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 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 include U.S. agency securities, mortgage-backed 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, 2018 and December 31, 2017.

The following table summarizes assets measured at fair value on a recurring basis at September 30, 2018 and December 31, 2017.



(Dollars in Thousands)	Level 1		Level 2		Level 3		Total Fair Value Measurements
September 30, 2018
AFS Securities:
States and political subdivisions	$	0	$	159,420	$	0	$	159,420
GSE residential CMOs	0		108,654		0		108,654
Private label residential CMOs	0		312		0		312
Private label commercial CMOs	0		61,210		0		61,210
Asset-backed and other	0		159,760		0		159,760
Totals	$	0	$	489,356	$	0	$	489,356

December 31, 2017
AFS Securities:
States and political subdivisions	$	0	$	159,458	$	0	$	159,458
GSE residential MBSs	0		49,530		0		49,530
GSE residential CMOs	0		111,119		0		111,119
Private label residential CMOs	0		1,003		0		1,003
Private label commercial CMOs	0		7,653		0		7,653
Asset-backed and other	0		86,545		0		86,545
Totals	$	0	$	415,308	$	0	$	415,308

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 $929,000 and $2,266,000 at September 30, 2018 and December 31, 2017.

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, 2018 and 2017.



	Three months ended September 30,				Nine months ended September 30,
(Dollars in thousands)	2018		2017		2018		2017
Changes in fair value of impaired loans still held	$	63	$	43	$	147	$	41

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, 2018 and December 31, 2017 totaled $11,000 and $0. The following table summarizes 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, 2018 and 2017.



	Three months ended September 30,				Nine months ended September 30,
(Dollars in thousands)	2018		2017		2018		2017
Changes in fair value of OREO still held	$	11	$	0	$	11	$	0

The following table summarizes assets measured at fair value on a nonrecurring basis at September 30, 2018 and December 31, 2017.



(Dollars in thousands)	Level 1		Level 2		Level 3		Total Fair Value Measurements
September 30, 2018
Impaired Loans
Commercial real estate:
Owner occupied	$	0	$	0	$	1,136	$	1,136
Multi-family	0		0		139		139
Non-owner occupied residential	0		0		297		297
Commercial and industrial	0		0		40		40
Residential mortgage:
First lien	0		0		1,239		1,239
Home equity - lines of credit	0		0		415		415
Total impaired loans	$	0	$	0	$	3,266	$	3,266

December 31, 2017
Impaired Loans
Commercial real estate:
Owner occupied	$	0	$	0	$	430	$	430
Non-owner occupied	0		0		4,066		4,066
Multi-family	0		0		165		165
Non-owner occupied residential	0		0		344		344
Commercial and industrial	0		0		53		53
Residential mortgage:
First lien	0		0		1,951		1,951
Home equity - lines of credit	0		0		161		161
Installment and other loans	0		0		3		3
Total impaired loans	$	0	$	0	$	7,173	$	7,173

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, 2018
Impaired loans	$	3,266	Appraisal of collateral	Management adjustments on appraisals for property type and recent activity	5% - 75% discount
				- Management adjustments for liquidation expenses	6% - 20% discount
December 31, 2017
Impaired loans	$	7,173	Appraisal of collateral	Management adjustments on appraisals for property type and recent activity	7% - 75% discount
				- Management adjustments for liquidation expenses	0% - 20% discount

Fair values of financial instruments

The following table presents carrying amounts and estimated fair values of the Company’s financial instruments at September 30, 2018 and December 31, 2017:



(Dollars in thousands)	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
September 30, 2018
Financial Assets
Cash and due from banks	$	21,892	$	21,892	$	21,892	$	0	$	0
Interest-bearing deposits with banks	19,125		19,125		19,125		0		0
Restricted investments in bank stocks	9,337		n/a		n/a		n/a		n/a
Securities available for sale	489,356		489,356		0		489,356		0
Loans held for sale	4,765		4,883		0		4,883		0
Loans, net of allowance for loan losses	1,071,129		1,059,620		0		0		1,059,620
Accrued interest receivable	5,393		5,393		0		2,480		2,913
Financial Liabilities
Deposits	1,429,170		1,426,373		0		1,426,373		0
Short-term borrowings	45,353		45,353		0		45,353		0
Long-term debt	83,543		82,790		0		82,790		0
Accrued interest payable	588		588		0		588		0
Off-balance sheet instruments	0		0		0		0		0

December 31, 2017
Financial Assets
Cash and due from banks	$	21,734	$	21,734	$	21,734	$	0	$	0
Interest-bearing deposits with banks	8,073		8,073		8,073		0		0
Restricted investments in bank stocks	9,997		n/a		n/a		n/a		n/a
Securities available for sale	415,308		415,308		0		415,308		0
Loans held for sale	6,089		6,272		0		6,272		0
Loans, net of allowance for loan losses	997,216		994,617		0		0		994,617
Accrued interest receivable	5,048		5,048		0		2,580		2,468
Financial Liabilities
Deposits	1,219,515		1,213,288		0		1,213,288		0
Short-term borrowings	93,576		93,576		0		93,576		0
Long-term debt	83,815		83,949		0		83,949		0
Accrued interest payable	495		495		0		495		0
Off-balance sheet instruments	0		0		0		0		0

The methods utilized to estimate the fair value of financial instruments at December 31, 2017 did not necessarily represent an exit price. In accordance with our adoption of ASU 2016-01 in 2018, the methods utilized to measure the fair value of financial instruments at September 30, 2018 represent an approximation of exit price; however, an actual exit price may differ.