FAIR VALUE

Fair Value Measurement

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an 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. A fair value hierarchy has also been established which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The following three levels of inputs are used to measure fair value:

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

The fair values of most trading securities and securities available for sale are 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 relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

The Corporation’s derivative instruments are interest rate swaps that are similar to those that trade in liquid markets. As such, significant fair value inputs can generally be verified and do not typically involve significant management judgments (Level 2 inputs).

The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals prepared by third-parties. 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 appraisers to adjust for differences between the comparable sales and income data available. Management also adjusts appraised values based on the length of time that has passed since the appraisal date and other factors. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Assets and liabilities measured at fair value on a recurring basis are as follows at March 31, 2019 and December 31, 2018:



				Fair Value Measurements at March 31, 2019 Using:
				Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs			Significant Unobservable Inputs
Description	Total			(Level 1)		(Level 2)			(Level 3)
Assets:
Securities Available For Sale:
U.S. Government sponsored entities	130,375			0		130,375			0
States and political subdivisions	121,090			0		121,090			0
Residential and multi-family mortgage	207,491			0		207,491			0
Corporate notes and bonds	11,904			0		11,904			0
Pooled SBA	28,801			0		28,801			0
Other	947			947		0			0
Total Securities Available For Sale	$	500,608		$	947	$	499,661		$	0
Interest Rate swaps	$	906		$	0	$	906		$	0
Trading Securities:
Corporate equity securities	$	6,947		$	6,947	0			0
Mutual funds	871			871		0			0
Certificates of deposit	179			179		0			0
Corporate notes and bonds	594			594		0			0
U.S. Government sponsored entities	51			0		51			0
Total Trading Securities	$	8,642		$	8,591	$	51		$	0
Liabilities:
Interest rate swaps	$	(1,227	)	$	0	$	(1,227	)	$	0

				Fair Value Measurements at December 31, 2018 Using:
				Quoted Prices in					Significant
				Active Markets for		Significant Other			Unobservable
				Identical Assets		Observable Inputs			Inputs
Description	Total			(Level 1)		(Level 2)			(Level 3)
Assets:
Securities Available For Sale:
U.S. Government sponsored entities	$	132,694		$	0	$	132,694		$	0
States and political subdivisions	136,031			0		136,031			0
Residential and multi-family mortgage	206,053			0		206,053			0
Corporate notes and bonds	11,777			0		11,777			0
Pooled SBA	29,374			0		29,374			0
Other	934			934		0			0
Total Securities Available For Sale	$	516,863		$	934	$	515,929		$	0
Interest Rate swaps	$	485		$	0	$	485		$	0
Trading Securities:
Corporate equity securities	5,828			5,828		0			0
Mutual funds	1,058			1,058		0			0
Certificates of deposit	268			268		0			0
Corporate notes and bonds	581			581		0			0
U.S. Government sponsored entities	51			0		51			0
Total Trading Securities	$	7,786		$	7,735	51			0
Liabilities:
Interest rate swaps	$	(686	)	$	0	$	(686	)	$	0

Assets and liabilities measured at fair value on a non-recurring basis are as follows at March 31, 2019 and December 31, 2018:



			Fair Value Measurements at March 31, 2019 Using:
			Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs	Significant Unobservable Inputs
Description	Total		(Level 1)	(Level 2)	(Level 3)
Assets:
Impaired loans:
Commercial, industrial, and agricultural	$	540	0	0	$	540
Commercial mortgages	$	1,166	0	0	$	1,166

			Fair Value Measurements at December 31, 2018 Using
			Quoted Prices in		Significant
			Active Markets for	Significant Other	Unobservable
			Identical Assets	Observable Inputs	Inputs
Description	Total		(Level 1)	(Level 2)	(Level 3)
Assets:
Impaired loans:
Commercial, industrial, and agricultural	$	2,055	0	0	$	2,055
Commercial mortgages	$	679	0	0	$	679

Impaired loans, measured for impairment using the fair value of collateral for collateral dependent loans, had a recorded investment of $4,244 with a valuation allowance of $2,538 as of March 31, 2019, resulting in a provision for loan losses of $777 for the corresponding three month period. Impaired loans had a recorded investment of $3,918 with a valuation allowance of $1,184 as of December 31, 2018. Impaired loans carried at fair value resulted in a provision for loan losses of $272 for the three months ended March 31, 2018.

The estimated fair values of impaired collateral dependent loans, such as commercial or residential mortgages, are determined primarily through third-party appraisals. When a collateral dependent loan, such as a commercial or residential mortgage loan, becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal, and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral and a further reduction for estimated costs to sell the property is applied, which results in an amount that is considered to be the estimated fair value. If a loan becomes impaired and the appraisal of related loan collateral is outdated, management applies an appropriate adjustment factor based on its experience with current valuations of similar collateral in determining the loan’s estimated fair value and resulting allowance for loan losses. Third-party appraisals are not customarily obtained in respect of unimpaired loans, unless in management’s view changes in circumstances warrant obtaining an updated appraisal.

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 March 31, 2019:



	Fair value	Valuation Technique	Unobservable Inputs	Range (Weighted Average)
Impaired loans – commercial, industrial, and agricultural	$540	Valuation of third party appraisal on underlying collateral	Loss severity rates	39%-78% (63%)
Impaired loans – commercial mortgages	$1,166	Valuation of third party appraisal on underlying collateral	Loss severity rates	15-90% (37%)

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 December 31, 2018:



	Fair value	Valuation Technique	Unobservable Inputs	Range (Weighted Average)
Impaired loans – commercial, industrial, and agricultural	$2,055	Valuation of third party appraisal on underlying collateral	Loss severity rates	20%-60% (34%)
Impaired loans – commercial mortgages	$679	Valuation of third party appraisal on underlying collateral	Loss severity rates	15%-39% (33%)

Fair Value of Financial Instruments

The following table presents the carrying amount and fair value of financial instruments at March 31, 2019:



	Carrying			Fair Value Measurement Using:								Total
	Amount			Level 1			Level 2			Level 3		Fair Value
ASSETS
Cash and cash equivalents	$	55,282		$	55,282		$	0		$	0	$	55,282
Securities available for sale	500,608			947			499,661			0		500,608
Trading securities	8,642			8,591			51			0		8,642
Loans held for sale	2,952			0			2,957			0		2,957
Net loans	2,505,744			0			0			2,483,864		2,483,864
FHLB and other restricted interests	23,129			n/a			n/a			n/a		n/a
Interest rate swaps	906			0			906			0		906
Accrued interest receivable	11,862			7			3,567			8,288		11,862
LIABILITIES
Deposits	$	(2,657,359	)	$	(2,303,454	)	$	(354,791	)	$	0	$	(2,658,245	)
FHLB and other borrowings	(240,005		)	0			(240,503		)	0		(240,503		)
Subordinated debentures	(70,620		)	0			(65,325		)	0		(65,325		)
Interest rate swaps	(1,227		)	0			(1,227		)	0		(1,227		)
Accrued interest payable	(916		)	0			(916		)	0		(916		)

The following table presents the carrying amount and fair value of financial instruments at December 31, 2018:



	Carrying			Fair Value Measurement Using:								Total
	Amount			Level 1			Level 2			Level 3		Fair Value
ASSETS
Cash and cash equivalents	$	45,563		$	45,563		$	0		$	0	$	45,563
Securities available for sale	516,863			934			515,929			0		516,863
Trading securities	7,786			7,735			51			0		7,786
Loans held for sale	367			0			368			0		368
Net loans	2,454,853			0			0			2,433,417		2,433,417
FHLB and other restricted interests	24,508			n/a			n/a			n/a		n/a
Interest rate swaps	485			0			485			0		485
Accrued interest receivable	10,843			6			3,368			7,469		10,843
LIABILITIES
Deposits	$	(2,610,786	)	$	(2,215,349	)	$	(397,370	)	$	0	$	(2,612,719	)
FHLB and other borrowings	(245,117		)	0			(242,592		)	0		(242,592		)
Subordinated debentures	(70,620		)	0			(65,794		)	0		(65,794		)
Interest rate swaps	(686		)	0			(686		)	0		(686		)
Accrued interest payable	(863		)	0			(863		)	0		(863		)

In accordance with our adoption of ASU 2016-01 in 2018, the methods utilized to measure the fair value of financial instruments at March 31, 2019 and December 31, 2018 represent an approximation of exit price; however, an actual exit price may differ.

While estimates of fair value are based on management’s judgment of the most appropriate factors as of the balance sheet date, there is no assurance that the estimated fair values would have been realized if the assets had been disposed of or the liabilities settled at that date, since market values may differ depending on various circumstances. The estimated fair values would also not apply to subsequent dates. The fair value of other equity interests is based on the net asset values provided by the underlying investment partnership. Accounting Standards Updated ("ASU") 2015-7 removes the requirement to categorize within the fair value hierarchy all investments measured using the net asset value per share practical expedient and related disclosures.In addition, other assets and liabilities that are not financial instruments, such as premises and equipment, are not included in the disclosures.

Also, non-financial assets such as, among other things, the estimated earnings power of core deposits, the earnings potential of trust accounts, the trained workforce, and customer goodwill, which typically are not recognized on the balance sheet, may have value but are not included in the fair value disclosures.