FAIR VALUE MEASUREMENT AND DISCLOSURE

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 eligible financial instruments and other items at fair value. The Company has 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 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

Loans Held For Sale: The fair value of loans held for sale is determined using quoted secondary market prices or executed sales agreements and is classified as Level 2.

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.

The fair value of equity AFS securities is reported utilizing market prices based on recent trading activity. The equity securities are traded on inactive markets and are classified as Level 2.

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 June 30, 2016 and December 31, 2015, 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 fair value of interest rate lock commitments is determined based on current market prices for similar assets in the secondary market and, therefore, classified as Level 2 within the fair value hierarchy.

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of June 30, 2016 and December 31, 2015, 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)
June 30, 2016
Financial assets:
Loans held for sale	$	22,928	$	—	$	22,928	$	—
AFS securities:
Obligations of U.S. government-sponsored enterprises	5,131		—		5,131		—
Obligations of states and political subdivisions	10,044		—		10,044		—
Mortgage-backed securities issued or guaranteed by U.S. government-sponsored enterprises	470,471		—		470,471		—
Collateralized mortgage obligations issued or guaranteed by U.S. government-sponsored enterprises	307,612		—		307,612		—
Subordinated corporate bonds	5,623		—		5,623		—
Equity securities	645		—		645		—
Customer loan swaps	15,001		—		15,001		—
Interest rate lock commitments	523		—		523		—
Financial liabilities:
Junior subordinated debt interest rate swaps	13,265		—		13,265		—
FHLBB advance interest rate swaps	1,172		—		1,172		—
Customer loan swaps	15,001		—		15,001		—
December 31, 2015
Financial assets:
Loans held for sale	$	10,958	$	—	$	10,958	$	—
AFS securities:
Obligations of U.S. government-sponsored enterprises	5,040		—		5,040		—
Obligations of states and political subdivisions	17,694		—		17,694		—
Mortgage-backed securities issued or guaranteed by U.S. government-sponsored enterprises	419,046		—		419,046		—
Collateralized mortgage obligations issued or guaranteed by U.S. government-sponsored enterprises	306,857		—		306,857		—
Subordinated corporate bonds	996		—		996		—
Equity securities	705		—		705		—
Customer loan swaps	3,166		—		3,166		—
Interest rate lock commitments	139		—		139		—
Financial liabilities:
Junior subordinated debt interest rate swaps	9,229		—		9,229		—
FHLBB advance interest rate swaps	576		—		576		—
Customer loan swaps	3,166		—		3,166		—

The Company did not have any transfers between Level 1 and Level 2 of the fair value hierarchy during the six months ended June 30, 2016. 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 market 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 the 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 carrying value to NRV. Accordingly, certain collateral-dependent impaired loans are 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 of a tranche 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 Non-Recurring 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 and other intangible assets.

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 ALL upon transfer to OREO. Upon acquisition of a property, a current appraisal is used or an internal valuation is prepared to substantiate fair value of the property. After foreclosure, management periodically, but at least annually, obtains updated valuations of the OREO properties 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 within the consolidated statements of income. As management considers appropriate, adjustments are made to the appraisal obtained for the OREO property to account for recent sales activity of comparable properties, changes in the condition of the property, and changes in market conditions. These adjustments are not observable in an active market and are classified as Level 3.

Goodwill and Other Intangible Assets: Goodwill represents the excess 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/or an estimation of the impact of business conditions and investor activities on the long-term value of the goodwill. Should an impairment of either reporting unit's goodwill occur, the associated goodwill is written-down to fair value and the impairment charge is recorded within non-interest expense in the consolidated statements of income. The Company conducts an annual impairment test of goodwill in the fourth quarter each year, or more frequently as necessary. There have been no indications or triggering events during for the six months ended June 30, 2016 for which management believes that it is more likely than not that goodwill is impaired.

The Company's core deposit intangible assets represent the estimated value of acquired customer relationships and are amortized on a straight-line basis over the estimated life of those relationships. Core deposit intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If necessary, management will test the core deposit intangibles for impairment by comparing its carrying value to the expected undiscounted cash flows of the assets. If the undiscounted cash flows of the intangible assets exceed its carrying value then the intangible assets are deemed to be fully recoverable and not impaired. However, if the undiscounted cash flows of the intangible assets are less than its carrying value, then an impairment charge is recorded to mark the carrying value of the intangible assets to fair value. There were no events or changes in circumstances for the six months ended June 30, 2016 that indicated the carrying amount may not be recoverable.

The table below highlights financial and non-financial assets measured and recorded at fair value on a non-recurring basis as of June 30, 2016 and December 31, 2015.



	Fair Value		Readily Available Market Prices (Level 1)		Observable Market Data (Level 2)		Company Determined Fair Value (Level 3)
June 30, 2016
Financial assets:
Collateral-dependent impaired loans	$	522	$	—	$	—	$	522
MSRs⁽¹⁾	1,369		—		1,369		—
Non-financial assets:
OREO	855		—		—		855
December 31, 2015
Financial assets:
Collateral-dependent impaired loans	$	1,971	$	—	$	—	$	1,971
MSRs⁽¹⁾	440		—		440		—
Non-financial assets:
OREO	1,304		—		—		1,304

(1) Represents MSRs deemed to be impaired and a valuation allowance established to carry at fair value.

The following table presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a non-recurring basis at June 30, 2016 and December 31, 2015:



	Fair Value		Valuation Methodology	Unobservable input	Discount Range (Weighted-Average)
June 30, 2016
Collateral-dependent impaired loans:
Partially charged-off	$	150	Market approach appraisal of collateral	Management adjustment of appraisal	0%	(0%)
				Estimated selling costs	0 - 10%	(4%)
Specifically reserved	372		Market approach appraisal of collateral	Management adjustment of appraisal	0 - 50%	(16%)
				Estimated selling costs	10%	(10%)
OREO	855		Market approach appraisal of collateral	Management adjustment of appraisal	0 - 73%	(10%)
				Estimated selling cost	10%	(10%)
December 31, 2015
Collateral-dependent impaired loans:
Partially charged-off	$	399	Market approach appraisal of collateral	Management adjustment of appraisal	0%	(0%)
				Estimated selling costs	0 - 10%	(7%)
Specifically reserved	1,572		Market approach appraisal of collateral	Management adjustment of appraisal	0 - 57%	(45%)
				Estimated selling costs	10%	(10%)
OREO	1,304		Market approach appraisal of collateral	Management adjustment of appraisal	0 - 43%	(18%)
				Estimated selling costs	10%	(10%)

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.

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 demand, interest 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.

Borrowings: The carrying amounts of short-term borrowings from the FHLB, securities sold under repurchase agreements, notes payable 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.

Subordinated Debentures: The fair values of are based on quoted prices from similar instruments in inactive markets.

The following table presents the carrying amounts and estimated fair value for financial instrument assets and liabilities measured at June 30, 2016:



	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	$	96,443	$	96,443	$	96,443	$	—	$	—
AFS securities	799,526		799,526		—		799,526		—
HTM securities	93,609		97,692		—		97,692		—
Loans held for sale	22,928		22,928		—		22,928		—
Residential real estate loans⁽¹⁾	796,125		815,775		—		—		815,775
Commercial real estate loans⁽¹⁾	1,006,218		993,814		—		—		993,814
Commercial loans⁽¹⁾⁽²⁾	402,580		405,395		—		—		405,395
Home equity loans⁽¹⁾	339,035		339,449		—		—		339,449
Consumer loans⁽¹⁾	17,625		18,767		—		—		18,767
MSRs⁽³⁾	1,410		1,864		—		1,864		—
Interest receivable	8,757		8,757		—		8,757		—
Customer loan swaps	15,001		15,001		—		15,001		—
Interest rate lock commitments	523		523		—		523		—
Financial liabilities:
Deposits	$	2,773,487	$	2,776,511	$	—	$	2,776,511	$	—
FHLB advances	45,000		45,943		—		45,943		—
Commercial repurchase agreements	30,030		30,909		—		30,909		—
Other borrowed funds	556,769		558,059				558,059		—
Subordinated debentures	58,677		40,800		—		40,800		—
Interest payable	643		643		—		643		—
Junior subordinated debt interest rate swaps	13,265		13,265		—		13,265		—
FHLBB advance interest rate swaps	1,172		1,172		—		1,172		—
Customer loan swaps	15,001		15,001		—		15,001		—


(1)	The presented carrying amount is net of the allocated ALL.


(2)	Includes the HPFC loan portfolio.


(3)	Reported fair value represents all MSRs currently being serviced by the Company, regardless of carrying amount.

The following table presents the carrying amounts and estimated fair value for financial instrument assets and liabilities measured at December 31, 2015:



	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	$	79,488	$	79,488	$	79,488	$	—	$	—
AFS securities	750,338		750,338		—		750,338		—
HTM securities	84,144		85,647		—		85,647		—
Loans held for sale	10,958		10,958		—		10,958		—
Residential real estate loans⁽¹⁾	808,180		820,774		—		—		820,774
Commercial real estate loans⁽¹⁾	922,257		911,316		—		—		911,316
Commercial loans⁽¹⁾⁽²⁾	371,684		371,854		—		—		371,854
Home equity loans⁽¹⁾	349,215		348,963		—		—		348,963
Consumer loans⁽¹⁾	17,704		18,163		—		—		18,163
MSRs⁽³⁾	2,161		2,947		—		2,947		—
Interest receivable	7,985		7,985		—		7,985		—
Customer loan swaps	3,166		3,166		—		3,166		—
Interest rate lock commitments	139		139		—		139		—
Financial liabilities:
Deposits	$	2,726,379	$	2,726,300	$	—	$	2,726,300	$	—
FHLB advances	55,000		56,001		—		56,001		—
Commercial repurchase agreements	30,052		30,931		—		30,931		—
Other borrowed funds	428,711		428,778		—		428,778		—
Subordinated debentures	58,599		42,950		—		42,950		—
Interest payable	641		641		—		641		—
Junior subordinated debt interest rate swaps	9,229		9,229		—		9,229		—
FHLBB advance interest rate swaps	576		576		—		576		—
Customer loan swaps	3,166		3,166		—		3,166		—


(1)	The presented carrying amount is net of the allocated ALL.


(2)	Includes the HPFC loan portfolio.


(3)	Reported fair value represents all MSRs currently being serviced by the Company, regardless of carrying amount.