FAIR VALUE

Fair value is 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. Certain financial instruments and all non-financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity's own assumptions about market participant assumptions based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are:

Level 1 – quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access at the measurement date.

Level 2 – significant other observable inputs other than Level 1 prices such as prices for similar assets and liabilities in active markets; quoted prices for identical or similar instruments in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 – at least one significant unobservable input that reflects a company's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

In instances in which multiple levels of inputs are used to measure fair value, hierarchy classification is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

The Company used the following methods and significant assumptions to estimate fair value for instruments measured on a recurring basis:

Securities

Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, securities are classified within Level 2 and fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flow. Level 2 securities would include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. All of the Company’s securities are classified as available for sale.

The Company had no fair value liabilities measured on a recurring basis at September 30, 2017 and December 31, 2016. The following table summarizes assets measured at fair value on a recurring basis at September 30, 2017 and December 31, 2016.



(Dollars in Thousands)	Level 1		Level 2		Level 3		Total Fair Value Measurements
September 30, 2017
AFS Securities:
States and political subdivisions	$	0	$	158,260	$	0	$	158,260
GSE residential MBSs	0		51,552		0		51,552
GSE residential CMOs	0		113,899		0		113,899
Private label residential CMOs	0		2,398		0		2,398
Private label commercial CMOs	0		7,671		0		7,671
Asset-backed	0		87,566		0		87,566
Total debt securities	0		421,346		0		421,346
Equity securities	0		109		0		109
Total securities	$	0	$	421,455	$	0	$	421,455

December 31, 2016
AFS Securities:
U.S. Government Agencies	$	0	$	39,592	$	0	$	39,592
States and political subdivisions	0		164,282		0		164,282
GSE residential MBSs	0		116,944		0		116,944
GSE residential CMOs	0		69,383		0		69,383
GSE commercial CMOs	0		4,856		0		4,856
Private label residential CMOs	0		5,006		0		5,006
Total debt securities	0		400,063		0		400,063
Equity securities	0		91		0		91
Total securities	$	0	$	400,154	$	0	$	400,154

Certain financial assets are measured at fair value on a nonrecurring basis. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets. The Company used the following methods and significant assumptions to estimate fair value for these financial assets.

Impaired Loans

Loans are designated as impaired when, in the judgment of management and based on current information and events, it is probable that all amounts due, according to the contractual terms of the loan agreement, will not be collected. The measurement of loss associated with impaired loans for all loan classes can be based on either the observable market price of the loan, the fair value of the collateral, or discounted cash flows based on a market rate of interest for performing TDRs. For collateral-dependent loans, fair value is measured based on the value of the collateral securing the loan, less estimated costs to sell. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The value of the real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction, or if management adjusts the appraisal value, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal, if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3). Impaired loans with an allocation to the ALL are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of income. Specific allocations to the ALL or partial charge-offs totaled $1,439,000 and $1,967,000 at September 30, 2017 and December 31, 2016. The following table presents changes in the fair value for impaired loans still held at September 30, considered in the determination of the provision for loan losses, for the three and nine months ended September 30, 2017 and 2016.



	Three months ended September 30,				Nine months ended September 30,
(Dollars in thousands)	2017		2016		2017		2016

Changes in fair value of impaired loans still held	$	43	$	684	$	41	$	815

Foreclosed Real Estate

OREO property acquired through foreclosure is initially recorded at the fair value of the property at the transfer date less estimated selling cost. Subsequently, OREO is carried at the lower of its carrying value or the fair value less estimated selling cost. Fair value is usually determined based upon an independent third-party appraisal of the property or occasionally upon a recent sales offer. Specific charges to value OREO at the lower of cost or fair value on properties held at September 30, 2017 and December 31, 2016 totaled $0 and $43,000. The following table presents changes in the fair value of OREO for properties still held at September 30, charged to real estate expenses, for the three and nine months ended September 30, 2017 and 2016.



	Three months ended September 30,				Nine months ended September 30,
(Dollars in thousands)	2017		2016		2017		2016

Changes in fair value of OREO still held	$	0	$	42	$	0	$	109

The following table summarizes assets measured at fair value on a nonrecurring basis at September 30, 2017 and December 31, 2016.



(Dollars in thousands)	Level 1		Level 2		Level 3		Total Fair Value Measurements
September 30, 2017
Impaired Loans
Commercial real estate:
Owner-occupied	$	0	$	0	$	474	$	474
Multi-family	0		0		173		173
Non-owner occupied residential	0		0		363		363
Commercial and industrial	0		0		59		59
Residential mortgage:
First lien	0		0		1,619		1,619
Home equity - lines of credit	0		0		164		164
Installment and other loans	0		0		5		5
Total impaired loans	$	0	$	0	$	2,857	$	2,857

December 31, 2016
Impaired Loans
Commercial real estate:
Owner-occupied	$	0	$	0	$	777	$	777
Non-owner occupied	0		0		736		736
Multi-family	0		0		199		199
Non-owner occupied residential	0		0		409		409
Acquisition and development:
Commercial and land development	0		0		1		1
Commercial and industrial	0		0		66		66
Residential mortgage:
First lien	0		0		1,994		1,994
Home equity - lines of credit	0		0		162		162
Installment and other loans	0		0		6		6
Total impaired loans	$	0	$	0	$	4,350	$	4,350

Foreclosed real estate
Residential	$	0	$	0	$	88	$	88

The following table presents additional qualitative information about assets measured on a nonrecurring basis and for which the Company has utilized Level 3 inputs to determine fair value.



(Dollars in thousands)	Fair Value Estimate		Valuation Techniques	Unobservable Input	Range
September 30, 2017
Impaired loans	$	2,857	Appraisal of collateral	Management adjustments on appraisals for property type and recent activity	10% - 75% discount
				- Management adjustments for liquidation expenses	0% - 20% discount
December 31, 2016
Impaired loans	$	4,350	Appraisal of collateral	Management adjustments on appraisals for property type and recent activity	10% - 75% discount
				- Management adjustments for liquidation expenses	0% - 41% discount
Foreclosed real estate	88		Appraisal of collateral	Management adjustments on appraisals for property type and recent activity	13% - 17% discount
				- Management adjustments for liquidation expenses	10% - 18% discount

Fair values of financial instruments

In addition to those disclosed above, the Company used the following methods and significant assumptions to estimate fair value for the indicated instruments:

Cash and Due from Banks and Interest-Bearing Deposits with Banks

The carrying amounts of cash and due from banks and interest-bearing deposits with banks approximate fair value.

Loans Held for Sale

LHFS are carried at the lower of cost or fair value. These loans typically consist of one-to-four family residential loans originated for sale into the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale.

Loans

For variable rate loans that reprice frequently and have no significant change in credit risk, fair value is based on carrying value. Fair value for fixed rate loans is estimated using discounted cash flow analyses, using interest rates currently being offered in the market for loans with similar terms to borrowers of similar credit quality.

Restricted Investment in Bank Stock

These investments are carried at cost. The Company is required to maintain minimum investment balances in these stocks, which are not actively traded and therefore have no readily determinable market value.

Deposits

The fair value disclosed for demand deposits is, by definition, equal to the amount payable on demand at the reporting date (that is, the carrying amount). The carrying amount of variable rate, fixed-term money market accounts and certificates of deposit approximates fair value at the reporting date. Fair value for fixed rate certificates of deposits and Individual Retirement Accounts are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market to a schedule of aggregated expected maturities on time deposits.

Short-Term Borrowings

The carrying amounts of federal funds purchased, borrowings under Repurchase Agreements, and other short-term borrowings maturing within 90 days approximate their fair values. Fair values of other short-term borrowings are estimated using discounted cash flow analysis based on the Company’s current borrowing rates for similar types of borrowing arrangements.

Long-Term Debt

Fair value of the Company’s fixed rate long-term borrowings is estimated using a discounted cash flow analysis based on the Company’s current incremental borrowing rate for similar types of borrowing arrangements. The carrying amounts of variable rate long-term borrowings approximates fair value at the reporting date.

Accrued Interest

The carrying amounts of accrued interest receivable and payable approximate fair value.

Off-Balance-Sheet Instruments

The Company generally does not charge commitment fees. Fees for standby letters of credit and other off-balance sheet instruments are not significant.

The following table presents estimated fair values of the Company’s financial instruments at September 30, 2017 and December 31, 2016:



(Dollars in thousands)	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
September 30, 2017
Financial Assets
Cash and due from banks	$	18,296	$	18,296	$	18,296	$	0	$	0
Interest-bearing deposits with banks	4,178		4,178		4,178		0		0
Restricted investments in bank stocks	9,469		n/a		n/a		n/a		n/a
AFS securities	421,455		421,455		0		421,455		0
Loans held for sale	8,217		8,463		0		8,463		0
Loans, net of allowance for loan losses	968,449		968,428		0		0		968,428
Accrued interest receivable	4,252		4,252		0		1,858		2,394
Financial Liabilities
Deposits	1,216,727		1,213,148		0		1,213,148		0
Short-term borrowings	91,571		91,571		0		91,571		0
Long-term debt	63,903		64,369		0		64,369		0
Accrued interest payable	462		462		0		462		0
Off-balance sheet instruments	0		0		0		0		0
December 31, 2016
Financial Assets
Cash and due from banks	$	16,072	$	16,072	$	16,072	$	0	$	0
Interest-bearing deposits with banks	14,201		14,201		14,201		0		0
Restricted investments in bank stocks	7,970		n/a		n/a		n/a		n/a
AFS securities	400,154		400,154		0		400,154		0
Loans held for sale	2,768		2,843		0		2,843		0
Loans, net of allowance for loan losses	870,616		870,470		0		0		870,470
Accrued interest receivable	4,672		4,672		0		2,643		2,029
Financial Liabilities
Deposits	1,152,452		1,149,727		0		1,149,727		0
Short-term borrowings	87,864		87,864		0		87,864		0
Long-term debt	24,163		24,966		0		24,966		0
Accrued interest payable	437		437		0		437		0
Off-balance sheet instruments	0		0		0		0		0