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. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs. There is a hierarchy of three levels of inputs that may be used to measure fair value:



Level 1	Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.



Level 2	Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities which use observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in active markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.



Level 3	Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Following is a description of the inputs and valuation methodologies used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.

Available-for-Sale Securities. The fair value of available-for-sale securities is determined by various valuation methodologies. Where quoted market prices are available in an active market, securities are classified within Level 1. If quoted market prices are not available, then fair values are estimated by using quoted prices of securities with similar characteristics or independent asset pricing services and pricing models, the inputs of which are market-based or independently sources market parameters, including but not limited to, yield curves, interest rates, volatilities, prepayments, defaults, cumulative loss projections and cash flows. Such securities are classified in Level 2 of the valuation hierarchy. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.

The following table presents the Company’s assets that are measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall as of December 31, 2019 and 2018 (in thousands):



			Fair Value Measurements Using:
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2019
Available-for-sale securities:
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	107,320	$	—	$	107,320	$	—
Obligations of states and political subdivisions	178,433		—		177,460		973
Mortgage-backed securities	396,126		—		396,126		—
Other securities	4,169		219		3,950		—
Total available-for-sale securities	$	686,048	$	219	$	684,856	$	973
December 31, 2018
Available-for-sale securities:
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	198,649	$	—	$	198,649	$	—
Obligations of states and political subdivisions	192,579		—		191,612		967
Mortgage-backed securities	298,672		—		298,672		—
Other securities	2,374		364		2,010		—
Total available-for-sale securities	$	692,274	$	364	$	690,943	$	967

The change in fair value of assets measured on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2019 and 2018 is summarized as follows (in thousands):



	Obligations of State and Political Subdivisions				Trust Preferred Securities
	December 31, 2019		December 31, 2018		December 31, 2019		December 31, 2018
Beginning balance	$	967	$	—	$	—	$	2,548
Transfers into Level 3	—		967		—		—
Transfers out of Level 3	—		—		—		—
Total gains or losses
Included in net income	6		—		—		—
Included in other comprehensive income (loss)	—		—		—		18
Purchases, issuances, sales and settlements
Purchases	—		—		—		—
Issuances	—		—		—		—
Sales	—		—		—		(2,522		)
Settlements	—		—		—		(44		)
Ending balance	$	973	$	967	$	—	$	—
Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets and liabilities still held at the reporting date	$	—	$	—	$	—	$	—

Following is a description of the valuation methodologies used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.

Impaired Loans (Collateral Dependent)

Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment and estimating fair value include using the fair value of the collateral for collateral dependent loans.

If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value. Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.

Management establishes a specific allowance for loans that have an estimated fair value that is below the carrying value. The total carrying amount of loans for which a change in specific allowance has occurred as of December 31, 2019 was $13,775,000 and a fair value of $12,727,000 resulting in specific loss exposures of $1,047,600. As of December 31, 2018, the total carrying amount of loans for which a change specific allowance has occurred was $19,481,000. These loans had a fair value of $16,437,000 which resulted in specific loss exposures of $3,044,000.

When there is little prospect of collecting principal or interest, loans, or portions of loans, may be charged-off to the allowance for loan losses. Losses are recognized in the period an obligation becomes uncollectible. The recognition of a loss does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the loan even though partial recovery may be affected in the future.

Foreclosed Assets Held For Sale

Other real estate owned acquired through loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the allowance for loan losses. Due to the subjective nature of establishing the fair value when the asset is acquired, the actual fair value of the other real estate owned or foreclosed asset could differ from the original estimate. If it is determined that fair value declines subsequent to foreclosure, a valuation allowance is recorded through noninterest expense. Operating costs associated with the assets after acquisition are also recorded as noninterest expense. Gains and losses on the disposition of other real estate owned and foreclosed assets are netted and posted to other noninterest expense. The total carrying amount of other real estate owned as of December 31, 2019 was $3,644,000. Other real estate owned included in the total carrying amount and measured at fair value on a nonrecurring basis during the period amounted to $935,000. The total carrying amount of other real estate owned as of December 31, 2018 was $2,534,000. Other real estate owned included in the total carrying amount and measured at fair value on a nonrecurring basis during the period amounted to $836,000.

Mortgage Servicing Rights

As of December 31, 2019, mortgage servicing rights had a carrying value of $1,690,000 and a fair value of $1,444,000 resulting in a valuation reserve of $245,000. The fair value used to determine the valuation reserve for mortgage servicing rights was estimated using the discounted cash flow models. Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the fair value hierarchy.

The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at December 31, 2019 and 2018 (in thousands):



	Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2019
Impaired loans (collateral dependent)	$	12,727	$	—	$	—	$	12,727
Foreclosed assets held for sale	935		—		—		935
Mortgage servicing rights	1,444,000		—		—		1,444
December 31, 2018
Impaired loans (collateral dependent)	$	16,437	$	—	$	—	$	16,437
Foreclosed assets held for sale	836		—		—		836

Sensitivity of Significant Unobservable Inputs

The following table presents quantitative information about unobservable inputs used in Level 3 fair value measurements other than goodwill at December 31, 2019.



	Fair Value (in thousands)	Valuation Technique	Unobservable Inputs	Range (Weighted Average)
Impaired loans (collateral dependent)	12,727	Third party valuations	Discount to reflect realizable value	0	%	-	40%		(	20	%	)
Foreclosed assets held for sale	935	Third party valuations	Discount to reflect realizable value less estimated selling costs	0	%	-	40%		(	35	%	)
Mortgage servicing rights	1,444	Third party valuations	Discounts to reflect realizable value	9.50	%	-	12.50	%	(	9.7	%	)

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements other than goodwill at December 31, 2018.



	Fair Value (in thousands)		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
Impaired loans (collateral dependent)	16,437		Third party valuations	Discount to reflect realizable value	0%	-	40%	(	20%	)
Foreclosed assets held for sale	$	836	Third party valuations	Discount to reflect realizable value less estimated selling costs	0%	-	40%	(	35%	)

The following tables present estimated fair values of the Company’s financial instruments at December 31, 2019 and 2018 in accordance with FAS 107-1 and APB 28-1, codified with ASC 820 (in thousands):



	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
December 31, 2019
Financial Assets
Cash and due from banks	$	84,154	$	84,154	$	84,154	$	—	$	—
Federal funds sold	926		926		926		—		—
Certificates of deposit investments	4,625		4,625		—		4,625		—
Available-for-sale securities	686,048		686,048		219		684,856		973
Held-to-maturity securities	69,542		69,572		—		69,572		—
Loans held for sale	1,820		1,820		—		1,820		—
Loans net of allowance for loan losses	2,666,616		2,622,053		—		—		2,622,053
Interest receivable	15,577		15,577		—		15,577		—
Federal Reserve Bank stock	9,401		9,401		—		9,401		—
Federal Home Loan Bank stock	4,105		4,105		—		4,105		—
Financial Liabilities
Deposits	2,917,336		2,924,144		—		2,332,866		591,278
Securities sold under agreements to repurchase	208,109		208,016		—		208,016		—
Interest payable	2,261		2,261		—		2,261		—
Federal Home Loan Bank borrowings	113,895		114,510		—		114,510		—
Other borrowings	5,000		5,000		5,000		—		—
Junior subordinated debentures	18,858		15,596		—		15,596		—



December 31, 2018
Financial Assets
Cash and due from banks	$	140,735	$	140,735	$	140,735	$	—	$	—
Federal funds sold	665		665		665		—		—
Certificates of deposit investments	7,569		7,569		—		7,569		—
Available-for-sale securities	692,274		692,274		364		690,943		967
Held-to-maturity securities	69,436		67,909		—		67,909		—
Loans held for sale	1,508		1,508		—		1,508		—
Loans net of allowance for loan losses	2,616,822		2,541,037		—		—		2,541,037
Interest receivable	16,881		16,881		—		16,881		—
Federal Reserve Bank stock	7,390		7,390		—		7,390		—
Federal Home Loan Bank stock	3,095		3,095		—		3,095		—
Financial Liabilities
Deposits	2,988,686		2,991,177		—		2,396,917		594,260
Securities sold under agreements to repurchase	192,330		192,179		—		192,179		—
Interest payable	1,758		1,758		—		1,758		—
Federal Home Loan Bank borrowings	119,745		119,704		—		119,704		—
Other borrowings	7,724		7,724		—		7,724		—
Junior subordinated debentures	29,000		24,418		—		24,418		—