FAIR VALUES

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Corporation used the following methods and significant assumptions to estimate fair value:

Available for Sale Securities: The fair values of securities available for sale are usually determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs), or matrix pricing, which is a mathematical technique widely used to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3 inputs).

Equity Investments: Securities that are held to fund a non-qualified deferred compensation plan and securities that have a readily determinable fair market value, are recorded with changes in fair value included in earnings. The fair values of equity investments are determined by quoted market prices (Level 1 inputs).

Impaired Loans: At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value have been partially charged-off or receive specific allocations as part of the allowance for loan loss accounting. For collateral dependent loans, fair value is commonly based on 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 independent 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. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, typically resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

OREO: Assets acquired through or instead of loan foreclosures are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly 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 independent 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.

Appraisals for both collateral-dependent impaired loans and OREO are performed by certified general appraisers (commercial properties) or certified residential appraisers (residential properties) whose qualifications and licenses have been reviewed and verified by the Corporation. Once received, appraisals are reviewed for reasonableness of assumptions, approaches utilized, Uniform Standards of Professional Appraisal Practice and other regulatory compliance, as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. Appraisals are generally completed within the previous 12 month period prior to a property being placed into OREO. On impaired loans, appraisal values are adjusted based on the age of the appraisal, the position of the lien, the type of the property and its condition.

Derivatives: The fair values of interest rate swaps are based on valuation models using observable market data as of the measurement date (Level 2 inputs). Derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices, and indices to generate continuous yield or pricing curves, prepayment rates, and volatility factors to value the position. The Corporation also incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counter-party's nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Corporation has considered the impact of any applicable credit enhancements, such as collateral postings. Although the Corporation has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with credit risk participations are based on credit default rate assumptions (Level 3 inputs).

Assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):



			Fair Value Measurement at December 31, 2018 Using
Financial Assets:	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Obligations of U.S. Government and U.S. Government sponsored enterprises	$	5,472	$	—	$	5,472	$	—
Mortgage-backed securities, residential	183,192		—		183,192		—
Obligations of states and political subdivisions	44,152		—		44,152		—
Corporate bonds and notes	247		—		247		—
SBA loan pools	9,195		—		9,195		—
Total available for sale securities	$	242,258	$	—	$	242,258	$	—

Equity Investments	$	1,075	$	1,075	$	—	$	—
Derivative assets	3,142		—		3,142		—

Financial Liabilities:
Derivative liabilities	$	3,282	$	—	$	3,142	$	140

There were no transfers between Level 1 and Level 2 during the twelve month period ending December 31, 2018.



			Fair Value Measurement at December 31, 2017 Using
Financial Assets:	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Obligations of U.S. Government and U.S. Government sponsored enterprises	$	15,491	$	—	$	15,491	$	—
Mortgage-backed securities, residential	219,909		—		219,909		—
Obligations of states and political subdivisions	53,132		—		53,132		—
Corporate bonds and notes	251		—		251		—
SBA loan pools	4,308		—		4,308		—
Total available for sale securities	$	293,091	$	—	$	293,091	$	—

Equity investments	$	1,192	$	1,192	$	—	$	—
Derivative assets	974		—		974		—

Financial Liabilities:
Derivative liabilities	$	1,049	$	—	$	974	$	75

There were no transfers between Level 1 and Level 2 during the twelve month periods ending December 31, 2018 and 2017.

The table below presents a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31:



	Assets (Liabilities)
	Corporate Bonds and Notes					Derivative Liabilities
(in thousands)	2018		2017			2018			2017
Balance of recurring Level 3 assets at January 1	$	—	$	250		$	(75	)	$	(68	)
Derivative instruments entered into	—		—			(1		)	(5		)
Total gains or losses for the period:
Included in earnings - other non-interest income	—		—			(64		)	(2		)
Included in other comprehensive income	—		1			—			—
Transfers out of Level 3	—		(251		)	—			—
Balance of recurring Level 3 assets at December 31	$	—	$	—		$	(140	)	$	(75	)

During the year ended December 31, 2017, one corporate bond was transferred from Level 3 and into Level 2 due to the availability of pricing in secondary markets.

The following table presents information related to Level 3 recurring fair value measurement at December 31, 2018 and December 31, 2017 (in thousands):



Description	Fair Value at December 31, 2018		Valuation Technique	Unobservable Inputs	Range [Weighted Average] at December 31, 2018
Derivative liabilities	$	140	Historical trend	Credit default rate	7.46% - 7.46% [7.46%]



Description	Fair Value at December 31, 2017		Valuation Technique	Unobservable Inputs	Range [Weighted Average] at December 31, 2017
Derivative liabilities	$	75	Historical trend	Credit default rate	5.67% - 5.67% [5.67%]

Assets and liabilities measured at fair value on a non-recurring basis are summarized below (in thousands):



			Fair Value Measurement at December 31, 2018 Using
Financial Assets:	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Gains (Losses)
Impaired Loans:
Commercial mortgages:
Commercial mortgages	$	1,456	$	—	$	—	$	1,456	$	240
Total impaired loans	$	1,456	$	—	$	—	$	1,456	$	240

Other real estate owned:
Commercial mortgages:
Commercial mortgages	$	213	$	—	$	—	$	213	$	—
Residential mortgages	204		—		—		204		—
Consumer loans:
Home equity lines and loans	157		—		—		157		(14		)
Total other real estate owned, net	$	574	$	—	$	—	$	574	$	(14	)



			Fair Value Measurement at December 31, 2017 Using
Financial Assets:	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Gains (Losses)
Impaired Loans:
Commercial and agricultural:
Commercial and industrial	$	96	$	—	$	—	$	96	$	(70	)
Commercial mortgages:
Commercial mortgages	411		—		—		411		(105		)
Total impaired loans	$	507	$	—	$	—	$	507	$	(175	)

Other real estate owned:
Commercial mortgages:
Commercial mortgages	$	1,483	$	—	$	—	$	1,483	$	(43	)
Residential mortgages	382		—		—		382		—
Consumer loans:
Home equity lines and loans	75		—		—		75		—
Total other real estate owned, net	$	1,940	$	—	$	—	$	1,940	$	(43	)

The following table presents information related to Level 3 non-recurring fair value measurement at December 31, 2018 and 2017 (in thousands):



Asset	Fair Value at December 31, 2018		Valuation Technique	Unobservable Inputs	Range [Weighted Average] at December 31, 2018
Impaired loans:
Commercial mortgages:
Commercial mortgages	$	1,456	Sales comparison	Discount to appraised value	11.76% - 11.76% [11.76%]
	$	1,456

OREO:
Commercial and agricultural:
Commercial and industrial	$	213	Sales comparison	Discount to appraised value	10.00% - 24.80% [17.72%]
Residential mortgages	204		Sales comparison	Discount to appraised value	20.80% - 39.78% [22.94%]
Consumer loans:
Home equity lines and loans	157		Sales comparison	Discount to appraised value	20.80% - 20.80% [20.80%]
	$	574



Asset	Fair Value at December 31, 2017		Valuation Technique	Unobservable Inputs	Range [Weighted Average] at December 31, 2017
Impaired loans:
Commercial and agricultural:
Commercial and industrial	$	96	Sales comparison	Discount to appraised value	0.00% - 36.07% [33.02%]
Commercial mortgages:
Commercial mortgages	411		Sales comparison	Discount to appraised value	10.00% - 89.98% [51.35%]
	$	507

OREO:
Commercial mortgages:
Commercial mortgages	$	1,483	Sales comparison	Discount to appraised value	10.00% - 22.95% [19.75%]
Residential mortgages	$	382	Sales comparison	Discount to appraised value	17.28% - 27.97% [20.77%]
Consumer loans:
Home equity lines and loans	75		Sales comparison	Discount to appraised value	20.80% - 20.80% [20.80%]
	$	1,940

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts and estimated fair values of other financial instruments, at December 31, 2018 and December 31, 2017, are as follows (in thousands):



			Fair Value Measurements at December 31, 2018 Using
Financial assets:	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Estimated Fair Value (1)
Cash and due from financial institutions	$	33,040	$	33,040	$	—	$	—	$	33,040
Interest-bearing deposits in other financial institutions	96,932		96,932		—		—		96,932
Equity investments	1,909		1,909		—		—		1,909
Securities available for sale	242,258		—		242,258		—		242,258
Securities held to maturity	4,875		—		1,838		3,020		4,858
FHLBNY and FRBNY stock	3,138		—		—		—		N/A
Loans, net and loans held for sale (2)	1,293,464		—		—		1,287,495		1,287,495
Accrued interest receivable	4,480		80		697		3,703		4,480
Derivative assets	3,142		—		3,142		—		3,142

Financial liabilities:
Deposits:
Demand, savings, and insured money market accounts	$	1,419,011	$	1,419,011	$	—	$	—	$	1,419,011
Time deposits	150,226		—		150,938		—		150,938
Securities sold under agreements to repurchase	—		—		—		—		—
FHLBNY overnight advances	—		—		—		—		—
FHLBNY term advances	—		—		—		—		—
Accrued interest payable	232		26		206		—		232
Derivative liabilities	3,282		—		3,142		140		3,282

(1) Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

(2) Due to the adoption of ASU 2016-01, the fair value of loans, net and loans held for sale are estimated using exit pricing as of December 31, 2018. Prior to the adoption of ASU 2016-01, the fair value of loans, net and loans held for sale were presented using entrance pricing, therefore, prior year presentation is not comparable.



			Fair Value Measurements at December 31, 2017 Using
Financial Assets:	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Estimated Fair Value (1)
Cash and due from financial institutions	$	27,966	$	27,966	$	—	$	—	$	27,966
Interest-bearing deposits in other financial institutions	2,763		2,763		—		—		2,763
Equity investments	1,192		1,192		—		—		1,192
Securities available for sale	293,091		—		293,091		—		293,091
Securities held to maturity	3,781		—		1,830		1,946		3,776
FHLBNY and FRBNY stock	5,784		—		—		—		N/A
Loans, net (2)	1,290,663		—		—		1,289,584		1,289,584
Loans held for sale (2)	542		—		542		—		542
Accrued interest receivable	4,642		1		867		3,774		4,642
Derivative assets	974		—		974		—		974

Financial liabilities:
Deposits:
Demand, savings, and insured money market accounts	$	1,349,084	$	1,349,084	$	—	$	—	$	1,349,084
Time deposits	118,362		—		118,598		—		118,598
Securities sold under agreements to repurchase	10,000		—		10,058		—		10,058
FHLBNY overnight advances	57,700		—		57,700		—		57,700
FHLBNY term advances	2,000		—		2,001		—		2,001
Accrued interest payable	148		24		124		—		148
Derivative liabilities	1,049		—		974		75		1,049