8. FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (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. There are three levels of inputs that may be used to measure fair values:

Level 1:	Quoted prices (unadjusted) for 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 that Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or 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 as asset or liability.

The Company used the following methods and significant assumptions to estimate the fair value:

Investment Securities: The fair values for investment securities are determined by quoted market prices (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

Loans Held for Sale, at Fair Value: The fair value of loans held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan or other observable market data, such as outstanding commitments from third party investors (Level 2).

Derivatives: The fair values of derivatives are based on valuation models using observable market data as of the measurement date (Level 2). Our derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rates, and volatility factors to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services.

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Other Real Estate Owned: Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by Management. Once received, a member of the Credit Department reviews the assumptions and approaches utilized in the appraisal, as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. Appraisals on collateral dependent impaired loans and other real estate owned (consistent for all loan types) are obtained on an annual basis, unless a significant change in the market or other factors warrants a more frequent appraisal. On an annual basis, Management compares the actual selling price of any collateral that has been sold to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value for other properties. The most recent analysis performed indicated that a discount up to 15 percent should be applied to appraisals on properties. The discount is determined based on the nature of the underlying properties, aging of appraisal and other factors. For each collateral-dependent impaired loan we consider other factors, such as certain indices or other market information, as well as property specific circumstances to determine if an adjustment to the appraised value is needed. In situations where there is evidence of change in value, the Bank will determine if there is need for an adjustment to the specific reserve on the collateral dependent impaired loans. When the Bank applies an interim adjustment, it generally shows the adjustment as an incremental specific reserve against the loan until it has received the full updated appraisal. As of December 31, 2014, all collateral-dependent impaired loans and other real estate owned valuations were supported by an appraisal less than 12 months old, except for one property that has an appraisal that is 14 months old. An updated appraisal had been ordered on the property. The loan has been performing and was current at December 31, 2014.

The following table summarizes, for the periods indicated, assets measured at fair value on a recurring basis, including financial assets for which the Company has elected the fair value option:

			Fair Value Measurements Using
			Quoted
			Prices In
			Active
			Markets		Significant
			For		Other			Significant
			Identical		Observable			Unobservable
			Assets		Inputs			Inputs
(In thousands)	December 31, 2014		(Level 1)		(Level 2)			(Level 3)
Assets:
Securities available for sale:
U.S. government-sponsored entities	$	35,670	$	—	$	35,670		$	—
Mortgage-backed securities-residential		242,289		—		242,289			—
SBA pool securities		7,944		—		7,944			—
State and political subdivisions		41,394		—		41,394			—
Single-issuer trust preferred security		2,400		—		2,400			—
CRA investment fund		2,955		2,955		—			—
Loans held for sale, at fair value		839		—		839			—
Total	$	333,491	$	2,955	$	330,536		$	—

Financial Liabilities Derivatives	$	—	$	—	$	(169	)	$	—

(In thousands)	December 31, 2013
Assets:
Securities available for sale:
U.S. government-sponsored entities	$	14,770	$	—	$	14,770		$	—
Mortgage-backed securities-residential		189,080		—		189,080			—
State and political subdivisions		59,343		—		59,343			—
Single-issuer trust preferred security		2,370		—		2,370			—
CRA investment fund		2,884		2,884		—			—
Loans held for sale, at fair value		2,001		—		2,001			—
Total	$	270,448	$	2,884	$	267,564		$	—

The Company has elected the fair value option for loans held for sale. These loans are intended for sale and the Company believes that the fair value is the best indicator of the resolution of these loans. Interest income is recorded based on the contractual terms of the loan and in accordance with the Company's policy on loans held for investment. None of these loans are 90 days or more past due nor on nonaccrual as of December 31, 2014 and December 31, 2013.

The following tables present residential loans held for sale, at fair value for the periods indicated:

	December 31, 2014		December 31, 2013
Residential loans contractual balance	$	826	$	1,975
Fair value adjustment		13		26
Total fair value of residential loans held for sale	$	839	$	2,001

There were no transfers between Level 1 and Level 2 during the year ended December 31, 2014.

The following table summarizes, for the periods indicated, assets measured at fair value on a non-recurring basis:

			Fair Value Measurements Using
			Quoted
			Prices In
			Active
			Markets		Significant
			For		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
(In thousands)	December 31, 2014		(Level 1)		(Level 2)		(Level 3)
Assets:
Impaired loans:
Primary residential mortgage	$	543	$	—	$	—	$	543
OREO		580		—		—		580

(In thousands)	December 31, 2013
Assets:
Impaired loans:
Primary residential mortgage	$	85	$	—	$	—	$	85
Owner-occupied commercial real estate		1,593		—		—		1,593
OREO		980		—		—		980

Impaired loans that are measured for impairment using the fair value of the collateral for collateral dependent loans, had a recorded investment of $648 thousand, with a valuation allowance of $105 thousand at December 31, 2014. Impaired loans that are measured for impairment using the fair value of the collateral for collateral dependent loans, had a recorded investment of $2.1 million, with a valuation allowance of $471 thousand at December 31, 2013.

At both December 31, 2014 and 2013, OREO at fair value represents one commercial property. The Company recorded a valuation allowance of $400 thousand and $1.01 million during 2014 and 2013, respectively.

The carrying amounts and estimated fair values of financial instruments at December 31, 2014 are as follows:

			Fair Value Measurements at December 31, 2014 Using
	Carrying
(In thousands)	Amount		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	31,207	$	30,707	$	500	$	—	$	31,207
Securities available for sale		332,652		2,955		329,697		—		332,652
FHLB and FRB stock		11,593		—		—		—		N/A
Loans held for sale, at fair value		839		—		839		—		839
Loans, net of allowance for loan losses		2,230,787		—		—		2,213,604		2,213,604
Accrued interest receivable		5,371		—		924		4,447		5,371
Financial liabilities
Deposits	$	2,298,693	$	1,968,207	$	329,579	$	—	$	2,297,786
Overnight borrowings		54,600		—		54,600				54,600
Federal Home Loan Bank advances		83,692		—		84,677		—		84,677
Financial Liabilities Derivatives
Accrued interest payable		496		103		393		—		496

The carrying amounts and estimated fair values of financial instruments at December 31, 2013 are as follows:

			Fair Value Measurements at December 31, 2013 Using
	Carrying
(In thousands)	Amount		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	35,147	$	34,397	$	750	$	—	$	35,147
Securities available for sale		268,447		2,884		265,563		—		268,447
FHLB and FRB stock		10,032		—		—		—		N/A
Loans held for sale, at fair value		2,001		—		2,001		—		2,001
Loans, net of allowance for loan losses		1,558,828		—		—		1,528,937		1,528,937
Accrued interest receivable		4,086		—		817		3,269		4,086
Financial liabilities
Deposits	$	1,647,250	$	1,490,417	$	156,078	$	—	$	1,646,495
Overnight borrowings		54,900		—		54,900		—		54,900
Federal Home Loan Bank advances		74,692		—		75,728		—		75,728
Accrued interest payable		340		49		291		—		340

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

Cash and cash equivalents: The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. Cash and due from banks is classified as Level 1. Certificates of deposit are classified as Level 2.

FHLB and FRB stock: It is not practicable to determine the fair value of FHLB or FRB stock due to restrictions placed on its transferability.

Loans: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

Deposits: The fair values disclosed for demand deposits (e.g., interest and noninterest checking, savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date, (i.e., the carrying amount) resulting in a Level 1 classification. The carrying amounts of variable-rate certificates of deposit approximate the fair values at the reporting date resulting in Level 2 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

Overnight borrowings: The carrying amounts of overnight borrowings approximate fair values and are classified as Level 2.

Federal Home Loan Bank advances: The fair values of the Company's long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

Accrued interest receivable/payable: The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification. Accrued interest on deposits and securities are included in Level 2. Accrued interest on loans are included in Level 3.

Off-balance sheet instruments: Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The fair value of commitments is not material.