Fair Value Measurements

Determination of Fair Value

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the fair value measurements and disclosures topic of FASB ASC 825, Financial Instruments, the fair value of a financial instrument is the price that would be received to sell 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 at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. The fair value guidance provides a consistent definition of fair value, which focuses on exit price in the principal or most advantageous market for the asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.



Level 1 –	Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2 –	Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3 –	Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:

Securities available for sale and equity securities: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).

Derivative asset (liability) - cash flow hedges: Cash flow hedges are recorded at fair value on a recurring basis. Cash flow hedges are valued by a third party using significant assumptions that are observable in the market and can be corroborated by market data. All of the Company's cash flow hedges are classified as Level 2.

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis during the period (dollars in thousands):



			Fair Value Measurements at December 31, 2018 Using
	Balance as of December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2018		Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Federal agencies and GSEs	$	134,039	$	—	$	134,039	$	—
Mortgage-backed and CMOs	111,867		—		111,867		—
State and municipal	79,902		—		79,902		—
Corporate	6,845		—		6,845		—
Total securities available for sale	$	332,653	$	—	$	332,653	$	—
Equity securities	$	1,830	$	—	$	1,830	$	—
Liabilities:
Derivative - cash flow hedges	$	804	$	—	$	804	$	—



			Fair Value Measurements at December 31, 2017 Using
	Balance as of December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2017		Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Federal agencies and GSEs	$	112,127	$	—	$	112,127	$	—
Mortgage-backed and CMOs	105,316		—		105,316		—
State and municipal	93,626		—		93,626		—
Corporate	8,062		—		8,062		—
Equity Securities	2,206		—		2,206		—
Total securities available for sale	$	321,337	$	—	$	321,337	$	—

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:

Loans held for sale: Loans held for sale are carried at fair value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the years ended December 31, 2018 and 2017. Gains and losses on the sale of loans are recorded within mortgage banking income on the consolidated statements of income.

Impaired loans: 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 agreements will not be collected when due. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the Company's collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal, of one year or less, conducted by an independent, licensed appraiser using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the property is more than one year old and not solely based on observable market comparables or management determines the fair value of the collateral is further impaired below the appraised value, then a Level 3 valuation is considered to measure the fair value. The value of business equipment is based upon an outside appraisal, of one year or less, if deemed significant, or the net book value on the applicable business's financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of income.

Other real estate owned: Measurement for fair values for other real estate owned are the same as impaired loans. Any fair value adjustments are recorded in the period incurred as a valuation allowance against OREO with the associated expense included in OREO expense, net on the consolidated statements of income.

The following table summarizes the Company's assets that were measured at fair value on a nonrecurring basis during the period (dollars in thousands):



			Fair Value Measurements at December 31, 2018 Using
	Balance as of December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2018		Level 1		Level 2		Level 3
Assets:
Loans held for sale	$	640	$	—	$	640	$	—
Impaired loans, net of valuation allowance	171		—		—		171
Other real estate owned, net	869		—		—		869



			Fair Value Measurements at December 31, 2017 Using
	Balance as of December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2017		Level 1		Level 2		Level 3
Assets:
Loans held for sale	$	1,639	$	—	$	1,639	$	—
Impaired loans, net of valuation allowance	1,391		—		—		1,391
Other real estate owned, net	1,225		—		—		1,225

Quantitative Information About Level 3 Fair Value Measurements as of December 31, 2018 and 2017:



Assets	Valuation Technique	Unobservable Input	Rate

Impaired loans	Discounted appraised value	Selling cost	8.00%
Impaired loans	Discounted cash flow analysis	Market rate for borrower (discount rate)	3.25% - 9.80%

Other real estate owned	Discounted appraised value	Selling cost	8.00%

FASB ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments, including those financial assets and financial liabilities that are not required to be measured and reported at fair value on a recurring or nonrecurring basis. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. Additionally, in accordance with ASU 2016-01, which the Company adopted January 1, 2018 on a prospective basis, the Company uses the exit price notion, rather than the entry price notion, in calculating the fair values of financial instruments not measured at fair value on a recurring basis.

The carrying values and estimated fair values of the Company's financial instruments at December 31, 2018 are as follows (dollars in thousands):



	Fair Value Measurements at December 31, 2018 Using
	Carrying Value		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs		Fair Value Balance
	Carrying Value		Level 1		Level 2		Level 3		Fair Value Balance
Financial Assets:
Cash and cash equivalents	$	64,255	$	64,255	$	—	$	—	$	64,255
Equity securities	1,830		—		1,830		—		1,830
Securities available for sale	332,653		—		332,653		—		332,653
Restricted stock	5,247		—		5,247		—		5,247
Loans held for sale	640		—		640		—		640
Loans, net of allowance	1,344,671		—		—		1,334,236		1,334,236
Bank owned life insurance	18,941		—		18,941		—		18,941
Accrued interest receivable	5,449		—		5,449		—		5,449

Financial Liabilities:
Deposits	$	1,566,227	$	—	$	1,570,721	$	—	$	1,570,721
Repurchase agreements	35,243		—		35,243		—		35,243
Junior subordinated debt	27,927		—		—		22,577		22,577
Accrued interest payable	795		—		795		—		795
Derivative - cash flow hedges	804		—		804		—		804

The carrying values and estimated fair values of the Company's financial instruments at December 31, 2017 are as follows (dollars in thousands):



	Fair Value Measurements at December 31, 2017 Using
	Carrying Value		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs		Fair Value Balance
	Carrying Value		Level 1		Level 2		Level 3		Fair Value Balance
Financial Assets:
Cash and cash equivalents	$	52,477	$	52,477	$	—	$	—	$	52,477
Securities available for sale	321,337		—		321,337		—		321,337
Restricted stock	6,110		—		6,110		—		6,110
Loans held for sale	1,639		—		1,639		—		1,639
Loans, net of allowance	1,322,522		—		—		1,317,737		1,317,737
Bank owned life insurance	18,460		—		18,460		—		18,460
Accrued interest receivable	5,231		—		5,231		—		5,231

Financial Liabilities:
Deposits	$	1,534,726	$	—	$	1,527,956	$	—	$	1,527,956
Repurchase agreements	10,726		—		10,726		—		10,726
Other short-term borrowings	20,000		—		20,000		—		20,000
Junior subordinated debt	27,826		—		—		28,358		28,358
Accrued interest payable	674		—		674		—		674