FAIR VALUE MEASUREMENTS

Fair value is based upon the exchange price that would be received for an asset or paid to transfer a liability (an 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. A fair value hierarchy is utilized to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs used to measure fair value are as follows:

Level 1: Quoted prices (unadjusted) or 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 and other inputs that are observable or can be corroborated by observable market data.

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

Accordingly, securities available-for-sale and derivative financial instruments are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record other assets at fair value on a nonrecurring basis, such as loans held for sale, impaired loans held for investment and property held for sale. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Available-for-Sale Securities: Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities.

Derivative Financial Instruments: Derivative financial instruments are recorded at fair value on a recurring basis. Fair value measurement is based on pricing models run by a third-party, utilizing observable market-based inputs. All future floating cash flows are projected and both floating and fixed cash flows are discounted to the valuation date. As a result, we classify interest rate swaps as Level 2.

Loans Held for Sale: Loans held for sale are carried at the lower of cost or market value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, we classify loans subject to nonrecurring fair value adjustments as Level 2.

Loans: We do not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the original contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the discounted cash flows or collateral value exceeds the recorded investments in such loans. These loans are carried at recorded loan investment and therefore are not included in the following tables of loans measured at fair value. Impaired loans internally graded as substandard, doubtful, or loss are evaluated using the fair value of collateral method. All other impaired loans are measured for impairment using the discounted cash flows method. Impaired loans where an allowance is established based on the fair value of collateral are included in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, we record the impaired loan as nonrecurring Level 2. When a current appraised value is not available and there is no observable market price, we record the impaired loan as nonrecurring Level 3.

When impaired loans are deemed required to be included in the fair value hierarchy, management immediately begins the process of evaluating the estimated fair value of the underlying collateral to determine if a related specific allowance for loan losses or charge-off is necessary. Current appraisals are ordered once a loan is deemed impaired if the existing appraisal is more than twelve months old, or more frequently if there is known deterioration in value. For recently identified impaired loans, a current appraisal may not be available at the financial statement date. Until the current appraisal is obtained, the original appraised value is discounted, as appropriate, to compensate for the estimated depreciation in the value of the loan’s underlying collateral since the date of the original appraisal. Such discounts are generally estimated based upon management’s knowledge of sales of similar collateral within the applicable market area and its knowledge of other real estate market-related data as well as general economic trends. When a new appraisal is received (which is generally within 3 months of a loan being identified as impaired), management then re-evaluates the fair value of the collateral and adjusts any specific allocated allowance for loan losses, as appropriate. In addition, management also assigns a discount of 7–10% for the estimated costs to sell the collateral.

Property Held for Sale: Property held for sale consists of real estate acquired in foreclosure or other settlement of loans. Such assets are carried on the balance sheet at the lower of the investment in the real estate or its fair value less estimated selling costs. The fair value of foreclosed properties is determined on a nonrecurring basis generally utilizing current appraisals performed by an independent, licensed appraiser applying an income or market value approach using observable market data (Level 2). Updated appraisals of foreclosed properties are generally obtained if the existing appraisal is more than 18 months old or more frequently if there is a known deterioration in value. However, if a current appraisal is not available, the original appraised value is discounted, as appropriate, to compensate for the estimated depreciation in the value of the real estate since the date of its original appraisal. Such discounts are generally estimated based upon management’s knowledge of sales of similar property within the applicable market area and its knowledge of other real estate market-related data as well as general economic trends (Level 3). Upon foreclosure, any fair value adjustment is charged against the allowance for loan losses. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense in the consolidated statements of income.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis.



	Balance at		Fair Value Measurements Using:
Dollars in thousands	March 31, 2017		Level 1		Level 2		Level 3
Available for sale securities
U.S. Government sponsored agencies	$	14,564	$	—	$	14,564	$	—
Mortgage backed securities:
Government sponsored agencies	132,975		—		132,975		—
Nongovernment sponsored entities	3,998		—		3,998		—
State and political subdivisions	5,020		—		5,020		—
Corporate debt securities	18,309		—		18,309		—
Other equity securities	137		—		137		—
Tax-exempt state and political subdivisions	107,025		—		107,025		—
Total available for sale securities	$	282,028	$	—	$	282,028	$	—

Derivative financial assets
Interest rate swaps	$	257	$	—	$	257	$	—

Derivative financial liabilities
Interest rate swaps	$	3,823	$	—	$	3,823	$	—



	Balance at		Fair Value Measurements Using:
Dollars in thousands	December 31, 2016		Level 1		Level 2		Level 3
Available for sale securities
U.S. Government sponsored agencies	$	15,174	$	—	$	15,174	$	—
Mortgage backed securities:
Government sponsored agencies	138,846		—		138,846		—
Nongovernment sponsored entities	4,653		—		4,653		—
Corporate debt securities	18,170		—		18,170		—
Other equity securities	137		—		137		—
Tax-exempt state and political subdivisions	89,562		—		89,562		—
Total available for sale securities	$	266,542	$	—	$	266,542	$	—

Derivative financial assets
Interest rate swaps	$	200	$	—	$	200	$	—

Derivative financial liabilities
Interest rate swaps	$	4,611	$	—	$	4,611	$	—

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below.



	Balance at		Fair Value Measurements Using:
Dollars in thousands	March 31, 2017		Level 1		Level 2		Level 3
Residential mortgage loans held for sale	$	172	$	—	$	172	$	—

Collateral-dependent impaired loans
Construction and development	$	945	$	—	$	945	$	—
Residential real estate	296		—		130		166
Total collateral-dependent impaired loans	$	1,241	$	—	$	1,075	$	166

Property held for sale
Commercial real estate	$	976	$	—	$	976	$	—
Construction and development	18,407		—		18,407		—
Residential real estate	518		—		518		—
Total property held for sale	$	19,901	$	—	$	19,901	$	—



	Balance at		Fair Value Measurements Using:
Dollars in thousands	December 31, 2016		Level 1		Level 2		Level 3
Residential mortgage loans held for sale	$	176	$	—	$	176	$	—

Collateral-dependent impaired loans
Construction and development	$	945	$	—	$	945	$	—
Residential real estate	130		—		130		—
Total collateral-dependent impaired loans	$	1,075	$	—	$	1,075	$	—

Property held for sale
Commercial real estate	$	976	$	—	$	976	$	—
Construction and development	19,327		—		19,327		—
Residential real estate	279		—		279		—
Total property held for sale	$	20,582	$	—	$	20,582	$	—

The following summarizes the methods and significant assumptions we used in estimating our fair value disclosures for financial instruments, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis.

Cash and cash equivalents: The carrying values of cash and cash equivalents approximate their estimated fair value.

Securities: Estimated fair values of securities are based on quoted market prices, where available. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable securities.

Other investments: Other investments consists of FHLB stock, which does not have readily determinable fair values and is carried at cost and an investment in a limited partnership which owns interests in a diversified portfolio of qualified affordable housing projects which is reflected at its carrying value.

Loans held for sale: The carrying values of loans held for sale approximate their estimated fair values.

Loans: The estimated fair values for loans are computed based on scheduled future cash flows of principal and interest, discounted at interest rates currently offered for loans with similar terms to borrowers of similar credit quality. No prepayments of principal are assumed.

Accrued interest receivable and payable: The carrying values of accrued interest receivable and payable approximate their estimated fair values.

Deposits: The estimated fair values of demand deposits (i.e. non-interest bearing checking, NOW, money market and savings accounts) and other variable rate deposits approximate their carrying values. Fair values of fixed maturity deposits are estimated using a discounted cash flow methodology at rates currently offered for deposits with similar remaining maturities. Any intangible value of long-term relationships with depositors is not considered in estimating the fair values disclosed.

Short-term borrowings: The carrying values of short-term borrowings approximate their estimated fair values.

Long-term borrowings: The fair values of long-term borrowings are estimated by discounting scheduled future payments of principal and interest at current rates available on borrowings with similar terms.

Subordinated debentures owed to unconsolidated subsidiary trusts: The carrying values of subordinated debentures owed to unconsolidated subsidiary trusts approximate their estimated fair values.

Derivative financial instruments: The fair value of the interest rate swaps is valued using independent pricing models.

Off-balance sheet instruments: The fair values of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit standing of the counter parties. The amounts of fees currently charged on commitments and standby letters of credit are deemed insignificant and therefore, the estimated fair values and carrying values are not shown below.

The carrying values and estimated fair values of our financial instruments are summarized below:



	March 31, 2017				Fair Value Measurements Using:
Dollars in thousands	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents	$	58,221	$	58,221	$	—	$	58,221	$	—
Securities available for sale	282,028		282,028		—		282,028		—
Other investments	13,328		13,328		—		13,328		—
Loans held for sale, net	172		172		—		172		—
Loans, net	1,292,915		1,301,676		—		1,075		1,300,601
Accrued interest receivable	6,024		6,024		—		6,024		—
Derivative financial assets	257		257		—		257		—
	$	1,652,945	$	1,661,706	$	—	$	361,105	$	1,300,601
Financial liabilities
Deposits	$	1,301,241	$	1,315,973	$	—	$	1,315,973	$	—
Short-term borrowings	228,868		228,868		—		228,868		—
Long-term borrowings	46,215		48,128		—		48,128		—
Subordinated debentures owed to unconsolidated subsidiary trusts	19,589		19,589		—		19,589		—
Accrued interest payable	733		733		—		733		—
Derivative financial liabilities	3,823		3,823		—		3,823		—
	$	1,600,469	$	1,617,114	$	—	$	1,617,114	$	—



	December 31, 2016				Fair Value Measurements Using:
Dollars in thousands	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents	$	46,616	$	46,616	$	—	$	46,616	$	—
Securities available for sale	266,542		266,542		—		266,542		—
Other investments	12,942		12,942		—		12,942		—
Loans held for sale, net	176		176		—		176		—
Loans, net	1,307,862		1,321,235		—		1,075		1,320,160
Accrued interest receivable	6,167		6,167		—		6,167		—
Derivative financial assets	200		200		—		200		—
	$	1,640,505	$	1,653,878	$	—	$	333,718	$	1,320,160
Financial liabilities
Deposits	$	1,295,519	$	1,309,820	$	—	$	1,309,820	$	—
Short-term borrowings	224,461		224,461		—		224,461		—
Long-term borrowings	46,670		49,013		—		49,013		—
Subordinated debentures owed to unconsolidated subsidiary trusts	19,589		19,589		—		19,589		—
Accrued interest payable	736		736		—		736		—
Derivative financial liabilities	4,611		4,611		—		4,611		—
	$	1,591,586	$	1,608,230	$	—	$	1,608,230	$	—