14. FAIR VALUE

Fair value measurement is determined based on the assumptions that market participants would use in pricing the asset or liability in an exchange. The definition of fair value includes the exchange price which is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal market for the asset or liability. Market participant assumptions include assumptions about risk, the risk inherent in a particular valuation technique used to measure fair value and/or the risk inherent in the inputs to the valuation technique, as well as the effect of credit risk on the fair value of liabilities. The Company uses three levels of the fair value inputs to measure assets, as described below.

Basis of Fair Value Measurement:

Level 1 – Valuations based on quoted prices in active markets for identical investments.

Level 2 – Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Level 2 inputs include: (i) quoted prices for similar investments in active markets, (ii) quoted prices for identical investments traded in non-active markets (i.e., dealer or broker markets) and (iii) inputs other than quoted prices that are observable or inputs derived from or corroborated by market data for substantially the full term of the investment.

Level 3 – Valuations based on inputs that are unobservable, supported by little or no market activity, and significant to the overall fair value measurement.

The types of instruments valued based on quoted market prices in active markets include most U.S. Treasury securities. Such instruments are generally classified within Level 1 and Level 2 of the fair value hierarchy. The Company does not adjust the quoted price for such instruments.

The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include U.S. Government agency securities, state and municipal obligations, MBS, CMOs and corporate bonds. Such instruments are generally classified within Level 2 of the fair value hierarchy.

The types of instruments valued based on significant unobservable inputs that reflect the Company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability are generally classified within Level 3 of the fair value hierarchy.

U.S. GAAP sets requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term fair value, and provides guidance for determining fair values when the volume and level of activity for the asset or liability have significantly decreased, particularly when there is no active market or where the price inputs being used represent distressed sales. It also provides guidelines for making fair value measurements more consistent with principles, reaffirming the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets become inactive.

The following table presents the carrying amounts and fair values of the Company’s financial instruments (in thousands).

	Level in	December 31, 2014				December 31, 2013
	Fair Value Hierarchy	Carrying Amount		Fair Value		Carrying Amount		Fair Value

Financial Assets:
Cash and due from banks	Level 1	$	54,516	$	54,516	$	131,352	$	131,352
Federal funds sold	Level 2		1,000		1,000		1,000		1,000
Interest-bearing time deposits in other banks	Level 2		10,000		10,017		10,000		10,000
Federal Reserve Bank, Federal Home Loan
Bank and other stock	N/A		8,600		N/A		2,863		N/A
Investment securities held to maturity	Level 2		62,270		64,796		11,666		12,234
Investment securities available for sale	Level 2		298,670		298,670		400,780		400,780
Loans held for sale	Level 2		26,495		26,495		175		175
Loans, net of allowance	Level 2, 3 (1)		1,336,227		1,329,041		1,051,585		1,056,279
Accrued interest and loan fees receivable	Level 2		5,676		5,676		5,441		5,441

Financial Liabilities:
Non-maturity deposits	Level 2		1,337,301		1,337,301		1,284,982		1,284,982
Time deposits	Level 2		218,759		219,089		225,079		225,946
Borrowings	Level 2		130,000		130,004		-		-
Accrued interest payable	Level 2		136		136		160		160
Derivatives	Level 3		752		752		932		932

(1) Impaired loans are generally classified within Level 3 of the fair value hierarchy.

Fair value estimates are made at a specific point in time and may be based on judgments regarding losses expected in the future, risk, and other factors that are subjective in nature. The methods and assumptions used to produce the fair value estimates follow.

For securities held to maturity and securities available for sale, the estimated fair value equals quoted market price if available. If a quoted market price is not available, fair value is estimated using a quoted market price for similar securities. For cash and due from banks, federal funds sold, accrued interest and loan fees receivable, non-maturity deposits and accrued interest payable, the carrying amount is a reasonable estimate of fair value. Determining the fair value of Federal Reserve Bank, Federal Home Loan Bank and other stock is not practicable due to restrictions placed on its transferability. Interest-bearing time deposits in other banks, time deposits and borrowings are valued using a replacement cost of funds approach.

Fair values are estimated for portfolios of loans with similar characteristics. The fair value of performing loans was calculated by discounting projected cash flows through their estimated maturity using market discount rates that reflect the general credit and interest rate characteristics of the loan category. The maturity horizon is based on the Bank’s history of repayments for each type of loan and an estimate of the effect of current economic conditions. Assumptions regarding credit risk, cash flows, and discount rates are made using available market information and specific borrower information.

Loans identified as impaired are measured using one of three methods: the loan’s observable market price, the fair value of collateral less estimated costs to sell or the present value of expected future cash flows. Those measured using the loan’s observable market price or the fair value of collateral are recorded at fair value. For each period presented, no impaired loans were measured using the loan’s observable market price. If an impaired loan has had a charge-off or if the fair value of the collateral is less than the recorded investment in the loan, the Company establishes a specific reserve and reports the loan as non-recurring Level 3. The fair value of collateral of impaired loans is generally based on recent real estate appraisals. 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 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.

For the periods presented, loans held for sale were performing and carried at cost. The carrying cost is a reasonable estimate of fair value due to their short-term nature.

Fair value of OREO is generally based on third party appraisals or realtor evaluations of the property. These appraisals and evaluations 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 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. In cases where the carrying amount exceeds the fair value, less estimated costs to sell, an impairment loss is recognized through a valuation allowance, and the property is reported as non-recurring Level 3. The Company held no OREO at December 31, 2014 and 2013.

The fair value of commitments to extend credit is estimated by either discounting cash flows or using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the current creditworthiness of the counter-parties. The estimated fair value of written financial guarantees and letters of credit is based on fees currently charged for similar agreements. The fees charged for the commitments were not material in amount.

During the third and fourth quarters of 2013, the Company entered into derivative swap contracts with the purchaser of its Visa Class B shares. The fair value of these derivatives is measured using an internal model that includes the use of probability weighted scenarios for estimates of Visa’s aggregate exposure to the litigation matters, with consideration of amounts funded by Visa into its escrow account for this litigation. As a result, the Company estimates a fair value for these derivatives at 12% of the net sale proceeds from the Company’s sale of the related Visa Class B shares. Since this estimation process requires application of judgment in developing significant unobservable inputs used to determine the possible outcomes and the probability weighting assigned to each scenario, these derivatives have been classified as Level 3 within the valuation hierarchy. (See also Note 3. Investment Securities contained herein.)

Assets measured at fair value on a non-recurring basis are as follows (in thousands):

Assets:	December 31, 2014		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Impaired loans (1)	$	16,559	$	16,559
Total	$	16,559	$	16,559

(1) Collateral dependent.

Assets:	December 31, 2013		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Impaired loans (1)	$	16,942	$	16,942
Total	$	16,942	$	16,942

(1) Collateral dependent.

The Company had no liabilities measured at fair value on a non-recurring basis at December 31, 2014 and 2013.

The following presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis (dollars in thousands):

	Fair Value at December 31,				Valuation	Unobservable
Assets:	2014		2013		Technique	Inputs	Discount
Impaired loans (1):

Commercial and industrial	$	3,049	$	3,384	Third party appraisal and/or internal evaluation	Discount to appraised value (2), (3); estimated selling costs	5.6% to 50%

Commercial real estate		6,521		7,426	Third party appraisal and/or internal evaluation	Discount to appraised value (3); estimated selling costs	5.6% to 6.6%

Residential mortgages		5,422		5,050	Third party appraisal	Discount to appraised value (3); estimated selling costs		25%

Home equity		1,567		1,082	Third party appraisal	Discount to appraised value (3); estimated selling costs		25%
Total	$	16,559	$	16,942

(1) Collateral dependent.

(2) The Company also makes adjustments to the appraised value based upon evaluation of corporate assets, such as inventory and accounts receivable, and other factors. Higher discounts may be applied to certain assets, such as inventory and accounts receivable.

(3) The Company also makes adjustments to the appraised value based upon various information known to management about the property, market conditions and other factors.

The following presents fair value measurements on a recurring basis as of December 31, 2014 and 2013 (in thousands):

			Fair Value Measurements Using
			Significant Other Observable Inputs		Significant Unobservable Inputs
Assets:	December 31, 2014		(Level 2)		(Level 3)
U.S. Government agency securities	$	41,577	$	41,577	$	-
Corporate bonds		6,408		6,408		-
Collateralized mortgage obligations		21,997		21,997		-
Mortgage-backed securities		90,919		90,919		-
Obligations of states and political
subdivisions		137,769		137,769		-
Total	$	298,670	$	298,670	$	-

Liabilities:
Derivatives		752	$	-	$	752
Total	$	752	$	-	$	752

			Fair Value Measurements Using
			Significant Other Observable Inputs		Significant Unobservable Inputs
Assets:	December 31, 2013		(Level 2)		(Level 3)
U.S. Government agency securities	$	100,095	$	100,095	$	-
Corporate bonds		15,651		15,651		-
Collateralized mortgage obligations		30,104		30,104		-
Mortgage-backed securities		97,767		97,767		-
Obligations of states and political
subdivisions		157,163		157,163		-
Total	$	400,780	$	400,780	$	-

Liabilities:
Derivatives		932	$	-	$	932
Total	$	932	$	-	$	932

Reconciliations for assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2014, 2013 and 2012 follow (in thousands).

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
	Assets			Liabilities
	Collateralized Mortgage Obligations			Derivatives
Balance at January 1, 2012	$	7,994		$	-
Sales		(7,994	)		-
Balance at December 31, 2012		-			-
Net increases		-			932
Balance at December 31, 2013		-			932
Net decreases		-			(180	)
Balance at December 31, 2014	$	-		$	752