(4) Fair Value Measurement

Fair value measurement and disclosure guidance defines fair value as the price that would be received to sell the asset or transfer the liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. This guidance provides additional information on determining when the volume and level of activity for the asset or liability has significantly decreased. The guidance also includes information on identifying circumstances when a transaction may not be considered orderly.

Fair value measurement and disclosure guidance provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed and significant adjustments to the related prices may be necessary to estimate fair value in accordance with the fair value measurement and disclosure guidance.

This guidance clarifies that when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly. In those situations, the entity must evaluate the weight of the evidence to determine whether the transaction is orderly. The guidance provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value.

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. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own belief about the assumptions market participants would use in pricing the asset or liability based upon the best information available in the circumstances. Fair value measurement and disclosure guidance 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. An asset’s or liability’s placement in the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement or disclosure. The fair value hierarchy is as follows:

Level 1 Inputs - Unadjusted quoted prices in active markets that are accessible at the measurement date for

identical, unrestricted assets or liabilities;

Level 2 Inputs - Quoted prices in markets that are not active, or inputs that are observable either directly or

indirectly, for substantially the full term of the asset or liability;

Level 3 Inputs - Prices or valuation techniques that require inputs that are both significant to the fair value

measurement and unobservable (i.e., supported by little or no market activity).

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.

There were no transfers of assets between fair value Level 1 and Level 2 for the three months ended March 31, 2014. The following tables illustrate the assets measured at fair value on a recurring basis segregated by hierarchy fair value levels.



(Dollars in thousands)			Fair value measurements at March 31, 2014 using:
	Total carrying value at		Quoted prices in active markets		Significant other observable inputs		Significant unobservable inputs
Assets:	March 31, 2014		(Level 1)		(Level 2)		(Level 3)
U.S. Treasury and U.S. government agencies	$	12,571	$	-	$	12,571	$	-
Mortgage-backed U.S. government agencies		36,117		-		36,117		-
State and political subdivision obligations		71,170		-		71,170		-
Equity securities		1,551		521		1,030		-
	$	121,409	$	521	$	120,888	$	-



(Dollars in thousands)			Fair value measurements at December 31, 2013 using:
	Total carrying value at		Quoted prices in active markets		Significant other observable inputs		Significant unobservable inputs
Assets:	December 31, 2013		(Level 1)		(Level 2)		(Level 3)
U.S. Treasury and U.S. government agencies	$	12,834	$	-	$	12,834	$	-
Mortgage-backed U.S. government agencies		39,392		-		39,392		-
State and political subdivision obligations		69,038		-		69,038		-
Equity securities		1,539		519		1,020		-
	$	122,803	$	519	$	122,284	$	-

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis, but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

The following tables illustrate the assets measured at fair value on a nonrecurring basis segregated by hierarchy fair value levels.



(Dollars in thousands)			Fair value measurements at March 31, 2014 using:
	Total carrying value at		Quoted prices in active markets		Significant other observable inputs		Significant unobservable inputs
Assets:	March 31, 2014		(Level 1)		(Level 2)		(Level 3)
Impaired Loans	$	6,000	$	-	$	-	$	6,000
Foreclosed Assets Held for Sale		778		-		-		778
Mortgage Servicing Rights		226		-		-		226



(Dollars in thousands)			Fair value measurements at December 31, 2013 using:
	Total carrying value at		Quoted prices in active markets		Significant other observable inputs		Significant unobservable inputs
Assets:	December 31, 2013		(Level 1)		(Level 2)		(Level 3)
Impaired Loans	$	6,535	$	-	$	-	$	6,535
Foreclosed Assets Held for Sale		465		-		-		465
Mortgage Servicing Rights		223		-		-		223

The following tables present additional quantitative information about assets measured at fair value on a nonrecurring basis and for which Mid Penn has utilized Level 3 inputs to determine the fair value as of March 31, 2014 and December 31, 2013.



(Dollars in thousands)	Quantitative Information about Level 3 Fair Value Measurements
March 31, 2014	Fair Value Estimate		Valuation Technique	Unobservable Input	Range	Weighted Average
Impaired Loans	$	6,000	Appraisal of collateral (1)	Appraisal adjustments (2)	10% - 95%	28%
Foreclosed Assets Held for Sale		778	Appraisal of collateral (1), (3)	Appraisal adjustments (2)	15% - 40%	24%
Mortgage Servicing Rights		226	Multiple of annual service fee	Estimated prepayment speed based on rate and term	240% - 400%	352%


(Dollars in thousands)	Quantitative Information about Level 3 Fair Value Measurements
December 31, 2013	Fair Value Estimate		Valuation Technique	Unobservable Input	Range	Weighted Average
Impaired Loans	$	6,535	Appraisal of collateral (1)	Appraisal adjustments (2)	10% - 95%	25%
Foreclosed Assets Held for Sale		465	Appraisal of collateral (1), (3)	Appraisal adjustments (2)	15% - 40%	24%
Mortgage Servicing Rights		223	Multiple of annual service fee	Estimated prepayment speed based on rate and term	240% - 400%	349%

(1)

Fair value is generally determined through independent appraisals of the underlying collateral, which generally includes various level 3 inputs which are not observable.

(2)

Appraisals may be adjusted downward by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal. Higher downward adjustments are caused by negative changes to the collateral or conditions in the real estate market, actual offers or sales contracts received, or age of the appraisal.

(3)

Includes qualitative adjustments by management and estimated liquidation expenses.

The following methodologies and assumptions were used to estimate the fair value of Mid Penn’s financial instruments:

Cash and Cash Equivalents:

The carrying value of cash and cash equivalents is considered to be a reasonable estimate of fair value.

Interest-bearing Balances with other Financial Institutions:

The estimate of fair value was determined by comparing the present value of quoted interest rates on like deposits with the weighted average yield and weighted average maturity of the balances.

Securities Available for Sale:

The fair value of securities classified as available for sale is determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather relying on the securities’ relationship to other benchmark quoted prices.

Impaired Loans:

Mid Penn’s rating system assumes any loans classified as substandard and non-accrual to be impaired, and all of these loans are considered collateral dependent; therefore, all of Mid Penn’s impaired loans, whether reporting a specific allocation or not, are considered collateral dependent.

It is Mid Penn’s policy to obtain updated third party valuations on all impaired loans collateralized by real estate within 30 days of the credit being classified as substandard non-accrual. Prior to receipt of the updated real estate valuation Mid Penn will use any existing real estate valuation to determine any potential allowance issues; however no allowance recommendation will be made until which time Mid Penn is in receipt of the updated valuation.

In some instances Mid Penn is not holding real estate as collateral and is relying on business assets (personal property) for repayment. In these circumstances a collateral inspection is performed by Mid Penn personnel to determine an estimated value. The value is based on net book value, as provided by the financial statements, and discounted accordingly based on determinations made by management. Occasionally, Mid Penn will employ an outside service to provide a fair estimate of value based on auction sales or private sales. Management reviews the estimates of these third parties and discounts them accordingly based on management’s judgment, if deemed necessary. Mid Penn considers the estimates used in its impairment analysis to be Level 3 inputs.

Mid Penn actively monitors the values of collateral on impaired loans. This monitoring may require the modification of collateral values over time or changing circumstances by some factor, either positive or negative, from the original values. All collateral values will be assessed by management at least every 18 months for possible revaluation by an independent third party.

Mid Penn does not currently, or plan to in the future, use automated valuation methodologies as a method of valuing real estate collateral.

Loans:

For variable-rate loans that reprice frequently and which entail no significant changes in credit risk, carrying values approximated fair value. The fair value of other loans are estimated by calculating the present value of the cash flow difference between the current rate and the market rate, for the average maturity, discounted quarterly at the market rate.

Foreclosed Assets Held for Sale:

Certain assets included in foreclosed assets held for sale are carried at fair value and accordingly is presented as measured on a non-recurring basis. Values are estimated using Level 3 inputs, based on appraisals that consider the sales prices of property in the proximate vicinity.

Accrued Interest Receivable and Payable:

The carrying amount of accrued interest receivable and payable approximates their fair values.

Restricted Investment in Bank Stocks:

The carrying amount of required and restricted investment in correspondent bank stock approximates fair value, and considers the limited marketability of such securities.

Mortgage Servicing Rights:

The fair value of servicing rights is based on the present value of estimated future cash flows on pools of mortgages stratified by rate and maturity date.

Deposits:

The fair value for demand deposits (e.g., interest and noninterest checking, savings, and money market deposit accounts) is by definition, equal to the amount payable on demand at the reporting date (i.e. their carrying amounts). Fair value for fixed-rate certificates of deposit was estimated using a discounted cash flow calculation by combining all fixed-rate certificates into a pool with a weighted average yield and a weighted average maturity for the pool and comparing the pool with interest rates currently being offered on a similar maturity.

Short-term Borrowings:

Because of time to maturity, the estimated fair value of short-term borrowings approximates the book value.

Long-term Debt:

The estimated fair values of long-term debt were determined using discounted cash flow analysis, based on currently available borrowing rates for similar types of borrowing arrangements.

Commitments to Extend Credit and Letters of Credit:

The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account market interest rates, the remaining terms and present credit worthiness of the counterparties. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements.

The following table summarizes the carrying value and fair value of financial instruments at March 31, 2014 and December 31, 2013.



(Dollars in thousands)	March 31, 2014				December 31, 2013
	Carrying		Fair		Carrying		Fair
	Value		Value		Value		Value
Financial assets:
Cash and cash equivalents	$	14,030	$	14,030	$	8,623	$	8,623
Interest-bearing time balances with other financial institutions		5,323		5,323		7,513		7,513
Investment securities		121,409		121,409		122,803		122,803
Net loans and leases		543,316		547,776		540,145		548,923
Restricted investment in bank stocks		3,146		3,146		2,969		2,969
Accrued interest receivable		2,904		2,904		2,704		2,704
Mortgage servicing rights		226		226		223		223

Financial liabilities:
Deposits	$	606,675	$	608,611	$	608,130	$	610,419
Short-term borrowings		28,544		28,544		23,833		23,833
Long-term debt		23,100		23,244		23,145		22,988
Accrued interest payable		486		486		393		393

Off-balance sheet financial instruments:
Commitments to extend credit	$	-	$	-	$	-	$	-
Financial standby letters of credit		-		-		-		-

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of Mid Penn’s financial instruments as of March 31, 2014 and December 31, 2013. Carrying values approximate fair values for cash and cash equivalents, interest-bearing time balances with other financial institutions, restricted investment in bank stocks, mortgage servicing rights, accrued interest receivable and payable, and short-term borrowings. Other than cash and cash equivalents, which are considered Level 1 Inputs and mortgage servicing rights, which are Level 3 inputs, these instruments are Level 2 Inputs. These tables exclude financial instruments for which the carrying amount approximates fair value.



					Fair Value Measurements
					Quoted Prices
					in Active Markets				Significant
(Dollars in thousands)					for Identical Assets		Significant Other		Unobservable
	Carrying				or Liabilities		Observable Inputs		Inputs
March 31, 2014	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
Financial instruments - assets
Net loans and leases	$	543,316	$	547,776	$	-	$	-	$	547,776

Financial instruments - liabilities
Deposits	$	606,675	$	608,611	$	-	$	608,611	$	-
Long-term debt		23,100		23,244		-		23,244		-


					Fair Value Measurements
					Quoted Prices
					in Active Markets				Significant
(Dollars in thousands)					for Identical Assets		Significant Other		Unobservable
	Carrying				or Liabilities		Observable Inputs		Inputs
December 31, 2013	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
Financial instruments - assets
Net loans and leases	$	540,145	$	548,923	$	-	$	-	$	548,923

Financial instruments - liabilities
Deposits	$	608,130	$	610,419	$	-	$	610,419	$	-
Long-term debt		23,145		22,988		-		22,988		-