Note (10)—Fair value of financial instruments:

FASB ASC 820-10 defines fair value as 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. ASC 820-10 also establishes a framework for measuring the fair value of assets and liabilities according to a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets and liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The hierarchy maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that are derived from assumptions based on management’s estimate of assumptions that market participants would use in pricing the asset or liability based on the best information available under the circumstances.

The hierarchy is broken down into the following three levels, based on the reliability of inputs:

Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date.

Level 2: Significant other 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.

Level 3: Significant unobservable inputs for assets or liabilities that are derived from assumptions based on management’s estimate of assumptions that market participants would use in pricing the assets or liabilities.

The Company records the fair values of financial assets and liabilities on a recurring and non-recurring basis using the following methods and assumptions:

During the first quarter of 2018, the Company adopted ASU 2016-01, “Recognition and Measurement of Financial Assets and Liabilities.” The amendments included within this standard, which are applied prospectively, require the Company to disclose fair value of financial instruments measured at amortized cost on the balance sheet to measure the fair value using an exit price notion. Prior to adopting the amendments included in the standard, the Company measured fair value under an entry price notion.

Investment securities—Investment securities are recorded at fair value on a recurring basis. Fair values for securities are based on quoted market prices, where available. If quoted prices are not available, fair values are based on quoted market prices of similar instruments or are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the pricing relationship or correlation among other benchmark quoted securities. Investment securities valued using quoted market prices of similar instruments or that are valued using matrix pricing are classified as Level 2. When significant inputs to the valuation are unobservable, the available-for-sale securities are classified within Level 3 of the fair value hierarchy.

Where no active market exists for a security or other benchmark securities, fair value is estimated by the Company with reference to discount margins for other high-risk securities.

Loans held for sale—Loans held for sale are carried at fair value. Fair value is determined using current secondary market prices for loans with similar characteristics, that is, using Level 2 inputs.

Derivatives—The fair value of the interest rate swaps are based upon fair values provided from entities that engage in interest rate swap activity and is based upon projected future cash flows and interest rates. Fair value of commitments is based on fees currently charged to enter into similar agreements, and for fixed-rate commitments, the difference between current levels of interest rates and the committed rates is also considered. These financial instruments are classified as Level 2.

Other real estate owned—Other real estate owned (“OREO”) is comprised of commercial and residential real estate obtained in partial or total satisfaction of loan obligations and excess land and facilities held for sale. OREO acquired in settlement of indebtedness is recorded at the lower of the carrying amount of the loan or the fair value of the real estate less costs to sell. Fair value is determined on a nonrecurring basis based on appraisals by qualified licensed appraisers and is adjusted for management’s estimates of costs to sell and holding period discounts. The valuations are classified as Level 3.

Mortgage servicing rights—Servicing rights are carried at fair value. Fair value is determined using an income approach with various assumptions including expected cash flows, market discount rates, prepayment speeds, servicing costs, and other factors. Mortgage servicing rights are disclosed as Level 3.

Impaired loans—Loans considered impaired under FASB ASC 310, Receivables, are loans for which, based on current information and events, it is probable that the creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Fair value adjustments for impaired loans are recorded on a non-recurring basis as either partial write downs based on observable market prices or current appraisal of the collateral. Impaired loans are classified as Level 3.

The following table contains the estimated fair values and the related carrying values of the Company's financial instruments. Items which are not financial instruments are not included. Due to the adoption of ASU 2016-01 as of January 1, 2018, the fair value as presented below is measured using the exit price notion in the periods after adoption and may not be comparable with prior periods presented as a result of the change in methodology.

			Fair Value
September 30, 2018	Carrying amount		Level 1		Level 2		Level 3		Total
Financial assets:
Cash and cash equivalents	$	181,630	$	181,630	$	—	$	—	$	181,630
Investment securities		609,568		—		609,568		—		609,568
Federal Home Loan Bank Stock		13,432	N/A		N/A		N/A		N/A
Loans, net		3,510,923		—		—		3,508,972		3,508,972
Loans held for sale		323,486		—		323,486		—		323,486
Interest receivable		14,943		—		14,943		—		14,943
Mortgage servicing rights		79,890		—		—		79,890		79,890
Derivatives		13,662		—		13,662		—		13,662
Financial liabilities:
Deposits:
Without stated maturities	$	3,076,790	$	3,076,790	$	—	$	—	$	3,076,790
With stated maturities		1,052,683		—		1,052,825		—		1,052,825
Securities sold under agreement to repurchase and federal funds sold		50,117		50,117		—		—		50,117
Federal Home Loan Bank advances		129,921		—		130,023		—		130,023
Subordinated debt		30,930		—		30,000		—		30,000
Interest payable		3,616		990		2,626		—		3,616
Derivatives		4,076		—		4,076		—		4,076

			Fair Value
December 31, 2017	Carrying amount		Level 1		Level 2		Level 3		Total
Financial assets:
Cash and cash equivalents	$	119,751	$	119,751	$	—	$	—	$	119,751
Investment securities		543,992		—		540,388		3,604		543,992
Federal Home Loan Bank Stock		11,412	N/A		N/A		N/A		N/A
Loans, net		3,142,870		—		3,064,373		77,027		3,141,400
Loans held for sale		526,185		—		526,185		—		526,185
Interest receivable		13,069		—		13,069		—		13,069
Mortgage servicing rights, net		76,107		—		—		76,107		76,107
Derivatives		9,690		—		9,690		—		9,690
Financial liabilities:
Deposits:
Without stated maturities	$	2,976,066	$	2,976,066	$	—	$	—	$	2,976,066
With stated maturities		688,329		—		682,403		—		682,403
Securities sold under agreement to repurchase and federal funds sold		14,293		14,293		—		—		14,293
Federal Home Loan Bank Stock		302,372		—		302,465		—		302,465
Subordinated debt		30,930		—		36,670				36,670
Interest payable		1,504		575		929		—		1,504
Derivatives		1,699		—		1,699		—		1,699

The balances and levels of the assets measured at fair value on a recurring basis at September 30, 2018 are presented in the following tables:

At September 30, 2018	Quoted prices in active markets for identical assets (liabilities) (level 1)		Significant other observable inputs (level 2)		Significant unobservable inputs (level 3)		Total
Recurring valuations:
Financial assets:
Investment securities:
U.S. government agency securities	$	—	$	984	$	—	$	984
Mortgage-backed securities		—		467,714		—		467,714
Municipals, tax-exempt		—		130,672		—		130,672
Treasury securities		—		7,131		—		7,131
Equity securities		—		3,067		—		3,067
Total	$	—	$	609,568		—	$	609,568
Loans held for sale		—		323,486		—		323,486
Mortgage servicing rights		—		—		79,890		79,890
Derivatives		—		13,662		—		13,662
Financial Liabilities:
Derivatives	$	—	$	4,076	$	—	$	4,076

The balances and levels of the assets measured at fair value on a non-recurring basis at September 30, 2018 are presented in the following tables:

At September 30, 2018	Quoted prices in active markets for identical assets (liabilities) (level 1)		Significant other observable inputs (level 2)		Significant unobservable inputs (level 3)		Total
Non-recurring valuations:
Financial assets:
Other real estate owned	$	—	$	—	$	1,333	$	1,333
Impaired loans(1):
Commercial and industrial		—		—		1,695		1,695
Construction		—		—		830		830
Residential real estate:
1-4 family mortgage		—		—		146		146
Commercial real estate:
Owner occupied		—		—		82		82
Non-owner occupied		—		—		1,244		1,244
Total	$	—	$	—	$	3,997	$	3,997

(1)	Includes both impaired non-purchased loans and PCI loans.

The balances and levels of the assets measured at fair value on a recurring basis at December 31, 2017 are presented in the following tables:

At December 31, 2017	Quoted prices in active markets for identical assets (liabilities) (level 1)		Significant other observable inputs (level 2)		Significant unobservable inputs (level 3)		Total
Recurring valuations:
Financial assets:
Available-for-sale securities:
U.S. government agency securities	$	—	$	986	$	—	$	986
Mortgage-backed securities		—		418,781		—		418,781
Municipals, tax-exempt		—		109,251		—		109,251
Treasury securities		—		7,252		—		7,252
Equity securities		—		4,118		3,604		7,722
Total	$	—	$	540,388	$	3,604	$	543,992
Loans held for sale		—		526,185		—		526,185
Mortgage servicing rights		—		—		76,107		76,107
Derivatives		—		9,690		—		9,690
Financial Liabilities:
Derivatives	$	—	$	1,699	$	—	$	1,699

The balances and levels of the assets measured at fair value on a non-recurring basis at December 31, 2017 are presented in the following tables:

At December 31, 2017	Quoted prices in active markets for identical assets (liabilities) (level 1)		Significant other observable inputs (level 2)		Significant unobservable inputs (level 3)		Total
Non-recurring valuations:
Financial assets:
Other real estate owned	$	—	$	—	$	13,174	$	13,174
Impaired Loans⁽¹⁾:
Commercial and industrial		—		—		1,971		1,971
Construction		—		—		4,211		4,211
Residential real estate:
1-4 family mortgage		—		—		21,902		21,902
Commercial real estate:
Owner occupied		—		—		10,030		10,030
Non-owner occupied		—		—		13,593		13,593
Consumer and other		—		—		25,320		25,320
Total	$	—	$	—	$	77,027	$	77,027

(1)	Includes both impaired non-purchased loans and PCI loans.

There were no transfers between Level 1, 2 or 3 during the periods presented.

The following table summarizes changes in fair value on available-for-sale securities measured at fair value on a recurring basis using significant unobservable inputs, or Level 3 inputs, during the three and nine months ended September 30, 2018 and 2017.

						Available-for-sale securities
	Three Months Ended September 30,					Nine Months Ended September 30,
	2018		2017			2018			2017
Balance at beginning of period		—	$	4,549		$	3,604		$	4,549
Reclassification of equity securities without a readily determinable fair value to other assets ⁽¹⁾		—		—			(3,604	)		—
Impairment of equity securities				(945	)					(945	)
Balance at end of period	$	—	$	3,604		$	—		$	3,604

(1)	See Note 1, “Basis of Presentation” in the Notes to the consolidated financial statements for additional details regarding the adoption of ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities.

As of December 31, 2017, there was no established market for certain other securities, and as such, the Company had estimated that historical costs approximated market value. As of January 1, 2018, the Company adopted ASU 2016-01 (See Note 1) and reclassified $3,604 of these other securities without readily determinable market values to other assets. An impairment of an equity security without a readily determinable fair value was considered to be other-than-temporary and was written down to its fair value resulting in an impairment loss of $975 during the three months ended September 30, 2017.

The following table presents information as of September 30, 2018 about significant unobservable inputs (Level 3) used in the valuation of assets measured at fair value on a nonrecurring basis:

Financial instrument

Fair Value

Valuation technique

Significant Unobservable inputs

Range of

inputs

Impaired loans⁽¹⁾

3,997

Valuation of collateral

Discount for comparable sales

0%-30%

Other real estate owned

1,333

Appraised value of property less costs to sell

Discount for costs to sell

0%-15%

(1)	Includes both impaired non-purchased loans and PCI loans.

The following table presents information as of December 31, 2017 about significant unobservable inputs (Level 3) used in the valuation of assets measured at fair value on a nonrecurring basis:

Financial instrument

Fair Value

Valuation technique

Significant Unobservable inputs

Range of

inputs

Impaired loans⁽¹⁾

77,027

Valuation of collateral

Discount for comparable sales

0%-30%

Other real estate owned

13,174

Appraised value of property less costs to sell

Discount for costs to sell

0%-15%

(1)	Includes both impaired non-purchased loans and PCI loans.

Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, a member of the lending administrative department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry wide statistics.

Fair value option:

The Company elected to measure all loans originated for sale at fair value under the fair value option as permitted under ASC 825. Electing to measure these assets at fair value reduces certain timing differences and better matches the changes in fair value of the loans with changes in the fair value of derivative instruments used to economically hedge them.

Net losses of $3,212 and $7,409 resulting from fair value changes of the mortgage loans were recorded to income during the three and nine months ended September 30, 2018, while net losses of $272 and net gains of $9,198 were recorded to income during the three and nine months ended September 30, 2017. The amount does not reflect changes in fair values of related derivative instruments used to hedge exposure to market-related risks associated with these mortgage loans. The change in fair value of both loans held for sale and the related derivative instruments are recorded in Mortgage Banking Income in the Consolidated Statements of Income. Election of the fair value option allows the Company to reduce the accounting volatility that would otherwise result from the asymmetry created by accounting for the financial instruments at the lower of cost or fair value and the derivatives at fair value. The fair value option election does not apply to the GNMA optional repurchase loans recorded as of December 31, 2017 which do not meet the requirements under FASB ASC Topic 825 to be accounted for under the fair value option. At September 30, 2018, there were $58,435 of delinquent GNMA loans that had previously been sold. The Company determined there not to be a more-than-trivial benefit based on an analysis of interest rates and an assessment of potential reputational risk associated with these loans. As such, the Company had $0 in rebooked GNMA loans included in loans held for sale as of September 30, 2018. GNMA optional repurchase loans totaled $43,035 at December 31, 2017 and are included in loans held for sale on the accompanying Consolidated Balance Sheet. See Note 1, “Basis of presentation” in the Notes to the consolidated financial statements for additional details regarding rebooked GNMA loans.

The Company’s valuation of loans held for sale incorporates an assumption for credit risk; however, given the short-term period that the Company holds these loans, valuation adjustments attributable to instrument-specific credit risk is nominal. Interest income on loans held for sale measured at fair value is accrued as it is earned based on contractual rates and is reflected in loan interest income in the Consolidated Statements of Income.

The following table summarizes the differences between the fair value and the principal balance for loans held for sale measured at fair value as of September 30, 2018 and December 31, 2017:

September 30, 2018	Aggregate fair value		Aggregate Unpaid Principal Balance		Difference
Mortgage loans held for sale measured at fair value	$	323,486	$	315,845	$	7,641
Past due loans of 90 days or more		—		—		—
Nonaccrual loans		—		—		—

December 31, 2017
Mortgage loans held for sale measured at fair value	$	482,089	$	467,039	$	15,050
Past due loans of 90 days or more		320		320		—
Nonaccrual loans		741		741		—