Note 24 Fair Value Measurements

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to disclose the fair value of its financial instruments. Fair value is defined as 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. For disclosure purposes, the Company groups its financial and non-financial assets and liabilities into three different levels based on the nature of the instrument and the availability and reliability of the information that is used to determine fair value. The three levels are defined as follows:

Level 1—Includes assets or liabilities in which the inputs to the valuation methodologies are based on unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2—Includes assets or liabilities in which the inputs to the valuation methodologies are based on similar assets or liabilities in inactive markets, quoted prices for identical or similar assets or liabilities in inactive markets, and inputs other than quoted prices that are observable, such as interest rates, yield curves, volatilities, prepayment speeds, and other inputs obtained from observable market input.

Level 3—Includes assets or liabilities in which the inputs to the valuation methodology are based on at least one significant assumption that is not observable in the marketplace. These valuations may rely on management’s judgment and may include internally-developed model-based valuation techniques.

Level 1 inputs are considered to be the most transparent and reliable and level 3 inputs are considered to be the least transparent and reliable. The Company assumes the use of the principal market to conduct a transaction of each particular asset or liability being measured and then considers the assumptions that market participants would use when pricing the asset or liability. Whenever possible, the Company first looks for quoted prices for identical assets or liabilities in active markets (level 1 inputs) to value each asset or liability. However, when inputs from identical assets or liabilities on active markets are not available, the Company utilizes market observable data for similar assets and liabilities. The Company maximizes the use of observable inputs and limits the use of unobservable inputs to occasions when observable inputs are not available. The need to use unobservable inputs generally results from the lack of market liquidity of the actual financial instrument or of the underlying collateral. Although, in some instances, third party price indications may be available, limited trading activity can challenge the observability of these quotations.

Changes in the valuation inputs used for measuring the fair value of financial instruments may occur due to changes in current market conditions or other factors. Such changes may necessitate a transfer of the financial instruments to another level in the hierarchy based on the new inputs used. The Company recognizes these transfers at the end of the reporting period that the transfer occurs. During 2015 and 2014, there were no transfers of financial instruments between the hierarchy levels.

The following is a description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of each instrument under the valuation hierarchy:

Fair Value of Financial Instruments Measured on a Recurring Basis

Investment securities available-for-sale—Investment securities available-for-sale are carried at fair value on a recurring basis. To the extent possible, observable quoted prices in an active market are used to determine fair value and, as such, these securities are classified as level 1. At December 31, 2015 and 2014, the Company did not hold any level 1 securities. When quoted market prices in active markets for identical assets or liabilities are not available, quoted prices of securities with similar characteristics, discounted cash flows or other pricing characteristics are used to estimate fair values and the securities are then classified as level 2. At December 31, 2015, the Company’s level 2 securities included mortgage-backed securities comprised of residential mortgage pass-through securities and other residential mortgage-backed securities. At December 31, 2014, the Company’s level 2 securities included asset backed securities, mortgage-backed securities comprised of residential mortgage pass-through securities, and other residential mortgage-backed securities. All other investment securities are classified as level 3.

Derivatives—The Company's derivative instruments are limited to interest rate swaps that may be accounted for as fair value hedges or non-designated hedges. The fair values of the swaps incorporate credit valuation adjustments in order to appropriately reflect nonperformance risk in the fair value measurements. The credit valuation adjustment is the dollar amount of the fair value adjustment related to credit risk and utilizes a probability weighted calculation to quantify the potential loss over the life of the trade. The credit valuation adjustments are calculated by determining the total expected exposure of the derivatives (which incorporates both the current and potential future exposure) and then applying the respective counterparties’ credit spreads to the exposure offset by marketable collateral posted, if any. Certain derivative transactions are executed with counterparties who are large financial institutions ("dealers"). International Swaps and Derivative Association Master Agreements ("ISDA") and Credit Support Annexes ("CSA") are employed for all contracts with dealers. These contracts contain bilateral collateral arrangements. The fair value inputs of these financial instruments are determined using discounted cash flow analysis through the use of third-party models whose significant inputs are readily observable market parameters, primarily yield curves, with appropriate adjustments for liquidity and credit risk, and are classified as level 2.

Warrant liability—The Company measured the fair value of the warrant liability on a recurring basis using a Black-Scholes option pricing model through the modification date as described in Note 18. The Company’s shares became publicly traded on September 20, 2012 and prior to that, had limited private trading; therefore, expected volatility was estimated using a time-based weighted migration of the Company’s own stock price volatility coupled with the median historical volatility, for a period commensurate with the expected term of the warrants, of eight comparable companies with publicly traded shares, and is deemed a significant unobservable input to the valuation model, as such this liability was classified as level 3.

Clawback liability—Prior to the termination of the FDIC loss-share agreements in 2015, the Company periodically measured the net present value of expected future cash payments to be made by the Company to the FDIC. The expected cash flows were calculated in accordance with the loss-share agreements and were based primarily on the expected losses on the covered assets, which involve significant inputs that are not market observable, as such this liability was classified as level 3.

The tables below present the financial instruments measured at fair value on a recurring basis as of December 31, 2015 and 2014, on the consolidated statements of financial condition utilizing the hierarchy structure described above:


	December 31, 2015
	Level 1		Level 2		Level 3		Total
Assets:
Investment securities available-for-sale:
Mortgage-backed securities (“MBS”):
Residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises	$	—	$	310,978	$	—	$	310,978
Other residential MBS issued or guaranteed by U.S. Government agencies or sponsored enterprises		—		845,543		—		845,543
Other securities		—		—		725		725
Derivatives		—		2,347		—		2,347
Total assets at fair value	$	—	$	1,158,868	$	725	$	1,159,593
Liabilities:
Warrant liability	$	—	$	—	$	—	$	—
Clawback liability		—		—		—		—
Derivatives	$	—	$	8,315	$	—	$	8,315
Total liabilities at fair value	$	—	$	8,315	$	—	$	8,315


	December 31, 2014
	Level 1		Level 2		Level 3		Total
Assets:
Investment securities available-for-sale:
Mortgage-backed securities (“MBS”):
Residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises	$	—	$	404,215	$	—	$	404,215
Other residential MBS issued or guaranteed by U.S. Government agencies or sponsored enterprises		—		1,074,580		—		1,074,580
Other securities		—		—		419		419
Derivatives		—		1,428		—		1,428
Total assets at fair value	$	—	$	1,480,223	$	419	$	1,480,642
Liabilities:
Warrant liability	$	—	$	—	$	3,328	$	3,328
Clawback Liability		—		—		36,338		36,338
Derivatives		—		4,728		—		4,728
Total liabilities at fair value	$	—	$	4,728	$	39,666	$	44,394

The table below details the changes in level 3 financial instruments during 2015 and 2014:


		Other	Warrant		Clawback
		Securities	liability		liability
Balance at December 31, 2013	$	419	$	6,281	$	32,465
Change in value		—		(2,953)		2,509
Amortization		—		—		1,364
Net change in Level 3		—		(2,953)		3,873
Balance at December 31, 2014		419		3,328		36,338
Change in value		—		106		1,242
Addition from business acquisition		306		—		—
Settlements		—		(368)		—
Warrant reclassification to equity		—		(3,066)		—
Amortization		—		—		1,131
Termination of FDIC agreement		—		—		(38,711)
Net change in Level 3		306		(3,328)		(36,338)
Balance at December 31, 2015	$	725	$	—	$	—

Fair Value of Financial Instruments Measured on a Non-recurring Basis

Certain assets may be recorded at fair value on a non-recurring basis as conditions warrant. These non-recurring fair value measurements typically result from the application of lower of cost or fair value accounting or a write-down occurring during the period.

The Company records collateral dependent loans that are considered to be impaired at their estimated fair value. A loan is considered impaired when it is probable that the Company will be unable to collect all contractual amounts due in accordance with the terms of the loan agreement. Collateral dependent impaired loans are measured based on the fair value of the collateral. The Company relies on third-party appraisals and internal assessments in determining the estimated fair values of these loans. The inputs used to determine the fair values of loans are considered level 3 inputs in the fair value hierarchy. During 2015, the Company measured 11 loans not accounted for under ASC 310-30 at fair value on a non-recurring basis. These loans carried specific reserves totaling $4.3 million at December 31, 2015. During 2015, the Company added specific reserves of $4.3 million for ten loans with carrying balances of $11.5 million at December 31, 2015. The Company also eliminated specific reserves of $0.2 million for four loans during 2015, primarily due to paydowns, charge offs, or transfers to OREO.

During 2014, the Company measured 19 loans not accounted for under ASC 310-30 at fair value on a non-recurring basis. These loans carried specific reserves totaling $0.2 million at December 31, 2014. During 2014, the Company added specific reserves of $0.3 million for nine loans with carrying balances of $2.4 million at December 31, 2014. The Company also eliminated specific reserves of $1.0 million for 13 loans during 2014, primarily due to paydowns, charge offs, or transfers to OREO.

The Company may be required to record fair value adjustments on loans held-for-sale on a non-recurring basis. The non-recurring fair value adjustments could involve lower of cost or fair value accounting and may include write-downs.

OREO is recorded at the lower of the cost basis or the fair value of the collateral less estimated selling costs. The estimated fair values of OREO are updated periodically and further write-downs may be taken to reflect a new basis. The Company recognized $1.6 and $2.1 million of OREO impairments in the consolidated statements of operations during 2015 and 2014, respectively. The fair values of OREO are derived from third party price opinions or appraisals that generally use an income approach or a market value approach. If reasonable comparable appraisals are not available, then the Company may use internally developed models to determine fair values. The inputs used to determine the fair values of OREO are considered level 3 inputs in the fair value hierarchy.

Premises and equipment held-for-sale are written down to estimated fair value less costs to sell in the period in which the held-for-sale criteria are met. Fair value is estimated in a process which considers current local commercial real estate market conditions and the judgment of the sales agent and often invoices obtaining third party appraisals from certified real estate appraisers. These fair value measurements are classified as level 3. Unobservable inputs to these measurements, which include estimates and judgments often used in conjunction with appraisals, are not readily quantifiable. The Company recognized $1.4 million of impairments in its consolidated statements of operations related to banking centers classified as held-for-sale during the year ended December 31, 2015.

The table below provides information regarding the assets recorded at fair value on a non-recurring basis at December 31, 2015 and 2014:


	December 31, 2015
			Losses from fair
	Total		value changes
Other real estate owned	$	20,814	$	1,580
Impaired loans		37,363		1,424
Premises and equipment		2,101		1,411


	December 31, 2014
			Losses from fair
	Total		value changes
Other real estate owned	$	29,120	$	2,103
Impaired loans		32,091		552

The Company did not record any liabilities for which the fair value was made on a non-recurring basis during 2015 and 2014.

The following table provides information about the valuation techniques and unobservable inputs used in the valuation of financial instruments classified as level 3 of the fair value hierarchy as of December 31, 2015. The table below excludes non-recurring fair value measurements of collateral value used for impairment measures for OREO and premises and equipment. These valuations utilize third party appraisal or broker price opinions, and are classified as level 3 due to the significant judgment involved:


	Fair value at				Quantitative
	December 31, 2015		Valuation Technique	Unobservable Input	Measures
Other available-for-sale securities	$	725	Cash investment in private equity fund, par value	Cash, par value
Impaired loans		37,363	Appraised value	Appraised values
				Discount rate	0% - 25%