Note 17 - Fair Value Measurement

The following disclosures are made in conjunction with the application of fair value measurements.

FASB ASC 820 “Fair Value Measurement” establishes a fair value hierarchy based on the nature of data inputs for fair value determinations, under which the Corporation is required to value each asset using assumptions that market participants would utilize to value that asset. When the Corporation uses its own assumptions, it is required to disclose additional information about the assumptions used and the effect of the measurement on earnings or the net change in assets for the period.

The Corporation’s investment securities available for sale, which generally include state and municipal securities, U.S. government agencies and mortgage-related securities, are reported at fair value. These securities are valued by an independent third party. The third party’s evaluations are based on market data. They utilize evaluated pricing models that vary by asset and incorporate available trade, bid and other market information. For securities that do not trade on a daily basis, their pricing applications apply available information such as benchmarking and matrix pricing. The market inputs normally sought in the evaluation of securities include benchmark yields, reported trades, broker/dealer quotes (only obtained from market makers or broker/dealers recognized as market participants), issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. For certain securities, additional inputs may be used or some market inputs may not be applicable. Inputs are prioritized differently on any given day based on market conditions.

U.S. Government agencies are evaluated and priced using multi-dimensional relational models and option-adjusted spreads. State and municipal securities are evaluated on a series of matrices including reported trades and material event notices. Mortgage-related securities are evaluated using matrix correlation to treasury or floating index benchmarks, prepayment speeds, monthly payment information and other benchmarks. Other available for sale investments are evaluated using a broker-quote based application, including quotes from issuers.

The value of the investment portfolio is determined using three broad levels of inputs:

Level 1 - Quoted prices in active markets for identical securities.

Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3 - Instruments whose significant value drivers are unobservable.

These levels are not necessarily an indication of the risks or liquidity associated with these investments. The following tables summarize the assets at September 30, 2013 and December 31, 2012 that are recognized on the Corporation’s balance sheet using fair value measurement determined based on the differing levels of input.

Fair value of assets measured on a recurring and non-recurring basis as of September 30, 2013:


(dollars in millions)	Total		Level 1		Level 2		Level 3
Assets Measured at Fair Value on a Recurring Basis:
Investment securities available for sale:
U.S. Treasury securities	$	0.1	$	0.1	$	—	$	—
Obligations of the U.S. government agencies		90.9		—		90.9		—
Obligations of state & political subdivisions		40.1		—		40.1		—
Mortgage-backed securities		124.3		—		124.3		—
Collateralized mortgage obligations		47.3		—		47.3		—
Mutual funds		11.5		11.5		—		—
Other investments		5.7		—		5.7		—

Total investment securities available for sale		319.9		11.6		308.3		—
Trading securities		2.4		—		2.4		—

Total assets measured on a recurring basis at fair value	$	322.3	$	11.6	$	310.7	$	—


Assets Measured at Fair Value on a Non-Recurring Basis
Mortgage servicing rights	$	0.8	$	—	$	—	$	0.8
Impaired loans and leases		18.1		—		—		18.1
Other real estate owned (“OREO”)		1.3		—		—		1.3

Total assets measured on a non-recurring basis at fair value	$	20.2	$	—	$	—	$	20.2

Fair value of assets measured on a recurring and non-recurring basis as of December 31, 2012:


(dollars in millions)	Total		Level 1		Level 2		Level 3
Assets Measured at Fair Value on a Recurring Basis:
Investment securities available for sale:
Obligations of the U.S. government agencies	$	73.9	$	—	$	73.9	$	—
Obligations of state & political subdivisions		30.4		—		30.4		—
Mortgage-backed securities		131.8		—		131.8		—
Collateralized mortgage obligations		62.7		—		62.7		—
Mutual funds		13.6		13.6		—		—
Other investments		4.2		—		4.2		—

Total investment securities available for sale		316.6		13.6		303.0		—
Trading securities		1.4		—		1.4		—

Total assets measured on a recurring basis at fair value	$	318.0	$	13.6	$	304.4	$	—


Assets Measured at Fair Value on a Non-Recurring Basis
Mortgage servicing rights	$	0.9	$	—	$	—	$	0.9
Impaired loans and leases		19.7		—		—		19.7
OREO		0.9		—		—		0.9

Total assets measured on a non-recurring basis at fair value	$	21.5	$	—	$	—	$	21.5

During the three and nine months ended September 30, 2013 a net increase of $256 thousand and a net decrease of $188 thousand, respectively, were recorded in the Allowance as a result of adjusting the carrying value and estimated fair value of the impaired loans in the above tables. As it relates to the fair values of assets measured on a recurring basis, there have been no transfers between levels during the nine months ended September 30, 2013.

Impaired Loans

The Corporation evaluates and values impaired loans at the time the loan is identified as impaired, and the fair values of such loans are estimated using Level 3 inputs in the fair value hierarchy. Each loan’s collateral has a unique appraisal and management’s discount of the value is based on the factors unique to each impaired loan. The significant unobservable input in determining the fair value is management’s subjective discount on appraisals of the collateral securing the loan, which range from 10% - 50%. Collateral may consist of real estate and/or business assets including equipment, inventory and/or accounts receivable and the value of these assets is determined based on the appraisals by qualified licensed appraisers hired by the Corporation. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, estimated costs to sell, and/or management’s expertise and knowledge of the client and the client’s business.

The Corporation has an appraisal policy in which an appraisal is obtained for a commercial loan at the point at which the loan either becomes nonperforming or is downgraded to a substandard or worse classification. For consumer loans, the Corporation obtains updated appraisals when a loan becomes 90 days past due or when it receives other information that may indicate possible impairment. Based on the appraisals obtained by the Corporation, an appropriate Allowance is allocated to the particular loan.

Other Real Estate Owned

Other real estate owned consists of properties acquired as a result of foreclosures and deeds in-lieu-of foreclosure. Properties are classified as OREO and are reported at the lower of cost or fair value less cost to sell, and are classified as Level 3 in the fair value hierarchy.

Mortgage Servicing Rights

MSRs do not trade in an active, open market with readily observable prices. Accordingly, the Corporation obtains the fair value of the MSRs using a third-party pricing provider. The provider determines the fair value by discounting projected net servicing cash flows of the remaining servicing portfolio. The valuation model used by the provider considers market loan prepayment predictions and other economic factors which the Corporation considers to be significant unobservable inputs. The fair value of MSRs is mostly affected by changes in mortgage interest rates since rate changes cause the loan prepayment acceleration factors to increase or decrease. All assumptions are market driven. The Corporation has a sufficient understanding of the third party service’s valuation models, assumptions and inputs used in determining the fair value of MSRs to enable management to maintain an appropriate system of internal control. Mortgage servicing rights are classified within Level 3 of the fair value hierarchy as the valuation is model driven and primarily based on unobservable inputs.