Estimated Fair Value of Financial Instruments

The Corporation discloses estimated fair values for its financial instruments. Fair value estimates, methods and assumptions are set forth below for the Corporation’s financial instruments.

Fair Value Measurements

The fair value of financial assets and liabilities recorded at fair value is categorized in three levels. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. These levels are as follows:


•	Level 1 — Valuations based on quoted prices in active markets, such as the New York Stock Exchange. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

•

Level 2 — Valuations of assets and liabilities traded in less active dealer or broker markets. Valuations include quoted prices for similar assets and liabilities traded in the same market; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable. Valuations may be obtained from, or corroborated by, third-party pricing services.

•

Level 3 — Assets and liabilities with valuations that include methodologies and assumptions that may not be readily observable, including option pricing models, discounted cash flow models, yield curves and similar techniques. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities, but in all cases are corroborated by external data, which may include third-party pricing services.

Limitations

Estimates of fair value are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Estimates of fair value are based on existing on-and-off balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the Corporation has an Investment and Trust Services Division that contributes net fee income annually. The Investment and Trust Services Division is not considered a financial instrument and its value has not been incorporated into the fair value estimates. Other significant assets and liabilities that are not considered financial instruments include premises and equipment and deferred tax assets. The estimated fair values of the Corporation’s financial instruments at June 30, 2014 and December 31, 2013 are summarized as follows:



	June 30, 2014										December 31, 2013
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3		Carrying Value		Estimated Fair Value
	(Dollars in thousands)
Financial assets
Cash and due from banks, Federal funds sold and interest bearing deposits in other banks	$	47,795	$	47,795	$	47,795	$	—	$	—	$	52,272	$	52,272
Securities	219,422		219,422		—		219,422		—		216,122		216,122
Restricted stock	5,741		N/A		N/A		N/A		N/A		5,741		N/A
Portfolio loans, net	899,935		885,456		—		—		885,456		884,794		884,211
Loans held for sale	2,856		2,856		—		2,874		—		4,483		4,487
Accrued interest receivable	3,572		3,572		—		925		2,647		3,621		3,621
Financial liabilities
Deposits:
Demand, savings and money market	573,139		573,139		—		573,139		—		542,739		542,739
Certificates of deposit	475,799		477,357		—		477,357		—		502,850		504,381
Short-term borrowings	3,362		3,362		—		3,362		—		4,576		4,576
Federal Home Loan Bank advances	46,813		46,763		—		46,763		—		46,708		46,923
Junior subordinated debentures	16,238		16,650		—		16,650		—		16,238		16,778
Accrued interest payable	688		688		—		688		—		789		789

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. As of June 30, 2014 and December 31, 2013, Cash and due from banks, Federal funds sold and interest bearing deposits in other banks were classified as Level 1.

Restricted stock

It is not practical to determine the fair value of Restricted stock due to restrictions placed on its transferability. Restricted stock is carried at cost and valued based on the ultimate recoverability of par value.

Loans

Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that re-price 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. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price. The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

Deposits

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 2 classification. The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date resulting in a Level 2 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows 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.

Short-term Borrowings

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.

Other Borrowings

The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analysis based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

The fair values of the Company’s Junior Subordinated Debentures are estimated using discounted cash flow analysis 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 Level 2 and Level 3 classification. The level disclosed should be consistent with the asset and liability that the accrued interest is associated with.

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.

The following table presents information about the Corporation’s assets and liabilities measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013, and the valuation techniques used by the Corporation to determine those fair values.



Description	Fair Value as of June 30, 2014		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
Securities available for sale:
U.S. Government agencies and corporations	$	58,631	$	—	$	58,631	$	—
Mortgage backed securities: residential	99,531		—		99,531		—
Residential collateralized mortgage obligations	26,988		—		26,988		—
State and political subdivisions	34,272		—		34,272		—
Interest rate swaps	121		—		121		—
Total	$	219,543	$	—	$	219,543	$	—
Description	Fair Value as of December 31, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
Securities available for sale:
U.S. Government agencies and corporations	$	65,388	$	—	$	65,388	$	—
Mortgage backed securities: residential	94,430		—		94,430		—
Residential collateralized mortgage obligations	18,655		—		18,655		—
State and political subdivisions	32,965		—		32,965		—
Preferred Securities	4,684		—		—		4,684
Interest rate swaps	222		—		222		—
Total	$	216,344	$	—	$	211,660	$	4,684

Fair value measurements of U.S. Government agencies, collateralized mortgage obligations, and mortgage backed securities use pricing models that vary and may consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures (level 2). Fair value of debt securities such as obligations of state and political subdivisions may be determined by matrix pricing. Matrix pricing is a mathematical technique that is used to value debt securities without relying exclusively on quoted prices for specific securities, but rather by relying on the securities relationship to other benchmark quoted prices.

In 2013 the Corporation implemented an interest rate program for commercial loan customers. The interest rate program,

provides the customer with a fixed rate loan while creating a variable rate asset for the Corporation through the customer

entering into an interest rate swap with the Corporation on terms that match the loan. The Corporation offsets its risk exposure

by entering into an offsetting interest rate swap with an unaffiliated institution. These interest rate swaps do not qualify as

designated hedges, therefore, each swap is accounted for as a standalone derivative. Valuations for interest rate swaps are derived from third-party models whose significant inputs are readily observable market parameters, primarily yield curves, with appropriate adjustments for liquidity and credit risk. These fair value measurements are classified as Level 2.

There were no transfers between Levels 1 and 2 of the fair value hierarchy during the periods ended June 30, 2014 and December 31, 2013. For the available for sale securities, the Corporation obtains fair value measurements from an independent third-party service or independent brokers.

Certain assets and liabilities are measured at fair value on a nonrecurring basis in accordance with GAAP. The adjustments to fair value generally result from the application of accounting guidance that requires assets and liabilities to be recorded at lower of cost or fair value, or assessed for impairment. The Corporation has assets that, under certain conditions, are subject to measurement at fair value on a nonrecurring basis. At June 30, 2014 and December 31, 2013, such assets consist primarily of impaired loans and other property. The Corporation has estimated the fair values of these assets using Level 3 inputs, specifically discounted cash flow projections.

The following table presents the balances of assets and liabilities measured at fair value on a nonrecurring basis:



June 30, 2014	Quoted Market Prices in Active Markets (Level 1)	Internal Models with Significant Observable Market Parameters (Level 2)	Internal Models with Significant Unobservable Market Parameters (Level 3)
	(Dollars in thousands)
Impaired Loans:
Commercial real estate			$	2,146
Commercial			207
Residential real estate			—
Total			$	2,353



December 31, 2013	Quoted Market Prices in Active Markets (Level 1)	Internal Models with Significant Observable Market Parameters (Level 2)	Internal Models with Significant Unobservable Market Parameters (Level 3)
	(Dollars in thousands)
Impaired Loans:
Commercial real estate			$	11,241
Commercial			289
Residential real estate			5,231
Home equity loans			4,464
Indirect			443
Consumer			318
Total			$	21,986

Other real estate owned:
Commercial real estate			$	304
Residential real estate			275
Total			$	579

Impaired loans: Impaired loans that are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal balance of $3,210, with a valuation allowance of $857 at June 30, 2014, resulting in a reduction to provision for loan losses of $5 and $11 for the three and six month period ended June 30, 2014. At June 30, 2013, impaired loans measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal balance of $5,096, with a valuation allowance of $1,699, resulting in a reduction to provision for loan losses of $300 and $3 for the three and six month period ended June 30, 2013.

Appraisals for both collateral-dependent impaired loans and 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 Corporation. Once received, the Corporation 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. On a periodic basis, the Company compares the actual selling price of 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.

Fair value adjustments for these items typically occur when there is evidence of impairment. Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair market value of the collateral. The Corporation measures fair value based on the value of the collateral securing the loans. Collateral may be in the form of real estate or personal property including equipment and inventory. The vast majority of collateral is real estate. The value of the collateral is determined based on internal estimates as well as third party appraisals or non-binding broker quotes. These measurements were classified as Level 3.

Other Real Estate: Other real estate includes foreclosed assets and properties securing residential and commercial loans. Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. 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.

Foreclosed assets are adjusted to fair value less costs to sell upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at lower of carry value or fair value less costs to sell. Fair value is generally based upon internal estimates and third party appraisals or non-binding broker quotes and, accordingly, considered a Level 3 classification.

The following table presents additional quantitative information about assets measured at fair value on a

nonrecurring basis for which the Corporation has utilized Level 3 inputs to determine fair value (dollars in thousands).

Changes in Level 3 Fair Value Measurements

There were no assets measured at fair value on a recurring basis using significant unobservable inputs that were transferred to Level 3 as of or during the six months ended June 30, 2014.

Fair Value

Valuation Technique

Unobservable Input

Collateral dependent impaired loans

Sales comparison approach

Adjustment for differences between the comparable sales