(11) Fair Value Measurement

The Corporation uses a fair value hierarchy to measure fair value. The Corporation uses a fair value hierarchy to measure fair value. This hierarchy describes three levels of inputs that may be used to measure fair value. Level 1: Quoted prices for identical assets in active markets that are identifiable on the measurement date; Level 2: Significant other observable inputs, such as quoted prices for similar assets, 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 the Corporation’s own view about the assumptions that market participants would use in pricing an asset.

Debt securities: The fair values of securities available for sale are determined by 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 inputs). Additionally, at December 31, 2012, management used significant unobservable inputs to determine the fair value of one security (Level 3 inputs). These inputs include appraised values of the underlying collateral and estimated costs to sell the collateral. The value of the collateral has been discounted to represent the value in a distressed sale situation.

Equity securities: The Corporation’s equity securities are not actively traded in an open market. The fair values of these equity securities available for sale is determined by using market data inputs for similar securities that are observable (Level 2 inputs).

Impaired loans: The fair values of impaired loans are determined using the fair values of collateral for collateral dependent loans, or discounted cash flows. The Corporation uses independent appraisals, discounted cash flow models and other available data to estimate the fair value of collateral (Level 3 inputs).

Other real estate owned: The fair value of other real estate owned is determined using the fair value of collateral. The Corporation uses appraisals and other available data to estimate the fair value of collateral (Level 3 inputs). The appraised values are discounted to represent an estimated value in a distressed sale. Additionally, estimated costs to sell the property are used to further adjust the value.

Assets measured at fair value are summarized below.


	Fair Value Measurements at September 30, 2013 Using:
	(Level 1)		(Level 2)		(Level 3)
Assets:
Assets measured at fair value on a recurring basis:
U.S. Treasury securities and obligations of U.S. Government agencies	$	—	$	53,964	$	—
Obligations of states and political subdivisions		—		81,475		—
Mortgage-backed securities in government sponsored entities		—		64,484		—
Equity securities in financial institutions		—		433		—
Assets measured at fair value on a nonrecurring basis:
Impaired loans	$	—	$	—	$	16,066
Other real estate owned		—		—		158


	Fair Value Measurements at December 31, 2012 Using:
	(Level 1)		(Level 2)		(Level 3)
Assets:
Assets measured at fair value on a recurring basis:
U.S. Treasury securities and obligations of U.S. Government agencies	$	—	$	54,286	$	—
Obligations of states and political subdivisions		—		79,338		468
Mortgage-backed securities in government sponsored entities		—		69,435		—
Equity securities in financial institutions		—		434		—
Assets measured at fair value on a nonrecurring basis:
Impaired loans	$	—	$	—	$	22,084
Other real estate owned		—		—		471

The following table presents quantitative information about the Level 3 significant unobservable inputs for assets and liabilities measured at fair value on a nonrecurring basis at September 30, 2013.


	Quantitative Information about Level 3 Fair Value Measurements
September 30, 2013	Fair Value Estimate		Valuation Technique	Unobservable Input	Range
Impaired loans	$	16,066	Appraisal of collateral	Appraisal adjustments	10% - 30%
				Liquidation expense	0% - 10%
				Holding period	0 - 30 months
			Discounted cash flows	Discount rates	3.8% - 8.3%
Other real estate owned	$	158	Appraisal of collateral	Appraisal adjustments	10% - 30%
				Liquidation expense	0% - 10%

The following table presents quantitative information about the Level 3 significant unobservable inputs for assets and liabilities measured at fair value on a nonrecurring basis at December 31, 2012.


	Quantitative Information about Level 3 Fair Value Measurements
December 31, 2012	Fair Value Estimate		Valuation Technique	Unobservable Input	Range
Obligations of states and political subdivisions	$	468	Appraisal of collateral	Appraisal adjustments	20% - 30%
				Liquidation expense	8% - 12%
Impaired loans	$	22,084	Appraisal of collateral	Appraisal adjustments	10% - 30%
				Liquidation expense	0% - 10%
				Holding period	0 - 30 months
			Discounted cash flows	Discount rates	2% - 8.5%
Other real estate owned	$	471	Appraisal of collateral	Appraisal adjustments	10% - 30%
				Liquidation expense	0% - 10%

The following table presents the changes in the Level 3 fair-value category for the period ended September 30, 2013. The Corporation classifies financial instruments in Level 3 of the fair value hierarchy when there is reliance on at least one significant unobservable input to the valuation model. In addition to the unobservable inputs, the valuation models for Level 3 financial instruments typically also rely on a number of inputs that are readily observable, either directly or indirectly.


Securities available for sale
Beginning balance January 1, 2013	$	468
Settlements		(468	)

Ending balance September 30, 2013	$	—

The carrying amount and fair values of financial instruments are as follows.


September 30, 2013	Carrying Amount		Total Fair Value		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from financial institutions	$	50,093	$	50,093	$	50,093	$	—	$	—
Securities available for sale		200,356		200,356		—		200,356		—
Other securities		15,433		15,433		15,433		—		—
Loans, available for sale		4,891		4,891		4,891		—		—
Loans, net of allowance for loan losses		802,274		821,717		—		—		821,717
Bank owned life insurance		19,013		19,013		19,013		—		—
Accrued interest receivable		4,540		4,540		4,540		—		—
Mortgage servicing rights		454		454		—		—		454
Financial Liabilities:
Nonmaturing deposits		702,215		702,215		702,215		—		—
Time deposits		240,243		242,067		—		—		242,067
Federal Home Loan Bank advances		37,735		38,710		—		—		38,710
Securities sold under agreement to repurchase		20,810		20,810		20,810		—		—
Subordinated debentures		29,427		21,412		—		—		21,412
Accrued interest payable		159		159		159		—		—


December 31, 2012	Carrying Amount		Total Fair Value		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from financial institutions	$	46,131	$	46,131	$	46,131	$	—	$	—
Securities available for sale		203,961		203,961		—		203,493		468
Other securities		15,567		15,567		15,567		—		—
Loans, available for sale		1,873		1,873		1,873		—		—
Loans, net of allowance for loan losses		795,811		812,950		—		—		812,950
Bank owned life insurance		18,590		18,590		18,590		—		—
Accrued interest receivable		3,709		3,709		3,709		—		—
Mortgage servicing rights		308		308		—		—		308
Financial Liabilities:
Nonmaturing deposits		662,387		662,387		662,387		—		—
Time deposits		264,002		265,974		—		—		265,974
Federal Home Loan Bank advances		40,261		41,658		—		—		41,658
Securities sold under agreement to repurchase		23,219		23,219		23,219		—		—
Subordinated debentures		29,427		26,855		—		—		26,855
Accrued interest payable		185		185		185		—		—

Cash and due from financial institutions: The carrying amounts for cash and due from financial institutions approximate fair value because they have original maturities of less than 90 days and do not present unanticipated credit concerns.

Available-for-sale securities: The fair value of securities are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for specific securities. Instead, this method relies on the securities relationship to other benchmark quoted securities (Level 2 inputs). For equity securities, management uses market information related to the value of similar institutions to determine the fair value (Level 2 inputs). At December 31, 2012, management used significant unobservable inputs to determine the fair value of one security (Level 3 inputs). These inputs included appraised values of the underlying collateral and estimated costs to sell the collateral. The value of the collateral has been discounted to represent the value in a distressed sale situation.

Other securities: The carrying value of regulatory stock approximates fair value based on applicable redemption provisions.

Loans, available-for-sale: Loans held for sale are priced individually at market rates on the day that the loan is locked for commitment to an investor. Because the holding period of such loans is typically short, the carrying value generally approximates the fair value at the time the commitment is received. All loans in the held-for-sale account conform to Fannie Mae underwriting guidelines, with specific intent of the loan being purchased by an investor at the predetermined rate structure.

Loans, net of allowance for loan losses: Fair values for loans, other than impaired, are estimated for portfolios of loans with similar financial characteristics. The fair value of performing loans has been estimated by discounting expected future cash flows of the underlying portfolios. The discount rates used in these calculations are generally derived from the treasury yield curve and are calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate inherent in the loan. The estimated maturity is based on the Corporation’s historical experience with repayments for each loan classification. Changes in these significant unobservable inputs used in discounted cash flow analysis, such as the discount rate or prepayment speeds, could lead to changes in the underlying fair value.

Bank owned life insurance: The carrying value of bank owned life insurance approximates the fair value based on applicable redemption provisions.

Accrued interest receivable and payable and securities sold under agreements to repurchase: The carrying amounts for accrued interest receivable, accrued interest payable and securities sold under agreements to repurchase approximate fair value because they are generally received or paid in 90 days or less and do not present unanticipated credit concerns.

Deposits: The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings and NOW accounts, and money market accounts, is equal to the amount payable on demand.

The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the current market rates currently offered for deposits of similar remaining maturities.

The deposits’ fair value estimates do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible.

Federal Home Loan Bank advances: Rates available to the Corporation for borrowed funds with similar terms and remaining maturities are used to estimate the fair value of borrowed funds.

Subordinated debentures: The fair value of subordinated debentures is based on the discounted value of contractual cash flows of the underlying debt agreements. The discount rate is estimated using the current rate for the borrowing from the Federal Home Loan Bank (FHLB) with the most similar terms.

Mortgage servicing rights: Mortgage servicing rights are measured at the lower of amortized cost or fair value. Periodic impairment assessments are performed based on fair value estimates at the reporting date. The fair value of mortgage servicing rights are estimated based on a valuation model which calculates the present value of estimated future cash flows associated with servicing the underlying loans. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimated prepayment speeds, market discount rates and the cost to service each loan. The fair value measurements are classified as Level 3.