$	—	$	—	$	1,980
Impaired loans ⁽¹⁾	$	5,837	$	—	$	—	$	5,837


(1)	Represents the carrying value of loans for which adjustments are based on the appraised value of the collateral, if collateral dependent, or the present value of expected future cash flows, discounted at the loan's effective interest rate.



(In Thousands)	December 31, 2016
Description	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial Assets - Recurring
Available-for-sale investment securities
U.S. Government agencies	$	4,994	$	—	$	4,994	$	—
Municipals	44,359		—		44,359		—
Mortgage backed securities	119,807		—		119,807		—
Asset backed securities	12,864		—		8,364		4,500
Corporate bonds	8,666		—		8,666		—
Certificate of deposit	2,009		—		2,009		—
CRA mutual fund	1,391		—		1,391		—
Total available-for-sale investment securities	194,090		—		189,590		4,500

Residential loans held for sale	35,676		—		35,676		—
Derivative assets	993		—		—		993
Total Financial Assets - Recurring	$	230,759	$	—	$	225,266	$	5,493

Financial Liabilities - Recurring
Derivative liabilities	$	325	$	—	$	—	$	325

Financial Assets - Non-Recurring
Impaired loans (1)	$	6,922	$	—	$	—	$	6,922


(1)	Represents the carrying value of loans for which adjustments are based on the appraised value of the collateral, if collateral dependent, or the present value of expected future cash flows, discounted at the loan's effective interest rate.

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows for the three month periods ended September 30, 2017 and 2016:



	Net Derivatives			Securities Available-for-Sale		Total
	(In Thousands)

Balance, beginning of period	$	606		$	4,226	$	4,832
Realized and unrealized gains (losses) included in earnings	(197		)	—		(197		)
Unrealized gains (losses) included in other comprehensive income	—			95		95
Purchases, settlements, paydowns, and maturities	—			—		—
Transfer into Level 3	—			—		—
Balance, September 30, 2017	$	409		$	4,321	$	4,730

	Net Derivatives			Securities Available-for-Sale		Total
	(In Thousands)

Balance, beginning of period	$	287		$	—	$	287
Realized and unrealized gains (losses) included in earnings	75			—		75
Unrealized gains (losses) included in other comprehensive income	—			—		—
Purchases, settlements, paydowns, and maturities	—			—		—
Transfer into Level 3	—			—		—
Balance, September 30, 2016	$	362		$	—	$	362

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows for the nine month periods ended September 30, 2017 and 2016:



	Net Derivatives			Securities Available-for-Sale			Total
	(In Thousands)

Balance, January 1, 2017	$	668		$	4,500		$	5,168
Realized and unrealized gains (losses) included in earnings	(259		)	—			(259		)
Unrealized gains (losses) included in other comprehensive income	—			(179		)	(179		)
Purchases, settlements, paydowns, and maturities	—			—			—
Transfer into Level 3	—			—			—
Balance, September 30, 2017	$	409		$	4,321		$	4,730

	Net Derivatives			Securities Available-for-Sale			Total
	(In Thousands)

Balance, January 1, 2016	$	273		$	—		$	273
Realized and unrealized gains (losses) included in earnings	89			—			89
Unrealized gains (losses) included in other comprehensive income	—			—			—
Purchases, settlements, paydowns, and maturities	—			—			—
Transfer into Level 3	—			—			—
Balance, September 30, 2016	$	362		$	—		$	362

The following tables present quantitative information as of September 30, 2017 and December 31, 2016 about Level 3 fair value measurements for assets measured at fair value:



	September 30, 2017
Description	Fair Value Estimate		Valuation Techniques	Unobservable Input	Range (Weighted Average)
	(In Thousands)
Financial Assets - Recurring
Asset backed securities	$	4,321	Valuation service	Discounted cash flows	3% - 6% (5%)
Derivative assets	436		Market pricing (3)	Estimated pullthrough	75% - 90% (85.5%)
Derivative liabilities	27		Market pricing (3)	Estimated pullthrough	75% - 90% (85.5%)

Financial Assets - Non-recurring
Impaired loans - Real estate secured	$	598	Appraisal of collateral (1)	Liquidation expenses (2)	0% - 20% (10%)
Impaired loans - Non-real estate secured	$	5,239	Cash flow basis	Liquidation expenses (2)	0% - 20% (10%)
Other real estate owned	$	1,980	Appraisal of collateral (1)	Discounts to reflect current market conditions and estimated selling costs	10%


(1)	Fair value is generally determined through independent appraisals of the underlying collateral on real estate secured loans, which generally include various Level 3 inputs which are not identifiable.


(2)	Valuations of impaired loans may be adjusted by management for qualitative factors such as liquidation expenses. The range and weighted average of liquidation expense adjustments are presented as a percent of the appraisal.


(3)	Market pricing on derivative assets and liabilities is adjusted by management for the anticipated percent of derivative assets and liabilities that will create a realized gain or loss. The range and weighted average of estimated pull-through is presented.



	December 31, 2016
Description	Fair Value Estimate		Valuation Techniques	Unobservable Input	Range (Weighted Average)
	(In Thousands)
Financial Assets - Recurring
Asset backed securities	$	4,500	Valuation service	Discounted cash flows	3% - 6% (5%)
Derivative assets	$	993	Market pricing (3)	Estimated pullthrough	75% - 90% (89.0%)
Derivative liabilities	$	325	Market pricing (3)	Estimated pullthrough	75% - 90% (89.0%)

Financial Assets - Non-recurring
Impaired loans - Real estate secured	$	1,371	Appraisal of collateral (1)	Liquidation expenses (2)	0% - 20% (10%)
Impaired loans - Non-real estate secured	$	5,551	Cash flow basis	Liquidation expenses (2)	0% - 20% (5%)


(1)	Fair value is generally determined through independent appraisals of the underlying collateral on real estate secured loans, which generally include various Level 3 inputs which are not identifiable.


(2)	Valuations of impaired loans may be adjusted by management for qualitative factors such as liquidation expenses. The range and weighted average of liquidation expense adjustments are presented as a percent of the appraisal.


(3)	Market pricing on derivative assets and liabilities is adjusted by management for the anticipated percent of derivative assets and liabilities that will create a realized gain or loss. The range and weighted average of estimated pull-through is presented.

Financial instruments recorded using FASB ASC 825-10

Under FASB ASC 825-10, the Corporation may elect to report most financial instruments and certain other items at fair value on an instrument-by-instrument basis with changes in fair value reported in net income. After the initial adoption, the election is made at the acquisition of an eligible financial asset, financial liability or firm commitment or when certain specified reconsideration events occur. The fair value election, with respect to an item, may not be revoked once an election is made.

The following tables reflect the difference between the fair value carrying amount of residential mortgage loans held for sale, measured at fair value under FASB ASC 825-10, and the aggregate unpaid principal amount the Corporation is contractually entitled to receive at maturity.



	September 30, 2017
(In Thousands)	Aggregate Fair Value		Difference		Contractual Principal
Residential mortgage loans held for sale	$	26,234	$	985	$	25,249



	December 31, 2016
(In Thousands)	Aggregate Fair Value		Difference		Contractual Principal
Residential mortgage loans held for sale	$	35,676	$	1,004	$	34,672

The Corporation has elected to account for residential loans held for sale at fair value to eliminate the mismatch that would occur by recording changes in market value on derivative instruments used to hedge loans held for sale while carrying the loans at the lower of cost or market.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments (not previously described) for which it is practicable to estimate that value:

Cash and Short-Term Investments

For those short-term instruments, the carrying amount is a reasonable estimate of fair value. As such they are classified as Level 1 for noninterest-bearing deposits and Level 2 for interest-bearing deposits due from banks or federal funds sold.

Restricted Stock

It is not practical to determine the fair value of restricted stock due to the restrictions placed on its transferability.

Loans, Net of Allowance

For certain homogeneous categories of loans, such as some residential mortgages, and other consumer loans, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics resulting in a Level 3 classification. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities resulting in a Level 3 classification.

Deposits and Borrowings

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date resulting in a Level 1 classification. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities also resulting in a Level 1 classification. The fair value of all other deposits and borrowings is determined using the discounted cash flow method thereby resulting in a Level 2 classification. The discount rate was equal to the rate currently offered on similar products.

Trust Preferred Debentures

The fair values of the Corporation's trust preferred debentures are estimated using discounted cash flow analysis based on the Corporation's incremental borrowing rates for similar types of borrowing arrangements.

Accrued Interest

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification depending upon the level of the asset or liability, with which, the accrual is associated.

Off-Balance Sheet Financial Instruments

The fair value of commitments to extend credit is estimated using the fees currently charged to enter 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 interest rates. The fair value of stand-by letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. At September 30, 2017 and December 31, 2016, the majority of off-balance-sheet items are variable rate instruments or convert to variable rate instruments if drawn upon. Therefore, the fair value of these items is largely based on fees, which are nominal and immaterial.

Fair Value of Financial Instruments

The estimated fair values, and related carrying amounts, of the Corporation's financial instruments are as follows:



	September 30, 2017				December 31, 2016

	Carrying Amount		Total Fair Value		Carrying Amount		Total Fair Value
	(In Thousands)
Financial assets:
Cash and short-term investments	$	129,933	$	129,933	$	91,059	$	91,059
Securities held-to-maturity	15,778		16,416		9,200		9,293
Securities available-for-sale	395,040		395,040		194,090		194,090
Restricted stock	14,447		14,447		10,092		10,092
Loans, net	1,953,968		1,992,323		1,069,366		1,080,820
Derivatives	487		487		993		993
Total financial assets	$	2,509,653	$	2,548,646	$	1,374,800	$	1,386,347

Financial liabilities:
Deposits	$	2,286,212	$	2,252,241	$	1,054,327	$	1,040,402
Short-term borrowings	79,527		79,336		186,009		185,910
Long-term borrowings	60,000		59,491		60,000		59,954
Trust preferred debentures	3,863		3,689		—		—
Derivatives	71		71		325		325
Total financial liabilities	$	2,429,673	$	2,394,828	$	1,300,661	$	1,286,591