FAIR VALUE MEASUREMENTS

In accordance with ASU 2016-01 - Recognition and measurement of Financial Assets and Financial Liabilities, fair value is based upon 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 is utilized to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs used to measure fair value are as follows:

Level 1: Quoted prices (unadjusted) or 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 and 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.

Accordingly, securities available-for-sale and derivative financial instruments are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record other assets at fair value on a nonrecurring basis, such as loans held for sale, property held for sale and impaired loans held for investment. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Cash and Cash Equivalents: The carrying amount of cash and cash equivalents is a reasonable estimate of fair value due to their short term nature.

Debt Securities Available for Sale: Debt Securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Certain trust preferred securities classified as corporate debt securities are Level 3 due to limited market trades of these classes of securities.

Other Investments: The carrying value of other investments, consisting principally of Federal Home Loan Bank stock, is a reasonable estimate of fair value of this stock. This stock is non-transferable and can only be redeemed at its par value by FHLB.

Derivative Financial Instruments: Derivative financial instruments are recorded at fair value on a recurring basis. Fair value measurement is based on pricing models run by a third-party, utilizing observable market-based inputs. All future floating cash flows are projected and both floating and fixed cash flows are discounted to the valuation date. As a result, we classify interest rate swaps as Level 2.

Loans Held for Sale: Loans held for sale are carried at the lower of cost or fair value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, we classify loans subject to nonrecurring fair value adjustments as Level 2.

Loans: We do not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the original contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the discounted cash flows or collateral value exceeds the recorded investments in such loans. These loans are carried at recorded loan investment and therefore are not included in the following tables of loans measured at fair value. Impaired loans internally graded as substandard or doubtful are evaluated using the fair value of collateral method. All other impaired loans are measured for impairment using the discounted cash flows method. Impaired loans where an allowance is established based on the fair value of collateral are included in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, we record the impaired loan as nonrecurring Level 2. When a current appraised value is not available and there is no observable market price, we record the impaired loan as nonrecurring Level 3.

When impaired loans are deemed required to be included in the fair value hierarchy, management immediately begins the process of evaluating the estimated fair value of the underlying collateral to determine if a related specific allowance for loan losses or charge-off is necessary. Current appraisals are ordered once a loan is deemed impaired if the existing appraisal is more than twelve months old, or more frequently if there is known deterioration in value. For recently identified impaired loans, a current appraisal may not be available at the financial statement date. Until the current appraisal is obtained, the original appraised value is discounted, as appropriate, to compensate for the estimated depreciation in the value of the loan’s underlying collateral since the date of the original appraisal. Such discounts are generally estimated based upon management’s knowledge of sales of similar collateral within the applicable market area and its knowledge of other real estate market-related data as well as general economic trends. When a new appraisal is received (which is generally within 3 months of a loan being identified as impaired), management then re-evaluates the fair value of the collateral and adjusts any specific allocated allowance for loan losses, as appropriate. In addition, management also assigns a discount of 7–10% for the estimated costs to sell the collateral.

Property Held for Sale: Property held for sale consists of real estate acquired in foreclosure or other settlement of loans. Foreclosed assets are initially recorded at fair value, less estimated selling costs, when acquired establishing a new cost basis. Such assets are carried on the balance sheet at the lower of the investment in the real estate or its fair value less estimated selling costs. The fair value of foreclosed properties is determined on a nonrecurring basis generally utilizing current appraisals performed by an independent, licensed appraiser applying an income or market value approach using observable market data (Level 2). Updated appraisals of foreclosed properties are generally obtained if the existing appraisal is more than 18 months old or more frequently if there is a known deterioration in value. However, if a current appraisal is not available, the original appraised value is discounted, as appropriate, to compensate for the estimated depreciation in the value of the real estate since the date of its original appraisal. Such discounts are generally estimated based upon management’s knowledge of sales of similar property within the applicable market area and its knowledge of other real estate market-related data as well as general economic trends (Level 3). Upon foreclosure, any fair value adjustment is charged against the allowance for loan losses. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense in the consolidated statements of income.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis.



	Balance at		Fair Value Measurements Using:
Dollars in thousands	December 31, 2019		Level 1		Level 2		Level 3
Available for sale securities
U.S. Government sponsored agencies	$	20,864	$	—	$	20,864	$	—
Mortgage backed securities:
Government sponsored agencies	70,975		—		70,975		—
Nongovernment sponsored entities	10,229		—		10,229		—
State and political subdivisions	49,973		—		49,973		—
Corporate debt securities	18,200		—		18,200		—
Asset-backed securities	33,014		—		33,014		—
Tax-exempt state and political subdivisions	73,100		—		73,100		—
Total available for sale securities	$	276,355	$	—	$	276,355	$	—

Derivative financial liabilities
Interest rate swaps	$	988	$	—	$	988	$	—



	Balance at		Fair Value Measurements Using:
Dollars in thousands	December 31, 2018		Level 1		Level 2		Level 3
Available for sale securities
U.S. Government sponsored agencies	$	26,140	$	—	$	26,140	$	—
Mortgage backed securities:
Government sponsored agencies	80,309		—		80,309		—
Nongovernment sponsored entities	614		—		614		—
State and political subdivisions	19,243		—		19,243		—
Corporate debt securities	14,512		—		14,512		—
Asset-backed securities	25,175		—		25,175		—
Tax-exempt state and political subdivisions	127,154		—		127,154		—
Total available for sale securities	$	293,147	$	—	$	293,147	$	—

Derivative financial assets
Interest rate swaps	$	555	$	—	$	555	$	—

Derivative financial liabilities
Interest rate swaps	$	411	$	—	$	411	$	—

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the tables below.



	Balance at		Fair Value Measurements Using:
Dollars in thousands	December 31, 2019		Level 1		Level 2		Level 3
Residential mortgage loans held for sale	$	1,319	$	—	$	1,319	$	—

Collateral-dependent impaired loans
Commercial	$	4,831	$	—	$	4,831	$	—
Commercial real estate	1,863		—		1,863		—
Construction and development	425		—		425		—
Residential real estate	692		—		566		126
Total collateral-dependent impaired loans	$	7,811	$	—	$	7,685	$	126

Property held for sale
Commercial real estate	$	1,304	$	—	$	1,304	$	—
Construction and development	12,182		—		12,182		—
Residential real estate	705		—		705		—
Total property held for sale	$	14,191	$	—	$	14,191	$	—



	Balance at		Fair Value Measurements Using:
Dollars in thousands	December 31, 2018		Level 1		Level 2		Level 3
Residential mortgage loans held for sale	$	400	$	—	$	400	$	—

Collateral-dependent impaired loans
Commercial	$	2,660	—		$	2,611	$	49
Commercial real estate	420		—		420		—
Construction and development	759		—		759		—
Residential real estate	763		—		763		—
Total collateral-dependent impaired loans	$	4,602	$	—	$	4,553	$	49

Property held for sale
Commercial real estate	$	1,677	$	—	$	1,677	$	—
Construction and development	16,363		—		16,363		—
Residential real estate	403		—		403		—
Total property held for sale	$	18,443	$	—	$	18,443	$	—

The following tables present the carrying amount, fair value, and placement in the fair value hierarchy of our financial instruments as of December 31, 2019 and December 31, 2018.



	At December 31,
	2019				Fair Value Measurements Using:
Dollars in thousands	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents	$	61,888	$	61,888	$	—	$	61,888	$	—
Securities available for sale	276,355		276,355		—		276,355		—
Other investments	12,972		12,972		—		12,972		—
Loans held for sale, net	1,319		1,319		—		1,319		—
Loans, net	1,900,425		1,901,020		—		7,685		1,893,335
Accrued interest receivable	8,439		8,439		—		8,439		—
Cash surrender value of life insurance policies	43,603		43,603		—		43,603		—
Derivative financial assets	—		—		—		—		—
	$	2,305,001	$	2,305,596	$	—	$	412,261	$	1,893,335
Financial liabilities
Deposits	$	1,913,237	$	1,918,610	$	—	$	1,918,610	$	—
Short-term borrowings	199,345		199,345		—		199,345		—
Long-term borrowings	717		854		—		854		—
Subordinated debentures owed to unconsolidated subsidiary trusts	19,589		19,589		—		19,589		—
Accrued interest payable	1,234		1,234		—		1,234		—
Derivative financial liabilities	988		988		—		988		—
	$	2,135,110	$	2,140,620	$	—	$	2,140,620	$	—



	At December 31
		2018				Fair Value Measurements Using:
Dollars in thousands		Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents		$	59,540	$	59,540	$	—	$	59,540	$	—
Securities available for sale		293,147		293,147		—		293,147		—
Other investments		16,635		16,635		—		16,635		—
Loans held for sale, net		400		400		—		400		—
Loans, net		1,682,005		1,666,834		—		4,553		1,662,281
Accrued interest receivable		8,708		8,708		—		8,708		—
Cash surrender value of life insurance policies		42,386		42,386		—		42,386		—
Derivative financial assets		555		555		—		555		—
		$	2,103,376	$	2,088,205	$	—	$	425,924	$	1,662,281
Financial liabilities
Deposits		$	1,634,826	$	1,631,456	$	—	$	1,631,456	$	—
Short-term borrowings		309,084		309,084		—		309,084		—
Long-term borrowings		735		843		—		843		—
Subordinated debentures owed to unconsolidated subsidiary trusts		19,589		19,589		—		19,589		—
Accrued interest payable		1,102		1,102		—		1,102		—
Derivative financial liabilities		411		411		—		411		—
		$	1,965,747	$	1,962,485	$	—	$	1,962,485	$	—