(6) Fair Value of Financial Instruments

FASB Topic 820, Fair Value Measurements (“ASC 820”) defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. 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 can 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 value that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate the fair value of assets and liabilities:

Securities Available for Sale: The fair value of securities available for sale is determined utilizing an independent pricing service for identical assets or significantly similar securities. The pricing service uses a variety of techniques to arrive at fair value including market maker bids, quotes and pricing models. Inputs to the pricing models include recent trades, benchmark interest rates, spreads and actual and projected cash flows. This results in a Level 1 or Level 2 classification of the inputs for determining fair value. Interest and dividend income is recorded on the accrual method and is included in the Consolidated Statements of Income in the respective investment class under total interest and dividend income. The Company does not have any securities that would be designated as Level 3.

Other Real Estate Owned: Assets acquired through loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process to adjust for differences between the comparable sales and income data available. This results in a Level 3 classification of the inputs for determining fair value.

Impaired Loans: At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally have had a chargeoff through the allowance for loan losses. For collateral dependent loans, fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process to adjust for differences between the comparable sales and income data available. Such adjustments may be significant and typically result in a Level 3 classification of the inputs for determining fair value. When obtained, non‑real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Indications of value for both collateral‑dependent impaired loans and other real estate owned are obtained from third party providers or the Company’s internal Appraisal Department. All indications of value are reviewed for reasonableness by a member of the Appraisal Department for the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value via comparison with independent data sources such as recent market data or industry‑wide statistics.

Assets and liabilities measured at fair value under ASC 820 on a recurring basis are summarized below:

	Fair Value Measurements at September 30, 2018 Using:
(dollars in thousands)	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)



Securities available for sale:
U.S. government sponsored enterprises	$	150,053	$	-	$	150,053	$	-
State and political subdivisions		180		-		180		-
Mortgage backed securities and collateralized mortgage obligations		269,093		-		269,093		-
Corporate bonds		29,977		-		29,977		-
Small Business Administration - guaranteed participation securities		57,894		-		57,894		-
Other securities		685		-		685		-

Total securities available for sale	$	507,882	$	-	$	507,882	$	-

	Fair Value Measurements at December 31, 2017 Using:
(dollars in thousands)	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)


Securities available for sale:
U.S. government sponsored enterprises	$	137,851	$	-	$	137,851	$	-
State and political subdivisions		525		-		525		-
Mortgage backed securities and collateralized mortgage obligations		325,683		-		325,683		-
Corporate bonds		40,162		-		40,162		-
Small Business Administration - guaranteed participation securities		67,059		-		67,059		-
Other securities		685		-		685

Total securities available for sale	$	571,965	$	-	$	571,965	$	-

There were no transfers between Level 1 and Level 2 during the three and nine months ended September 30, 2018 and 2017.

Assets measured at fair value on a non‑recurring basis are summarized below:

	Fair Value Measurements at September 30, 2018 Using:
(dollars in thousands)	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Valuation technique	Unobservable inputs	Range (Weighted Average)

Other real estate owned	$	2,306	$	-	$	-	$	2,306	Sales comparison approach	Adjustments for differences between comparable sales		1% - 14% (7%)

Impaired loans:
Real estate mortgage - 1 to 4 family		326		-		-		326	Sales comparison approach	Adjustments for differences between comparable sales		5% - 14% (10%)

	Fair Value Measurements at December 31, 2017 Using:
(dollars in thousands)	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Valuation technique	Unobservable inputs	Range (Weighted Average)

Other real estate owned	$	3,246	$	-	$	-	$	3,246	Sales comparison approach	Adjustments for differences between comparable sales		1% - 14% (7%)

Impaired loans:
Real estate mortgage - 1 to 4 family		844		-		-		844	Sales comparison approach	Adjustments for differences between comparable sales		5% - 14% (10%)

Other real estate owned, that is carried at fair value less costs to sell, was approximately $2.3 million at September 30, 2018 and consisted of $560 thousand of commercial real estate and $1.7 million of residential real estate properties. Valuation charges of $60 thousand and $674 thousand are included in earnings for the three and nine months ended September 30, 2018, respectively.

Of the total impaired loans of $22.5 million at September 30, 2018, $326 thousand are collateral dependent and are carried at fair value measured on a non‑recurring basis. Due to the sufficiency of chargeoffs taken on these loans and the adequacy of the underlying collateral, there were no specific valuation allowances for these loans at September 30, 2018. There were no gross chargeoffs related to commercial impaired loans for the three and nine months ended September 30, 2018. Gross chargeoffs related to residential impaired loans included in the table above were $70 thousand for the nine‑months ended September 30, 2018, there were no gross chargeoffs related to residential impaired loans for the three‑months ended September 30, 2018.

Other real estate owned, that is carried at fair value less costs to sell, was approximately $3.2 million at December 31, 2017 and consisted of $541 thousand of commercial real estate and $2.7 million of residential real estate properties. A valuation charge of $1.1 million is included in earnings for the year ended December 31, 2017.

Of the total impaired loans of $24.1 million at December 31, 2017, $844 thousand are collateral dependent and are carried at fair value measured on a non‑recurring basis. Due to the sufficiency of chargeoffs taken on these loans and the adequacy of the underlying collateral, there were no specific valuation allowances for these loans at December 31, 2017. Gross chargeoffs related to residential impaired loans included in the table above amounted to $151 thousand at December 31, 2017.

In accordance with FASB Topic 825, Financial Instruments (“ASC 825”), the carrying amounts and estimated fair values (represents exit price) of financial instruments, at September 30, 2018 and December 31, 2017 are as follows:

(dollars in thousands)	Carrying		Fair Value Measurements at September 30, 2018 Using:
	Value		Level 1		Level 2		Level 3		Total
Financial assets:
Cash and cash equivalents	$	465,449		465,449		-		-		465,449
Securities available for sale		507,882		-		507,882		-		507,882
Held to maturity securities		23,462		-		23,849		-		23,849
Federal Reserve Bank and Federal Home Loan Bank stock		8,953		N/A		N/A		N/A		N/A
Net loans		3,781,180		-		-		3,719,619		3,719,619
Accrued interest receivable		11,552		100		2,242		9,210		11,552
Financial liabilities:
Demand deposits		403,047		403,047		-		-		403,047
Interest bearing deposits		3,796,877		2,640,883		1,143,702		-		3,784,585
Short-term borrowings		176,377		-		176,377		-		176,377
Accrued interest payable		778		92		686		-		778

(dollars in thousands)	Carrying		Fair Value Measurements at December 31, 2017 Using:
	Value		Level 1		Level 2		Level 3		Total

Financial assets:
Cash and cash equivalents	$	612,740		612,740		-		-		612,740
Securities available for sale		571,965		35		571,930		-		571,965
Held to maturity securities		27,551		-		28,701		-		28,701
Federal Reserve Bank and Federal Home Loan Bank stock		8,779		N/A		N/A		N/A		N/A
Net loans		3,592,237		-		-		3,598,213		3,598,213
Accrued interest receivable		11,441		243		2,440		8,758		11,441
Financial liabilities:
Demand deposits		398,399		398,399		-		-		398,399
Interest bearing deposits		3,774,927		2,707,961		1,076,213		-		3,784,174
Short-term borrowings		242,991		-		242,991		-		242,991
Accrued interest payable		537		77		460		-		537