Fair Value Disclosures

Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. The Corporation determines the fair value of financial instruments based on the fair value hierarchy. The Corporation maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Corporation. Unobservable inputs are inputs that reflect the Corporation’s assumptions that market participants would use in pricing the asset or liability based on the best information available in the circumstances, including assumptions about risk. Three levels of inputs are used to measure fair value. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input significant to the fair value measurement. Transfers between levels are recognized at the end of the reporting period.

Level 1: Valuations are based on quoted prices in active markets for identical assets or liabilities that the Corporation can access at the measurement date. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

Level 2: Valuations are based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

Level 3: Valuations are based on inputs that are unobservable and significant to the overall fair value measurement. Assets and liabilities utilizing Level 3 inputs include: financial instruments whose value is determined using pricing models, discounted cash-flow methodologies, or similar techniques, as well as instruments for which the fair value calculation requires significant management judgment or estimation.

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

Investment Securities

Where quoted prices are available in an active market for identical instruments, investment securities are classified within Level 1 of the valuation hierarchy. Level 1 investment securities include U.S. Treasury securities, most equity securities and money market mutual funds. Mutual funds are registered investment companies which are valued at net asset value of shares on a market exchange at the end of each trading day. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Examples of instruments, which would generally be classified within Level 2 of the valuation hierarchy, include securities issued by U.S. Government sponsored enterprises, mortgage-backed securities, collateralized mortgage obligations, corporate and municipal bonds and certain equity securities. In cases where there is limited activity or less transparency around inputs to the valuation, investment securities are classified within Level 3 of the valuation hierarchy.

Fair values for securities are determined using independent pricing services and market-participating brokers. The Corporation’s independent pricing service utilizes evaluated pricing models that vary by asset class and incorporate available trade, bid and other market information for structured securities, cash flow and, when available, loan performance data. Because many fixed income securities do not trade on a daily basis, the pricing service’s evaluated pricing applications apply information as applicable through processes, such as benchmarking of like securities, sector groupings, and matrix pricing, to prepare evaluations. If at any time, the pricing service determines that it does not have sufficient verifiable information to value a particular security, the Corporation will utilize valuations from another pricing service. Management has a sufficient understanding of the third party service’s valuation models, assumptions and inputs used in determining the fair value of securities to enable management to maintain an appropriate system of internal control.

On a quarterly basis, the Corporation reviews changes, as submitted by the pricing service, in the market value of its security portfolio. Individual changes in valuations are reviewed for consistency with general interest rate movements and any known credit concerns for specific securities. Additionally, on a quarterly basis, the Corporation has its security portfolio priced by a second pricing service to determine consistency with another market evaluator, except for municipal bonds which are priced by another service provider on a sample basis. If, upon the Corporation’s review or in comparing with another service, a material difference between pricing evaluations were to exist, the Corporation may submit an inquiry to the current pricing service regarding the data used to determine the valuation of a particular security. If the Corporation determines there is market information that would support a different valuation than from the current pricing service’s evaluation, the Corporation can submit a challenge for a change to that security’s valuation. There were no material differences in valuations noted at June 30, 2016.

Derivative Financial Instruments

The fair values of derivative financial instruments are based upon the estimated amount the Corporation would receive or pay to terminate the contracts or agreements, taking into account current interest rates and, when appropriate, the current creditworthiness of the counterparties. Derivative financial instruments are classified within Level 2 of the valuation hierarchy.

Contingent Consideration Liability

The Corporation estimates the fair value of the contingent consideration liability by using a discounted cash flow model of future contingent payments based on projected revenue related to the acquired business. The estimated fair value of the contingent consideration liability is reviewed on a quarterly basis and any valuation adjustments resulting from a change of estimated future contingent payments based on projected revenue of the acquired business affecting the contingent consideration liability will be recorded through noninterest expense. Changes in the original assumptions utilized at the time the acquisition closes and identified during the measurement period are recorded in accordance with ASC Topic 805 as an adjustment to goodwill. Due to the significant unobservable input related to the projected revenue, the contingent consideration liability is classified within Level 3 of the valuation hierarchy. An increase in the projected revenue may result in a higher fair value of the contingent consideration liability. Alternatively, a decrease in the projected revenue may result in a lower estimated fair value of the contingent consideration liability.

For the Sterner Insurance Associates acquisition, the potential remaining two cash payments that could result from the contingent consideration arrangement range from $0 to a maximum of $3.9 million based on the results for the twelve-month periods ended June 30, 2016 and 2017, respectively. Due to updates to the original assumptions utilized for determining the contingent consideration liability for the Sterner acquisition completed on July 1, 2014, the Corporation recorded a purchase accounting adjustment, in accordance with ASC Topic 805, in the first quarter of 2015 which resulted in an increase to the contingent consideration liability and an increase to goodwill of $1.5 million.

For the Girard Partners acquisition, the potential remaining three cash payments that could result from the contingent consideration arrangement range from $0 to a maximum of $12.9 million cumulative based on the results for the three-year periods ended December 31, 2016, 2017, and 2018, respectively. The Corporation recorded a reduction to the contingent liability during the fourth quarter of 2015 which resulted in a reduction of noninterest expense of $550 thousand. The adjustment reflected that projected revenue levels for earn-out payments in the second through fifth years post-acquisition are anticipated to be lower than originally projected.

The following table presents the assets and liabilities measured at fair value on a recurring basis at June 30, 2016 and December 31, 2015, classified using the fair value hierarchy:



	At June 30, 2016
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets/ Liabilities at Fair Value
Assets:
Available-for-sale securities:
U.S. government corporations and agencies	$	—	$	47,446	$	—	$	47,446
State and political subdivisions	—		98,867		—		98,867
Residential mortgage-backed securities	—		3,635		—		3,635
Collateralized mortgage obligations	—		2,928		—		2,928
Corporate bonds	—		93,445		—		93,445
Money market mutual funds	7,009		—		—		7,009
Equity securities	765		—		—		765
Total available-for-sale securities	7,774		246,321		—		254,095
Interest rate locks with customers	—		2,432		—		2,432
Total assets	$	7,774	$	248,753	$	—	$	256,527
Liabilities:
Contingent consideration liability	$	—	$	—	$	5,213	$	5,213
Interest rate swap	—		1,203		—		1,203
Forward loan sale commitments	—		510		—		510
Total liabilities	$	—	$	1,713	$	5,213	$	6,926



	At December 31, 2015
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets/ Liabilities at Fair Value
Assets:
Available-for-sale securities:
U.S. treasuries	$	4,887	$	—	$	—	$	4,887
U.S. government corporations and agencies	—		102,156		—		102,156
State and political subdivisions	—		102,032		—		102,032
Residential mortgage-backed securities	—		13,354		—		13,354
Collateralized mortgage obligations	—		3,133		—		3,133
Corporate bonds	—		86,675		—		86,675
Money market mutual funds	16,726		—		—		16,726
Equity securities	807		—		—		807
Total available-for-sale securities	22,420		307,350		—		329,770
Interest rate locks with customers	—		1,089		—		1,089
Forward loan sale commitments	—		—		—		—
Total assets	$	22,420	$	308,439	$	—	$	330,859
Liabilities:
Contingent consideration liability	$	—	$	—	$	5,577	$	5,577
Interest rate swap	—		438		—		438
Forward loan sale commitments	—		102		—		102
Total liabilities	$	—	$	540	$	5,577	$	6,117

At June 30, 2016 and December 31, 2015, the Corporation had no assets measured at fair value on a recurring basis utilizing Level 3 inputs.

The following table presents the change in the balance of the contingent consideration liability related to acquisitions for which the Corporation utilized Level 3 inputs to determine fair value on a recurring basis for the six months ended June 30, 2016 and 2015:



	Six Months Ended June 30, 2016
(Dollars in thousands)	Balance at December 31, 2015		Contingent Consideration from New Acquisition		Payment of Contingent Consideration		Adjustment of Contingent Consideration		Balance at June 30, 2016
Sterner Insurance Associates	$	1,144	$	—	$	—	$	490	$	1,634
Girard Partners	4,241		—		900		238		3,579
John T. Fretz Insurance Agency	192		—		260		68		—
Total contingent consideration liability	$	5,577	$	—	$	1,160	$	796	$	5,213



	Six Months Ended June 30, 2015
(Dollars in thousands)	Balance at December 31, 2014		Contingent Consideration from New Acquisition*		Payment of Contingent Consideration		Adjustment of Contingent Consideration			Balance at June 30, 2015
Sterner Insurance Associates	$	680	$	1,525	$	—	$	402		$	2,607
Girard Partners	5,503		$	—	$	620	$	(112	)	4,771
John T. Fretz Insurance Agency	358		—		260		80			178
Total contingent consideration liability	$	6,541	$	1,525	$	880	$	370		$	7,556

*Includes adjustments during the measurement period in accordance with ASC Topic 805.

The Corporation recorded an increase to the contingent liability related to Sterner Insurance Associates during the second quarter of 2016 which resulted in an increase in noninterest expense of $183 thousand. The adjustment reflected that projected revenue levels for earn-out payments in the second through third years post-acquisition are anticipated to be higher than originally projected.

The Corporation may be required to periodically measure certain assets and liabilities at fair value on a non-recurring basis in accordance with GAAP. These adjustments to fair value usually result from the application of lower of cost or market accounting or impairment charges of individual assets. The following table represents assets measured at fair value on a non-recurring basis at June 30, 2016 and December 31, 2015:



	At June 30, 2016
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets/Liabilities at Fair Value
Impaired loans held for investment	$	—	$	—	$	43,624	$	43,624
Total	$	—	$	—	$	43,624	$	43,624



	At December 31, 2015
(Dollars in thousands)	Level 1		Level 2		Level 3		Assets/Liabilities at Fair Value
Impaired loans held for investment	$	—	$	—	$	48,611	$	48,611
Total	$	—	$	—	$	48,611	$	48,611

The following table presents assets and liabilities and off-balance sheet items not measured at fair value on a recurring or non-recurring basis in the Corporation’s consolidated balance sheets but for which the fair value is required to be disclosed at June 30, 2016 and December 31, 2015. The disclosed fair values are classified using the fair value hierarchy.



	At June 30, 2016
(Dollars in thousands)	Level 1		Level 2			Level 3		Fair Value			Carrying Amount
Assets:
Cash and short-term interest-earning assets	$	93,190	$	—		$	—	$	93,190		$	93,190
Held-to-maturity securities	—		32,946			—		32,946			32,885
Loans held for sale	—		4,766			—		4,766			4,657
Net loans and leases held for investment	—		—			2,233,013		2,233,013			2,284,260
Mortgage servicing rights	—		—			6,785		6,785			5,896
Other real estate owned	—		3,131			—		3,131			3,131
Total assets	$	93,190	$	40,843		$	2,239,798	$	2,373,831		$	2,424,019
Liabilities:
Deposits:
Demand and savings deposits, non-maturity	$	2,016,892	$	—		$	—	$	2,016,892		$	2,016,892
Time deposits	—		361,256			—		361,256			360,192
Total deposits	2,016,892		361,256			—		2,378,148			2,377,084
Short-term borrowings	—		259,971			—		259,971			260,216
Subordinated notes	—		50,250			—		50,250			49,450
Total liabilities	$	2,016,892	$	671,477		$	—	$	2,688,369		$	2,686,750
Off-Balance-Sheet:
Commitments to extend credit	$	—	$	(1,874	)	$	—	$	(1,874	)	$	—



	At December 31, 2015
(Dollars in thousands)	Level 1		Level 2			Level 3		Fair Value			Carrying Amount
Assets:
Cash and short-term interest-earning assets	$	60,799	$	—		$	—	$	60,799		$	60,799
Held-to-maturity securities	—		41,061			—		41,061			40,990
Loans held for sale	—		4,708			—		4,708			4,680
Net loans and leases held for investment	—		—			2,099,082		2,099,082			2,112,774
Mortgage servicing rights	—		—			8,047		8,047			5,877
Other real estate owned	—		1,276			—		1,276			1,276
Total assets	$	60,799	$	47,045		$	2,107,129	$	2,214,973		$	2,226,396
Liabilities:
Deposits:
Demand and savings deposits, non-maturity	$	1,939,954	$	—		$	—	$	1,939,954		$	1,939,954
Time deposits	—		455,527			—		455,527			454,406
Total deposits	1,939,954		455,527			—		2,395,481			2,394,360
Short-term borrowings	—		22,302			—		22,302			24,211
Subordinated notes	$	—	$	50,375		$	—	$	50,375		$	49,377
Total liabilities	$	1,939,954	$	528,204		$	—	$	2,468,158		$	2,467,948
Off-Balance-Sheet:
Commitments to extend credit	$	—	$	(1,788	)	$	—	$	(1,788	)	$	—

The following valuation methods and assumptions were used by the Corporation in estimating the fair value for financial instruments measured at fair value on a non-recurring basis and financial instruments not measured at fair value on a recurring or non-recurring basis in the Corporation’s consolidated balance sheets but for which the fair value is required to be disclosed:

Cash and short-term interest-earning assets: The carrying amounts reported in the balance sheet for cash and due from banks, interest-earning deposits with other banks, federal funds sold and other short-term investments approximates those assets’ fair values. Cash and short-term interest-earning assets are classified within Level 1 in the fair value hierarchy.

Held-to-maturity securities: Fair values for the held-to-maturity investment securities are estimated by using pricing models or quoted prices of securities with similar characteristics and are classified in Level 2 in the fair value hierarchy.

Loans held for sale: The fair value of the Corporation’s mortgage loans held for sale are generally determined using a pricing model based on current market information obtained from external sources, including interest rates, bids or indications provided by market participants on specific loans that are actively marketed for sale. These loans are primarily residential mortgage loans and are generally classified in Level 2 due to the observable pricing data. Loans held for sale are carried at the lower of cost or estimated fair value. There were no valuation adjustments for loans held for sale at June 30, 2016 and December 31, 2015.

Loans and leases held for investment: The fair values for loans and leases held for investment are estimated using discounted cash flow analyses, using a discount rate based on current interest rates at which similar loans with similar terms would be made to borrowers and include components for credit risk, operating expense and embedded prepayment options. An overall valuation adjustment is made for specific credit risks in addition to general portfolio risk and is significant to the valuation. As permitted, the fair value of the loans and leases are not based on the exit price concept as discussed in the first paragraph of this note. Loans and leases are classified within Level 3 in the fair value hierarchy.

Impaired loans held for investment: Impaired loans held for investment include those collateral-dependent loans for which the practical expedient was applied, resulting in a fair-value adjustment to the loan. Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or fair value. Fair value is measured based on the value of the collateral securing these loans less costs to sell and is classified at a Level 3 in the fair value hierarchy. The fair value of collateral is based on appraisals performed by qualified licensed appraisers hired by the Corporation. At June 30, 2016, impaired loans held for investment had a carrying amount of $44.0 million with a valuation allowance of $410 thousand. At December 31, 2015, impaired loans held for investment had a carrying amount of $48.9 million with a valuation allowance of $322 thousand.

Mortgage servicing rights: The Corporation estimates the fair value of mortgage servicing rights using discounted cash flow models that calculate the present value of estimated future net servicing income. The model uses readily available prepayment speed assumptions for the interest rates of the portfolios serviced. Mortgage servicing rights are classified within Level 3 of the valuation hierarchy. The Corporation reviews the mortgage servicing rights portfolio on a quarterly basis for impairment and the mortgage servicing rights are carried at the lower of amortized cost or estimated fair value. At June 30, 2016 and December 31, 2015, mortgage servicing rights had a carrying amount of $5.9 million, with no valuation allowance.

Goodwill and other identifiable assets: Certain non-financial assets subject to measurement at fair value on a non-recurring basis include goodwill and other identifiable intangible assets. During the six months ended June 30, 2016, there were no triggering events that required valuation of goodwill and other identifiable intangible assets.

Other real estate owned: The fair value of other real estate owned is estimated based upon the appraised value less costs to sell. The real estate is stated at an amount equal to the loan balance prior to foreclosure, plus costs incurred for improvements to the property but no more than the fair value of the property, less estimated costs to sell. New appraisals are generally obtained on an annual basis. Other real estate owned is classified within Level 2 of the valuation hierarchy.

Deposit liabilities: The fair values for demand and savings accounts, with no stated maturities, is the amount payable on demand at the reporting date (carrying value) and are classified within Level 1 in the fair value hierarchy. The fair values for time deposits with fixed maturities are estimated by discounting the final maturity using interest rates currently offered for deposits with similar remaining maturities. Time deposits are classified within Level 2 in the fair value hierarchy.

Short-term borrowings: The fair value of short-term borrowings are estimated using current market rates for similar borrowings and are classified within Level 2 in the fair value hierarchy.

Subordinated notes: The fair value of the subordinated notes are estimated by discounting the principal balance using the treasury yield curve for the term to the call date as the Corporation has the option to call the subordinated notes. The subordinated notes are classified within Level 2 in the fair value hierarchy.

Off-balance-sheet instruments: Fair values for the Corporation’s off-balance-sheet instruments are based on the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing and are classified within Level 2 in the fair value hierarchy.