FAIR VALUES OF FINANCIAL INSTRUMENTS:

Accounting guidance 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 value:

Level 1: Quoted prices (unadjusted) of 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 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 reporting entity's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The fair value of securities available-for-sale is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs).

For those securities that cannot be priced using quoted market prices or observable inputs, a Level 3 valuation is determined. These securities are primarily trust preferred securities, which are priced using Level 3 due to current market illiquidity, and state and municipal securities. The fair value of the trust preferred securities is obtained from a third party provider without adjustment. Management obtains values from other pricing sources to validate the Standard & Poors pricing that they currently utilizes. The fair value of state and municipal obligations are derived by comparing the securities to current market rates plus an appropriate credit spread to determine an estimated value. Illiquidity spreads are then considered. Credit reviews are performed on each of the issuers. The significant unobservable inputs used in the fair value measurement of the Corporation’s state and municipal obligations are credit spreads related to specific issuers. Significantly higher credit spread assumptions would result in significantly lower fair value measurement. Conversely, significantly lower credit spreads would result in a significantly higher fair value measurement.

The fair value of derivatives is based on valuation models using observable market data as of the measurement date (Level 2 inputs).



	December 31, 2019 Fair Value Measurement Using
(Dollar amounts in thousands)	Level 1		Level 2			Level 3		Carrying Value
U.S. Government entity mortgage-backed securities	$	—	$	103,633		$	—	$	103,633
Mortgage-backed securities, residential	—		243,382			—		243,382
Mortgage-backed securities, commercial	—		22,104			—		22,104
Collateralized mortgage obligations	—		281,311			—		281,311
State and municipal obligations	—		261,869			2,565		264,434
Municipal taxable	—		730			—		730
U.S. Treasury	—		7,504			—		7,504
Collateralized debt obligations	—		—			3,619		3,619
TOTAL	$	—	$	920,533		$	6,184	$	926,717
Derivative Assets			$	828
Derivative Liabilities			(828		)



	December 31, 2018 Fair Value Measurement Using
(Dollar amounts in thousands)	Level 1		Level 2			Level 3		Carrying Value
U.S. Government entity mortgage-backed securities	$	—	$	25,364		$	—	$	25,364
Mortgage-backed securities, residential	—		178,743			—		178,743
Collateralized mortgage obligations	—		343,616			—		343,616
State and municipal obligations	—		230,800			3,135		233,935
Collateralized debt obligations	—		—			3,258		3,258
TOTAL	$	—	$	778,523		$	6,393	$	784,916
Derivative Assets			$	218
Derivative Liabilities			(218		)

There were no transfers between Level 1 and Level 2 during 2019 and 2018.

The table below presents a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the twelve months ended December 31, 2019 and 2018.



	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) December 31, 2019
	State and municipal obligations			Collateralized debt obligations			Total
Beginning balance, January 1	$	3,135		$	3,258		$	6,393
Total realized/unrealized gains or losses
Included in earnings	—			—			—
Included in other comprehensive income	—			498			498
Purchases	—			—			—
Settlements	(570		)	(137		)	(707		)
Ending balance, December 31	$	2,565		$	3,619		$	6,184



	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) December 31, 2018
	State and municipal obligations			Collateralized debt obligations			Total
Beginning balance, January 1	$	3,680		$	14,605		$	18,285
Total realized/unrealized gains or losses
Included in earnings	—			—			—
Included in other comprehensive income	—			(2,840		)	(2,840		)
Transfers	—			—			—
Settlements	(545		)	(8,507		)	(9,052		)
Ending balance, December 31	$	3,135		$	3,258		$	6,393

There were no unrealized gains and losses recorded in earnings for the years ended December 31, 2019, 2018 or 2017.

Impaired loans disclosed in footnote 7, which are measured for impairment using the fair value of collateral, are valued at Level 3. They are carried at a fair value of $100 thousand, after a valuation allowance of $48 thousand at December 31, 2019 and at a fair value of $1.6 million, net of a valuation allowance of $0.7 million at December 31, 2018. The impact to the provision for loan losses for the twelve months ended December 31, 2019 and December 31, 2018 was a $689 thousand decrease and a $112 thousand increase, respectively. Other real estate owned is valued at Level 3. Other real estate owned at December 31, 2019 with a value of $3.6 million was reduced $64 thousand for fair value adjustment. At December 31, 2019 other real estate owned was comprised of $3.5 million from commercial loans and $142 thousand from residential loans. Other real estate owned at December 31, 2018 with a value of $603 thousand was reduced $598 thousand for fair value adjustment. At December 31, 2018 other real estate owned was comprised of $171 thousand from commercial loans and $432 thousand from residential loans.

Fair value is measured based on the value of the collateral securing those loans, and is determined using several methods. Generally the fair value of real estate is determined based on appraisals by qualified licensed appraisers. Appraisals for real estate generally use three methods to derive value: cost, sales or market comparison and income approach. The cost method bases value on the cost to replace current property. The market comparison evaluates the sales price of similar properties in the same market area. The income approach considers net operating income generated by the property and the investor’s required return. The final fair value is based on a reconciliation of these three approaches. If an appraisal is not available, the fair value may be determined by using a cash flow analysis, a broker’s opinion of value, the net present value of future cash flows, or an observable market price from an active market. Fair value of other real estate is based upon the current appraised values of the properties as determined by qualified licensed appraisers and the Company’s judgment of other relevant market conditions. Appraisals are obtained annually and reductions in value are recorded as a valuation through a charge to expense. The primary unobservable input used by management in estimating fair value are additional discounts to the appraised value to consider market conditions and the age of the appraisal, which are based on management’s past experience in resolving these types of properties. These discounts range from 0% to 50%. Values for non-real estate collateral, such as business equipment, are based on appraisals performed by qualified licensed appraisers or the customers financial statements. Values for non real estate collateral use much higher discounts than real estate collateral. Other real estate and impaired loans carried at fair value are primarily comprised of smaller balance properties.

The following tables present quantitative information about recurring and non-recurring Level 3 fair value measurements at December 31, 2019 and 2018.



2019	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range
State and municipal obligations	$	2,565	Discounted cash flow	Discount rate	2.87%-4.44%
				Probability of default	—	%
Other real estate	$	3,625	Sales comparison/income approach	Discount rate for age of appraisal and market conditions	5.00%-20.00%
Impaired Loans	$	100	Sales comparison/income approach	Discount rate for age of appraisal and market conditions	0.00%-50.00%



2018	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range
State and municipal obligations	$	3,135	Discounted cash flow	Discount rate	2.64%-4.80%
				Probability of default	—	%
Other real estate	$	603	Sales comparison/income approach	Discount rate for age of appraisal and market conditions	5.00%-20.00%
Impaired Loans	$	1,639	Sales comparison/income approach	Discount rate for age of appraisal and market conditions	0.00%-50.00%

The following tables present impaired collateral dependent loans measured at fair value on a non-recurring basis by class of loans as of December 31, 2019 and 2018.



	December 31, 2019
(Dollar amounts in thousands)	Carrying Value		Allowance for Loan Losses Allocated		Fair Value
Commercial
Commercial & Industrial	$	148	$	48	$	100
Farmland	—		—		—
Non Farm, Non Residential	—		—		—
Agriculture	—		—		—
All Other Commercial	—		—		—
Residential
First Liens	—		—		—
Home Equity	—		—		—
Junior Liens	—		—		—
Multifamily	—		—		—
All Other Residential	—		—		—
Consumer
Motor Vehicle	—		—		—
All Other Consumer	—		—		—
TOTAL	$	148	$	48	$	100



	December 31, 2018
(Dollar amounts in thousands)	Carrying Value		Allowance for Loan Losses Allocated		Fair Value
Commercial
Commercial & Industrial	$	1,819	$	593	$	1,226
Farmland	211		44		167
Non Farm, Non Residential	—		—		—
Agriculture	346		100		246
All Other Commercial	—		—		—
Residential
First Liens	—		—		—
Home Equity	—		—		—
Junior Liens	—		—		—
Multifamily	—		—		—
All Other Residential	—		—		—
Consumer
Motor Vehicle	—		—		—
All Other Consumer	—		—		—
TOTAL	$	2,376	$	737	$	1,639

The carrying amounts and estimated fair values of financial instruments are shown below. Carrying amount is the estimated fair value for cash and due from banks, federal funds sold, accrued interest receivable and payable, demand deposits, short-term and certain other borrowings, and variable-rate loans or deposits that reprice frequently and fully. Security fair values are determined as previously described. It is not practicable to determine the fair value of restricted stock due to restrictions placed on their transferability. For fixed-rate loans or deposits, variable rate loans or deposits with infrequent repricing or repricing limits, and for longer-term borrowings, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Loan fair value estimates represent an exit price for 2019 and 2018. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of debt is based on current rates for similar financing. The fair value of off-balance sheet items is not considered material.

The carrying amount and estimated fair value of assets and liabilities are presented in the table below and were determined based on the above assumptions:



	December 31, 2019
	Carrying			Fair Value
(Dollar amounts in thousands)	Value			Level 1		Level 2			Level 3		Total
Cash and due from banks	$	127,426		$	26,275	$	101,151		$	—	$	127,426
Securities available-for-sale	926,717			—		920,533			6,184		926,717
Restricted stock	15,394			n/a		n/a			n/a		n/a
Loans, net	2,636,447			—		—			2,648,692		2,648,692
Accrued interest receivable	18,523			—		3,583			14,940		18,523
Deposits	(3,275,357		)	—		(3,278,099		)	—		(3,278,099		)
Short-term borrowings	(80,119		)	—		(80,119		)	—		(80,119		)
Accrued interest payable	(1,739		)	—		(1,739		)	—		(1,739		)



	December 31, 2018
	Carrying			Fair Value
(Dollar amounts in thousands)	Value			Level 1		Level 2			Level 3		Total
Cash and due from banks	$	74,388		$	23,418	$	50,970		$	—	$	74,388
Securities available-for-sale	784,916			—		778,523			6,393		784,916
Restricted stock	10,390			n/a		n/a			n/a		n/a
Loans, net	1,933,552			—		—			1,889,795		1,889,795
Accrued interest receivable	13,970			—		3,005			10,965		13,970
Deposits	(2,436,727		)	—		(2,426,128		)	—		(2,426,128		)
Short-term borrowings	(69,656		)	—		(69,656		)	—		(69,656		)
Accrued interest payable	(609		)	—		(609		)	—		(609		)