Fair Value

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined using quoted market prices. However, in many instances, quoted market prices are not available. In such instances, fair values are determined using various valuation techniques. Various assumptions and observable inputs must be relied upon in applying these techniques. GAAP establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

GAAP permits an entity to choose to measure certain eligible financial instruments and other items at fair value. The Company elected the fair value option for its loans held for sale. Electing the fair value option for loans held for sale enables the Company’s financial position to more clearly align with the economic value of the actively traded asset. The Company did not have any loans held for sale at December 31, 2014 or 2013.

The fair value hierarchy for valuation of an asset or liability is as follows:



Level 1:	Valuation is based upon unadjusted quoted prices in active markets for identical assets and liabilities that the entity has the ability to access as of the measurement date.



Level 2:	Valuation is determined from quoted prices for similar assets or liabilities in active markets, from quoted prices for identical or similar instruments in markets that are not active or by model-based techniques in which all significant inputs are observable in the market.



Level 3:	Valuation is derived from model-based and other techniques in which at least one significant input is unobservable and which may be based on the Company’s own estimates about the assumptions that market participants would use to value the asset or liability.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon model-based techniques incorporating various assumptions including interest rates, prepayment speeds and credit losses. Assets and liabilities valued using model-based techniques are classified as either Level 2 or Level 3, depending on the lowest level classification of an input that is considered significant to the overall valuation. A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Financial Instruments Recorded at Fair Value on a Recurring Basis

AFS Securities: The fair value of debt AFS securities is reported utilizing prices provided by an independent pricing service based on recent trading activity and other observable information including, but not limited to, dealer quotes, market spreads, cash flows, market interest rate curves, market consensus prepayment speeds, credit information, and the bond’s terms and conditions. The fair value of debt securities are classified as Level 2.

Trading Account Assets: Trading account assets are invested in mutual funds and classified as Level 1 based upon quoted prices.

Derivatives: The fair value of interest rate swaps is determined using inputs that are observable in the market place obtained from third parties including yield curves, publicly available volatilities, and floating indexes and, accordingly, are classified as Level 2 inputs. The credit value adjustments associated with derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. As of December 31, 2014 and 2013, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives due to collateral postings.

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of December 31, 2014 and 2013, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:



	Fair Value		Readily Available Market Prices (Level 1)		Observable Market Data (Level 2)		Company Determined Fair Value (Level 3)
December 31, 2014:
Financial assets:
AFS securities:
Obligations of U.S. government-sponsored enterprises	$	5,027	$	—	$	5,027	$	—
Obligations of states and political subdivisions	26,777		—		26,777		—
Mortgage-backed securities issued or guaranteed by U.S. government-sponsored enterprises	381,308		—		381,308		—
Collateralized mortgage obligations issued or guaranteed by U.S. government-sponsored enterprises	343,897		—		343,897		—
Private issue collateralized mortgage obligations	6,054		—		6,054		—
Trading account assets	2,457		2,457		—		—
Customer loan swaps	1,140		—		1,140		—
Financial liabilities:
Interest rate swap agreements	9,143		—		9,143		—
Customer loan swaps	1,140		—		1,140		—
December 31, 2013:
Financial assets:
AFS securities:
Obligations of states and political subdivisions	$	31,207	$	—	$	31,207	$	—
Mortgage-backed securities issued or guaranteed by U.S. government-sponsored enterprises	395,903		—		395,903		—
Collateralized mortgage obligations issued or guaranteed by U.S. government-sponsored enterprises	374,435		—		374,435		—
Private issue collateralized mortgage obligations	6,932		—		6,932		—
Trading account assets	2,488		2,488		—		—
Customer loan swaps	114		—		114		—
Financial liabilities:
Interest rate swap agreements	3,912		—		3,912		—
Customer loan swaps	114		—		114		—

The Company did not have any transfers between Level 1 and Level 2 of the fair value hierarchy during 2014. The Company’s policy for determining transfers between levels occurs at the end of the reporting period when circumstances in the underlying valuation criteria change and result in transfer between levels.

Financial Instruments Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain financial assets and financial liabilities at fair value on a nonrecurring basis in accordance with GAAP. These include assets that are measured at the lower of cost or fair value that were recognized at fair value below cost at the end of the period.

Collateral-Dependent Impaired Loans: Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. The Company's policy is to individually evaluate for impairment loans with a principal balance greater than $250,000 or more and are classified as substandard or doubtful and are on non-accrual status. Once the population of loans is identified for individual impairment assessment, the Company measures these loans for impairment by comparing NRV, which is the fair value of the collateral, less estimated costs to sell, to the carrying value of the loan. If NRV of the loan is less than the carrying value of the loan, then a loss is recognized as part of the ALL to adjust the loan's net carrying value to NRV. Accordingly, certain impaired loans may be subject to measurement at fair value on a non-recurring basis. Management has estimated the fair values of these assets using Level 2 inputs, such as the fair value of collateral based on independent third-party market approach appraisals for collateral-dependent loans, and Level 3 inputs where circumstances warrant an adjustment to the appraised value based on the age of the appraisal and/or comparable sales, condition of the collateral, and market conditions.

MSRs: The Company accounts for mortgage servicing assets at cost, subject to impairment testing. When the carrying value exceeds fair value, a valuation allowance is established to reduce the carrying cost to fair value. Fair value is based on a valuation model that calculates the present value of estimated net servicing income. The Company obtains a third-party valuation based upon loan level data including note rate, type and term of the underlying loans. The model utilizes a variety of observable inputs for its assumptions, the most significant of which are loan prepayment assumptions and the discount rate used to discount future cash flows. Other assumptions include delinquency rates, servicing cost inflation and annual unit loan cost. MSRs are classified within Level 2 of the fair value hierarchy.

Non-Financial Assets and Non-Financial Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company has no non-financial assets or non-financial liabilities measured at fair value on a recurring basis. Non-financial assets measured at fair value on a non-recurring basis consist of OREO and goodwill.

OREO: OREO properties acquired through foreclosure or deed in lieu of foreclosure are recorded at NRV, which is the fair value of the real estate, less estimated costs to sell. Any write-down of the recorded investment in the related loan is charged to the allowance for loan losses upon transfer to OREO. Upon acquisition of a property, a current appraisal or a broker’s opinion is used to substantiate fair value for the property. After foreclosure, management periodically obtains updated valuations of the OREO assets and, if additional impairments are deemed necessary, the subsequent write-downs for declines in value are recorded through a valuation allowance and a provision for losses charged to other non-interest expense on the consolidated statements of income. Certain assets require assumptions that are not observable in an active market in determination of fair value and are classified as Level 3.

Goodwill: Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. The fair value of goodwill is estimated by utilizing several standard valuation techniques, including discounted cash flow analyses, bank merger multiples, and an estimation of the impact of business conditions and investor activities on the long-term value of the goodwill.

In 2014, the annual goodwill impairment evaluation did not identify any impairment. In 2013, the Company recorded goodwill impairment of $2.8 million to write-down its financial services reporting unit to fair value of $3.9 million. Refer to Note 5 of the consolidated financial statements for discussion of goodwill impairment analysis and related significant inputs used, including Level 3 inputs. Additionally, the banking reporting unit was not deemed impaired.

The table below highlights financial and non-financial assets measured and recorded at fair value on a non-recurring basis as of December 31, 2014 and 2013. Not included in the table below because they are not recorded at fair value at December 31, 2014 and 2013 are: (i) impaired loans of $17.6 million and $19.4 million, respectively; (ii) MSR's reported of $319,000 and $322,000, respectively; and (iii) OREO properties of $305,000 and $612,000, respectively.



	Fair Value		Readily Available Market Prices (Level 1)		Observable Market Data (Level 2)		Company Determined Fair Value (Level 3)
December 31, 2014:
Financial assets:
Collateral-dependent impaired loans	$	3,581	$	—	$	—	$	3,581
MSRs⁽¹⁾	173		—		173		—
Non-financial assets:
OREO	1,282		—		—		1,282
December 31, 2013:
Financial assets:
Collateral-dependent impaired loans	$	8,557	$	—	$	—	$	8,557
MSRs⁽¹⁾	404		—		404		—
Non-financial assets:
OREO	1,583		—		—		1,583

(1) Represents MSRs deemed to be impaired and a valuation allowance was established to carry at fair value at December 31, 2014 and 2013.

The following table presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a non-recurring basis at December 31, 2014 and 2013:



	Fair Value		Valuation Methodology	Unobservable input	Discount Range (Weighted-Average)
December 31, 2014:
Collateral-dependent impaired loans:
Partially charged-off	$	1,569	Market approach appraisal of collateral	Management adjustment of appraisal	0 - 17%	(0%)
				Estimated selling costs	10%	(10%)
Specifically reserved	2,012		Market approach appraisal of collateral	Management adjustment of appraisal	0 - 50%	(22%)
				Estimated selling costs	10%	(10%)
OREO	1,282		Market approach appraisal of collateral	Management adjustment of appraisal	0 - 68%	(21%)
				Estimated selling costs	6 - 10%	(9%)
December 31, 2013:
Collateral-dependent impaired loans:
Partially charged-off	$	1,874	Market approach appraisal of collateral	Management adjustment of appraisal	0 - 85%	(14%)
Specifically reserved	6,683		Market approach appraisal of collateral	Management adjustment of appraisal	7 - 90%	(22%)
OREO	1,583		Market approach appraisal of collateral	Management adjustment of appraisal	0 - 41%	(16%)
				Estimated selling costs	6 - 10%	(10%)

At December 31, 2014, the Company amended its calculation of fair value for its collateral-dependent impaired loans for which a specific reserve is allocated. Historically, the specific reserve for collateral-dependent impaired loans was determined by any loan-to-value ratio in excess of 80% for consumer loans and any loan-to-value ratio in excess of 75% for commercial loans after applying any adjustments necessary to appraisals received to reflect changes in known factors, including, but not limited to, property condition and property location. For the December 31, 2014 valuation of fair value for the collateral-dependent impaired loans for which a specific reserve is allocated in accordance with Company policy, management calculated the reserve without consideration of loan-to-value ratios. Management calculated the estimated fair value of these impaired loans by reducing the appraised value of the collateral, adjusted for known factors, including, but not limited to, property condition, property location, by the estimated direct selling costs of the collateral. The amendment did not have a material impact on the ALL.

GAAP requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above. The following methods and assumptions were used by the Company in estimating the fair values of its other financial instruments.

Cash and Due from Banks: The carrying amounts reported in the consolidated statements of condition approximate fair value.

HTM securities: The fair value is estimated utilizing prices provided by an independent pricing service based on recent trading activity and other observable information including, but not limited to, dealer quotes, market spreads, cash flows, market interest rate curves, market consensus prepayment speeds, credit information, and the bond’s terms and conditions. The fair value is classified as Level 2.

FHLB and FRB Stock and Investments in CCTA and UBCT: The carrying amounts reported in the consolidated statements of condition approximate fair value.

Loans: For variable rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. The fair value of other loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Interest Receivable and Payable: The carrying amounts reported in the consolidated statements of condition approximate fair value.

Deposits: The fair value of deposits with no stated maturity is equal to the carrying amount. The fair value of CDs is estimated using a discounted cash flow calculation that applies interest rates and remaining maturities for currently offered CDs.

Borrowings: The carrying amounts of short-term borrowings from the FHLB, securities sold under repurchase agreements, and other short-term borrowings approximate fair value. The fair values of long-term borrowings and commercial repurchase agreements are based on the discounted cash flows using current rates for advances of similar remaining maturities.

Junior Subordinated Debentures: The carrying amounts reported in the consolidated statements of condition approximate fair value.

The following table presents the carrying amounts and estimated fair value for financial instrument assets and liabilities at December 31, 2014:



	Carrying Amount		Fair Value		Readily Available Market Prices (Level 1)		Observable Market Prices (Level 2)		Company Determined Market Prices (Level 3)
Financial assets:
Cash and due from banks	$	60,813	$	60,813	$	60,813	$	—	$	—
AFS securities	763,063		763,063		—		763,063		—
HTM securities	20,179		20,425		—		20,425		—
FHLB and FRB stock	20,391		20,391		20,391		—		—
Trading account assets	2,457		2,457		2,457		—		—
Residential real estate loans	579,946		596,172		—		—		596,172
Commercial real estate loans	635,609		631,434		—		—		631,434
Commercial loans	249,823		244,713		—		—		244,713
Home equity loans	269,176		270,904		—		—		270,904
Consumer loans	16,940		17,007		—		—		17,007
MSRs⁽¹⁾	493		1,447		—		1,447		—
Interest receivable	6,017		6,017		—		6,017		—
Investment in CCTA and UBCT	1,331		1,331		—		—		1,331
Customer interest rate swap agreement	1,140		1,140		—		1,140		—
Financial liabilities:
Deposits	$	1,932,097	$	1,933,805	$	1,361,604	$	572,201	$	—
FHLB advances	56,039		57,986		—		57,986		—
Commercial repurchase agreements	30,097		31,395		—		31,395		—
Other borrowed funds	446,842		446,909		446,909		—		—
Junior subordinated debentures	44,024		44,024		—		44,024		—
Interest payable	537		537		537		—		—
Interest rate swap agreements	9,143		9,143		—		9,143		—
Customer interest rate swap agreement	1,140		1,140		—		1,140		—

(1) Reported fair value represents all MSRs currently being serviced by the Company at December 31, 2014, regardless of carrying amount.

The following table presents the carrying amounts and estimated fair value for financial instrument assets and liabilities at December 31, 2013:



	Carrying Amount		Fair Value		Readily Available Market Prices (Level 1)		Observable Market Prices (Level 2)		Company Determined Market Prices (Level 3)
Financial assets:
Cash and due from banks	$	51,355	$	51,355	$	51,355	$	—	$	—
AFS securities	808,477		808,477		—		808,477		—
FHLB and FRB stock	19,724		19,724		19,724		—		—
Trading account assets	2,488		2,488		2,488		—		—
Residential real estate loans	563,425		577,153		—		—		577,153
Commercial real estate loans	536,107		535,961		—		—		535,961
Commercial loans	172,105		171,432		—		—		171,432
Home equity loans	269,888		271,041		—		—		271,041
Consumer loans	17,287		17,662		—		—		17,662
MSRs⁽¹⁾	726		1,494		—		1,494		—
Interest receivable	5,808		5,808		—		5,808		—
Investment in CCTA and UBCT	1,331		1,331		—		—		1,331
Customer interest rate swap agreement	114		114		—		114		—
Financial liabilities:
Deposits	$	1,813,824	$	1,817,199	$	1,324,221	$	492,978	$	—
FHLB advances	56,112		59,118		—		59,118		—
Commercial repurchase agreements	30,142		32,038		—		32,038		—
Other borrowed funds	399,916		400,144		400,144		—		—
Junior subordinated debentures	43,922		43,922		—		43,922		—
Interest payable	567		567		567		—		—
Interest rate swap agreements	3,912		3,912		—		3,912		—
Customer interest rate swap agreement	114		114		—		114		—

(1) Reported fair value represents all MSRs currently being serviced by the Company at December 31, 2013, regardless of carrying amount.