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 than 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 reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Investment Securities and Other Investments: The fair values for investment securities and other investments are determined by quoted market prices, if available (Level 1). For investment securities and other investments where quoted prices are not available, fair values are calculated based on market prices of similar investment securities and other investments (Level 2). For investment securities and other investments where quoted prices or market prices of similar investment securities and other investments are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Level 3 pricing is obtained from a third-party based upon similar trades that are not traded frequently without adjustment by the Company. At September 30, 2018, the Company held $5.0 million in Level 3 securities which consist of $4.7 million of non-rated Obligations of State and Political Subdivisions and $353 thousand of equity securities that are not actively traded. Absent the credit rating, significant assumptions must be made such that the credit risk input becomes an unobservable input and thus these investment securities and other investments are reported by the Company in a Level 3 classification.

Derivatives: The fair values of derivatives are based on valuation models using observable market data as of the measurement date (Level 2).

Impaired Loans: Fair values for impaired collateral dependent loans are generally based on appraisals obtained from licensed real estate appraisers and in certain circumstances includes consideration of offers obtained to purchase properties prior to foreclosure. Appraisals for commercial real estate generally use three methods to derive value: cost, sales or market comparison and income approach. The cost method bases value in the cost to replace the current property. Value of market comparison approach evaluates the sales price of similar properties in the same market area. The income approach considers net operating income generated by the property and an investor's required return. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Comparable sales adjustments are based on known sales prices of similar type and similar use properties and duration of time that the property has been on the market to sell. Such adjustments made in the appraisal process are typically significant and 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 the Company. Once received, a member of the Company’s Risk Management Area reviews the assumptions and approaches utilized in the appraisal. In determining the value of impaired collateral dependent loans and other real estate owned, significant unobservable inputs may be used which include: physical condition of comparable properties sold, net operating income generated by the property and investor rates of return.

Other Real Estate: Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate (ORE) are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property utilizing similar techniques as discussed above for Impaired Loans, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, impairment loss is recognized.

Loan Servicing Rights: On a quarterly basis, loan servicing rights are evaluated for impairment based upon the fair value of the rights as compared to carrying amount resulting in a Level 2 classification. The valuation model utilizes interest rate, prepayment speed, and default rate assumptions that market participants would use in estimating future net servicing income and that can be validated against available market data.

Loans Held-for-Sale: The fair values of loans held for sale are determined by using quoted prices for similar assets, adjusted for specific attributes of that loan resulting in a Level 2 classification.

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis, including financial assets and liabilities for which the Company has elected the fair value option, are summarized below:



	Fair Value Measurements at September 30, 2018 Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Obligations of State and Political Subdivisions	$	—	$	279,376	$	4,663	$	284,039
MBS/CMO - Residential	—		455,588		—		455,588
Equity Securities	—		—		353		353
Total Securities and Other Investments	$	—	$	734,964	$	5,016	$	739,980

Loans Held-for-Sale	$	—	$	9,178	$	—	$	9,178

Derivative Assets	$	—	$	3,490	$	—	$	3,490

Mortgage Servicing Rights	$	—	$	1,023	$	—	$	1,023

Derivative Liabilities	$	—	$	3,425	$	—	$	3,425



	Fair Value Measurements at December 31, 2017 Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Obligations of State and Political Subdivisions	$	—	$	267,660	$	5,649	$	273,309
MBS/CMO - Residential	—		467,332		—		467,332
Equity Securities	—		—		353		353
Total Securities and Other Investments	$	—	$	734,992	$	6,002	$	740,994

Loans Held-for-Sale	$	—	$	6,719	$	—	$	6,719

Derivative Assets	$	—	$	1,564	$	—	$	1,564

Mortgage Servicing Rights	$	—	$	547	$	—	$	547

Derivative Liabilities	$	—	$	1,633	$	—	$	1,633

There were no transfers between Level 1 and Level 2 for the periods ended September 30, 2018 and December 31, 2017.

At September 30, 2018, the aggregate fair value of the Loans Held-for-Sale was $9,178. Aggregate contractual principal balance was $9,019 with a difference of $159. At December 31, 2017, the aggregate fair value of the Loans Held-for-Sale was $6,719. Aggregate contractual principal balance was $6,576 with a difference of $143.

The tables below present a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2018 and 2017:



	Obligations of State and Political Subdivisions						Equity Securities
	2018			2017			2018		2017

Balance of Recurring Level 3 Assets at July 1	$	5,167		$	6,464		$	353	$	353
Total Gains or Losses Included in Other Comprehensive Income	(44		)	—			—		—
Maturities / Calls	(460		)	(450		)	—		—
Purchases	—			—			—		—
Balance of Recurring Level 3 Assets at September 30	$	4,663		$	6,014		$	353	$	353



	Obligations of State and Political Subdivisions						Equity Securities
	2018			2017			2018		2017

Balance of Recurring Level 3 Assets at January 1	$	5,649		$	7,295		$	353	$	353
Total Gains or Losses Included in Other Comprehensive Income	(66		)	34			—		—
Maturities / Calls	(920		)	(1,315		)	—		—
Purchases	—			—			—		—
Balance of Recurring Level 3 Assets at September 30	$	4,663		$	6,014		$	353	$	353

Of the total gain/loss for the three and nine months ended September 30, 2018, ($44) and ($66) was attributable to other changes in fair value, respectively. Of the total gain/loss for the three and nine months ended September 30, 2017, $0 and $34 was attributable to other changes in fair value, respectively.

Assets and Liabilities Measured on a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:



	Fair Value Measurements at September 30, 2018 Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Assets:
Impaired Loans
Commercial and Industrial Loans	$	—	$	—	$	2,192	$	2,192
Commercial Real Estate Loans	—		—		2,965		2,965



	Fair Value Measurements at December 31, 2017 Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Assets:
Impaired Loans
Commercial and Industrial Loans	$	—	$	—	$	3,354	$	3,354
Commercial Real Estate Loans	—		—		3,438		3,438

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $6,751 with a valuation allowance of $1,594, resulting in an increase to the provision for loan losses of $190 for the three months ended September 30, 2018 and a decrease to the provision for loan losses of $640 for the nine months ended September 30, 2018. For the three and nine months ended September 30, 2017, impaired loans resulted in an increase to the provision for loan losses of $1,583 and $1,587, respectively. Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $9,020 with a valuation allowance of $2,228, resulting in an increase to the provision for loan losses of $1,973 for the year ended December 31, 2017.

There was no Other Real Estate carried at fair value less costs to sell at September 30, 2018. No charge to earnings was included in the three and nine months ended September 30, 2018 and 2017. There was no Other Real Estate carried at fair value less costs to sell at December 31, 2017. No charge to earnings was included in the year ended December 31, 2017.

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2018 and December 31, 2017:



September 30, 2018	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)

Impaired Loans - Commercial and Industrial Loans	$	2,192	Sales comparison approach	Adjustment for physical condition of comparable properties sold	0%-100% (100%)
Impaired Loans - Commercial Real Estate Loans	$	2,965	Sales comparison approach	Adjustment for physical condition of comparable properties sold	18%-76% (54%)



December 31, 2017	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)

Impaired Loans - Commercial and Industrial Loans	$	3,354	Sales comparison approach	Adjustment for physical condition of comparable properties sold	0%-95% (84%)
Impaired Loans - Commercial Real Estate Loans	$	3,438	Sales comparison approach	Adjustment for physical condition of comparable properties sold	30%-76% (47%)

The carrying amounts and estimated fair values of the Company’s financial instruments not previously presented are provided in the tables below for the periods ending September 30, 2018 and December 31, 2017. Not all of the Company’s assets and liabilities are considered financial instruments, and therefore are not included in the tables. Because no active market exists for a significant portion of the Company’s financial instruments, fair value estimates were based on subjective judgments, and therefore cannot be determined with precision. In accordance with the adoption of ASU 2016-01, the table below for September 30, 2018, presents the fair values measured using an exit price notion. The fair value of loans as of December 31, 2017 was measured using an entrance price notion.



				Fair Value Measurements at September 30, 2018 Using
	Carrying Value			Level 1			Level 2			Level 3			Total
Financial Assets:
Cash and Short-term Investments	$	65,584		$	50,980		$	14,604		$	—		$	65,584
Loans, Net	2,315,417			—			—			2,274,223			2,274,223
FHLB Stock and Other Restricted Stock	13,048			N/A			N/A			N/A			N/A
Accrued Interest Receivable	15,218			—			3,972			11,246			15,218
Financial Liabilities:
Demand, Savings, and Money Market Deposits	(2,240,239		)	(2,240,239		)	—			—			(2,240,239		)
Time Deposits	(400,608		)	—			(399,625		)	—			(399,625		)
Short-term Borrowings	(220,389		)	—			(220,389		)	—			(220,389		)
Long-term Debt	(106,650		)	—			(93,587		)	(11,250		)	(104,837		)
Accrued Interest Payable	(1,152		)	—			(1,075		)	(77		)	(1,152		)



				Fair Value Measurements at December 31, 2017 Using
	Carrying Value			Level 1			Level 2			Level 3			Total
Financial Assets:
Cash and Short-term Investments	$	70,359		$	48,467		$	16,349		$	—		$	64,816
Loans, Net	2,119,152			—			—			2,120,154			2,120,154
FHLB Stock and Other Restricted Stock	13,048			N/A			N/A			N/A			N/A
Accrued Interest Receivable	13,258			—			3,574			9,684			13,258
Financial Liabilities:
Demand, Savings, and Money Market Deposits	(2,096,167		)	(1,096,167		)	—			—			(1,096,167		)
Time Deposits	(387,885		)	—			(388,640		)	—			(388,640		)
Short-term Borrowings	(133,499		)	—			(133,499		)	—			(133,499		)
Long-term Debt	(141,717		)	—			(129,366		)	(11,052		)	(140,418		)
Accrued Interest Payable	(1,058		)	—			(1,042		)	(16		)	(1,058		)