FAIR VALUES OF FINANCIAL INSTRUMENTS

The Corporation used fair value measurements to record fair value adjustments, to certain assets, and liabilities and to determine fair value disclosures. The accounting guidance defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. ASC 820 applies only when other guidance requires or permits assets or liabilities to be measured at fair value; it does not expand the use of fair value in any new circumstances.

As defined in ASC 820, fair value is the price to sell an asset or transfer a liability in an orderly transaction between market participants. It represents an exit price at the measurement date. Market participants are buyers and sellers, who are independent, knowledgeable, and willing and able to transact in the principal (or most advantageous) market for the asset or liability being measured. Current market conditions, including imbalances between supply and demand, are considered in determining fair value. The Corporation values its assets and liabilities in the principal market where it sells the particular asset or transfers the liability with the greatest volume and level of activity. In the absence of a principal market, the valuation is based on the most advantageous market for the asset or liability (i.e., the market where the asset could be sold or the liability transferred at a price that maximizes the amount to be received for the asset or minimizes the amount to be paid to transfer the liability).

Valuation inputs refer to the assumptions market participants would use in pricing a given asset or liability. Inputs can be observable or unobservable. Observable inputs are those assumptions which market participants would use in pricing the particular asset or liability. These inputs are based on market data and are obtained from a source independent of the Corporation. Unobservable inputs are assumptions based on the Corporation’s own information or estimate of assumptions used by market participants in pricing the asset or liability. Unobservable inputs are based on the best and most current information available on the measurement date. All inputs, whether observable or unobservable, are ranked in accordance with a prescribed fair value hierarchy which gives the highest ranking to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1) and the lowest ranking to unobservable inputs for which there is little or no market activity (Level 3). Fair values for assets or liabilities classified as Level 2 are based on one or a combination of the following factors: (i) quoted prices for similar assets; (ii) observable inputs for the asset or liability, such as interest rates or yield curves; or (iii) inputs derived principally from or corroborated by observable market data. The level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Corporation considers an input to be significant if it drives 10 percent or more of the total fair value of a particular asset or liability.

RECURRING MEASUREMENTS

Assets and liabilities are considered to be fair valued on a recurring basis if fair value is measured regularly (i.e., daily, weekly, monthly or quarterly). Recurring valuation occurs at a minimum on the measurement date. Assets and liabilities are considered to be fair valued on a nonrecurring basis if the fair value measurement of the instrument does not necessarily result in a change in the amount recorded on the balance sheet. Generally, nonrecurring valuation is the result of the application of other accounting pronouncements which require assets or liabilities to be assessed for impairment or recorded at the lower of cost or fair value. The fair value of assets or liabilities transferred in or out of Level 3 is measured on the transfer date, with any additional changes in fair value subsequent to the transfer considered to be realized or unrealized gains or losses.

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

Investment Securities

Where quoted, market prices are available in an active market and securities are classified within Level 1 of the valuation hierarchy. There are no securities classified within Level 1 of the hierarchy. 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. Level 2 securities include agencies, government-sponsored mortgage backs, state and municipal, equity securities and U.S. Treasuries. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include state and municipal, corporate obligations and equity securities. Level 3 fair value on state and municipal, corporate obligations and equity securities was determined using a discounted cash flow model that incorporated market estimates of interest rates and volatility in markets that have not been active.

Third party vendors compile prices from various sources and may apply such techniques as matrix pricing to determine the value of identical or similar investment securities (Level 2). Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather relying on the investment securities’ relationship to other benchmark quoted investment securities. Any investment security not valued based upon the methods above are considered Level 3.

Corporate Obligations

The pooled trust preferred securities in the portfolio fall within the scope of ASC 325-10 (formerly EITF 99-20) and include $6.4 million amortized cost, with a fair value of $2.7 million. The issuers in these securities are primarily banks, but some of the pools do include a limited number of insurance companies. The Corporation uses an other-than-temporary impairment (“OTTI”) evaluation process to compare the present value of expected cash flows to determine whether an adverse change in cash flows has occurred. The OTTI process considers the structure and term of the collateralized debt obligation (“CDO”) and the financial condition of the underlying issuers. Specifically, the process details interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities. Assumptions used in the process include expected future default rates and prepayments as well as recovery assumptions on defaults and deferrals. In addition, the process is used to “stress” each CDO, or make assumptions more severe than expected activity, to determine the degree to which assumptions could deteriorate before the CDO could no longer fully support repayment of the Corporation’s note class. In 2013, securities for which OTTI has been previously taken, had a decrease in unrealized losses of $1.4 million, net of tax, of which all was recorded in other comprehensive income.

Interest Rate Derivative Agreements

See information regarding the Corporation’s interest rate derivative products in Note 13. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.

The fair value of the interest rate swap and cap instruments were transferred from Level 3 to Level 2 as of March 31, 2012 due to the availability of additional valuation information. These instruments are valued using widely accepted valuation techniques including discounted cash flow analysis using observable inputs such as contractual terms and LIBOR-based rate curves.

The following table presents the fair value measurements of assets and liabilities recognized in the accompanying balance sheets measured at fair value on a recurring basis and the level within the ASC 820-10 fair value hierarchy in which the fair value measurements fall at December 31, 2013 and 2012.



			Fair Value Measurements Using:
			Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs		Significant Unobservable Inputs
December 31, 2013	Fair Value		(Level 1)	(Level 2)		(Level 3)
U.S. Treasury	$	15,973		$	15,973
U.S. Government-sponsored agency securities	3,545			3,545
State and municipal	230,987			223,752		$	7,235
U.S. Government-sponsored mortgage-backed securities	281,252			281,252
Corporate obligations	2,738					2,738
Equity securities	1,706			1,702		4
Interest rate swap asset	3,619			3,619
Interest rate cap	390			390
Interest rate swap liability	3,953			3,953



			Fair Value Measurements Using:
			Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs		Significant Unobservable Inputs
December 31, 2012	Fair Value		(Level 1)	(Level 2)		(Level 3)
U.S. Government-sponsored agency securities	$	4,640		$	4,640
State and municipal	158,194			140,094		$	18,100
U.S. Government-sponsored mortgage-backed securities	348,579			348,579
Corporate obligations	224					224
Equity securities	1,706			1,702		4
Interest rate swap asset	6,103			6,103
Interest rate cap	197			197
Interest rate swap liability	9,766			9,766

LEVEL 3 RECONCILIATION

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable Level 3 inputs for year ended December 31, 2013 and 2012.



	Year Ended December 31, 2013
	Available for Sale Securities
Beginning Balance	$	18,328
Total realized and unrealized gains and losses
Included in net income
Included in other comprehensive income	1,330
Purchases, issuances, and settlements	7,590
Transfers in/(out) of Level 3	(16,434		)
Principal payments	(837		)
Ending balance	$	9,977



	Year Ended December 31, 2012
	Available for Sale Securities			Interest Rate Swap Asset			Interest Rate Cap			Interest Rate Swap Liability
Beginning Balance	$	20,838		$	5,241		$	424		$	7,797
Total realized and unrealized gains and losses
Included in net income				(860		)				(863		)
Included in other comprehensive income	(1,141		)	481			(15		)
Purchases, issuances, and settlements
Transfers in/(out) of Level 3				(4,862		)	(409		)	(6,934		)
Principal payments	(1,369		)
Ending balance	$	18,328

There were no gains or losses for the period included in earnings that were attributable to the changes in unrealized gains or losses related to assets or liabilities held at December 31, 2013 or December 31, 2012.

TRANSFERS BETWEEN LEVELS



	Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs			Significant Unobservable Inputs
December 31, 2013	(Level 1)	(Level 2)			(Level 3)			Reason for Transfer
Transfers to/(from) Level:
Available for sale securities		$	(350	)	$	350		Selected state and municipal securities were transferred from Level 2 to Level 3 due to limited availability of similar securities in active markets
Available for sale securities transferred to held to maturity					$	(16,784	)	Selected state and municipal securities were transferred from available for sale to held to maturity. These securities are valued at amortized cost and are no longer classified within the fair value hierarchy.



	Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs		Significant Unobservable Inputs
December 31, 2012	(Level 1)	(Level 2)		(Level 3)			Reason for Transfer
Transfers to/(from) Level:							The interest rate swap and cap instruments were transferred from Level 3 to Level 2 as of March 31, 2012 due to the availability of additional valuation information. These instruments are valued using widely accepted valuation techniques including discounted cash flow analysis using observable inputs such as contractual terms and LIBOR-based rate curves.
Interest rate swap asset		$	4,862	$	(4,862	)
Interest rate cap		$	409	$	(409	)
Interest rate swap liability		$	6,934	$	(6,934	)

In 2013, approximately $350,000 of selected state and municipal securities were transferred from Level 2 to Level 3 due to limited availability of similar securities in active markets. Additionally, the Corporation transferred $16,784,000 of selected state and municipal securities from available for sale to held to maturity. These securities are valued at amortized cost and are no longer classified within the fair value hierarchy. All securities transferred to held to maturity were previously classified as Level 3 in the fair value hierarchy.

NONRECURRING MEASUREMENTS

Following is a description of valuation methodologies used for instruments measured at fair value on a non-recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy for year ended December 31, 2013 and 2012.



			Fair Value Measurements Using
			Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs	Significant Unobservable Inputs
December 31, 2013	Fair Value		(Level 1)	(Level 2)	(Level 3)
Impaired Loans (collateral dependent)	$	12,117			$	12,117
Other real estate owned	$	6,877			$	6,877



			Fair Value Measurements Using
			Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs	Significant Unobservable Inputs
December 31, 2012	Fair Value		(Level 1)	(Level 2)	(Level 3)
Impaired Loans (collateral dependent)	$	17,703			$	17,703
Other real estate owned	$	7,684			$	7,684

Impaired Loans (collateral dependent)

Loans for which it is probable that the Corporation will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value of the collateral for collateral dependent loans. If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value. A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance. If these allocations cause the allowance for loan losses to increase, such increase is reported as a component of the provision for loan losses. Loan losses are charged against the allowance when management believes the uncollectability of the loan is confirmed. During 2013, certain impaired loans were partially charged off or re-evaluated. Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.

Other Real Estate Owned

The fair value for impaired loans and other real estate owned is measured based on the value of the collateral securing those loans or real estate and is determined using several methods. The fair value of real estate is generally determined based on appraisals by qualified licensed appraisers. The appraisers typically determine the value of the real estate by utilizing an income or market valuation approach. If an appraisal is not available, the fair value may be determined by using a cash flow analysis. Fair value on other collateral such as business assets is typically ascertained by assessing, either singularly or some combination of, asset appraisals, accounts receivable aging reports, inventory listings and or customer financial statements. Both appraised values and values based on borrower’s financial information are discounted as considered appropriate based on age and quality of the information and current market conditions.

UNOBSERVABLE (LEVEL 3) INPUTS

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements, other than goodwill, at December 31, 2013 .



	Fair Value		Valuation Technique	Unobservable Inputs	Range (Weighted-Average)
State and municipal securities	$	7,235	Discounted cash flow	Maturity Call Date US Muni BQ curve Discount rate	1 month to 15 years BBB- 1% - 5%

Corporate obligations/Equity securities	$	2,742	Discounted cash flow	Risk free rate plus Premium for illiquidity	3 month LIBOR plus 200 bps

Impaired loans (collateral dependent)	$	12,117	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability	0% - 50% (3%)

Other real estate owned	$	6,877	Appraisals	Discount to reflect current market conditions	0% - 20% (2%)

The following is a discussion of the sensitivity of significant unobservable inputs on recurring fair value measurements, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement and of how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.

State and Municipal Securities

The significant unobservable inputs used in the fair value measurement of the Corporation's state and municipal securities are premiums for unrated securities and marketability discounts. Significant increases or decreases in either of those inputs in isolation would result in a significantly lower or higher fair value measurement. Generally, changes in either of those inputs will not affect the other input.

Corporate Obligations/Equity Securities

The significant unobservable inputs used in the fair value measurement of the Corporation's corporate obligations and equity securities are premiums for unrated securities and marketability discounts. Significant increases or decreased in either of those inputs in isolation would result in a significantly lower or higher fair value measurement. Generally changes in either of those inputs will not affect the other input.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table presents estimated fair values of the Corporation's financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at December 31, 2013 and December 31, 2012.



	2013
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets at December 31:
Cash and cash equivalents	$	109,434	$	109,434
Interest-bearing time deposits	55,069		55,069
Investment securities available for sale	536,201				$	526,224	$	9,977
Investment securities held to maturity	559,378				525,998		34,849
Mortgage loans held for sale	5,331				5,331
Loans	3,564,539						3,506,615
FRB and FHLB stock	38,990				38,990
Interest rate swap asset	4,009				4,009
Interest receivable	18,672				18,672
Liabilities at December 31:
Deposits	$	4,231,468	$	3,082,117	$	934,937
Borrowings:
Federal funds purchased	125,645				125,645
Securities sold under repurchase agreements	148,672				148,852
FHLB Advances	122,140				122,962
Subordinated debentures and term loans	126,807				82,607
Interest rate swap liability	3,953				3,953
Interest payable	1,771				1,771



	2012
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets at December 31:
Cash and cash equivalents	$	101,460	$	101,460
Interest-bearing time deposits	38,443		38,443
Investment securities available for sale	513,343				$	495,015	$	18,328
Investment securities held to maturity	361,020				366,590		11,584
Mortgage loans held for sale	22,300				22,300
Loans	2,832,843						2,852,614
FRB and FHLB stock	32,785				32,785
Interest rate swap asset	6,300				6,300
Interest receivable	16,367				16,367
Liabilities at December 31:
Deposits	$	3,346,383	$	2,478,706	$	865,793
Borrowings:
Federal funds purchased	18,862				18,862
Securities sold under repurchase agreements	141,828				142,318
FHLB Advances	94,238				97,357
Subordinated debentures and term loans	112,161				62,133
Interest rate swap liability	9,766				9,766
Interest payable	1,841				1,841

Cash and cash equivalents: The fair value of cash and cash equivalents approximates carrying value.

Interest-bearing time deposits: The fair value of interest-bearing time deposits approximates carrying value.

Investment securities: Fair value is based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Mortgage loans held for sale: The carrying amount approximates fair value due to the short duration between origination and date of sale.

Loans: The fair value for loans is estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. See Impaired Loans above.

Federal Reserve and Federal Home Loan Bank stock: The fair value of Federal Reserve Bank and Federal Home Loan Bank stock is based on the price which it may be resold to the Federal Reserve and Federal Home Loan Bank.

Derivative instruments: The fair value of interest rate swaps reflect the estimated amounts that would have been received to terminate these contracts at the reporting date based upon pricing or valuation models applied to current market information. Interest rate caps are valued using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates rose above the strike rate of the caps. The projected cash receipts on the caps are based on an expectation of future interest rates derived from observed market interest rate curves and volatilities.

Interest receivable and Interest payable: The fair value of interest receivable/payable approximates carrying value.

Deposits: The fair values of noninterest-bearing and interest-bearing demand accounts and savings deposits are equal to the amount payable on demand at the balance sheet date. The carrying amounts for variable rate, fixed-term certificates of deposit approximate their fair values at the balance sheet date. Fair values for fixed-rate certificates of deposit and other time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of aggregated expected monthly maturities on such time deposits.

Borrowings: The fair value of borrowings is estimated using a discounted cash flow calculation, based on current rates for similar debt.