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:

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. As such, mortgage servicing rights are considered 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.



	Fair Value
March 31, 2019	Carrying amount		Level 1		Level 2		Level 3		Total
Financial assets:
Cash and cash equivalents	$	195,414	$	195,414	$	—	$	—	$	195,414
Investment securities	670,835		—		670,835		—		670,835
Loans, net	3,756,977		—		—		3,746,515		3,746,515
Loans held for sale	248,054		—		248,054		—		248,054
Interest receivable	16,611		—		3,114		13,497		16,611
Mortgage servicing rights	64,031		—		—		64,031		64,031
Derivatives	19,002		—		19,002		—		19,002
Financial liabilities:
Deposits:
Without stated maturities	$	3,159,931	$	3,159,931	$	—	$	—	$	3,159,931
With stated maturities	1,143,260		—		1,147,498		—		1,147,498
Securities sold under agreement to repurchase and federal funds sold	36,695		36,695		—		—		36,695
Federal Home Loan Bank advances	161,553		—		161,654		—		161,654
Subordinated debt	30,930		—		30,000		—		30,000
Interest payable	7,112		294		6,818		—		7,112
Derivatives	12,400		—		12,400		—		12,400



	Fair Value
December 31, 2018	Carrying amount		Level 1		Level 2		Level 3		Total
Financial assets:
Cash and cash equivalents	$	125,356	$	125,356	$	—	$	—	$	125,356
Investment securities	658,805		—		658,805		—		658,805
Loans, net	3,638,579		—		—		3,630,500		3,630,500
Loans held for sale	278,815		—		278,815		—		278,815
Interest receivable	14,503		—		2,848		11,655		14,503
Mortgage servicing rights	88,829		—		—		88,829		88,829
Derivatives	14,316		—		14,316		—		14,316
Financial liabilities:
Deposits:
Without stated maturities	$	3,051,972	$	3,051,972	$	—	$	—	$	3,051,972
With stated maturities	1,119,745		—		1,122,076		—		1,122,076
Securities sold under agreement to repurchase and federal funds sold	15,081		15,081		—		—		15,081
Federal Home Loan Bank advances	181,765		—		181,864		—		181,864
Subordinated debt	30,930		—		30,000		—		30,000
Interest payable	5,015		530		4,485		—		5,015
Derivatives	11,637		—		11,637		—		11,637

The balances and levels of the assets measured at fair value on a recurring basis at March 31, 2019 are presented in the following table:



March 31, 2019	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	$	—	$	993	$	—	$	993
Mortgage-backed securities	—		511,716		—		511,716
Municipals, tax-exempt	—		147,640		—		147,640
Treasury securities	—		7,305		—		7,305
Equity securities	—		3,181		—		3,181
Total	$	—	$	670,835	$	—	$	670,835
Loans held for sale	$	—	$	248,054	$	—	$	248,054
Mortgage servicing rights	—		—		64,031		64,031
Derivatives	—		19,002		—		19,002
Financial Liabilities:
Derivatives	—		12,400		—		12,400

The balances and levels of the assets measured at fair value on a non-recurring basis at March 31, 2019 are presented in the following table:



At March 31, 2019	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	$	—	$	—	$	1,147	$	1,147
Impaired loans⁽¹⁾:
Commercial and industrial	$	—	$	—	$	3,186	$	3,186
Construction	—		—		6		6
Residential real estate:
1-4 family mortgage	—		—		260		260
Commercial real estate:
Owner occupied	—		—		272		272
Non-owner occupied	—		—		—		—
Consumer and other	—		—		—		—
Total	$	—	$	—	$	3,724	$	3,724

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

The balances and levels of the assets measured at fair value on a recurring basis at December 31, 2018 are presented in the following table:



At December 31, 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:
Available-for-sale securities:
U.S. government agency securities	$	—	$	989	$	—	$	989
Mortgage-backed securities	—		508,580		—		508,580
Municipals, tax-exempt	—		138,887		—		138,887
Treasury securities	—		7,242		—		7,242
Equity securities	—		3,107		—		3,107
Total	$	—	$	658,805	$	—	$	658,805
Loans held for sale	$	—	$	278,815	$	—	$	278,815
Mortgage servicing rights	—		—		88,829		88,829
Derivatives	—		14,316		—		14,316
Financial Liabilities:
Derivatives	—		11,637		—		11,637

The balances and levels of the assets measured at fair value on a non-recurring basis at December 31, 2018 are presented in the following table:



At December 31, 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	$	—	$	—	$	2,266	$	2,266
Impaired Loans⁽¹⁾:
Commercial and industrial	$	—	$	—	$	732	$	732
Construction	—		—		832		832
Residential real estate:
1-4 family mortgage	—		—		146		146
Commercial real estate:
Owner occupied	—		—		87		87
Non-owner occupied	—		—		6,921		6,921
Total	$	—	$	—	$	8,718	$	8,718

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

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

The following table provides a reconciliation for assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs, or Level 3 inputs, during the three months ended March 31, 2019 and 2018:



	Available-for-sale securities
	Three Months Ended March 31,
	2019		2018
Balance at beginning of period	$	—	$	3,604
Reclassification of equity securities without a readily determinable fair value to other assets	—		(3,604		)
Balance at end of period	$	—	$	—

The following table presents information as of March 31, 2019 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⁾	$	3,724	Valuation of collateral	Discount for comparable sales	0%-30%
Other real estate owned	$	1,147	Appraised value of property less costs to sell	Discount for costs to sell	0%-15%

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

The following table presents information as of December 31, 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⁾	$	8,718	Valuation of collateral	Discount for comparable sales	0%-30%
Other real estate owned	$	2,266	Appraised value of property less costs to sell	Discount for costs to sell	0%-15%

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

Loans considered impaired are reserved for at the time the loan is identified as impaired taking into account the fair value of the collateral less estimated selling costs. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on changes in market conditions from the time of valuation and management's knowledge of the client and client's business. Other real estate owned acquired in settlement of indebtedness is recorded at fair value of the real estate less estimated costs to sell. Subsequently, it may be necessary to record nonrecurring fair value adjustments for declines in fair value. Any write-downs based on the asset's fair value at the date of foreclosure are charged to the allowance for loan losses. 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) gains of $(1,207) and $2,121 resulting from fair value changes of mortgage loans held for sale were recorded in income during the three months ended March 31, 2019 and 2018, respectively. 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. There were $76,857 and $67,362 of delinquent GNMA loans that had previously been sold at March 31, 2019 and December 31, 2018. 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 did not record any rebooked GNMA loans on the balance sheet as of March 31, 2019 or December 31, 2018.

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 March 31, 2019 and December 31, 2018:



March 31, 2019	Aggregate fair value		Aggregate Unpaid Principal Balance		Difference
Mortgage loans held for sale measured at fair value	$	247,858	$	238,554	$	9,304
Past due loans of 90 days or more	—		—		—
Nonaccrual loans	196		196		—

December 31, 2018
Mortgage loans held for sale measured at fair value	$	278,418	$	267,907	$	10,511
Past due loans of 90 days or more	—		—		—
Nonaccrual loans	397		397		—