3. Fair Value Measurements

Fair Value Measurements and Disclosures

The Company determines fair values in compliance with The Fair Value Measurements and Disclosures Topic of the ASC (the “Fair Value Topic”). The Fair Value Topic defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. The Fair Value Topic defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. The Fair Value Topic assumes that transactions upon which fair value measurements are based occur in the principal market for the asset or liability being measured. Further, fair value measurements made under the Fair Value Topic exclude transaction costs and are not the result of forced transactions.

The Fair Value Topic creates a fair value hierarchy that classifies fair value measurements based upon the inputs used in valuing the assets or liabilities that are the subject of fair value measurements. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs, as indicated below.

Level 1 Inputs: Unadjusted quoted prices in active markets for identical assets or liabilities that the Company can access at the measurement date.

Level 2 Inputs: Observable inputs other than Level 1 prices. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, yield curves, prepayment speeds, default rates, credit risks and loss severities), and inputs that are derived from or corroborated by market data, among others.

Level 3 Inputs: Unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities. Level 3 inputs include pricing models and discounted cash flow techniques, among others.

Fair Value Option

The Company has elected to measure substantially all of PrimeLending’s mortgage loans held for sale and retained mortgage servicing rights (“MSR”) asset at fair value, under the provisions of the Fair Value Option. The Company elected to apply the provisions of the Fair Value Option to these items so that it would have the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. At March 31, 2016 and December 31, 2015, the aggregate fair value of PrimeLending’s mortgage loans held for sale accounted for under the Fair Value Option was $1.29 billion and $1.46 billion, respectively, and the unpaid principal balance of those loans was $1.23 billion and $1.41 billion, respectively. The interest component of fair value is reported as interest income on loans in the accompanying consolidated statements of operations.

The Company holds a number of financial instruments that are measured at fair value on a recurring basis, either by the application of the Fair Value Option or other authoritative pronouncements. The fair values of those instruments are determined primarily using Level 2 inputs. Those inputs include quotes from mortgage loan investors and derivatives dealers and data from independent pricing services.

The following tables present information regarding financial assets and liabilities measured at fair value on a recurring basis (in thousands).


	Level 1		Level 2		Level 3		Total
March 31, 2016	Inputs		Inputs		Inputs		Fair Value
Trading securities	$	12,916	$	355,508	$	1	$	368,425
Available for sale securities		17,979		648,349		—		666,328
Loans held for sale		—		1,244,799		40,545		1,285,344
Derivative assets		—		90,981		—		90,981
MSR asset		—		—		39,863		39,863
Securities sold, not yet purchased		60,149		105,555		—		165,704
Derivative liabilities		—		43,945		—		43,945


	Level 1		Level 2		Level 3			Total
December 31, 2015	Inputs		Inputs		Inputs			Fair Value
Trading securities	$	21,807	$	192,338	$	1	$	214,146
Available for sale securities		17,409		656,297		—		673,706
Loans held for sale		—		1,434,955		25,880		1,460,835
Derivative assets		—		35,676		—		35,676
MSR asset		—		—		52,285		52,285
Securities sold, not yet purchased		27,648		102,396		—		130,044
Derivative liabilities		—		5,426		—		5,426

The following tables include a rollforward for those financial instruments measured at fair value using Level 3 inputs (in thousands).


							Total Gains or Losses
							(Realized or Unrealized)
	Balance at								Included in Other
	Beginning of		Purchases/		Sales/		Included in		Comprehensive		Balance at
	Period		Additions		Reductions		Net Income		Income (Loss)		End of Period
Three months ended March 31, 2016
Trading securities	$	1	$	—	$	—	$	—	$	—	$	1
Loans held for sale		25,880		23,236		(4,237)		(4,334)		—		40,545
MSR asset		52,285		1,639		—		(14,061)		—		39,863
Total	$	78,166	$	24,875	$	(4,237)	$	(18,395)	$	—	$	80,409

Three months ended March 31, 2015
Available for sale securities	$	—	$	7,301	$	—	$	(1,369)	$	—	$	5,932
Loans held for sale		9,017		11,136		(271)		(387)		—		19,495
MSR asset		36,155		2,690		—		(7,197)		—		31,648
Total	$	45,172	$	21,127	$	(271)	$	(8,953)	$	—	$	57,075

All net realized and unrealized gains (losses) in the table above are reflected in the accompanying consolidated financial statements. The unrealized gains (losses) relate to financial instruments still held at March 31, 2016.

For Level 3 financial instruments measured at fair value on a recurring basis at March 31, 2016, the significant unobservable inputs used in the fair value measurements were as follows.


			Range
Financial instrument	Valuation Technique	Unobservable Input	(Weighted-Average)
Trading securities	Discounted cash flow	Discount rate	8	-	17	%	(	10	%)

Loans held for sale	Discounted cash flow / Market comparable	Projected price	88	-	96	%	(	96	%)

MSR asset	Discounted cash flow	Constant prepayment rate			16.92		%
		Discount rate			10.79		%

Trading securities include corporate debt securities that are valued using a discounted cash flow model with observable market data; however, due to the distressed nature of these bonds, the Company has determined that these securities should be valued as a Level 3 financial instrument.

The fair value of certain loans held for sale that cannot be sold through normal sale channels or are non-performing is measured using Level 3, or unobservable, inputs. The fair value of such loans is generally based upon estimates of expected cash flows using unobservable inputs, including listing prices of comparable assets, uncorroborated expert opinions, and/or management’s knowledge of underlying collateral.

The MSR asset, which is included in other assets within the Company’s consolidated balance sheets, is valued by projecting net servicing cash flows, which are then discounted to estimate the fair value. The fair value of the MSR asset is impacted by a variety of factors. Prepayment rates and discount rates, the most significant unobservable inputs, are discussed further in Note 7 to the consolidated financial statements.

The Company had no transfers between Levels 1 and 2 during the periods presented.

The following table presents the changes in fair value for instruments that are reported at fair value under the Fair Value Option (in thousands).


	Three Months Ended March 31, 2016						Three Months Ended March 31, 2015
			Other		Total				Other		Total
	Net		Noninterest		Changes in		Net		Noninterest		Changes in
	Gains (Losses)		Income		Fair Value		Gains (Losses)		Income		Fair Value
Loans held for sale	$	447	$	—	$	447	$	(6,695)	$	—	$	(6,695)
MSR asset		(14,061)		—		(14,061)		(7,197)		—		(7,197)

The Company also determines the fair value of certain assets and liabilities on a non-recurring basis. In particular, the fair value of all of the assets acquired and liabilities assumed in the SWS Merger was determined at the acquisition date. In addition, facts and circumstances may dictate a fair value measurement when there is evidence of impairment. Assets and liabilities measured on a non-recurring basis include the items discussed below.

Impaired Loans — The Company reports impaired loans based on the underlying fair value of the collateral through specific allowances within the allowance for loan losses. PCI loans with a fair value of $172.9 million, $822.8 million and $73.5 million were acquired by the Company upon completion of the merger with PlainsCapital (the “PlainsCapital Merger”), the FDIC-assisted transaction (the “FNB Transaction”) whereby the Bank acquired certain assets and assumed certain liabilities of First National Bank (“FNB”) and the SWS Merger, respectively (collectively, the “Bank Transactions”). Substantially all PCI loans acquired in the FNB Transaction are covered by FDIC loss-share agreements. The fair value of PCI loans was determined using Level 3 inputs, including estimates of expected cash flows that incorporated significant unobservable inputs regarding default rates, loss severity rates assuming default, prepayment speeds on acquired loans accounted for in pools (“Pooled Loans”), and estimated collateral values.

At March 31, 2016, estimates for these significant unobservable inputs were as follows.


	PCI Loans
	PlainsCapital		FNB		SWS
	Merger		Transaction		Merger
Weighted average default rate	60	%	55	%	51	%
Weighted average loss severity rate	51	%	34	%	30	%
Weighted average prepayment speed	0	%	6	%	0	%

At March 31, 2016, the resulting weighted average expected loss on PCI loans associated with the PlainsCapital Merger, FNB Transaction and SWS Merger was 31%, 19% and 15%, respectively.

The Company obtains updated appraisals of the fair value of collateral securing impaired collateral dependent loans at least annually, in accordance with regulatory guidelines. The Company also reviews the fair value of such collateral on a quarterly basis. If the quarterly review indicates that the fair value of the collateral may have deteriorated, the Company orders an updated appraisal of the fair value of the collateral. Because the Company obtains updated appraisals when evidence of a decline in the fair value of collateral exists, it typically does not adjust appraised values.

Other Real Estate Owned — The Company determines fair value primarily using independent appraisals of other real estate owned (“OREO”) properties. The resulting fair value measurements are classified as Level 2 or Level 3 inputs, depending upon the extent to which unobservable inputs determine the fair value measurement. The Company considers a number of factors in determining the extent to which specific fair value measurements utilize unobservable inputs, including, but not limited to, the inherent subjectivity in appraisals, the length of time elapsed since the receipt of independent market price or appraised value, and current market conditions. At March 31, 2016, the most significant unobservable input used in the determination of fair value of OREO was a discount to independent appraisals for estimated holding periods of OREO properties. Level 3 inputs were used to determine the initial fair value at acquisition of a large group of smaller balance properties that were acquired in the FNB Transaction. In the FNB Transaction, the Bank acquired OREO of $135.2 million, all of which is covered by FDIC loss-share agreements. At March 31, 2016 and December 31, 2015, the estimated fair value of covered OREO was $78.9 million and $99.1 million, respectively, and the underlying fair value measurements utilize Level 2 and Level 3 inputs. The fair value of non-covered OREO at March 31, 2016 and December 31, 2015 was $0.5 million and $0.4 million, respectively, and is included in other assets within the consolidated balance sheets. During the reported periods, all fair value measurements for non-covered OREO subsequent to initial recognition utilized Level 2 inputs.

The following table presents information regarding certain assets and liabilities measured at fair value on a non-recurring basis for which a change in fair value has been recorded during reporting periods subsequent to initial recognition (in thousands).


									Total Gains (Losses) for the
	Level 1		Level 2		Level 3		Total		Three Months Ended March 31,
March 31, 2016	Inputs		Inputs		Inputs		Fair Value		2016		2015
Non-covered impaired loans	$	—	$	—	$	39,722	$	39,722	$	(33)	$	349
Covered impaired loans		—		—		45,025		45,025		332		3,218
Non-covered other real estate owned		—		—		—		—		—		(28)
Covered other real estate owned		—		11,322		—		11,322		(9,765)		(950)

The Fair Value of Financial Instruments Subsection of the ASC requires disclosure of the fair value of financial assets and liabilities, including the financial assets and liabilities previously discussed. The methods for determining estimated fair value for financial assets and liabilities is described in detail in Note 3 to the consolidated financial statements included in the Company’s 2015 Form 10-K.

The following tables present the carrying values and estimated fair values of financial instruments not measured at fair value on either a recurring or non-recurring basis (in thousands).


			Estimated Fair Value
	Carrying		Level 1		Level 2		Level 3
March 31, 2016	Amount		Inputs		Inputs		Inputs		Total
Financial assets:
Cash and cash equivalents	$	527,509	$	527,509	$	—	$	—	$	527,509
Securities purchased under agreements to resell		96,646		—		96,646		—		96,646
Assets segregated for regulatory purposes		120,714		120,714		—		—		120,714
Held to maturity securities		310,478		—		313,553		—		313,553
Loans held for sale		58,989		—		58,989		—		58,989
Non-covered loans, net		5,317,615		—		463,987		4,891,840		5,355,827
Covered loans, net		346,169		—		—		484,424		484,424
Broker-dealer and clearing organization receivables		1,370,622		—		1,370,622		—		1,370,622
FDIC indemnification asset		80,522		—		—		77,817		77,817
Other assets		60,468		—		54,412		6,056		60,468

Financial liabilities:
Deposits		6,984,175		—		6,987,315		—		6,987,315
Broker-dealer and clearing organization payables		1,284,016		—		1,284,016		—		1,284,016
Short-term borrowings		832,921		—		832,921		—		832,921
Debt		299,202		—		292,817		—		292,817
Other liabilities		5,389		—		5,389		—		5,389


			Estimated Fair Value
	Carrying		Level 1		Level 2		Level 3
December 31, 2015	Amount		Inputs		Inputs		Inputs		Total
Financial assets:
Cash and cash equivalents	$	669,445	$	669,445	$	—	$	—	$	669,445
Securities purchased under agreements to resell		105,660		—		105,660		—		105,660
Assets segregated for regulatory purposes		158,613		158,613		—		—		158,613
Held to maturity securities		332,022		—		331,468		—		331,468
Loans held for sale		72,843		—		72,843		—		72,843
Non-covered loans, net		5,174,625		—		602,968		4,600,406		5,203,374
Covered loans, net		378,762		—		—		527,201		527,201
Broker-dealer and clearing organization receivables		1,362,499		—		1,362,499		—		1,362,499
FDIC indemnification asset		91,648		—		—		91,648		91,648
Other assets		68,786		—		53,214		15,572		68,786

Financial liabilities:
Deposits		6,952,683		—		6,955,919		—		6,955,919
Broker-dealer and clearing organization payables		1,338,305		—		1,338,305		—		1,338,305
Short-term borrowings		947,373		—		947,373		—		947,373
Debt		305,728		—		299,257		—		299,257
Other liabilities		3,699		—		3,699		—		3,699