FAIR VALUE MEASUREMENTS

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets and financial liabilities that are carried at fair value.

Recurring Fair Value Measurements

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of December 31, 2019 and December 31, 2018, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value.



	December 31, 2019
(in thousands)	Level 1 Inputs		Level 2 Inputs			Level 3 Inputs			Total Fair Value
Available for sale securities:
Mortgage-backed securities:
US Government-sponsored enterprises	$	—	$	321,969		$	—		$	321,969
US Government agency	—		99,661			—			99,661
Private label	—		19,533			—			19,533
Obligations of states and political subdivisions thereof	—		142,006			—			142,006
Corporate bonds	—		80,061			—			80,061
Derivative assets	—		6,791			59			6,850
Derivative liabilities	—		(8,102		)	(84		)	(8,186		)



	December 31, 2018
(in thousands)	Level 1 Inputs		Level 2 Inputs			Level 3 Inputs		Total Fair Value
Available for sale securities:
Mortgage-backed securities:
US Government-sponsored enterprises	$	—	$	404,952		$	—	$	404,952
US Government agency	—		110,512			—		110,512
Private label	—		20,382			—		20,382
Obligations of states and political subdivisions thereof	—		132,265			—		132,265
Corporate bonds	—		57,726			—		57,726
Derivative assets	—		2,156			8		2,164
Derivative liabilities	—		(1,353		)	—		(1,353		)

Securities Available for Sale: All securities and major categories of securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from independent pricing providers. The fair value measurements used by the pricing providers consider observable data that may include dealer quotes, market maker quotes and live trading systems. If quoted prices are not readily available, fair values are determined using matrix pricing models, or other model-based valuation techniques requiring observable inputs other than quoted prices such as market pricing spreads, credit information, callable features, cash flows, the U.S. Treasury yield curve, trade execution data, market consensus prepayment speeds, default rates, and the securities’ terms and conditions, among other things.

Derivative Assets and Liabilities

Cash Flow Hedges. The valuation of the Company's cash flow hedges are obtained from a third party. The pricing analysis is based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves. The inputs used to value the Company's cash flow hedges are all classified as Level 2 measurements.

Interest Rate Lock Commitments. The Company enters into IRLCs for residential mortgage loans, which commit the Company to lend funds to a potential borrower at a specific interest rate and within a specified period of time. The estimated fair value of commitments to originate residential mortgage loans for sale is based on quoted prices for similar loans in active markets. However, this value is adjusted by a factor which considers the likelihood of a loan in a lock position will ultimately close. The closing ratio is derived from the Company’s internal data and is adjusted using significant management judgment. As such, IRLCs are classified as Level 3 measurements.

Forward Sale Commitments. The Company utilizes forward sale commitments as economic hedges against potential changes in the values of the IRLCs and loans originated for sale. The fair values of the Company’s mandatory delivery loan sale commitments are determined similarly to the IRLCs using quoted prices in the market place that are observable. However, closing ratios included in the calculation are internally generated and are based on management’s judgment and prior experience, which are not considered observable factors. As such, mandatory delivery forward commitments are classified as Level 3 measurements.

Customer Loan Derivatives. The valuation of the Company’s customer loan derivatives is obtained from a third-party pricing service and is determined using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis is based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves. The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of master netting arrangements and any applicable credit enhancements, such as collateral postings.

Although the Company has determined that the majority of the inputs used to value its customer loan derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of December 31, 2019, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

The table below presents the changes in Level 3 assets and liabilities that were measured at fair value on a recurring basis in 2019 and 2018.



	Assets (Liabilities)
(in thousands)	Interest Rate Lock Commitments			Forward Commitments
December 31, 2017	$	(1	)	$	(221	)
Realized loss recognized in non-interest income	9			221
December 31, 2018	8			—
Realized gain (loss) recognized in non-interest income	51			(84		)
December 31, 2019	$	59		$	(84	)

Quantitative information about the significant unobservable inputs within Level 3 recurring assets and liabilities is as follows:



(in thousands, except ratios)	Fair Value December 31, 2019			Valuation Techniques	Unobservable Inputs	Significant Unobservable Input Value
Assets (Liabilities)
Interest Rate Lock Commitment	$	59		Historical trend	Closing Ratio	90		%
				Pricing Model	Origination Costs, per loan	$	1.7

Forward Commitments	(84		)	Quoted prices for similar loans in active markets.	Freddie Mac pricing system	Pair-off contract price
Total	$	(25	)

There were no level 3 assets and liabilities that were measured at fair value on a recurring basis in 2019 and 2018.

Non-Recurring Fair Value Measurements

The Company is required, on a non-recurring basis, to adjust the carrying value or provide valuation allowances for certain assets using fair value measurements in accordance with U.S. GAAP. The following is a summary of applicable non-recurring fair value measurements.



	December 31, 2019		December 31, 2018		December 31, 2019			Fair Value Measurement Date as of December 31, 2019
(in thousands)	Level 3 Inputs		Level 3 Inputs		Total Gains (Losses)			Level 3 Inputs
Assets
Impaired loans	$	9,625	$	15,213	$	5,588		December 2019
Capitalized servicing rights	4,301		4,882		—			December 2019
Other real estate owned	2,236		2,351		(166		)	August 2019
Premises held for sale	1,764		—		—			September 2019
Total	$	17,926	$	22,446	$	5,422

Quantitative information about the significant unobservable inputs within Level 3 non-recurring assets as of December 31, 2019 and December 31, 2018 is as follows:

Fair Value

Range (Weighted Average) ^(a)

(in thousands, except ratios)

December 31, 2019

Valuation Techniques

Unobservable Inputs

Assets

Impaired loans

6,137

Fair value of collateral - appraised value

Loss severity

0% to 55.00%

Appraised value

$0 to $6,915

Impaired loans

3,488

Discounted cash flow

Discount rate

2.88% to 9.50%

Cash flows

$22 to $1,002

Capitalized servicing rights

4,301

Discounted cash flow

Constant prepayment rate (CPR)

9.95

Discount rate

10.07

Other real estate owned

2,236

Fair value of collateral less selling costs

Appraised value

$2,695

Selling costs

10% to 20%

Premises held for sale^(b)

1,764

Fair value of asset less selling costs

Appraised value

$136 to $527

Selling Costs

6.00

Total

17,926

______________________________________


(a)	Where dollar amounts are disclosed, the amounts represent the lowest and highest fair value of the respective assets in the population except for adjustments for market/property conditions, which represents the range of adjustments to individuals properties.


(b)	The carrying value of premises held for sale was $1.8 million as of December 31, 2019. There were no premises held for sale as of December 31, 2018.

Fair Value

Range (Weighted Average) ^(a)

(in thousands, except ratios)

December 31, 2018

Valuation Techniques

Unobservable Inputs

Assets

Impaired loans

11,676

Fair value of collateral - appraised value

Loss severity

0% to 55.00%

Appraised value

$0 to $6,915

Impaired loans

3,537

Discount cash flow

Discount rate

2.88% to 9.50%

Cash flows

$22 to $1,072

Capitalized servicing rights

4,882

Discounted cash flow

Constant prepayment rate (CPR)

8.19

Discount rate

10.08

Other real estate owned

2,351

Fair value of collateral less selling costs

Appraised value

$2,700

Selling costs

12.93

Total

22,446

_____________________________________


(a)	Where dollar amounts are disclosed, the amounts represent the lowest and highest fair value of the respective assets in the population except for adjustments for market/property conditions, which represents the range of adjustments to individuals properties.

There were no Level 1 or Level 2 non-recurring fair value measurements for the periods ended December 31, 2019 and December 31, 2018.

Impaired Loans. Loans are generally not recorded at fair value on a recurring basis. Periodically, the Company records non-recurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Non-recurring adjustments can also include certain impairment amounts for collateral-dependent loans calculated when establishing the allowance for credit losses. Such amounts are generally based on the fair value of the underlying collateral supporting the loan and, as a result, the carrying value of the loan less the calculated valuation amount does not necessarily represent the fair value of the loan. Real estate collateral is typically valued using appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace. However, the choice of observable data is subject to significant judgment, and there are often adjustments based on judgment in order to make observable data comparable and to consider the impact of time, the condition of properties, interest rates, and other market factors on current values. Additionally, commercial real estate appraisals frequently involve discounting of projected cash flows, which relies inherently on unobservable data. Therefore, non-recurring fair value measurement adjustments that relate to real estate collateral have generally been classified as Level 3. Estimates of fair value for other collateral that supports commercial loans are generally based on assumptions not observable in the marketplace and therefore such valuations have been classified as Level 3.

Capitalized loan servicing rights. A loan servicing right asset represents the amount by which the present value of the estimated future net cash flows to be received from servicing loans exceed adequate compensation for performing the servicing. The fair value of servicing rights is estimated using a present value cash flow model. The most important assumptions used in the valuation model are the anticipated rate of the loan prepayments and discount rates. Adjustments are only recorded when the discounted cash flows derived from the valuation model are less than the carrying value of the asset. Although some assumptions in determining fair value are based on standards used by market participants, some are based on unobservable inputs and therefore are classified in Level 3 of the valuation hierarchy.

Other real estate owned (“OREO”). OREO results from the foreclosure process on residential or commercial loans issued by the Bank. Upon assuming the real estate, the Company records the property at the fair value of the asset less the estimated sales costs. Thereafter, OREO properties are recorded at the lower of cost or fair value less the estimated sales costs. OREO fair values are primarily determined based on Level 3 data including sales comparables and appraisals.

Premises held for sale. Premises held for sale, identified as part of the Company’s strategic review and branch optimization exercise, were transferred from premises and equipment at the lower of amortized cost or fair value less the estimated sales costs. Assets held for sale fair values are primarily determined based on Level 3 data including sales comparables and appraisals.

Summary of Estimated Fair Values of Financial Instruments

The following table represents estimated fair values, and related carrying amounts of the Company’s financial instruments as of December 31, 2019 and December 31, 2018. Certain financial instruments and all non-financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented herein may not necessarily represent the underlying fair value of the Company.



	December 31, 2019
(in thousands)	Carrying Amount			Fair Value			Level 1		Level 2			Level 3
Financial Assets
Cash and cash equivalents	$	56,910		$	56,910		$	56,910	$	—		$	—
Securities available for sale	663,230			663,230			—		663,230			—
FHLB bank stock	20,679			20,679			—		20,679			—
Net loans	2,625,739			2,634,147			—		—			2,634,147
Accrued interest receivable	3,294			3,294			—		3,294			—
Cash surrender value of bank-owned life insurance policies	75,863			75,863			—		75,863			—
Derivative assets	6,850			6,850			—		6,791			59

Financial Liabilities
Non-maturity deposits	$	1,763,116		$	1,751,481		$	—	$	1,751,481		$	—
Time deposits	932,635			932,886			—		932,886			—
Other short-term borrowings	44,832			44,831			—		44,831			—
Federal Home Loan Bank advances	426,564			425,989			—		425,989			—
Subordinated borrowings	59,920			59,920			—		59,920			—
Derivative liabilities	(8,186		)	(8,186		)	—		(8,102		)	(84		)



	December 31, 2018
(in thousands)	Carrying Amount			Fair Value			Level 1		Level 2		Level 3
Financial Assets
Cash and cash equivalents	$	98,754		$	98,754		$	98,754	$	—	$	—
Securities available for sale	725,837			725,837			—		725,837		—
FHLB bank stock	35,659			35,659			—		35,659		—
Net loans	2,476,361			2,415,863			—		—		2,415,863
Accrued interest receivable	3,533			3,533			—		3,533		—
Cash surrender value of bank-owned life insurance policies	73,810			73,810			—		73,810		—
Derivative assets	2,164			2,164			—		2,156		8

Financial Liabilities
Non-maturity deposits	$	1,550,445		$	1,476,673		$	—	$	1,476,673	$	—
Time deposits	932,793			927,577			—		927,577		—
Other short-term borrowings	36,211			36,171			—		36,171		—
Federal Home Loan Bank advances	644,611			643,065			—		643,065		—
Subordinated borrowings	37,973			37,973			—		37,973		—
Junior subordinated borrowings	5,000			3,923			—		3,923		—
Derivative liabilities	(1,353		)	(1,353		)	—		—		(1,353		)

Other than as discussed above, the following methods and assumptions were used by management to estimate the fair value of significant classes of financial instruments for which it is practicable to estimate that value.

Cash and cash equivalents. Carrying value is assumed to represent fair value for cash and cash equivalents that have original maturities of 90 days or less.

FHLB bank stock and restricted securities. Carrying value approximates fair value based on the redemption provisions of the issuers.

Cash surrender value of life insurance policies. Carrying value approximates fair value.

Loans, net. The fair value of loans were calculated on an individual basis with consideration given to the loans' underlying characteristics, including account types, remaining terms, annual interest rates or coupons, interest types, timing of principal and interest payments, current market rates, risk ratings, credit ratings and remaining balances. A discounted cash flow model is used to estimate the fair value of the loans using assumptions for the coupon rates, remaining maturities, prepayment speeds, liquidity premiums, projected default probabilities, losses given defaults, and estimates of prevailing discount rates.

Accrued interest receivable. Carrying value approximates fair value.

Deposits. The fair value of demand, non-interest bearing checking, savings and money market deposits is determined as the amount payable on demand at the reporting date. The fair value of time deposits is estimated by discounting the estimated future cash flows using market rates offered for deposits of similar remaining maturities.

Borrowed funds. The fair value of borrowed funds is estimated by discounting the future cash flows using market rates for similar borrowings. Such funds include all categories of debt and debentures in the table above.

Subordinated borrowings. The Company utilizes a pricing service along with internal models to estimate the valuation of its subordinated debentures with variable rates.

Off-balance-sheet financial instruments. Off-balance-sheet financial instruments include standby letters of credit and other financial guarantees and commitments considered immaterial to the Company’s financial statements.