14. FAIR VALUE

FASB ASC No. 820-10 defines fair value as 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. FASB ASC 820-10 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair values:

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.

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below:

				Fair Value Measurements at
				December 31, 2014 Using:
	Carrying Value			Quoted Prices In Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
(In thousands)
Financial Assets:
Available for sale securities
U.S. GSE securities	$	95,425			$	95,425
State and municipal obligations	63,693				63,693
U.S. GSE Residential mortgage-backed securities	101,425				101,425
U.S. GSE Residential collateralized mortgage Obligations	258,599				258,599
U.S. GSE Commercial mortgage-backed securities	2,945				2,945
U.S. GSE Commercial collateralized mortgage Obligations	24,082				24,082
Other Asset-backed securities	23,037				23,037
Corporate Bonds	17,978				17,978
Total available for sale	$	587,184			$	587,184

Financial Liabilities:
Derivatives	$	(943	)		$	(943	)

			Fair Value Measurements at
			December 31, 2013 Using:

	Carrying Value			Quoted Prices In Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
(In thousands)
Financial Assets:
Available for sale securities
U.S. GSE securities	$	152,757			$	152,757
State and municipal obligations	61,656				61,656
U.S. GSE Residential mortgage-backed securities	14,435				14,435
U.S. GSE Residential collateralized mortgage Obligations	279,191				279,191
U.S. GSE Commercial mortgage-backed securities	2,834				2,834
U.S. GSE Commercial collateralized mortgage Obligations	26,910				26,910
Non Agency commercial mortgage-backed securities	3,578				3,578
Other Asset backed securities	33,818				33,818
Total available for sale	$	575,179			$	575,179

Financial Liabilities:
Derivatives	$	(164	)		$	(164	)

Assets measured at fair value on a non-recurring basis are summarized below:

			Fair Value Measurements at
			December 31, 2014 Using:

	Carrying Value			Quoted Prices In Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
(In thousands)
Impaired loans	$	558				$	558

			Fair Value Measurements at
			December 31, 2013 Using:

	Carrying Value			Quoted Prices In Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
(In thousands)
Impaired loans	$	1,329				$	1,329
Other real estate owned	2,242					2,242

Impaired loans with allocated allowance for loan losses at December 31, 2014, had a carrying amount of $0.5 million, which is made up of the outstanding balance of $0.7 million, net of a valuation allowance of $0.2 million. This resulted in an additional provision for loan losses of $0.2 million that is included in the amount reported on the income statement. Impaired loans with allocated allowance for loan losses at December 31, 2013, had a carrying amount of $1.3 million, which is made up of the outstanding balance of $1.5 million, net of a valuation allowance of $0.2 million. This resulted in an additional provision for loan losses of $0.2 million that is included in the amount reported on the Consolidated Statements of Income.

There was no Other Real Estate Owned at December 31, 2014. Other real estate owned at December 31, 2013 had a carrying amount of $2.2 million and no valuation allowance recorded. Accordingly, there was no additional provision for loan losses included in the amount reported on the Consolidated Statements of Income.

The Company used the following method and assumptions in estimating the fair value of its financial instruments:

Cash and Due from Banks and Federal Funds Sold: Carrying amounts approximate fair value, since these instruments are either payable on demand or have short-term maturities. Cash on hand and non-interest due from bank accounts are Level 1 and interest bearing Cash Due from Banks and Federal Funds Sold are Level 2.

Securities Available for Sale and Held to Maturity: The estimated fair values are based on independent dealer quotations on nationally recognized securities exchanges, if available (Level 1). For securities where quoted prices are not available, fair value is based on matrix pricing, which is a mathematical technique widely used in the industry 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).

Restricted Securities: It is not practicable to determine the fair value of FHLB, ACBB and FRB stock due to restrictions placed on its transferability.

Derivatives: Represents an interest rate swap and the estimated fair values are based on valuation models using observable market data as of measurement date (Level 2).

Loans: The estimated fair values of real estate mortgage loans and other loans receivable are based on discounted cash flow calculations that use available market benchmarks when establishing discount factors for the types of loans resulting in a Level 3 classification. Exceptions may be made for adjustable rate loans (with resets of one year or less), which would be discounted straight to their rate index plus or minus an appropriate spread. All nonaccrual loans are carried at their current fair value. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price and therefore, while permissible for presentation purposed under ASC 825-10, do not conform to ASC 820-10.

Impaired Loans: For impaired loans, the Company evaluates the fair value of the loan in accordance with current accounting guidance. For loans that are collateral dependent, the fair value of the collateral is used to determine the fair value of the loan. The fair value of the collateral is determined based upon recent appraised values. The fair value of other real estate owned is also evaluated in accordance with current accounting guidance and determined based upon recent appraised values. 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 independent appraisers to adjust for differences between the comparable sales and income data available. Adjustments may relate to location, square footage, condition, amenities, market rate of leases as well as timing of comparable sales. All appraisals undergo a second review process to insure that the methodology employed and the values derived are accurate. The fair value of the loan is compared to the carrying value to determine if any write-down or specific reserve is required. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Appraisals for collateral-dependent impaired loans are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, the Credit Administration department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. On a quarterly basis, the Company compares the actual selling price of collateral that has been sold to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value. Management also considers the appraisal values for commercial properties associated with current loan origination activity. Collectively, this information is reviewed to help assess current trends in commercial property values. For each collateral dependent impaired loan, management considers information that relates to the type of commercial property to determine if such properties may have appreciated or depreciated in value since the date of the most recent appraisal. Adjustments to fair value are made only when the analysis indicates a probable decline in collateral values. Adjustments made in the appraisal process are not deemed material to the overall financial statements given the level of impaired loans measured at fair value on a nonrecurring basis.

Deposits: The estimated fair value of certificates of deposits are based on discounted cash flow calculations that use a replacement cost of funds approach to establishing discount rates for certificates of deposits maturities resulting in a Level 2 classification. Stated value is fair value for all other deposits resulting in a Level 1 classification.

Borrowed Funds: The estimated fair value of borrowed funds are based on discounted cash flow calculations that use a replacement cost of funds approach to establishing discount rates for funding maturities resulting in a Level 2 classification.

Junior Subordinated Debentures: The estimated fair value is based on estimates using market data for similarly risk weighted items and takes into consideration the convertible features of the debentures into common stock of the Company which is an unobservable input resulting in a Level 3 classification.

Accrued Interest Receivable and Payable: For these short-term instruments, the carrying amount is a reasonable estimate of the fair value resulting in a Level 1 or 2 classification.

Off-Balance-Sheet Liabilities: The fair value of off-balance-sheet commitments to extend credit is estimated using fees currently charged to enter into similar agreements. The fair value is immaterial as of December 31, 2014 and December 31, 2013.

Fair value estimates are made at specific points in time and are based on existing on-and off-balance sheet financial instruments. Such estimates are generally subjective in nature and dependent upon a number of significant assumptions associated with each financial instrument or group of financial instruments, including estimates of discount rates, risks associated with specific financial instruments, estimates of future cash flows, and relevant available market information. Changes in assumptions could significantly affect the estimates. In addition, fair value estimates do not reflect the value of anticipated future business, premiums or discounts that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument, or the tax consequences of realizing gains or losses on the sale of financial instruments.

The estimated fair values and recorded carrying values of the Company’s financial instruments are as follows:

			Fair Value Measurement at
			December 31, 2014 Using:

(In thousands)	Carrying Amount			Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Financial Assets:
Cash and due from banks	$	45,109		$	45,109	$	—	$	—	$	45,109

Interest bearing deposits with banks	6,621			—		6,621		—		6,621
Securities available for sale	587,184			—		587,184		—		587,184
Securities restricted	10,037			n/a		n/a		n/a		n/a
Securities held to maturity	214,927			—		216,289		—		216,289
Loans, net	1,320,690			—		—		1,317,625		1,317,625
Accrued interest receivable	6,425			—		2,721		3,704		6,425

Financial Liabilities:
Certificates of deposit	141,362			—		142,264		—		142,264
Demand and other deposits	1,692,417			1,692,417		—		—		1,692,417
Federal funds purchased	75,000			75,000		—		—		75,000
Federal Home Loan Bank advances	138,327			98,070		40,165		—		138,235
Repurchase agreements	36,263			—		36,991		—		36,991
Junior Subordinated Debentures	16,002			—		—		16,528		16,528
Derivatives	943			—		943		—		943
Accrued interest payable	308			77		231		—		308

			Fair Value Measurement at
			December 31, 2013 Using:

(In thousands)	Carrying Amount			Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Financial Assets:
Cash and due from banks	$	39,997		$	39,997	$	—	$	—	$	39,997

Interest bearing deposits with banks	5,576			—		5,576		—		5,576
Securities available for sale	575,179			—		575,179		—		575,179
Securities restricted	7,034			n/a		n/a		n/a		n/a
Securities held to maturity	201,328			—		197,338		—		197,338
Loans, net	997,262			—		—		1,002,314		1,002,314
Accrued interest receivable	5,648			—		2,747		2,901		5,648

Financial Liabilities:
Certificates of deposit	100,895			—		101,509		—		101,509
Demand and other deposits	1,438,184			1,438,184		—		—		1,438,184
Federal funds purchased	64,000			64,000		—		—		64,000
Federal Home Loan Bank advances	98,000			57,994		40,060		—		98,054
Repurchase agreements	11,370			—		11,803		—		11,803
Junior Subordinated Debentures	16,002			—		—		15,215		15,215
Derivatives	164			—		164		—		164
Accrued interest payable	225			76		149		—		225