FAIR VALUE

Fair Value Measurement

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an 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. A fair value hierarchy has also been established which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The following three levels of inputs are used to measure fair value:

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 fair values of most trading securities and securities available for sale are 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 relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

The Corporation’s derivative instruments are interest rate swaps that are similar to those that trade in liquid markets. As such, significant fair value inputs can generally be verified and do not typically involve significant management judgments (Level 2 inputs).

The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals prepared by third-parties. 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 by the appraisers to adjust for differences between the comparable sales and income data available. Management also adjusts appraised values based on the length of time that has passed since the appraisal date and other factors. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Assets and liabilities measured at fair value on a recurring basis are as follows at September 30, 2018 and December 31, 2017:



			Fair Value Measurements at September 30, 2018 Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	Total		(Level 1)		(Level 2)		(Level 3)
Assets:
Securities Available For Sale:
U.S. Government sponsored entities	$	145,509	$	—	$	145,509	$	—
States and political subdivisions	138,395		—		138,395		—
Residential and multi-family mortgage	194,635		—		194,635		—
Corporate notes and bonds	12,036		—		12,036		—
Pooled SBA	30,833		—		30,833		—



Other	926			926		—			—
Total Securities Available For Sale	$	522,334		$	926	$	521,408		$	—
Interest Rate swaps	$	191		$	—	$	191		$	—
Trading Securities:
Corporate equity securities	$	6,643		$	6,643	—			—
Mutual funds	1,687			1,687		—			—
Certificates of deposit	228			228		—			—
Corporate notes and bonds	278			278		—			—
U.S. Government sponsored entities	51			—		51			—
Total Trading Securities	$	8,887		$	8,836	$	51		$	—
Liabilities,
Interest rate swaps	$	(182	)	$	—	$	(182	)	$	—

				Fair Value Measurements at December 31, 2017 Using
				Quoted Prices in					Significant
				Active Markets for		Significant Other			Unobservable
				Identical Assets		Observable Inputs			Inputs
Description	Total			(Level 1)		(Level 2)			(Level 3)
Assets:
Securities Available For Sale:
U.S. Government sponsored entities	$	108,148		$	—	$	108,148		$	—
States and political subdivisions	137,723			—		137,723			—
Residential and multi-family mortgage	109,636			—		109,636			—
Corporate notes and bonds	17,200			—		17,200			—
Pooled SBA	36,040			—		36,040			—
Other	962			962		—			—
Total Securities Available For Sale	$	409,709		$	962	$	408,747		$	—
Interest Rate swaps	$	149		$	—	$	149		$	—
Trading Securities:
Corporate equity securities	5,125			5,125		—			—
Mutual funds	1,499			1,499		—			—
Certificates of deposit	220			220		—			—
Corporate notes and bonds	254			254		—			—
U.S. Government sponsored entities	52			—		52			—
Total Trading Securities	$	7,150		$	7,098	52			—
Liabilities,
Interest rate swaps	$	(310	)	$	—	$	(310	)	$	—

The table below presents a reconciliation of the fair value of securities available for sale measured on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2018 and 2017:



	2018		2017
Balance, January 1	$	—	$	2,049
Total gains:
Included in other comprehensive income (unrealized)	—		134
Sale of available-for-sale securities	—		(2,183		)
Balance, September 30	$	—	$	—

The Corporation did not have any Level 3 securities during the three months ended September 30, 2018 and 2017.

Assets and liabilities measured at fair value on a non-recurring basis are as follows at September 30, 2018 and December 31, 2017:

Fair Value Measurements at September 30, 2018 Using

Quoted Prices in

Active Markets

for

Identical Assets

Significant Other

Observable Inputs

Significant

Unobservable

Inputs

Description

Total

(Level 1)

(Level 2)

(Level 3)

Assets:

Impaired loans:

Commercial mortgages

324

—

324

Fair Value Measurements at December 31, 2017 Using

Quoted Prices in

Significant

Active Markets

for

Significant Other

Unobservable

Identical Assets

Observable Inputs

Inputs

Description

Total

(Level 1)

(Level 2)

(Level 3)

Assets:

Impaired loans:

Commercial mortgages

—

Impaired loans, measured for impairment using the fair value of collateral for collateral dependent loans, had a recorded investment of $1,310 with a valuation allowance of $986 as of September 30, 2018, resulting in a provision (benefit) for loan losses of $(634) and $352 for the corresponding three and nine month periods ended September 30, 2018. Impaired loans had a recorded investment of $646 with a valuation allowance of $635 as of December 31, 2017. Impaired loans carried at fair value resulted in a negative provision for loan losses of $(22) and $(395) for the three and nine month periods ended September 30, 2017.

The estimated fair values of impaired collateral dependent loans such as commercial or residential mortgages are determined primarily through third-party appraisals. When a collateral dependent loan, such as a commercial or residential mortgage loan, becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal, and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral and a further reduction for estimated costs to sell the property is applied, which results in an amount that is considered to be the estimated fair value. If a loan becomes impaired and the appraisal of related loan collateral is outdated, management applies an appropriate adjustment factor based on its experience with current valuations of similar collateral in determining the loan’s estimated fair value and resulting allowance for loan losses. Third-party appraisals are not customarily obtained in respect of unimpaired loans, unless in management’s view changes in circumstances warrant obtaining an updated appraisal.

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2018:



	Fair value		Valuation Technique	Unobservable Inputs	Weighted Average (Range)
Impaired loans – commercial mortgages	$	324	Valuation of third party appraisal on underlying collateral	Loss severity rates	15% (10-15%)

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2017:



	Fair value		Valuation Technique	Unobservable Inputs	Weighted Average (Range)
Impaired loans – commercial mortgages	$	11	Valuation of third party appraisal on underlying collateral	Loss severity rates	10% (10%)

Fair Value of Financial Instruments

The following table presents the carrying amount and fair value of financial instruments at September 30, 2018:



	Carrying			Fair Value Measurement Using:								Total
	Amount			Level 1			Level 2			Level 3		Fair Value
ASSETS
Cash and cash equivalents	$	36,500		$	36,500		$	—		$	—	$	36,500
Securities available for sale	522,334			926			521,408			—		522,334
Trading securities	8,887			8,836			51			—		8,887
Loans held for sale	775			—			775			—		775
Net loans	2,364,445			—			—			2,334,576		2,334,576
FHLB and other restricted interests	16,885			n/a			n/a			n/a		n/a
Other equity interests	6,951											6,951
Interest rate swaps	191			—			191			—		191
Accrued interest receivable	11,221			7			3,748			7,466		11,221
LIABILITIES
Deposits	$	(2,522,379	)	$	(2,132,769	)	$	(391,848	)	$	—	$	(2,524,617	)
FHLB and other borrowings	(252,422		)	—			(248,986		)	—		(248,986		)
Subordinated debentures	(70,620		)	—			(68,202		)	—		(68,202		)
Interest rate swaps	(182		)	—			(182		)	—		(182		)
Accrued interest payable	(820		)	—			(820		)	—		(820		)

The following table presents the carrying amount and fair value of financial instruments at December 31, 2017:



	Carrying			Fair Value Measurement Using:								Total
	Amount			Level 1			Level 2			Level 3		Fair Value
ASSETS
Cash and cash equivalents	$	35,345		$	35,345		$	—		$	—	$	35,345
Securities available for sale	409,709			962			408,747			—		409,709
Trading securities	7,150			7,098			52			—		7,150
Loans held for sale	852			—			853			—		853
Net loans	2,126,266			—			—			2,126,824		2,126,824
FHLB and other restricted interests	17,035			n/a			n/a			n/a		n/a
Other equity interests	4,482											4,482
Interest rate swaps	149			—			149			—		149
Accrued interest receivable	9,254			6			2,651			6,597		9,254
LIABILITIES
Deposits	$	(2,167,815	)	$	(1,802,844	)	$	(362,756	)	$	—	$	(2,165,600	)
FHLB and other borrowings	(257,359		)	—			(257,361		)	—		(257,361		)
Subordinated debentures	(70,620		)	—			(63,575		)	—		(63,575		)
Interest rate swaps	(310		)	—			(310		)	—		(310		)
Accrued interest payable	(554		)	—			(554		)	—		(554		)

The methods utilized to estimate the fair value of financial instruments at December 31, 2017 did not necessarily represent an exit price. In accordance with our adoption of ASU 2016-01 in 2018, the methods utilized to measure the fair value of financial instruments at September 30, 2018 represent an approximation of exit price; however, an actual exit price may differ.

While estimates of fair value are based on management’s judgment of the most appropriate factors as of the balance sheet date, there is no assurance that the estimated fair values would have been realized if the assets had been disposed of or the liabilities settled at that date, since market values may differ depending on various circumstances. The estimated fair values would also not apply to subsequent dates. Other equity interests fair value is based on the net asset values provided by underlying investment partnership. ASU 2015-7 removes the requirement to categorize within the fair value hierarchy all investments measured using the net asset value per share practical expedient and related disclosures.

In addition, other assets and liabilities that are not financial instruments, such as premises and equipment, are not included in the disclosures. Also, non-financial assets such as, among other things, the estimated earnings power of core deposits, the earnings potential of trust accounts, the trained workforce, and customer goodwill, which typically are not recognized on the balance sheet, may have value but are not included in the fair value disclosures.