Note 12—Fair Value of Assets and Liabilities

The Corporation uses its best judgment in estimating the fair value of the Corporation’s assets and liabilities; however, there are inherent weaknesses in any estimation technique. Therefore, the fair value estimates herein are not necessarily indicative of the amounts that could be realized in sales transactions on the dates indicated. The estimated fair value amounts have been measured as of their respective period-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values subsequent to the respective reporting dates may be different than the amounts reported at each period end.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date. GAAP establishes a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:

Level 1: Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

Level 2: Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets; inputs to the valuation methodology include quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs to the valuation methodology that utilize model-based techniques for which all significant assumptions are observable in the market.

Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement; inputs to the valuation methodology that utilize model-based techniques for which significant assumptions are not observable in the market; or inputs to the valuation methodology that require significant management judgment or estimation, some of which may be internally developed.

Since management maximizes the use of observable inputs and minimizes the use of unobservable inputs when determining fair value, an asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Management reviews and updates the fair value hierarchy classifications on a quarterly basis.

Assets Measured at Fair Value on a Recurring Basis

Securities available-for-sale

The fair values of investment securities were measured using information from a third-party pricing service. The pricing service uses quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique, used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities, but rather, by relying on the securities’ relationship to other benchmark quoted prices. At least annually, the Corporation reviews a random sample of the pricing information received from the third-party pricing service by comparing it to price quotes from third-party brokers. Historically, price deviations have been immaterial.



				Fair Value Measurements
			(Level 1)			(Level 2)	(Level 3)
			Quoted Prices in		Significant Other		Significant Other
			Active Markets for		Observable		Unobservable
(dollars in thousands)	Total		Identical Assets		Inputs		Inputs
September 30, 2018
Securities available-for-sale:
U.S. Treasury notes	$	13,572	$	13,572	$	0	$	0
U.S. agency		14,742		0		14,742		0
U.S. agency mortgage-backed, residential		72,066		0		72,066		0
State and municipal		45,709		0		45,709		0

December 31, 2017
Securities available-for-sale:
U.S. Treasury notes	$	14,071	$	14,071	$	0	$	0
U.S. agency		17,303		0		17,303		0
U.S. agency mortgage-backed, residential		75,175		0		75,175		0
State and municipal		52,042		0		52,042		0

Assets Measured at Fair Value on a Nonrecurring Basis

Impaired loans

Impaired loans are those that are accounted for under FASB ASC Topic 310, in which the Corporation has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These loans are included as Level 3 fair values, based on the lowest level of input that is significant to the fair value measurements. At September 30, 2018, the fair value of impaired loans with a valuation allowance or charge-off was $8,683,000, net of valuation allowances of $1,347,000 and charge-offs of $159,000. At December 31, 2017 the fair value of impaired loans with a valuation allowance or charge-off was $1,331,000, net of valuation allowances of $243,000 and charge-offs of $506,000.

Foreclosed Real Estate

Other real estate property acquired through foreclosure is initially recorded at fair value of the property at the transfer date less estimated selling cost. Subsequently, other real estate owned is carried at the lower of its carrying value or the fair value less estimated selling cost. Fair value is usually determined based on an independent third-party appraisal of the property or occasionally on a recent sales offer. At September 30, 2018 and December 31, 2017, there were no foreclosed real estate assets with a valuation allowance or write-down.

Mortgage Servicing Rights

Mortgage servicing rights are initially recorded at fair value upon the sale of residential mortgage loans to secondary market investors. The fair value of servicing rights is based on the present value of estimated future cash flows on pools of mortgages stratified by rate and original time to maturity. Mortgage servicing rights are subsequently evaluated for impairment on a quarterly basis. Significant inputs to the valuation include expected cash flow, expected net servicing income, a cash flow discount rate and the expected life of the underlying loans. At September 30, 2018, the fair value of the mortgage servicing rights asset was $1,081,000. At December 31, 2017, the fair value of the mortgage servicing rights asset was $769,000.



				Fair Value Measurements
				(Level 1)		(Level 2)		(Level 3)
				Quoted Prices in				Significant Other
				Active Markets for		Significant Other		Unobservable
(dollars in thousands)		Total		Identical Assets		Observable Inputs		Inputs
September 30, 2018
Impaired loans	$	8,683	$	0	$	0	$	8,683
Mortgage servicing rights		1,081		0		0		1,081

December 31, 2017
Impaired loans	$	1,331	$	0	$	0	$	1,331
Mortgage servicing rights		769		0		0		769

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Corporation has utilized Level 3 inputs to determine fair value:



	Quantitative Information about Level 3 Fair Value Measurements
	Fair Value		Valuation	Unobservable		Weighted
(dollars in thousands)	Estimate		Techniques	Input	Range	Average
September 30, 2018
Impaired loans	$	311	Appraisal (1)	Appraisal adjustments (2)	15% - 25%	23%
Impaired loans		8,372	Financial statements (3)	Valuation adjustments (2)	0% - 52%	50%
Mortgage servicing rights		1,081	Multiple of annual	Estimated prepayment speed	7.2% - 8.3%	7.4%
			service fee	based on rate and term
December 31, 2017
Impaired loans	$	1,331	Appraisal (1)	Appraisal adjustments (2)	24% - 52%	38%
Mortgage servicing rights		769	Multiple of annual	Estimated prepayment speed	6.9% - 8.5%	7.6%
			service fee	based on rate and term

(1) Fair value is generally determined through independent appraisals, which generally include various level 3 inputs
that are not identifiable.
(2) Appraisals and financial statement amounts may be adjusted downward by the Corporation's management for qualitative
factors such as econcomic conditions and estimated liquidation expenses. The range of liquidation expenses and other
adjustments are a percent of the appraisal or financial statement book value.
(3) Internal financial statements provided by customers.

Disclosures about Fair Value of Financial Instruments

The following methods and assumptions were used to estimate the fair value of the Corporation’s financial instruments as of September 30, 2018 and December 31, 2017:

Cash and cash equivalents

The carrying amount is a reasonable estimate of fair value.

Securities available for sale

The fair value of securities available for sale is determined in accordance with the methods described under FASB ASC Topic 820 as described above.

Restricted investment in bank stocks

The carrying amount of restricted investment in bank stocks is a reasonable estimate of fair value. The Corporation is required to maintain minimum investment balances in these stocks. These stocks are not actively traded and, therefore, have no readily determinable market value.

Loans held for sale

The fair value of loans held for sale is determined, when possible, using quoted secondary-market prices. If no such quoted prices exist, the fair value of a loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of that loan.

Loans, net

The fair value of loans, for September 30, 2018, are estimated on an exit price basis incorporating adjustments for such factors as credit, liquidity and marketability factors. This is not comparable with the fair values disclosed for December 31, 2017, which were based on an entrance price basis. For that date, fair values of variable rate loans that reprice frequently and with no significant change in credit risk were based on carrying values. The fair values of other loans as of that date were estimated using discounted cash flow analyses which used interest rates then being offered for loans with similar terms to borrowers of similar credit quality.

Interest receivable

The carrying value of interest receivable is a reasonable estimate of fair value.

Deposits

The fair value of demand deposits, savings accounts and money market deposits is the amount payable on demand at the reporting date. The fair values of time deposits are estimated using a discounted cash flow analyses. The discount rates used are based on rates currently offered for deposits with similar remaining maturities. The fair values of variable rate time deposits that reprice frequently are based on carrying value. The fair values of time deposit liabilities do not take into consideration the value of the Corporation’s long-term relationships with depositors, which may have significant value.

Short-term borrowings

For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Long-term debt

Long-term debt includes FHLBP advances (Level 2) and junior subordinated debt (Level 3). The fair value of FHLBP advances is estimated using discounted cash flow analysis, based on quoted prices for new FHLBP advances with similar credit risk characteristics, terms and remaining maturity. These prices are obtained from this active market and represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party. The fair value of junior subordinated debt is estimated using discounted cash flow analysis, based on market rates and spread characteristics of similar debt with similar credit risk characteristics, terms and remaining maturity.

Interest payable

The carrying value of interest payable is a reasonable estimate of fair value.

Off-balance sheet instruments

Off-balance sheet instruments consist of lending commitments and letters of credit and are based on fees currently charged in the market to enter into similar arrangements, taking into account the remaining terms of the agreements and counterparties’ credit standing. These amounts were not considered material.

The following presents the carrying amounts and estimated fair values of the Corporation’s financial instruments as of September 30, 2018 and December 31, 2017.



						Fair Value Estimates
					(Level 1)		(Level 2)			(Level 3)
					Quoted Prices		Significant		Significant
					in Active		Other		Other
	Carrying		Estimated		Markets for		Observable		Unobservable
(dollars in thousands)	Amount		Fair Value		Identical Assets		Inputs		Inputs
September 30, 2018
Financial assets
Cash and cash equivalents	$	85,348	$	85,348	$	85,348	$	0	$	0
Securities available-for-sale		146,089		146,089		13,572		132,517		0
Restricted investment in bank stocks		6,122		6,122		0		6,122		0
Loans held for sale		3,795		3,928		0		3,928		0
Loans, net		1,475,793		1,452,672		0		0		1,452,672
Interest receivable		5,142		5,142		0		5,142		0
Mortgage servicing rights		876		1,081		0		0		1,081

Financial liabilities
Deposits	$	1,470,259	$	1,452,587	$	0	$	1,452,587	$	0
Short-term borrowings		8,624		8,624		0		8,624		0
Long-term debt		135,310		132,178		0		123,740		8,438
Interest payable		865		865		0		865		0

Off-balance sheet instruments		0		0		0		0		0

December 31, 2017
Financial assets
Cash and cash equivalents	$	79,524	$	79,524	$	79,524	$	0	$	0
Securities available-for-sale		158,591		158,591		14,071		144,520		0
Restricted investment in bank stocks		6,311		6,311		0		6,311		0
Loans held for sale		1,715		1,798		0		1,798		0
Loans, net		1,383,075		1,368,753		0		0		1,368,753
Interest receivable		4,968		4,968		0		4,968		0
Mortgage servicing rights		672		769		0		0		769

Financial liabilities
Deposits	$	1,384,507	$	1,369,008	$	0	$	1,369,008	$	0
Short-term borrowings		20,495		20,495		0		20,495		0
Long-term debt		130,310		127,586		0		119,474		8,112
Interest payable		626		626		0		626		0

Off-balance sheet instruments		0		0		0		0		0