Note 7: Disclosures about Fair Value of Assets and Liabilities

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 Quoted prices in active markets for identical assets or liabilities

Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in 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 supported by little or no market activity and are significant to the fair value of the assets or liabilities

Recurring Measurements

The following tables present the fair value measurements of assets and liabilities recognized in the accompanying balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at March 31, 2020 and December 31, 2019:


	Fair Value Measurements Using
			Quoted Prices in		Significant
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
	Fair		Assets		Inputs		Inputs
Assets	Value		(Level 1)		(Level 2)		(Level 3)
	(In thousands)
March 31, 2020
Trading securities	$	465,157	$	—	$	465,157	$	—
Available-for-sale securities:
Treasury notes		2,043		2,043		—		—
Federal agencies		306,575		—		306,575		—
Municipals		5,951		—		5,951		—
Mortgage-backed - Government-sponsored entity (GSE) - residential		24,484		—		24,484		—
Loans held for sale		18,938		—		18,938		—
Mortgage servicing rights		69,978		—		—		69,978
Derivative assets - interest rate lock commitments		2,079		—		—		2,079
Derivative assets - forward contracts		96		—		96		—
Derivative assets - interest rate swaps		3,214		—		3,214		—
Derivative liabilities - interest rate lock commitments		80		—		—		80
Derivative liabilities - forward contracts		1,273		—		1,273		—
Derivative liabilities - interest rate swaps		3,214		—		3,214		—


December 31, 2019
Trading securities	$	269,891	$	—	$	269,891	$	—
Available-for-sale securities:
Treasury notes		4,765		4,765		—		—
Federal agencies		244,973		—		244,973		—
Municipals		5,937		—		5,937		—
Mortgage-backed - Government-sponsored entity (GSE) - residential		34,568		—		34,568		—
Loans held for sale		19,592		—		19,592		—
Mortgage servicing rights		74,387		—		—		74,387
Derivative assets - interest rate lock commitments		186		—		—		186
Derivative asset - interest rate swap		511		—		511		—
Derivative liabilities - forward contracts		27		—		27		—
Derivative liabilities - interest rate swap		511		—		511		—

Following is a description of the valuation methodologies and inputs 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. There have been no significant changes in the valuation techniques during the three months ended March 31, 2020 and the year ended December 31, 2019. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Trading and Available-for-Sale Securities

Where quoted market prices are available in an active market, securities such as U.S. Treasuries are classified within Level 1 of the valuation hierarchy. 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 sourced 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 including federal agencies, mortgage-backed securities, U.S. Treasuries, and Federal Housing Administration participation certificates. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.

Loans Held for Sale

Certain loans held for sale at fair value are saleable into the secondary mortgage markets and their fair values are estimated using observable quoted market or contracted prices, or market price equivalents, which would be used by other market participants. These saleable loans are considered Level 2.

Mortgage Servicing Rights

Mortgage servicing rights do not trade in an active, open market with readily observable prices. Accordingly, fair value is estimated using discounted cash flow models having significant inputs of discount rate, prepayment speed, and default rate. Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the hierarchy.

The Chief Financial Officer’s (CFO) office contracts with a pricing specialist to generate fair value estimates on a quarterly basis. The CFO’s office challenges the reasonableness of the assumptions used and reviews the methodology to ensure the estimated fair value complies with accounting standards generally accepted in the United States.

Derivative Financial Instruments

The Company estimates the fair value of interest rate lock commitments based on the value of the underlying mortgage loan, quoted mortgage backed security prices, estimates of the fair value of the mortgage servicing rights, and an estimate of the probability that the mortgage loan will fund within the terms of the interest rate lock commitment, net of expenses. With respect to its interest rate lock commitments, management determined that a Level 3 classification was most appropriate based on the various significant unobservable inputs utilized in estimating the fair value of its interest rate lock commitments. The Company estimates the fair value of forward sales commitments based on market quotes of mortgage backed security prices for securities similar to the ones used, which are considered Level 2. The fair value of interest rate swaps is based on prices that are obtained from a third party that uses observable market inputs, thereby supporting a Level 2 classification. Changes in fair value of the Company’s derivative financial instruments are recognized through noninterest income and/or noninterest expenses on its condensed consolidated statement of income.

Level 3 Reconciliation

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying balance sheets using significant unobservable (Level 3) inputs:


	Three Months Ended March 31,
	2020		2019
	(In thousands)
Mortgage servicing rights
Balance, beginning of period	$	74,387	$	77,844
Additions
Originated and purchased servicing		3,929		1,020
Subtractions
Paydowns		(1,858)		(1,110)
Changes in fair value due to changes in valuation inputs or assumptions used in the valuation model		(6,480)		(1,505)
Balance, end of period	$	69,978	$	76,249

Derivative Assets - interest rate lock commitments
Balance, beginning of period	$	186	$	70
Changes in fair value		1,893		1
Balance, end of period	$	2,079	$	71

Derivative Liabilities - interest rate lock commitments
Balance, beginning of period	$	—	$	—
Changes in fair value		80		1
Balance, end of period	$	80	$	1

Nonrecurring Measurements

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 March 31, 2020 and December 31, 2019.


	Fair Value Measurements Using
			Quoted Prices in		Significant
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
	Fair		Assets		Inputs		Inputs
Assets	Value		(Level 1)		(Level 2)		(Level 3)
	(In thousands)
March 31, 2020
Impaired loans (collateral-dependent)	$	1,306	$	—	$	—	$	1,306
December 31, 2019
Impaired loans (collateral-dependent)	$	1,570	$	—	$	—	$	1,570

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheet, as well as the general classification of such assets pursuant to the valuation hierarchy. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Collateral-Dependent Impaired Loans, Net of Allowance for Loan Losses

The estimated fair value of collateral-dependent impaired loans is based on the appraised fair value of the collateral, less estimated cost to sell. Collateral-dependent impaired loans are classified within Level 3 of the fair value hierarchy.

The Company considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect the fair value. Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary by the Company’s Chief Credit Officer’s (CCO) office. Appraisals are reviewed for accuracy and consistency by the CCO’s office. Appraisers are selected from the list of approved appraisers maintained by management. The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral. These discounts and estimates are developed by the CCO’s office by comparison to historical results.

Unobservable (Level 3) Inputs:

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


			Valuation
	Fair Value		Technique	Unobservable Inputs	Range
	(In thousands)
At March 31, 2020:
Collateral-dependent impaired loans	$	1,306	Market comparable properties	Marketability discount	44% - 75%
Mortgage servicing rights	$	69,978	Discounted cash flow	Discount rate	8% - 13%
				Constant prepayment rate	2% - 43%
Derivative assets - interest rate lock commitments	$	2,079	Discounted cash flow	loan closing rates	56-99%
Derivative liabilities - interest rate lock commitments	$	80	Discounted cash flow	loan closing rates	56-99%

At December 31, 2019:
Collateral-dependent impaired loans	$	1,570	Market comparable properties	Marketability discount	37%-55%
Mortgage servicing rights	$	74,387	Discounted cash flow	Discount rate	8% - 13%
				Constant prepayment rate	1% - 39%
Derivative assets - interest rate lock commitments	$	186	Discounted cash flow	loan closing rates	73-99%

Sensitivity of Significant Unobservable Inputs

The following is a discussion of the sensitivity of significant unobservable inputs, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement, and of how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.

Mortgage Servicing Rights

The significant unobservable inputs used in the fair value measurement of the Company’s mortgage servicing rights are discount rates and constant prepayment rates. Significant increases or decreases in any of those inputs in isolation would result in a significantly different fair value measurement.

Fair Value of Financial Instruments

The following table presents the carrying amount and estimated fair values of the Company’s financial instruments not carried at fair value and the level within the fair value hierarchy in which the fair value measurements fall at March 31, 2020 and December 31, 2019.


			Fair Value Measurements Using
					Quoted Prices in		Significant
					Active Markets		Other		Significant
					for Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
Assets	Value		Value		(Level 1)		(Level 2)		(Level 3)
	(In thousands)
March 31, 2020
Financial assets:
Cash and cash equivalents	$	568,082	$	568,082	$	568,082	$	—	$	—
Securities purchased under agreements to resell		6,685		6,685		—		6,685		—
FHLB stock		46,156		46,156		—		46,156		—
Loans held for sale		2,777,070		2,777,070		—		2,777,070		—
Loans, net		3,501,770		3,475,393		—		—		3,475,393
Interest receivable		18,139		18,139		—		18,139		—
Financial liabilities:
Deposits		6,722,705		6,730,101		3,967,232		2,762,869		—
Lines of credit		—		—		—		—		—
Short-term subordinated debt		12,650		12,650		—		12,650		—
FHLB advances		431,917		431,283		—		431,283		—
Interest payable		10,219		10,219		—		10,219		—


December 31, 2019
Financial assets:
Cash and cash equivalents	$	506,709	$	506,709	$	506,709	$	—	$	—
Securities purchased under agreements to resell		6,723		6,723		—		6,723		—
FHLB stock		20,369		20,369		—		20,369		—
Loans held for sale		2,074,197		2,074,197		—		2,074,197		—
Loans, net		3,012,468		2,999,580		—		—		2,999,580
Interest receivable		18,359		18,359		—		18,359		—
Financial liabilities:
Deposits		5,478,075		5,478,682		3,303,736		2,174,946		—
Lines of credit		6,540		6,540		—		6,540		—
Short-term subordinated debt		12,200		12,200		—		12,200		—
FHLB advances		162,699		162,803		—		162,803		—
Interest payable		11,938		11,938		—		11,938		—