Note 8. Fair Value Measurements

ASC 825, “ Financial Instruments Available for Sale”, requires disclosure of the estimated fair value of an entity’s assets and liabilities considered to be financial instruments. For the Company, as for most financial institutions, the majority of its assets and liabilities are considered to be financial instruments. However, many such instruments lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. Accordingly, estimated fair values are determined by the Company using the best available data and an estimation methodology it believes to be suitable for each category of financial instruments. Also, it is the Company’s general practice and intent to hold its financial instruments to maturity whether or not categorized as “available-for-sale” and not to engage in trading or sales activities, except for the sale of commercial loans to secondary markets. For fair value disclosure purposes, the Company utilized certain value measurement criteria required under the ASC 820, “Fair Value Measurements and Disclosures”, and discussed below.

Estimated fair values have been determined by the Company using the best available data and an estimation methodology it believes to be suitable for each category of financial instruments. Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Also, there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values.

Cash and cash equivalents, which are comprised of cash and due from banks, the Company’s balance at the Federal Reserve Bank and securities purchased under agreements to resell, had recorded values of $398.9 million and $999.1 million as of September 30, 2017 and December 31, 2016, respectively, which approximated fair values.

The estimated fair values of investment securities are based on quoted market prices, if available, or estimated using a methodology based on management’s inputs. The fair values of the Company’s investment securities held-to-maturity and loans held for sale are based on using “unobservable inputs” that are the best information available in the circumstances. Level 3 investment securities fair values are based on the present value of cash flows, which discounts expected cash flows from principal and interest using yield to maturity at the measurement date.

FHLB and Atlantic Central Bankers Bank stock is held as required by those respective institutions and is carried at cost. Federal law requires a member institution of the FHLB to hold stock according to predetermined formulas. Atlantic Central Bankers Bank requires its correspondent banking institutions to hold stock as a condition of membership.

Commercial loans held for sale have estimated fair values based upon either market indications of the sales price of such loans from recent sales transactions or discounted cash flow analysis.

The net loan portfolio at September 30, 2017 and December 31, 2016 has been valued using the present value of discounted cash flow where market prices were not available. The discount rate used in these calculations is the estimated current market rate adjusted for credit risk. Accrued interest receivable has a carrying value that approximates fair value.

On December 30, 2014, the Bank entered into an agreement for, and closed on, the sale of a portion of its discontinued commercial loan portfolio. The purchaser of the loan portfolio was a newly formed entity, 2014-1 LLC (Walnut Street). The price paid to the Bank for the loan portfolio which had a face value of approximately $267.6 million, was approximately $209.6 million, of which approximately $193.6 million was in the form of two notes issued by Walnut Street to the Bank; a senior note in the principal amount of approximately $178.2 million bearing interest at 1.5% per year and maturing in December 2024 and a subordinate note in the principal amount of approximately $15.4 million, bearing interest at 10.0% per year and maturing in December 2024. The balance of these notes comprises the balance of the investment in unconsolidated entity. The fair value was established by the sales price and subsequently subjected to cash flow analysis. The change in value of investment in unconsolidated entity in the income statement includes interest paid and changes in estimated fair value.

Discontinued assets held for sale as of September 30, 2017 are held at the lower of cost basis or market value. For loans, market value was determined using the income approach which converts expected cash flows from the loan portfolio by unit of measurement to a present value estimate. Unit of measurement was determined by loan type and for significant loans on an individual loan basis. The fair values of the Company’s loans classified as assets held for sale are based on “unobservable inputs” that are the best information available in the circumstances. Level 3 fair values are based on the present value of cash flows by unit of measurement. For commercial loans, a market adjusted rate to discount expected cash flows from outstanding principal and interest to expected maturity at the measurement date was utilized. For other real estate owned, market value was based upon appraisals of the underlying collateral by third party appraisers, reduced by 7% to 10% for estimated selling costs.

The estimated fair values of demand deposits (comprising of interest and non-interest bearing checking accounts, savings accounts, and certain types of money market accounts) are equal to the amount payable on demand at the reporting date (generally, their carrying amounts). The fair values of securities sold under agreements to repurchase and short term borrowings are equal to their carrying amounts as they are short term borrowings.

Time deposits and subordinated debentures have a fair value estimated using a discounted cash flow calculation that applies current interest rates to discount expected cash flows. Based upon time deposit maturities at September 30, 2017, the carrying values approximate their fair values. The carrying amount of accrued interest payable approximates its fair value.

The fair values of interest rate swaps are determined using models that use readily observable market inputs and a market standard methodology applied to the contractual terms of the derivatives, including the period to maturity and interest rate indices.

The fair value of commitments to extend credit is estimated based on the amount of unamortized deferred loan commitment fees. The fair value of letters of credit is based on the amount of unearned fees plus the estimated cost to terminate the letters of credit. Fair values of unrecognized financial instruments, including commitments to extend credit, and the fair value of letters of credit are considered immaterial.

The following tables provide information regarding carrying amounts and estimated fair values (in thousands):



	September 30, 2017
			Quoted prices in	Significant other	Significant
			active markets for	observable	unobservable
	Carrying	Estimated	identical assets	inputs	inputs
	amount	fair value	(Level 1)	(Level 2)	(Level 3)
Investment securities available-for-sale	$ 1,196,956	$ 1,196,956	$ -	$ 1,153,403	$ 43,553
Investment securities held-to-maturity	86,402	85,099	-	78,756	6,343
Securities purchased under agreements to resell	65,095	65,095	65,095	-	-
Federal Home Loan Bank and Atlantic Central Bankers Bank stock	991	991	-	-	991
Commercial loans held for sale	380,272	380,272	-	-	380,272
Loans, net of deferred loan fees and costs	1,374,060	1,373,325	-	-	1,373,325
Investment in unconsolidated entity, senior note	103,950	103,950	-	-	103,950
Investment in unconsolidated entity, subordinated note	3,761	3,761	-	-	3,761
Assets held for sale	314,994	314,994	-	-	314,994
Demand and interest checking	3,113,212	3,113,212	3,113,212	-	-
Savings and money market	452,183	452,183	452,183	-	-
Subordinated debentures	13,401	9,873	-	-	9,873
Securities sold under agreements to repurchase	180	180	180	-	-
Interest rate swaps, asset	722	722	-	722	-



	December 31, 2016
			Quoted prices in	Significant other	Significant
			active markets for	observable	unobservable
	Carrying	Estimated	identical assets	inputs	inputs
	amount	fair value	(Level 1)	(Level 2)	(Level 3)
Investment securities available-for-sale	$ 1,248,614	$ 1,248,614	$ -	$ 1,248,614	$ -
Investment securities held-to-maturity	93,467	91,799	-	85,760	6,039
Securities purchased under agreements to resell	39,199	39,199	39,199	-	-
Federal Home Loan Bank and Atlantic Central Bankers Bank stock	1,613	1,613	-	-	1,613
Commercial loans held for sale	663,140	663,140	-	-	663,140
Loans, net of deferred loan fees and costs	1,222,911	1,219,625	-	-	1,219,625
Investment in unconsolidated entity, senior note	118,389	118,389	-	-	118,389
Investment in unconsolidated entity, subordinated note	8,541	8,541	-	-	8,541
Assets held for sale	360,711	360,711	-	-	360,711
Demand and interest checking	3,816,524	3,816,524	3,816,524	-	-
Savings and money market	421,780	421,780	421,780	-	-
Subordinated debentures	13,401	9,290	-	-	9,290
Securities sold under agreements to repurchase	274	274	274	-	-
Interest rate swaps, asset	3,207	3,207	-	3,207	-

The assets and liabilities measured at fair value on a recurring basis, segregated by fair value hierarchy, are summarized below (in thousands):



		Fair Value Measurements at Reporting Date Using
		Quoted prices in active	Significant other	Significant
		markets for identical	observable	unobservable
	Fair value	assets	inputs	inputs
	September 30, 2017	(Level 1)	(Level 2)	(Level 3)

Investment securities available-for-sale
U.S. Government agency securities	$ 35,225	$ -	$ 35,225	$ -
Asset-backed securities	264,939	-	264,939	-
Obligations of states and political subdivisions	86,432	-	86,432	-
Residential mortgage-backed securities	364,437	-	364,437	-
Collateralized mortgage obligation securities	129,093	-	129,093	-
Commercial mortgage-backed securities	153,648	-	110,095	43,553
Foreign debt securities	59,995	-	59,995	-
Corporate debt securities	103,187	-	103,187	-
Total investment securities available-for-sale	1,196,956	-	1,153,403	43,553
Loans held for sale	380,272	-	-	380,272
Investment in unconsolidated entity, senior note	103,950	-	-	103,950
Investment in unconsolidated entity, subordinated note	3,761	-	-	3,761
Interest rate swaps, asset	722	-	722	-
	$ 1,685,661	$ -	$ 1,154,125	$ 531,536



		Fair Value Measurements at Reporting Date Using
		Quoted prices in active	Significant other	Significant
		markets for identical	observable	unobservable
	Fair value	assets	inputs	inputs
	December 31, 2016	(Level 1)	(Level 2)	(Level 3)

Investment securities available-for-sale
U.S. Government agency securities	$ 27,702	$ -	$ 27,702	$ -
Asset-backed securities	355,396	-	355,396	-
Obligations of states and political subdivisions	94,533	-	94,533	-
Residential mortgage-backed securities	342,569	-	342,569	-
Collateralized mortgage obligation securities	159,823	-	159,823	-
Commercial mortgage-backed securities	117,086	-	117,086	-
Foreign debt securities	56,497	-	56,497	-
Corporate debt securities	95,008	-	95,008	-
Total investment securities available-for-sale	1,248,614	-	1,248,614	-
Loans held for sale	663,140	-	-	663,140
Investment in unconsolidated entity, senior note	118,389	-	-	118,389
Investment in unconsolidated entity, subordinated note	8,541	-	-	8,541
Interest rate swaps, asset	3,207	-	3,207	-
	$ 2,041,891	$ -	$ 1,251,821	$ 790,070

In addition, ASC 820, “Fair Value Measurements and Disclosures”, establishes a common definition for fair value to be applied to assets and liabilities. It clarifies that fair value is an exit price, representing the amount 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. It also establishes a framework for measuring fair value and expands disclosures concerning fair value measurements. ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Level 1 valuation is based on quoted market prices for identical assets or liabilities to which the Company has access at the measurement date. Level 2 valuation is based on other observable inputs for the asset or liability, either directly or indirectly. This includes quoted prices for similar assets in active or inactive markets, inputs other than quoted prices that are observable for the asset or liability such as yield curves, volatilities, prepayment speeds, credit risks, default rates, or inputs that are derived principally from, or corroborated through, observable market data by market-corroborated reports. Level 3 valuation is based on “unobservable inputs” which the Company believes is the best information available in the circumstances. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The changes in the Company’s Level 3 assets measured at fair value on a recurring basis, segregated by fair value hierarchy level, are summarized below (in thousands):



	Fair Value Measurements Using
	Significant Unobservable Inputs
	(Level 3)

	Available-for-sale		Commercial loans
	securities		held for sale
	September 30, 2017	December 31, 2016	September 30, 2017	December 31, 2016
Beginning balance	$ -	$ -	$ 663,140	$ 489,938
Transfers into level 3	-	-	-	-
Transfers out of level 3	-	-	-	-
Total gains or losses (realized/unrealized)
Included in earnings	-	-	20,019	(3,078)
Included in other comprehensive income	-	-	-	-
Purchases, issuances, and settlements
Purchases	43,553
Issuances	-	-	398,410	528,584
Sales	-	-	(701,297)	(352,304)
Settlements	-	-	-	-
Ending balance	$ 43,553	$ -	$ 380,272	$ 663,140

The amount of total gains or (losses) for the period
included in earnings attributable to the change in
unrealized gains or losses relating to assets still
held at the reporting date.	$ -	$ -	$ 703	$ (2,674)


	Fair Value Measurements Using
	Significant Unobservable Inputs
	(Level 3)

	Investment in			Assets
	unconsolidated entity			held for sale
		September 30, 2017	December 31, 2016	September 30, 2017	December 31, 2016
Beginning balance		$ 126,930	$ 178,520	$ 360,711	$ 583,909
Transfers into level 3		-	-	-	-
Transfers out of level 3		-	-	-	-
Total gains or losses (realized/unrealized)
Included in earnings		(20)	(39,816)	638	(48,836)
Included in other comprehensive income		-	-	-	-
Purchases, issuances, and settlements
Purchases		-	-	-	-
Issuances		-	-	-	-
Sales		-	-	-	(63,712)
Settlements		(19,199)	(11,774)	(33,400)	(110,650)
Charge-offs		-	-	(12,955)	-
Ending balance		$ 107,711	$ 126,930	$ 314,994	$ 360,711

The amount of total gains or (losses) for the period
included in earnings attributable to the change in
unrealized gains or losses relating to assets still
held at the reporting date.		$ (20)	$ (39,816)	$ (1,776)	$ (48,836)



	Fair value at	Fair value at
Level 3 instruments only	September 30, 2017	December 31, 2016	Valuation techniques	Unobservable inputs	Range

Investment securities available-for-sale	$ 43,553	$ -	Discounted cash flow	Discount rate	7.0%-9.5%
Investment securities held-to-maturity	6,343	6,039	Discounted cash flow	Discount rate	8.00%
Federal Home Loan Bank and Atlantic	991	1,613	Cost	N/A	N/A
Central Bankers Bank stock
Loans, net of deferred loan fees and costs	1,373,325	1,219,625	Discounted cash flow	Discount rate	3.5%-7.2%
Commercial loans held for sale	380,272	663,140	Discounted cash flow	Discount rate	4.85%-7.05%
Investment in unconsolidated entity,	103,950	118,389	Discounted cash flow	Discount rate	4.75%
senior note				Default rate	1.00%
Investment in unconsolidated entity,	3,761	8,541	Discounted cash flow	Discount rate	11.00%
subordinated note				Default rate	1.00%
Assets held for sale	314,994	360,711	Discounted cash flow	Discount rate	3.67%-9.32%
Subordinated debentures	9,873	9,290	Discounted cash flow	Discount rate	7.00%

Assets measured at fair value on a nonrecurring basis, segregated by fair value hierarchy, during the periods shown are summarized below (in thousands):



		Fair Value Measurements at Reporting Date Using
		Quoted prices in active	Significant other	Significant
		markets for identical	observable	unobservable
	Fair value	assets	inputs	inputs
Description (1)	September 30, 2017	(Level 1)	(Level 2)	(Level 3)

Impaired loans - collateral dependent	$ 4,011	$ -	$ -	$ 4,011
Other real estate owned	-	-	-	-
Intangible assets	5,185	-	-	5,185
	$ 9,196	$ -	$ -	$ 9,196



		Fair Value Measurements at Reporting Date Using
		Quoted prices in active	Significant other	Significant
		markets for identical	observable	unobservable
	Fair value	assets	inputs	inputs
Description (1)	December 31, 2016	(Level 1)	(Level 2)	(Level 3)

Impaired loans - collateral dependent	$ 3,685	$ -	$ -	3,685
Other real estate owned	104	-	-	104
Intangible assets	6,906	-	-	6,906
	$ 10,695	$ -	$ -	$ 10,695

(1)

The method of valuation approach for the impaired loans was the market value approach based upon appraisals of the underlying collateral by external appraisers, reduced by 7% to 10% for estimated selling costs. Intangible assets are valued based upon internal analyses.

At September 30, 2017, principal on impaired loans and troubled debt restructurings that is accounted for on the basis of the value of underlying collateral is shown at estimated fair value of $4.0 million. To arrive at that fair value, related loan principal of $5.8 million was reduced by specific reserves of $1.8 million within the allowance for loan losses as of that date, representing the deficiency between principal and estimated collateral values, which were reduced by costs to sell. When the deficiency is deemed uncollectible, it is charged off by reducing the specific reserve and decreasing principal. Included in the impaired balance at September 30, 2017 were seven troubled debt restructured loans with a balance of $1.8 million which had specific reserves of $534,000. Valuation techniques consistent with the market and/or cost approach were used to measure fair value and primarily included observable inputs for the individual impaired loans being evaluated such as recent sales of similar assets or observable market data for operational or carrying costs. In cases where such inputs were unobservable, the loan balance is reflected within the Level 3 hierarchy. The fair value of other real estate owned is based on an appraisal of the property using the market approach for valuation.