FASB ASC No. 820-10 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) of 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 I 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 fair value of most securities available for sale is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

For those securities that cannot be priced using quoted market prices or observable inputs a Level 3 valuation is determined. These securities are primarily trust preferred securities, which are priced using Level 3 due to current market illiquidity and certain investments in state and municipal securities. The fair value of the trust preferred securities is obtained from a third party provider without adjustment. As described previously, management obtains values from other pricing sources to validate the Standard & Poors pricing that they currently utilize. The fair value of state and municipal obligations are derived by comparing the securities to current market rates plus an appropriate credit spread to determine an estimated value. Illiquidity spreads are then considered. Credit reviews are performed on each of the issuers. The significant unobservable inputs used in the fair value measurement of the Corporation’s state and municipal obligations are credit spreads related to specific issuers. Significantly higher credit spread assumptions would result in significantly lower fair value measurement. Conversely, significantly lower credit spreads would result in a significantly higher fair value measurements.

The fair value of derivatives is based on valuation models using observable market data as of the measurement date (Level 2 inputs).



	September 30, 2019
	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
(Dollar amounts in thousands)	Level 1		Level 2			Level 3		Total
U.S. Government agencies	$	—	$	107,276		$	—	$	107,276
Mortgage Backed Securities-residential	—		216,736			—		216,736
Mortgage Backed Securities-commercial	—		24,424			—		24,424
Collateralized mortgage obligations	—		308,038			—		308,038
State and municipal	—		267,091			2,565		269,656
Municipal taxable	—		732			—		732
U.S. Treasury	—		9,478			—		9,478
Collateralized debt obligations	—		—			3,604		3,604
TOTAL	$	—	$	933,775		$	6,169	$	939,944
Derivative Assets			1,099
Derivative Liabilities			(1,099		)



	December 31, 2018
	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
(Dollar amounts in thousands)	Level 1		Level 2			Level 3		Total
U.S. Government agencies	$	—	$	25,364		$	—	$	25,364
Mortgage Backed Securities-residential	—		178,743			—		178,743
Mortgage Backed Securities-commercial	—		—			—		—
Collateralized mortgage obligations	—		343,616			—		343,616
State and municipal	—		230,800			3,135		233,935
Collateralized debt obligations	—		—			3,258		3,258
TOTAL	$	—	$	778,523		$	6,393	$	784,916
Derivative Assets			218
Derivative Liabilities			(218		)

There were no transfers between Level 1 and Level 2 during 2019 and 2018.

The tables below presents a reconciliation and income statement classification of gains and losses for 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, 2019 and the year ended December 31, 2018.



	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
	Three Months Ended September 30, 2019
(Dollar amounts in thousands)	State and municipal obligations			Collateralized debt obligations			Total
Beginning balance, July 1	$	2,890		$	3,333		$	6,223
Total realized/unrealized gains or losses
Included in earnings	—			—			—
Included in other comprehensive income	—			315			315
Transfers	—			—			—
Settlements	(325		)	(44		)	(369		)
Ending balance, September 30	$	2,565		$	3,604		$	6,169




	Nine Months Ended September 30, 2019
(Dollar amounts in thousands)	State and municipal obligations			Collateralized debt obligations			Total
Beginning balance, January 1	$	3,135		$	3,258		$	6,393
Total realized/unrealized gains or losses
Included in earnings	—			—			—
Included in other comprehensive income	—			476			476
Transfers	—			—			—
Settlements	(570		)	(130		)	(700		)
Ending balance, September 30	$	2,565		$	3,604		$	6,169



	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
	Year Ended December 31, 2018
(Dollar amounts in thousands)	State and municipal obligations			Collateralized debt obligations			Total
Beginning balance, January 1	$	3,680		$	14,605		$	18,285
Total realized/unrealized gains or losses
Included in earnings	—			—			—
Included in other comprehensive income	—			(2,840		)	(2,840		)
Purchases	—			—			—
Settlements	(545		)	(8,507		)	(9,052		)
Ending balance, December 31	$	3,135		$	3,258		$	6,393

The following table presents quantitative information about recurring and non-recurring Level 3 fair value measurements at September 30, 2019.



(Dollar amounts in thousands)	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range
State and municipal obligations	$	2,565	Discounted cash flow	Discount rate Probability of default	2.87%-4.44% 0%
Other real estate	$	3,717	Sales comparison/income approach	Discount rate for age of appraisal and market conditions	5.00%-20.00%
Impaired Loans	$	120	Sales comparison/income approach	Discount rate for age of appraisal and market conditions	0.00%-50.00%

The following table presents quantitative information about recurring and non-recurring Level 3 fair value measurements at December 31, 2018.



(Dollar amounts in thousands)	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range
State and municipal obligations	$	3,135	Discounted cash flow	Discount rate Probability of default	2.64%-4.80% 0%
Other real estate	$	603	Sales comparison/income approach	Discount rate for age of appraisal and market conditions	5.00%-20.00%
Impaired Loans	1,639		Sales comparison/income approach	Discount rate for age of appraisal and market conditions	0.00%-50.00%

Impaired loans disclosed in footnote 2, which are measured for impairment using the fair value of collateral, are valued at Level 3. They are carried at a fair value of $120 thousand, after a valuation allowance of $33 thousand at September 30, 2019 and at a fair value of $1.6 million, net of a valuation allowance of $737 thousand at December 31, 2018. The impact to the provision for loan losses for the three and nine months ended September 30, 2019 and for the twelve months ended December 31, 2018 was a $625 thousand decrease, a $704 thousand decrease and a $112 thousand increase, respectively. Other real estate owned is valued at Level 3. Other real estate owned at September 30, 2019 with a value of $3.7 million was reduced $97 thousand for fair value adjustment. At September 30, 2019 other real estate owned was comprised of $3.5 million from commercial loans and $207 thousand from residential loans. Other real estate owned at December 31, 2018 with a value of $603 thousand was reduced $598 thousand for fair value adjustment. At December 31, 2018 other real estate owned was comprised of $171 thousand from commercial loans and $432 thousand from residential loans.

Fair value is measured based on the value of the collateral securing those loans, and is determined using several methods. Generally the fair value of real estate is determined based on appraisals by qualified licensed appraisers. Appraisals for real estate generally use three methods to derive value: cost, sales or market comparison and income approach. The cost method bases value on the cost to replace current property. The market comparison evaluates the sales price of similar properties in the same market area. The income approach considers net operating income generated by the property and the investor’s required return. The final fair value is based on a reconciliation of these three approaches. If an appraisal is not available, the fair value may be determined by using a cash flow analysis, a broker’s opinion of value, the net present value of future cash flows, or an observable market price from an active market. Fair value of other real estate is based upon the current appraised values of the properties as determined by qualified licensed appraisers and the Company’s judgment of other relevant market conditions. Appraisals are obtained annually and reductions in value are recorded as a valuation through a charge to expense. The primary unobservable input used by management in estimating fair value are additional discounts to the appraised value to consider market conditions and the age of the appraisal, which are based on management’s past experience in resolving these types of properties. These discounts range from 0% to 50%. Values for non-real estate collateral, such as business equipment, are based on appraisals performed by qualified licensed appraisers or the customers financial statements. Values for non real estate collateral use much higher discounts than real estate collateral. Other real estate and impaired loans carried at fair value are primarily comprised of smaller balance properties.

The following tables presents loans identified as impaired by class of loans, and carried at fair value on a non-recurring basis, as of September 30, 2019 and December 31, 2018, which are all considered Level 3.



	September 30, 2019
(Dollar amounts in thousands)	Carrying Value		Allowance for Loan Losses Allocated		Fair Value
Commercial
Commercial & Industrial	$	153	$	33	$	120
Farmland	—		—		—
Non Farm, Non Residential	—		—		—
Agriculture	—		—		—
All Other Commercial	—		—		—
Residential
First Liens	—		—		—
Home Equity	—		—		—
Junior Liens	—		—		—
Multifamily	—		—		—
All Other Residential	—		—		—
Consumer
Motor Vehicle	—		—		—
All Other Consumer	—		—		—
TOTAL	$	153	$	33	$	120



	December 31, 2018
(Dollar amounts in thousands)	Carrying Value		Allowance for Loan Losses Allocated		Fair Value
Commercial
Commercial & Industrial	$	1,819	$	593	$	1,226
Farmland	211		44		167
Non Farm, Non Residential	—		—		—
Agriculture	346		100		246
All Other Commercial	—		—		—
Residential
First Liens	—		—		—
Home Equity	—		—		—
Junior Liens	—		—		—
Multifamily	—		—		—
All Other Residential	—		—		—
Consumer
Motor Vehicle	—		—		—
All Other Consumer	—		—		—
TOTAL	$	2,376	$	737	$	1,639

The carrying amounts and estimated fair value of financial instruments at September 30, 2019 and December 31, 2018, are shown below. Carrying amount is the estimated fair value for cash and due from banks, federal funds sold, short-term borrowings, accrued interest receivable and payable, demand deposits, short-term debt and variable-rate loans or deposits that reprice frequently and fully. Security fair values were described previously. For fixed-rate, non-impaired loans or deposits, variable rate loans or deposits with infrequent repricing or repricing limits, and for longer-term borrowings, fair value is based on discounted cash flows using current market rates applied to the estimated life and considering credit risk. The valuation of impaired loans was described previously. Loan fair value estimates represent an exit price. Fair values of loans held for sale are based on market bids on the loans or similar loans. It was not practicable to determine the fair value of Federal Home Loan Bank stock due to restrictions placed on its transferability. Fair value of debt is based on current rates for similar financing. The fair value of off-balance sheet items is not considered material.



	September 30, 2019
	Carrying			Fair Value
(Dollar amounts in thousands)	Value			Level 1		Level 2			Level 3		Total
Cash and due from banks	$	80,193		$	22,625	$	57,568		$	—	$	80,193
Federal funds sold	—			—		—			—		—
Securities available-for-sale	939,944			—		933,775			6,169		939,944
Restricted stock	13,624			n/a		n/a			n/a		n/a
Loans, net	2,648,677			—		—			2,674,336		2,674,336
Accrued interest receivable	18,735			—		5,180			13,555		18,735
Deposits	(3,220,122		)	—		(3,210,216		)	—		(3,210,216		)
Short-term borrowings	(90,852		)	—		(90,852		)	—		(90,852		)
Accrued interest payable	(1,790		)	—		(1,790		)	—		(1,790		)



	December 31, 2018
	Carrying			Fair Value
(Dollar amounts in thousands)	Value			Level 1		Level 2			Level 3		Total
Cash and due from banks	$	74,388		$	23,418	$	50,970		$	—	$	74,388
Securities available-for-sale	784,916			—		778,523			6,393		784,916
Restricted stock	10,390			n/a		n/a			n/a		n/a
Loans, net	1,933,552			—		—			1,889,795		1,889,795
Accrued interest receivable	13,970			—		3,005			10,965		13,970
Deposits	(2,436,727		)	—		(2,426,128		)	—		(2,426,128		)
Short-term borrowings	(69,656		)	—		(69,656		)	—		(69,656		)
Accrued interest payable	(609		)	—		(609		)	—		(609		)