Fair Value Measurement

FASB ASC 820, “Fair Value Measurements and Disclosures,” defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. FASB ASC 820 also establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).

The three levels of the fair value hierarchy under FASB ASC Topic 820 are:

Level 1 – Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

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

Level 3 – Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

A. Assets and liabilities measured on a recurring basis

A description of the valuation methodologies used for financial instruments measured at fair value on a recurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Investment Securities

The value of the Corporation’s available for sale investment securities, which include obligations of the U.S. government and its agencies, mortgage-backed securities issued by U.S. government- and U.S. government sponsored agencies, obligations of state and political subdivisions, corporate bonds and other debt securities are determined by the Corporation, taking into account the input of an independent third party valuation service provider. The third party’s evaluations are based on market data, utilizing 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 models 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. Management reviews, annually, the process utilized by its independent third-party valuation service provider. On a quarterly basis, management tests the validity of the prices provided by the third party by selecting a representative sample of the portfolio and obtaining actual trade results, or if actual trade results are not available, competitive broker pricing. On an annual basis, management evaluates, for appropriateness, the methodology utilized by the independent third-party valuation service provider.

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-backed 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.

Interest Rate Swaps and Risk Participation Agreements

The Corporation’s interest rate swaps and RPAs are reported at fair value utilizing Level 2 inputs. Prices of these instruments are obtained through an independent pricing source utilizing pricing information which may include market observed quotations for swaps, LIBOR rates, forward rates and rate volatility. When entering into a derivative contract, the Corporation is exposed to fair value changes due to interest rate movements, and the potential non-performance of our contract counterparty. The Corporation has developed a methodology to value the non-performance risk based on internal credit risk metrics and the unique characteristics of derivative instruments, which include notional exposure rather than principle at risk and interest payment netting. The results of this methodology are used to adjust the base fair value of the instrument for the potential counterparty credit risk.

The following tables present the Corporation’s assets measured at fair value on a recurring basis as of June 30, 2018 and December 31, 2017:



As of June 30, 2018
(dollars in millions)	Total		Level 1		Level 2		Level 3
Investment securities available for sale:
U.S. Treasury securities	$	0.1	$	0.1	$	—	$	—
Obligations of U.S. government & agencies	183.3		—		183.3		—
Obligations of state & political subdivisions	17.4		—		17.4		—
Mortgage-backed securities	292.6		—		292.6		—
Collateralized mortgage obligations	36.6		—		36.6		—
Other debt securities	1.1		—		1.1		—
Total investment securities available for sale	$	531.1	$	0.1	$	531.0	$	—

Investment securities trading:
Mutual funds	$	8.2	$	8.2	$	—	$	—

Derivatives:
Interest rate swaps	$	6.3	$	—	$	6.3	$	—
Total recurring fair value measurements	$	545.6	$	8.3	$	537.3	$	—



As of December 31, 2017
(dollars in millions)	Total		Level 1		Level 2		Level 3
Investment securities available for sale:
U.S. Treasury securities	$	200.1	$	200.1	$	—	$	—
Obligations of U.S. government & agencies	151.0		—		151.0		—
Obligations of state & political subdivisions	21.3		—		21.3		—
Mortgage-backed securities	275.0		—		275.0		—
Collateralized mortgage obligations	36.7		—		36.7		—
Mutual funds	3.5		3.5		—		—
Other debt securities	1.6		—		1.6		—
Total investment securities available for sale	$	689.2	$	203.6	$	485.6	$	—

Investment securities trading:
Mutual funds	$	4.6	$	4.6	$	—	$	—

Derivatives:
Interest rate swaps	$	1.9	$	—	$	1.9	$	—
Total recurring fair value measurements	$	695.7	$	208.2	$	487.5	$	—

There have been no transfers between levels during the three and six months ended June 30, 2018.

B. Assets and liabilities measured on a non-recurring basis

Fair value is used on a nonrecurring basis to evaluate certain financial assets and financial liabilities in specific circumstances. Similarly, fair value is used on a nonrecurring basis for nonfinancial assets and nonfinancial liabilities such as foreclosed assets, OREO, intangible assets, nonfinancial assets and liabilities evaluated in a goodwill impairment analysis and other nonfinancial assets measured at fair value for purposes of assessing impairment. A description of the valuation methodologies used for financial and nonfinancial assets and liabilities measured at fair value, as well as the general classification of such assets and liabilities pursuant to the valuation hierarchy, is set forth below.

Impaired Loans

Management 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, management 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, a partial or full charge-off may be necessary.

Other Real Estate Owned

OREO consists of properties acquired as a result of foreclosures and deeds in-lieu-of foreclosure. Properties classified as OREO 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, management 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 management 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. Management has a sufficient understanding of the third party service’s valuation models, assumptions, and inputs used in determining the fair value of MSRs, enabling management to maintain an appropriate system of internal control. MSRs are classified within Level 3 of the fair value hierarchy as the valuation is model driven and primarily based on unobservable inputs.

The following tables present the Corporation’s assets measured at fair value on a non-recurring basis as of June 30, 2018 and December 31, 2017:



As of June 30, 2018
(dollars in millions)	Total		Level 1		Level 2		Level 3
MSRs	$	6.7	$	—	$	—	$	6.7
Impaired loans and leases	13.1		—		—		13.1
OREO	0.5		—		—		0.5
Total non-recurring fair value measurements	$	20.3	$	—	$	—	$	20.3



As of December 31, 2017
(dollars in millions)	Total		Level 1		Level 2		Level 3
MSRs	$	6.4	$	—	$	—	$	6.4
Impaired loans and leases	14.0		—		—		14.0
OREO	0.3		—		—		0.3
Total non-recurring fair value measurements	$	20.7	$	—	$	—	$	20.7

During the three and six months ended June 30, 2018, increases of $138 thousand and $167 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.