(

)

Assets and Liabilities Measured and Reported at Fair Value

Bancorp follows the provisions of authoritative guidance for fair value measurements. This guidance is definitional and disclosure oriented and addresses how companies should approach measuring fair value when required by US GAAP. The guidance also prescribes various disclosures about financial statement categories and amounts which are measured at fair value, if such disclosures are

not

already specified elsewhere in US GAAP. Bancorp adopted ASU

2016

01,

Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities,

effective

January 1, 2018.

The most significant change impacting Bancorp was a change in valuation methods for the loan portfolio for fair value reporting. GAAP

longer allows for valuing financial instruments for fair value purposes using an “entrance” pricing methodology. The use of an “exit” price methodology requires greater assumptions regarding life of loan losses and is a more complex calculation, the results of which can be seen below.

Authoritative guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between participants at the measurement date. The guidance also establishes a hierarchy to group assets and liabilities carried at fair value in

three

levels based upon the markets in which the assets and liabilities trade and the reliability of assumptions used to determine fair value. These levels are:

●

Level

Valuation is based upon quoted prices for identical instruments traded in active markets.

●

Level

Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are

not

active, and model-based valuation techniques for which all significant assumptions are observable in the market.

●

Level

Valuation is generated from model-based techniques that use significant assumptions

not

observable in the market. These unobservable assumptions would reflect internal estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques could include pricing models, discounted cash flows and other similar techniques.

Authoritative guidance requires maximum use of observable inputs and minimum use of unobservable inputs in fair value measurements. Where there exists limited or

observable market data, Bancorp derives its own estimates by generally considering characteristics of the asset/liability, the current economic and competitive environment and other factors. For this reason, results cannot be determined with precision and

may

not

be realized on an actual sale or immediate settlement of the asset or liability.

Bancorp’s investment securities available-for-sale and interest rate swaps are recorded at fair value on a recurring basis. Other accounts including mortgage servicing rights, impaired loans and other real estate owned

may

be recorded at fair value on a non-recurring basis, generally in the application of lower of cost or market adjustments or write-downs of specific assets.

The portfolio of investment securities available-for-sale is comprised of U.S. Treasury and other U.S. government obligations, debt securities of U.S. government-sponsored corporations (including mortgage-backed securities), obligations of state and political subdivisions and corporate equity securities. U.S. Treasury and corporate equity securities are priced using quoted prices of identical securities in an active market. These measurements are classified as Level

in the hierarchy above. All other securities are priced using standard industry models or matrices with various assumptions such as yield curves, volatility, prepayment speeds, default rates, time value, credit rating and market prices for similar instruments. These assumptions are generally observable in the market place and can be derived from or supported by observable data. These measurements are classified as Level

in the hierarchy above.

Interest rate swaps are valued using primarily Level

inputs. Fair value measurements generally based on benchmark forward yield curves and other relevant observable market data. For purposes of potential valuation adjustments to derivative positions, Bancorp evaluates the credit risk of its counterparties as well as its own credit risk. To date, Bancorp has

not

realized any losses due to counterparty’s inability to perform and the change in value of derivative assets and liabilities attributable to credit risk was

not

significant during

2018.

Below are the carrying values of assets measured at fair value on a recurring basis.

(In thousands)	Fair value at March 31, 2018
Assets	Total		Level 1		Level 2		Level 3
Investment securities available-for-sale
Government sponsored enterprise obligations	$	402,411	$	-	$	402,411	$	-
Mortgage-backed securities - government agencies		151,748		-		151,748		-
Obligations of states and political subdivisions		43,922		-		43,922		-

Total investment securities available-for-sale		598,081		-		598,081		-

Interest rate swaps		1,987		-		1,987		-

Total assets	$	600,068	$	-	$	600,068	$	-

Liabilities

Interest rate swaps	$	1,275	$	-	$	1,275	$	-

(In thousands)	Fair value at December 31, 2017
Assets	Total		Level 1		Level 2		Level 3
Investment securities available-for-sale

U.S. Treasury and other U.S. government obligations	$	149,984	$	149,984	$	-	$	-
Government sponsored enterprise obligations		213,844		-		213,844		-
Mortgage-backed securities - government agencies		161,507		-		161,507		-
Obligations of states and political subdivisions		49,189		-		49,189		-

Total investment securities available-for-sale		574,524		149,984		424,540		-

Interest rate swaps		579		-		579		-

Total assets	$	575,103	$	149,984	$	425,119	$	-

Liabilities

Interest rate swaps	$	259	$	-	$	259	$	-

Bancorp had

financial instruments classified within Level

of the valuation hierarchy for assets and liabilities measured at fair value on a recurring basis at

March 31, 2018

December 31, 2017.

MSRs are recorded at fair value upon capitalization, are amortized to correspond with estimated servicing income, and are periodically assessed for impairment based on fair value at the reporting date. Fair value is based on a valuation model that calculates the present value of estimated net servicing income. The model incorporates assumptions that market participants would use in estimating future net servicing income. These measurements are classified as Level

March 31, 2018

and

December 31, 2017

there was

valuation allowance for the mortgage servicing rights, as the fair value exceeded the cost. Accordingly, the MSRs are

not

included in either table below for

March 31, 2018

December 31, 2017.

See Note

for more information regarding MSRs.

For impaired loans in the table below, fair value is calculated as the carrying value of only loans with a specific valuation allowance, less the specific allowance, and the carrying value of collateral dependent loans that have been charged down to their fair value. Fair value of impaired loans was primarily measured based on the value of collateral securing these loans. Impaired loans are classified within Level

of the fair value hierarchy. Collateral

may

be real estate and/or business assets including equipment, inventory, and/or accounts receivable. Bancorp determines the value of real estate collateral based on independent appraisals performed by qualified licensed appraisers. These appraisals

may

utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised values are discounted for costs to sell and

may

be discounted further based on management’s historical knowledge, changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts by management are subjective and are typically significant unobservable inputs for determining fair value. For other assets, Bancorp relies on both internal and

third

party assessments of asset value, based on information provided by the borrower, following methodologies similar to those described for real estate. As of

March 31, 2018,

total impaired collateral dependent loans charged down to their fair value and impaired loans with a valuation allowance were

$7.4

million, and the specific allowance totaled

$1.5

million, resulting in a fair value of

$5.9

million, compared with total collateral dependent loans charged down to their fair value and impaired loans with a valuation allowance of

$2.6

million, and the specific allowance allocation totaling

$48

thousand, resulting in a fair value of

$2.6

million at

December 31, 2017.

Losses represent charge offs and changes in specific allowances for the periods indicated.

Other real estate owned (“OREO”), which is carried at the lower of cost or fair value, is periodically assessed for impairment based on fair value at the reporting date. Fair value is based on appraisals performed by external parties which use judgments and assumptions that are property-specific and sensitive to changes in the overall economic environment. Appraisals

may

be further discounted based on management’s historical knowledge and/or changes in market conditions from the date of the most recent appraisal. Many of these inputs are

not

observable and, accordingly, these measurements are classified as Level

For OREO in the table below, fair value is the carrying value of only parcels of OREO which have a carrying value equal to appraised value. Losses represent write-downs which occurred during the period indicated. At

March 31, 2018

and

December 31, 2017,

carrying value of all other real estate owned was

$360

thousand and

$2.6

million, respectively.

Below are the carrying values of assets measured at fair value on a non-recurring basis.

(In thousands)	Fair value at March 31, 2018								Losses for 3 month
									period ended
	Total		Level 1		Level 2		Level 3		March 31, 2018
Impaired loans	$	5,918	$	-	$	-	$	5,918	$	(1,711	)
Other real estate owned		360		-		-		360		-

Total	$	6,278	$	-	$	-	$	6,278	$	(1,711	)

(in thousands)	Fair value at December 31, 2017								Losses for 3 month
									period ended
	Total		Level 1		Level 2		Level 3		March 31, 2017
Impaired loans	$	2,569	$	-	$	-	$	2,569	$	(452	)
Other real estate owned		2,640		-		-		2,640		-

Total	$	5,209	$	-	$	-	$	5,209	$	(452	)

For the securities portfolio, Bancorp monitors the valuation technique used by pricing agencies to ascertain when transfers between levels have occurred. The nature of other assets and liabilities measured at fair value is such that transfers in and out of any level are expected to be rare. For the

three

months ended

March 31, 2018,

there were

transfers between Levels

For Level

assets measured at fair value on a non-recurring basis as of

March 31, 2018,

the significant unobservable inputs used in the fair value measurements are presented below.

				Significant	Weighted
	Fair		Valuation	unobservable	average of
(Dollars in thousands)	value		technique	input	input
Impaired loans - collateral dependent	$	5,918	Appraisal	Appraisal discounts		42.2	%
Other real estate owned		360	Appraisal	Appraisal discounts		10.0